Climate crisis forces insurers to rethink risk calculations

The impact of two months of rain in Rio Grande do Sul was comparable to the more than R$7bn in losses seen over two years of the pandemic

08/13/2024

Pasture burned by fire in the Campinas region, São Paulo: Insurers’ risk assessment models, based on historical series, are becoming less effective in the face of climate extremes — Foto: Luciano Claudino/Código 19/Agência O Globo

Pasture burned by fire in the Campinas region, São Paulo: Insurers’ risk assessment models, based on historical series, are becoming less effective in the face of climate extremes — Foto: Luciano Claudino/Código 19/Agência O Globo

Climate change, with its increasing frequency and intensity of events such as heavy rainfall, heatwaves, and droughts, is pushing the insurance industry to rethink how it manages risk. The growing realization is that this is the “elephant in the room” that insurers must address with urgency.

This shift is essential because what seems to be the new normal is challenging the sector’s traditional business model. “We’re witnessing events that used to occur once every hundred or 200 years happening more frequently. That’s an increase in risk, and when risk increases, insurance premiums rise. As a result, people stop purchasing insurance because it’s become more expensive—precisely at a time when insurance is more critical than ever,” said Marcos Falcão, CEO of IRB(Re), in an interview with Valor. He added that reinsurers will need to improve their valuation and pricing models to adapt. “This is a significant challenge for the entire industry.”

Earlier this year, IRB(Re) established a dedicated research and development unit to focus on climate risks. One of its first actions was hosting a forum in Rio de Janeiro, bringing together public and private sector leaders and researchers to discuss the current situation and explore ways to mitigate and adapt to the effects of climate change.

Not long ago, Brazil was considered relatively free from extreme natural events, unlike other countries, but “now they’ve learned the way here,” said BrasilSeg president Amauri Vasconcelos.

A striking example of this was the heavy rains that battered Rio Grande do Sul between April and May, causing devastation comparable to the impact of the two-year COVID-19 pandemic on insurers. For Mr. Vasconcelos, this highlights the immense destructive power of climate-related phenomena. “An isolated two-month event is nearing the scale of the largest disaster ever covered by the sector,” he noted.

Insurance companies in Brazil have paid out around R$7 billion in compensation related to COVID-19, with BrasilSeg alone disbursing around R$2 billion. In response to the floods in Rio Grande do Sul, the insurance market has paid out R$5.6 billion in claims as of the end of July, with estimates from the National Confederation of Insurers (CNSeg) suggesting that total compensation could reach between R$6 and R$8 billion.

This evolving climate landscape demands that the industry rethink how it assesses catastrophic risk. “We continue to rely on historical data models for risk assessment, but with the climate crisis, it’s clear that we’ve experienced a break in those historical patterns,” said Dyogo Oliveira, president of CNSeg. “This industry has an unmatched ability to manage risk, but we must make a significant effort to prepare the market for this increasing and inevitable challenge.”

Climate scientist Carlos Nobre underscored the urgency of the situation. “Current climate change is widespread, accelerating, and growing more severe. We are seeing record droughts, heatwaves, and wildfires,” he stated.

Mr. Nobre, president of the Brazilian Panel on Climate Change, warned that global temperatures have already risen more than 1.5 degrees Celsius, threatening the long-term survival of the Amazon. He also highlighted the rapid melting of glaciers and rising sea levels, with some areas of the Pacific seeing an increase of 20 to 25 centimeters.

Paulo Miller, an advisor to the directorate of prudential regulation and economic studies at the Superintendence of Private Insurance (SUSEP), described the climate crisis as the “elephant in the room” for the insurance industry. He emphasized that the sector must not approach this with an “extractive mentality”—seeking to exploit the market until it becomes uninsurable—but rather focus on keeping risks insurable by promoting sound risk management practices. “Beyond pricing and selling protection, insurance has a critical regulatory role in fostering good risk management among policyholders,” Mr. Miller explained.

One strategy proposed by insurers to address these challenges is to strengthen collaboration with academia, which generates scientific knowledge, and public authorities, while also promoting a broader insurance culture in the country. “The low penetration of insurance and the insufficient growth rate in Brazil, which falls short of what’s needed to protect our population, businesses, and assets, is a serious concern,” said Mr. Vasconcelos of BrasilSeg. He noted that in Rio Grande do Sul, estimated insurance payouts represented less than 10% of the R$97 billion in economic losses calculated from the recent floods.

In rural areas, losses from climate-related events over the past decade have totaled R$287 billion, with only a fraction, R$56 billion, covered by agricultural insurance or government reimbursements through the Agricultural Activity Guarantee Program (PROAGRO), a 50-year-old agricultural insurance program designed to protect farmers against uncontrollable natural losses. The rest of the losses were absorbed by producers, many of whom were driven to bankruptcy. “Ultimately, the burden falls on civil society. When climate risks intensify, and the insurance culture remains well below the global average, the entire society is affected,” Mr. Vasconcelos emphasized.

Source: Valor International

https://valorinternational.globo.com/
/by

Central Bank nears interest rate hike, managers say

Professionals anticipate COPOM will actualize monetary tightening following communication adjustments

08/13/2024

Genoa’s André Raduan, Itaú Asset’s Bruno Serra Fernandes, and Verde’s Luiz Parreiras — Foto: Divulgação

Genoa’s André Raduan, Itaú Asset’s Bruno Serra Fernandes, and Verde’s Luiz Parreiras — Foto: Divulgação

Central Bank’s Monetary Policy Committee (COPOM) is anticipated to consider an increase in the Selic, the policy interest rate, during its next session. Leading asset managers, including André Raduan from Genoa Capital, Bruno Serra Fernandes from Itaú Asset, and Luiz Parreiras from Verde Asset, suggest that this is in light of recent adjustments in the committee’s communications aimed at bolstering credibility as a leadership change looms at the Central Bank.

Speaking at a Warren Investimentos event, they noted that since last week’s remarks by Gabriel Galípolo, the director of monetary policy—including his latest speech—domestic assets have responded to the anticipation that the Central Bank’s new leadership in 2025 will adhere to a strict inflation targeting regime, potentially at the cost of higher interest rates.

Recent IPCA data (Brazil’s benchmark inflation index) indicating an uptick in the expected rate for next year suggests that the COPOM may have no alternative but to enact the discussed austerity measures.

The employment figures are better than anticipated, impacting wages and income, while economic activity has shown unexpected robustness. The Central Bank’s models indicate inflation trending above target, per André Raduan. Mr. Raduan elaborated, “There’s a general consensus that interest rates need to be increased. It’s a prudent measure to stabilize expectations and diminish the risk premium.” He added, “This sets the stage for more substantial rate cuts next year.”

If the exchange rate was stabilized between R$4.90 and R$5.00 per year, the Central Bank might maintain the current Selic rate of 10.5% for a more extended period. However, with a robust economy, historically low unemployment rates, and significant fiscal stimuli provided last year and this year, rising inflation beyond target could elevate expectations, suggests Mr. Parreiras.

“The exchange rate has complicated an already complex situation. It might necessitate a more assertive response from the Central Bank. The exchange rate, having risen from R$5 per dollar at the end of 2023 to R$5.70 recently, almost inevitably impacts expectations significantly,” Mr. Parreiras commented. “An interest rate hike seems increasingly necessary to regain control over inflation.”

Mr. Serra, a former director of monetary policy at the Central Bank, noted that investors have been concerned about potential restrictions on the Central Bank’s institutional role. “Central banks adjust interest rates as necessary—raising them when required and lowering them when possible. There can be no stable currency environment if there are constraints on these actions.” As the valve for uncertainty was currency depreciation, inflationary expectations rose. “The exchange rate would probably be much closer to R$5 [per dollar] than R$6 if we hadn’t had this doubt. The fact is that this doubt will gradually be cleared up in due course.”

When the market perceived that the Central Bank would maintain its usual approach, long-term interest rates quickly rebounded, suggesting that the next likely move would be to raise interest rates due to a more challenging economic environment, Mr. Serra explained.

Despite recent easing, he does not believe this will deter the COPOM from pursuing a rate hike. Echoing remarks made by Mr. Galípolo in a previous discussion, he emphasized that the Central Bank cannot simply revel in robust economic performance; it must remain vigilant “and remove the punch bowl just as the party gets going.”

Mr. Parreiras noted that even the stock market has rallied because of the decline in long-term interest rates, reflecting “an almost instantaneous gain in credibility.” The risk premiums monitored by Central Banks also declined. “The difference between being caught in a vicious cycle and entering a virtuous one appears almost magical, a matter of credibility. The market reacts swiftly once it shifts its perception.”

While the Brazilian Central Bank is leaning towards raising interest rates, the U.S. Federal Reserve is expected to begin reducing its rates. Mr. Serra contends that Jerome Powell’s Fed should not cut its benchmark rates too hastily but should proceed cautiously to avoid advocating for rapid reductions. “By allowing the market to anticipate a longer cycle, it achieves a more favorable outcome,” he noted, adding that in the U.S., the impact of monetary policy on economic activity is more immediate, unlike the delayed effects often observed in Brazil.

Mr. Raduan of Genoa Capital expressed that his firm is not anticipating a high likelihood of a recession, noting that both American consumers and companies are relatively deleveraged.

Conversely, Mr. Parreiras from Verde Asset highlighted the historical unpredictability of U.S. unemployment rates, which do not tend to rise gradually but rather in sudden spikes, posing a significant risk. “The economy is so robust that it overshadows the microeconomic conditions; it’s more about the prevailing attitudes, making it challenging to predict when unemployment will rise,” he explained.

Mr. Parreiras also speculated that the U.S. Federal Reserve is likely to enact up to three interest rate cuts by 2025. “In my view, the cuts could come sooner rather than later. The U.S. Federal Reserve was close to reducing rates by 0.50 percentage points in July but ultimately held back,” he noted.

*Por Adriana Cotias — São Paulo

Source: Valor International

https://valorinternational.globo.com/
/by