Asset AllocationOctober 18, 2024

How Will Increase in Natural Disasters Affect Insurance, Infrastructure Investors?

While those in insurance may seek more liquidity to defend against events like Hurricane Milton, many in infrastructure believe there must be better ways to anticipate such dangers.

Reported by Matt Toledo

The increase in natural disasters could affect the portfolio construction of insurers, while infrastructure investors feel they have inadequate data to assess their portfolios’ climate risk.

Damages from Hurricane Milton so far have been estimated to be between $25 billion and $60 billion, with another $8 billion to $15 billion in damage estimated from Hurricane Helene, according to Alan Dobbins, director of insurance research at investment management firm Conning. Those are just part of an ongoing trend in which the rate of weather-related events that cause significant damage has increased.

Insurers Need to be Ready for More

That has required regular reactions by insurance companies, which consider such events in their investment decisions.

In recent years, insurers’ portfolios have trended toward alternative investments and fixed income at the expense of equities. In an April report from Mercer, based on a survey of insurance executives, more than 73% of insurance asset managers invested in or planned to invest in private markets this year.

In a separate report from private equity company KKR & Co., 55% of insurance CIOs surveyed said they planned to increase their allocations to private credit, with 46% planning to increase private equity investments. Only 5% of CIOs surveyed by KKR said they would increase their allocations to public equities.

While insurers have been trending toward allocating more to alternative investments, an increase in climate disasters could cause insurance asset managers to focus on increasing liquidity. “The needs for liquidity are probably going to increase,” says Scott Hawkins, Conning’s head of insurance research.

Property and casualty insurers require large amounts of liquidity in the face of rising claims from hurricanes and other natural disasters. “Liquidity needs in non-life insurance are linked to claims volatility arising from natural disasters, large-scale accidents or sudden legal changes, which are unpredictable,” according to a report from the Geneva Association, an international insurance think tank focused on insurance and risk management issues.

“Climate change is something top of mind for [insurance] investment strategists, and they’ll be adjusting accordingly,” Hawkins says.

Many insurers this year have reported excess liquidity: According to the Mercer survey, 49% of insurers have excess liquidity in their portfolio, a motivation for investing more into the private markets, while 44% said they have the right amount of liquidity in their portfolio. Only 7% of insurers said they did not have enough liquidity.

“A significant part of their investment portfolios is made up of liquid assets, such as government and corporate bonds, which can be easily converted into cash,” the Geneva Association report stated, going on to add that even as alternatives become a larger part of insurer portfolios, prudent asset liability matching can make liquidity risk manageable.

Few Believe They Can Properly Assess Risk

Infrastructure investors naturally also need to consider the impact of natural disasters, but most say they do not have the tools to analyze climate risk on their investments. In a January report from the EDHEC Infrastructure and Private Assets Research Institute, part of the EDHEC Business School, with campuses in France and several other countries, based on a survey of 70 investment industry professionals, approximately 76% said that scenarios used by financial institutions to evaluate climate risks to infrastructure assets are inadequate.

Furthermore, most investors do not know how climate risks could affect unlisted infrastructure assets, with only 16% of respondents saying they have the tools to accurately gauge the effect of climate risk on the asset class. Among surveyed investors, 97% said that physical climate risk is something they do consider significant for the infrastructure asset class.

According to Macquarie Asset Management, which is currently using a data-driven approach to conduct climate risk assessments in its real assets infrastructure portfolio, this type of approach is essential. “This quantitative approach helps frame our views on adaptation measures that may need to be taken to reduce operational risks,” says Liam Gallagher, a Macquarie senior vice president.

The firm conducted a similar exercise in 2021 across its portfolio and continues to make stand-alone climate risk assessments of its new acquisitions and investments.

“The reality of these physical and transition risk impacts are issues we are managing today,” Gallagher says. “It is no longer an exercise to predict their potential impacts, but with a proactive and intentional approach, we can mitigate the risks and create long-term value in our investments.”