Odd Lots - What Extreme Weather Events Are Doing to Global Insurance Markets

Episode Date: December 8, 2022

Heatwaves, droughts, hurricanes, floods... in a year of commodity shortages and supply chain disruptions, a host of extreme weather events have added stress to the system. So how do companies address the financial risks associated with these events? Catastrophe bonds and reinsurance markets have existed for a long time, but the more extreme the disruptions, the more these industries change. On this episode of the podcast, we speak to Steve Evans, owner and editor-in-chief of Artemis.BM, about recent developments, new types of insurance products and how financial markets are incorporating the effects of climate change.See omnystudio.com/listener for privacy information.

Thanks for listening to Oddlots. Follow the show on Amazon Music for more future episodes or just ask Alexa, play the podcast, OddLots on Amazon Music. Oh, and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Wisenthall. Joe, do you know what day it is? It's a very special day. Like literally the day? What do you just tell me? It's November 30th. Yeah. Okay. Do you know what November 30th is? Go on.

By the time this episode comes out, it will not be November 30th, but we are recording it at the end of the month. And it is the end of hurricane season. Oh, I didn't right. So this is officially when the season comes to an end. That's right. It starts on June 1st and it ends at the end of November. And it has been an unusual season for hurricanes. I think it was really quiet right through August.

And I actually tweeted something about this. So maybe I jinxed it. But then in September, we had a whole bunch of hurricanes, I think four major ones, including Hurricane Ian, which was the deadliest hurricane to hit the U.S. in two decades. Yeah. This is always kind of, I mean, it's kind of random. It's interesting because I think of Florida as being like in Hurricane Alley right there. But it hadn't actually been hit by a hurricane in a long time. But this was a really big one.

I'm seeing something that at least over $50 billion in damage. And then beyond hurricanes, and we'll talk about them, obviously, like, weather and extreme weather events seems to come up a lot for us in terms of things we talk about, climate risk, drought, the heat of rivers and lakes. Right. Weather seems to be popping up a lot, but we haven't actually, like, really, like, talked about that as a consistent thing. No, so we had this erratic hurricane season, but we also had major droughts around the world, as you mentioned. And there was a drought even in the northeast in places like Connecticut, which is kind of unusual. Major extreme weather events seem to be happening more often. And this kind of begs the question of how the financial industry is thinking about this, because, of course, there is a lot of money that is related to things like the weather.

Right. And so we think of, you know, obviously when there is a major hurricane with people's homes and infrastructure being destroyed, there's sort of a straightforward insurance, reinsurance cost associated with that. And then, of course, all these other things that create business disruptions of various sorts. Again, going back to the drought, we recently talked about affecting the corn market on the Mississippi River. And so, yes, financial implications abound from unpredictable variations in the weather. Absolutely. And today, I am very pleased to say we are going to be discussing something that we've been meaning to for a long time, which is how the insurance industry is basically

handling extreme weather events and what the implications of extreme weather events are for the vast ecosystem of insurance links securities and products and reinsurance. There's this whole massive pool of money that is basically set up for these events, but it feels like we don't talk about it often enough. So we're going to rectify that today with someone who talks about it all the time. We're going to be speaking with Steve Evans. He is, of course, the owner of Artemis, which is a publication covering the insurance-linked securities market. And he is also the owner of reinsurance news. So really, the perfect person. The perfect guest. Yep. All right. Steve, thank you so much for coming on all thoughts.

Thank you, Tracy. Thank you, Joe. It's a pleasure to be here. And I've been looking forward to being one of the perfect guests as an avid listener. Thank you. So maybe just to begin with, can you talk about, like, from your perspective, from the insurance industry's perspective, does it seem like extreme weather is becoming more of an issue? Is this a topic that is cropping up more for you? Absolutely. It's an area that's cropping up even more these days.

I mean, extreme weather has been something that the insurance industry has provided capital to support for hundreds of years now. I mean, it's one of the major risks that the marine insurance market covered when you were heading off across the Atlantic to go and gather your commodities from overseas. You'd want to make sure that your boat was going to make it back in one piece and storms were one of the things that you wanted financial protection against. So the insurance industry's been in this space forever, really, since the industry began. But I guess over the last sort of two decades, it's become an increasingly important focus point, obviously with the climate change discussion alongside that as well. Now, I guess insurers and reinsurers are hedging

weather within many of their product sets, but then you have the specific area of the market that really interests me, which is around catastrophe, severe weather, and all of the areas you mentioned in your opener there. And this is an area that's just become much more sophisticated I guess. It's probably three decades now since the first major catastrophe models came along, which were software designed to really help people not predict when weather's going to happen, but understand the magnitude of the potential impacts it could have and how that would affect portfolios, whether that's portfolios of insurance risk or portfolios of property. And I guess the advent of the cat model, which really they pretty much came out of places,

like universities and the States and even Silicon Valley, one of the main cat modeling firms came out of. That's really helped the industry to get a better handle on catastrophe risk and help to develop the whole catastrophe reinsurance market into something that's a really meaningful piece of overall insurance capital today. And alongside that, we also have everything from weather derivatives to swaps between companies and what's called parametric insurance, which is another area of the market that's particularly interesting right now and moving forwards very rapidly, particularly with what we sort of always refer to as the insure tech trend where tech advancements are coming into insurance carriers. Finally, it's taken a while, but now companies

are increasingly looking at new ways to construct products to help their customers hedge risk as well. Just on the modeling point, so my impression of the insurance. Length Securities Industry is that one of the reasons it became so big was because of improvements in weather modeling and it gave investors maybe some reassurance that they were gauging and pricing weather-related risks more accurately. Has that been a major factor in the growth and development of this market? Absolutely. I mean, I guess there's two types of technology that really helped the Insurance Link Securities market come about. There's the advent of the cat model,

then the sort of advancement of the cat model into the two main peak perils, which are really predominantly US hurricane risk. That's really the peak exposure in the whole world, but then other cyclone and storm risks around the world and then earthquake risk being the other one. When the cat models came around, it helped companies to really understand

what exposure they were taking on. so I'm thinking about the insurance and reinsurance companies of the world there. And they realized that really the capacity within the insurance market itself was probably not sufficient for the really peak events. If you think about a cat-five hurricane barreling into Miami one day or San Francisco having a really serious earthquake event or Tokyo or any of the other big cities of the world. And there was a sort of a recognition that tapping into

the deepest, most liquid pool of capital available would be a beneficial thing for the insurance and reinsurance market. It's already funded by institutional investors, obviously on the shareholder side, but this was seen whether there could be the development of almost a companion source of risk capital that the companies in the insurance space could tap into. And so really the next bit of technology alongside the cat models was actually financial technology. So the plumbing of the financial world and predominantly the fund structure and securitisation as well that helped very bright people in the early days and very small companies that sometimes span out of existing reinsurers or sometimes set up as like individual hedge fund type managers and they started to

construct financial instruments that would allow catastrophe risk to be contained within them modeling to be put against that to develop the understanding for that risk and to enable a price to be put on it as well. And then that was issued out in a form that was investable. And so these sort of niche little hedge funds that set themselves up and started to target the space could build portfolios for their third-party investor base. So I think without the cat models, it would have been very hard to see the ILS market, as we call it, development. Every weekday, we help you make sense of the legal stories that shape the nation and the world. Listen for complete analysis of the biggest court cases, the latest actions from Congress and regulators, and the legal moves driving the markets.

From corporate law to constitutional law and from state courts to the Supreme Court. At Bloomberg Law, we go beyond the day's headlines. We speak with top attorneys, judges, scholars, and policy experts to break down what the rulings really do. mean. We do this every weekday, then bring you the best conversations in our daily podcast. Search for Bloomberg Law on YouTube, Apple, Spotify, or anywhere else you listen. On the East Coast, listen as you start your day. And on the West Coast, catch up in the evening. That's the Bloomberg Law podcast with me, June Grosso. Subscribe today wherever you get your podcast. So I have a short question first, but how big is this, are these markets that we're talking about?

So very difficult to give a accurate number. It's changing all the time with events and things like that and with inflows and outflows. But it's been estimated that global sort of reinsurance capital has been somewhere around the 600 billion-ish mark for a few years. The ILS capital within that is anywhere between 80 to 100 billion, depending on which type of structures and funds and things like that you include within it. So a thing that I maybe heard once or that my understanding is that part of the appeal of investments that essentially lose money when there's a big catastrophe is that, you know, people are always seeking uncorrelated returns. And so much of the economy is correlated because when there's a recession and everything has hit all at once. And that the physical catastrophes, whether they be hurricanes or earthquakes or other storms, are at a type of risk that is not going to be. cyclical related to the economy because hurricanes can happen in recessions or booms. And so does it work out like that in practice? And it's theory, I get that. That makes total sense. In practice, do securities that are linked to extreme events properly exhibit these sort of uncorrelated payout

structures? It's a very good question. Definitely the lack of correlation is an important aspect that attract investors to the space. Now, I say lack of correlation because I don't think anything is ever fully uncorrelated when you're talking about potentially world-changing events. So a good example, actually, is the Tohoku earthquake and tsunami in Japan. Now, that was a very major insurance market event. It had some impact to the ILS market, including to a number of catastrophe bonds, mostly in mark-to-market losses for the cap-on market,

but there were some drawdowns of principle as well. And when that event occurred, there was a decline in Japanese equities. There was a decline in the Japanese economy and things like that. But that all bounced back quite quickly. So I think predominantly natural catastrophe and weather risk are diversifying. I would never say totally uncorrelated because I think when the biggest sort of market-moving events occur in the NACAT space, they're still going to move some indices, but the recovery from the event should be far, far quicker. And so it's really a very, very far tail risk correlation, I would say.

A lot of people talk about ILS as being lightly correlated or loosely correlated, rather than being completely uncorrelated. And I think investors should really be educated to the degree that a correlation could occur, but it's probably not going to be something that you really need to worry about in the overall scheme of your portfolio. I remember this was something that came up when I was writing about the World Bank's pandemic bonds, which failed to trigger. And, you know, one of the selling points for those was, well, by pandemic exposure, it's going to be uncorrelated. But then you had this massive global pandemic and the markets absolutely dropped. And it turns out that, you know, it was rather correlated. But, okay, Steve, a related question. Can you talk a little bit about the pricing of

cat bonds or other insurance linked securities and products. Because this is also kind of a sensitive point, which is you want it priced enough that investors are going to come in and buy these things because they feel they're being accurately compensated for the risk that the bonds are potentially going to get written down to zero or something like that if there is a major catastrophe. But at the same time, you don't want the payout to be so rich that it becomes un-economical for the insurers or the governments who are actually issuing these things. So how are people thinking about that pricing aspect, especially as we get more extreme weather events? Are investors demanding more of a return for taking on this risk?

Sure. A very timely question because right at this point in time, certainly investors are demanding more return. There's been a particularly difficult number of years for the global reinsurance market as a whole and whenever the reinsurance market has significant losses from severe weather or catastrophes, then the ILS market will take a share because it is providing a significant proportion of the capital these days. So since 2017, obviously we had a severe hurricane season that year. We've had wildfires, floods, more hurricanes, some earthquakes, a number of other events. And there have been losses. And now the losses haven't been enough to significant dampen investor demand until you start to get repeat years. And actually, we have seen a

decline in investor demand through this year. But that's also happened at exactly the same time as we've had some financial market pressures. Obviously, there's the war, Russia's war in Ukraine going on, and then you've got inflation as well. And all of this has kind of come home to roost in one single year for the insurance market. And as a result, we see reinsurance. rates and pricing going up and in tandem rates for insurance-linked securities are going up as well. Because insurance and securities are essentially largely providing capital either to an insurance or reinsurance arrangement. And so the pricing kind of follows the pricing of the traditional insurance and reinsurance market to a degree. Now there are some capital efficiencies in terms

of being able to tap diversifying sources, being able to distribute risk into a enormous markets such as the capital markets as well, which can give some sort of capital efficiencies as well. But then there are additional costs sometimes with issuing insurance link securities because they are financial securitization structures. And so they do have additional cost attached to them sometimes as well. But the pricing does sort of tend to follow traditional reinsurance. And I guess the one thing that everybody in the insurance industry will always point to particularly when it comes to climate sort of variability and climate change and how the risk might be changing over time is that typically these are transactions on the traditional reinsurance

side they might be one year to three year on the insurance link security side they might be sort of two to five years and 10 year so you are getting a chance to reprice that risk now within an insurance link securities transaction there's also what's called an annual reset as well where a sponsor can adjust the profile of risk that's covered in the transaction, but at the same time, the metrics that are used to calculate the coupon payment for the investors also get adjusted as well. So as the risk changes, you get a chance to reprice the risk when you either renew a contract or you reset a contract. And so the idea is, in an ideal world, the pricing would keep up with the changes. Now, when the whole industry feels like perhaps it's been sort of

underpricing for a little while, which I think is something that most of the industry would recognise that we had some particularly big sort of inflows of capital. We also had some particularly benign years in terms of catastrophes through the sort of 2010s right up to sort of 2017 when suddenly the hurricane season exploded and we had three major storms. Or in a row. And I think now it's taken a few years for it to sort of sink in that there really is a need for higher pricing. Alongside that, without a doubt, there appears to be changes in sort of frequency of events and potentially severity as well, but also some climate scientists would say that the overall sort of the way a hurricane exhibits its damage might have changed or might be set

to change with climate change as well in terms of potentially carrying more water, potentially storms getting bigger, that sort of thing. So there's a lot of money spent on both the traditional catastrophe models that the industry is used now for about 30 years or so, but also increasingly on climate models and climate simulations as well, where people are trying to look ahead 20 to 40 years to try and see how the impact of storms such as hurricanes might change over us. a broader period of time. And really, there's just a lot more research nowadays with better technology being available as well to try and help people to price risk better, but also to perhaps ensure that the pricing is more sustainable over a longer period of time as well.

Yeah, I want to just talk further about that because I guess like, you know, part of the appeal of investing in the space is that there's just going to be some randomness. We talked about this sort of lightly correlated market. And you might have a year to a very extreme hurricane, and then you might have years and years where Florida and other major property areas really don't get hit much at all. But I would imagine that if there is a sort of significant climate change element to this, that perhaps some of this randomness could go away or that could get worse and worse in some sort of maybe predictable trajectory, can you talk a little bit more about the sort of intersection of extreme weather risk,

with the climate modeling that you're talking about and how it changes to the industry, if there's a perception that some of these things aren't random and that there are trends that are going to sustain themselves for years to come. That's actually quite a difficult question to answer, to be honest with you, without talking to the people with the money or the underwriters on the ground. But I guess my response to that would be that the industry is certainly looking far ahead now in terms of the research and analysis. that they're doing and they're really trying to understand where the trajectory of events is going.

But it can be very difficult to pinpoint that in any exact way. And Tracy began this by saying that this year's hurricane season was a little strange. Now, some of the forecasts in advance of the hurricane season from the main meteorological agencies were predicting huge numbers of storms and we just didn't see that. So you really can't go out and buy your protection based on a forecast. You've got to look at sort of recent history, plus factor in your forward-looking climate science and try and come up with something reasonable for the next season or two seasons or three seasons. Now, I'm sure at the CFO level of the big insurance companies, they're thinking much further ahead and wondering how they're going to adjust their pricing

to accommodate the potential climate of the future. But I think on the sort of underwriting side, the people who are sort of analyzing, underwriting and then pricing these risks, they're thinking about the duration of the contract and what could happen within that period of time. And there's other factors out there that have really been as damaging in some ways in terms of losses as the events themselves in some cases. And I'm thinking here about elements like social inflation, litigation, alongside inflated prices and how that is affecting property sort of rebuild costs. and things like that, there's a lot been going on over the last five years,

which has all sort of coincided with a particularly challenging period of catastrophe activity as well. And when hurricanes have hit Florida, and the industry's been hit by what we tend to call loss creep, a lot of that loss creep has ended up to be down to litigation. There's a lot of people who would call some of that litigation at least to be driven by fraud, and that really has inflated some of the claims payments that insurers make, which results in insurers claiming more back from their reinsurers and would even result in some insurance and securities potentially paying out in return for inflated loss costs that come through.

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actually have any idea what it means. So what is that exactly? Sure. So essentially, insurance is usually what we call an indemnity-based product, where it's a promise to make somebody whole again when something happens that meets the terms of the contract and the making whole is subject to certain exclusions and things like that, as with any insurance contract might be. That works really well, obviously for your average insurance consumer. It also works well for insurers buying reinsurance as well and they will do that on an indemnity basis as well. Paramedrics really came into the industry as well over two decades ago when we first saw them come into the marketplace and they're basically an insurance contract that will trigger based on the parameter of an event.

So it's some kind of data input be that wind speed, earthquake intensive, ground movement from an earthquake, flood depth, temperature. There's so many different triggers out there now in the parametric world. These are much more applicable in developing economies because there's often a lack of insurable interest on the ground, so there may not be very much insurance in force, but a sovereign government, for example, could buy drought protection that pays out based on a parametric index of how much moisture has fallen in that year in that country and that that's now quite a popular product in places like Africa. But there's people in Florida on the coast who will buy

parametric protection to cover their condos or their hotels or golf courses or whatever they may be against a hurricane of a certain wind speed moving through a specific area of the coastline that's going to be close to where they're based. For me, parametrics are something that I'd love to see continue to develop at the pace they're now beginning to because it's really accelerated over the last few years. There's some really good technology companies come into the space trying to build better parametric triggers, trying to build software for it, trying to automate claims payments to some degree as well, because that's the other beauty of a parametric trigger that there's no need for a lengthy claims assessment. You don't have to send an adjuster out to

look at a property, for example, to assess how much damage has been done. You can just see from the data input that it's above the level that is required to trigger the contract and trigger a payout. And then there's usually a third party. He'll validate that in some way. So claims payments can be as quick as, I mean, they're usually in the sort of two to four week range, but I've seen them made in 24 hours for certain parametric contracts, which is really fantastic because it means you can make somebody not whole because they're buying a certain amount of protection. but you can certainly deliver the capital they may need to help them recover far far more quickly. It does seem like the triggers for the payouts on parametric insurance products. So I understand you're trying to make specific parameters or data points that get hit by an event so that you have these automatic payouts.

But it does seem like getting the triggers right would still be an issue, right? because the investors would want to see something that they think isn't likely to happen, and then the people who are actually selling those products would want to have them set so that there is a realistic chance that if something happens, they would get that additional money. I don't know. It just seems like it would be slightly complicated to figure those out. It's certainly complicated, and I think this is an area that the industry struggled with

for a while when parametrics first came around. They tended to be quite simplistic in the way the triggers were structured. One of my favorites was Tokyo Disneyland, the theme park, bought it. It's the best Disneyland. Don't we all. They actually bought a catastrophe bond

back in the late 90s. I can't remember the exact year, but it was called Concentric Limited. And the reason it was called concentric was that the people who structured the deal, drew three circles around the centre of Tokyo Disneyland and if an earthquake occurred within those three concentric circles that worked out from Disneyland you'd get a different payout depending on which circle it fell in now of course if the earthquake epicenter was outside the furthest circle could

still be some damage they may not get any payout at all of course but that's really something that the buyer of the protection I guess has to has to reconcile with themselves and really they're buying this as kind of a form of just in time capital that's going to come in when the worst thing possible happens. There's some really sophisticated insurance buyers out there now who buy parametric cover as well and they'll buy their traditional property insurance tower, all of their other liability in commercial coverages, and then they'll buy some elements of parametric cover just really to provide them with capital inflows should the really bad events that they don't want to see happen occur. There's some good examples of this in Japan again, where around earthquake

risk, retailers and things like that will be buying an element of earthquake parametric insurance protection so that if there's a bad earthquake anywhere in the country, they know it's probably going to mean that they either can't get their stock in, they can't open, they lose power, all these bad things could happen to them. But the parametric insurance might pay them $20, 50, $500 million in a very quick period of time to help them recover. It's also very good in areas such as the developing world where aid inflows can actually be much slower than we might think. I mean, when you look at how fast aid flows into an area that has drought or famine, it can take months before there's any real buildup of capital. If their government can afford to buy or can get

donors to pay the premiums for parametric protection, that can actually flow into the country much more quickly. You mentioned drought in Africa. We started talking about this conversation that some of the things we've talked about, drought in the U.S., particularly with the Mississippi River, and then also elevated water levels due to heat waves, which are a really big story in Europe over the past summer, and we had some episodes where we talked about the effect that that is having on, say, nuclear plants that need the cool water from the river so that they cannot dump the hot water safely.

Are those types of things also insured against in some way? Like, are their products structured around all of these risks? Or would something like that be too niche really to have a financial infrastructure around it? Sure. The river level one is a very good example because there actually have been some parametric insurance products covering the river Rhine for specifically to. for the ability of shipping companies to continue moving up and down the river easily in delivering their goods. I don't know whether they triggered or not, but I know that the river levels did

get very close to where I understand the triggers to be last year. I don't imagine there's a huge amount of capacity deployed into those sorts of risks. They are quite niche, but certainly they can now be protected against. Something can be structured to do exactly that. On the nuclear power plant issue again if it's based on river levels then there certainly are people out there providing insurance on that basis already today i think where parametrics get really interesting for the future for me or around what we call non-damage business interruption so this is where something happens that impacts businesses and it's not a physical damage incident but there's something that has a knock-on effect. If you can start to put some understanding around those potential events that could cause

those effects, then you can possibly start to put parametric triggers around them as well. And there are some people looking at this quite seriously right now, both around sort of financial effects that could affect businesses, but also the knock-on effects of other events in the world that could hurt businesses. So things that cause shipping delays, for example, there are certainly companies out there looking at those sorts of risks as well. I want to ask a sort of existential question about this entire space, which is, you know, obviously as we get more extreme weather-related events, more natural catastrophes, you could see why people would want to have this kind of insurance in place. But on the other hand, one of the criticisms I've seen of catastrophe bonds,

and I guess this would extend to parametric insurance as well. One of the criticisms is that if you are offering more protection against extreme weather, then maybe that will disincentivize people from planning effectively for climate change or maybe changing their own behavior. The classic example of this is whether or not we should be providing insurance for people to build beach houses on the coast of Florida, right? Or whether we should not offer insurance for that risk because we know that climate change is going to happen and those houses are going to get swept away at some point. Is that a valid criticism in your opinion? Is it a valid criticism? I mean,

the insurance industry has provided protection to industries that perhaps some of us would certainly think nowadays maybe shouldn't have ever had that protection because it's enabled their businesses to some degree, I suppose. And that's really been the way of the insurance industry that they will sell protection to people for the right price. But it actually now speaks to a couple of things that are happening in the industry, which I'm particularly passionate about. One is around resilience. So there are a number of initiatives around the world. Again, these are largely in developing economies at the moment, but I think we'll start to see this. And actually, we are seeing this increasingly in developed world as well, but in a slightly different way. And this is around

the terms of your insurance coverage also requiring you to do something that's going to increase your resilience to those events as well. So whether that's a, you need to have a resilience plan in place, you need to have a plan for how you're going to deploy that money should the insurance pay out. And you need to demonstrate that that's going to go to the right people, particularly in the case of sovereign risk transfer where a government or country is buying it. But alongside that, there's also sort of examples where people are being encouraged to put in place, things that will help them to keep floodwaters out of their property, for example, and that can be tied into an insurance sale. Cyber risk is another interesting area because the cyber insurance market

is growing very fast. It has capacity issues because obviously it's an enormous risk that's actually quite hard to model in a lot of ways. So there's only a certain number of people who really want to put capital down for that. But most of the big, large commercial cyber insurance agreements of the world will have an element of cyber risk protection into them as well. There'll be cyber software. There'll be cyber security reviews. There'll be penetration testing, all sorts of things that go on as you buy your cyber insurance policy. And some of them may be conditional on whether you can actually buy that policy or not. If you're not willing to demonstrate that you're making some efforts to prevent cyber sort of exploits occur within your business,

you may find it harder or you may pay more for your cyber insurance protection. So I just have one more question and it relates to climate change. And it also sort of relates to ESG and government regulations. Because, you know, I feel like, okay, if I'm thinking about ensuring against hurricanes or flood risk in Florida, then I might be concerned about climate risk and whether that's going to amplify the number of highly destructive hurricanes in the future, and I have to model that out. But then the other thing I feel like that is always changing is not just the hurricanes itself, but how are the laws going to change and how are regulations going to change? And so essentially the risk of a different legal framework. Or, you know,

we just had the latest climate conference in Egypt and some new rule that comes out of that. And so, you know, not necessarily the extreme weather itself, but that governments say to some industry, you can't do this or you can do that or you have to price this higher, you have to pay this tax or something like that. How much of like the thinking is related to the straightforward risk of extreme weather as opposed to sort of like various mandates that may change the nature of business going forward as a result of governments trying to take action on climate change? That's a very interesting question. Obviously, there's a lot going on in the climate sort of legislative arena at the moment. And insurers are kind of exposed to that to a degree, I suppose.

I guess it's another input that really needs to be difficult to model for, but needs to be considered when they model and price their business. And the other thing is that the insurance and reinsurance industry are incredibly engaged in most of those discussions where they can be as well. And certainly there's some areas that the insurance and reinsurance industry might actually see potential future opportunity coming from, such as climate disclosure. So if the, say, for example, the Fortune 500 companies and the largest businesses in the world all have to start to disclose their weather exposure on their balance sheets or something, because that comes out of a COP conference. Obviously, if you start to disclose that kind of thing and your

shareholders are seeing these potential big negative numbers on your balance sheet, even if they don't manifest, it's still something that really any sensible business owners should be taking steps to protect against. So there's also potentially going to be more demand that comes out of climate legislation as well. I mean demand for risk transfer and insurance itself. So we've been focused on the weather and climate change for obvious reasons, but there's another thing happening which has an impact on the insurance industry as a whole, and that is just higher benchmark interest rates in general. Can you maybe talk a little bit about what that means for the insurance and the reinsurance market? And I guess the other big question would be, given the

combination of, we have this expectation that there will be more extreme natural disasters in the future, plus interest rates seem to be trending higher for the foreseeable future. Does that just inevitably mean that insurance rates are going to have to go up? Like, is that our inevitable future? I mean, while inflation remains at 10%, then just the cost of everything that potentially gets damaged is going up significantly from property to everything that you own. And as a result, insurance costs will go up to cover those items that we all love and want to keep. But I guess going back to the start of your question there, the interest rate aspect, there's certainly a negative initial effect on the insurance and reinsurance industry in terms of how it affects

some of their portfolios of assets on the bond side. That has caused some sort of, sort of decline in industry capital due to some of the volatility we've seen in financial markets through this year so far. But most of that would be expected to be recovered as obviously the instruments all move towards maturity and yields increase on them again. In the insurance and insurance and security space, interest rates are very relevant there as well because, say, a catastrophe bond, the return that investor gets is based on the coupon, which is the risk spread, so how much they're getting paid for the risk they're taking on. But then there's also the return from the collateral because these are fully collateralized instruments. So 100% of

the collateral is usually invested in something like a treasury money market bond or something like that. So it's a very safe asset. Now all of those assets are floating up with rising interest rates, which means that the returns from catastrophe bonds rise on top of it. And so that's maybe a positive for the investors there. And also, something that keeps the insurance and securities market are still appealing, even while other asset classes around the world are obviously inflating their returns as well. The question of, does insurance have to keep rising? I mean, I think that's the inflationary factor really there, and it's certainly something that right now, that's one of the key drivers for rates. And we're

expecting next year, well, the January renewals, which is the time of year when sort of 60 to 70% of global reinsurance gets renewed, they're going to see what we would call a hard market. So steeply increasing rates, people are projecting sort of anything up to 20, 30 percent increases, particularly for property catastrophe risks. More broadly in areas like liability, there will still be increases, it seems like even though there hasn't been the severe loss experience there. But then inflation obviously affects things like court judgment payouts and litigation costs. And so I would imagine that the more inflation is entrenched, the more costs for the insurance industry rise. And therefore, the more customers would have to pay for it as a result.

All right, Steve Evans, thank you so much for coming on odd lots. I'm glad we could finally have this conversation. You know, we've covered weather from a real economy perspective, but we haven't actually done it from a sort of financial industry perspective. So thank you so much. Sure. It was my pleasure. Really great to talk with you both. And I hope that was interesting.

Yeah, very much so. Thank you so much, dude. Thanks, Joe. Thanks, Tracy. So, Joe, I found that conversation to be fascinating. I do think, like, I guess I come out of it with more questions because it does seem like, you know, there is really this, there's always this tension in insurance. paying enough that investors want to take on this risk without making it sort of prohibitively expensive. But then also when it comes to a lot of the catastrophe bonds and weather-related insurance,

it seems like there is this added factor of should we be insuring some of these risks at all. You know, I say if people want to pay for the insurance, like people build on the Florida coast. You know, it's like, I don't think it should be like subsidized or it should be free. but, you know, if people want to pay for it, that's great. Well, there's also the question, and we didn't get into this with Steve, but you have seen a lot of governments and states issuing catastrophe bonds, selling those to private investors. And it does, this is something that I vaguely remember came up with the World Bank pandemic bonds as well.

But it does beg the question of, should the government be paying investors, you know, like a, well, it's not that impressive anymore, but three or four years ago it was impressive. of a 6% yield on a bond instead of just borrowing themselves directly in the market. Yeah, we need to do a whole thing on like municipal finance because I have like a, once you start getting the question of like, well, why is there like these specific bonds or why they then I, yes, maybe we could do a sort of state and local government financing episodes because I have a million questions about that. But you know, there are all kind of, you know, in terms of things that Steve have talked about, I want to do more on like software and just like modeling software.

And the software comes up in a lot of our conversations. There's that also. It comes up in the semiconductor conversations that we have. So I feel like I want to learn more about the software side of all this. We should talk to AIR, which are the big modeling guys for a lot of cat bonds. And then we should also talk to, on a related note, we should talk to the third party pricing services for bonds. Yeah, great. No one ever talks about them.

Okay, so this is an episode in which, like, we've come away with, what, three more episodes that we need to do? At least three more. And, you know, just the one thing that I keep coming back to is like, okay, if you have, like, insurance on some level, you sort of expected to be mean reverting. You sort of expect things to be random, these sort of, like, undiversifiable risks that you need these big pools of capital out there to protect you against. But I do wonder, you know, if there are certain areas, particularly. related to climate change in which the expectation is that there is some sort of extreme weather event that is going to march steadily worse and worse over time, that there is no natural mean reversion, that there is less chaos and randomness. It does make me wonder like the degree

to which some of these industries will be upended. Totally. And there are all sorts of philosophical questions thrown up by this as well, which is, of course, insurance can be a really effective way of actually altering behavior. Like maybe you shouldn't build houses on a beach in Florida and whether or not they're going to be partnering maybe with governments. Yeah, that was interesting. Yeah, to try to, you know, affect some of that. Fascinating conversation.

Yeah, I'm glad we finally had it. Shall we leave it there? Let's leave it there. All right. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthal.

You can follow me on Twitter. at the stalwart. Follow our guest, Steve Evans. He's at Steve underscore E. Follow our producers, Carmen Rodriguez at Carmen Armin and Dash Bennett at Dashbot. And follow all of the Bloomberg podcasts under the handle at podcasts. And for more Odd Lots content, go to Bloomberg.com slash oddlots where we post transcripts, Tracy and I blog. We also have a weekly newsletter that you can subscribe to. And on that note, we're going to be doing an Ask Me Anything episode where you can ask me and Tracy questions about anything you want. So record your questions in the form of a voice memo, include your name and location, and then forward that to odd lots at Bloomberg.net, and we'll listen to them, and we'll try to answer a bunch of your questions.

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