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Extreme Conditions: Exploring Spain’s Drought Impact and the Need for Catastrophe Insurance Coverage

Episodic extreme weather events and natural catastrophes could generate severe economic losses and ultimately lead to significant macroeconomic implications. Climate change and global warming scenarios might also have an incremental effect on the frequency and magnitude of adverse climate-related events, which can potentially have a disruptive effect on economic sectors such as agriculture. The economic losses generated by severe adverse weather events not only considers the actual damage of the event but also the cost of reconstruction. The usage of catastrophe insurance coverage is an important tool to manage the cost of a rapid and swift reconstruction which would otherwise be borne by households, businesses, or ultimately rely on uncertain government support.

The purpose of this commentary is to analyse some of the economic and fiscal implications of extreme weather events, in particular the drought in Spain, from a macroeconomic perspective, as well as the role of the insurance industry to mitigate and manage these risks for the public and private sector.

Key Highlights:
• The near term economic effects of the drought remain limited and concentrated in the agricultural sector. However, lower agricultural production could exacerbate the already high food price inflation in Spain.

• The short term direct fiscal impact associated with the latest drought remains limited. Over the medium- to longer-term, fiscal risks from extreme weather and climate events are estimated to remain moderate and manageable in Spain, although there is a significant risk that exceeding standard global warming scenarios could exacerbate economic and fiscal costs.

• Catastrophe insurance is an important tool to manage losses arising from extreme weather and climate-related events. In Spain, around 27% of losses deriving from flood, windstorms, wildfires and earthquakes were insured. This is in line with the EU average, in the time period 1980-2021.

“The economic and fiscal consequences of the severe drought and heat waves that hit Spain this year have so far been limited. In the medium and long term, it is estimated that fiscal risks from extreme weather and climate events will remain manageable in Spain, although there is a significant risk that exceeding standard global warming scenarios could exacerbate economic and fiscal costs,” said Javier Rouillet, Vice President, Global Sovereign Ratings at DBRS Morningstar. “Closing the relatively large insurance protection gap, the gap between economic and insured losses, in Spain and in the EU could help reduce fiscal risks for governments from extreme weather events and natural catastrophes,” said Mario De Cicco, Vice President, Insurance at DBRS Morningstar.