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climate change & insurance

Coping with climate change: risks and opportunities for insurers

Insurers face increased claims from climate change. The United States had 22 climate-change-related disasters in 2020, according to the National Oceanic and Atmospheric Administration. Each of those catastrophic events created losses of more than $1 billion, and the total losses of all events cost $95 billion.

Worldwide, markets such as China, the UK, and France may see property losses double by 2040 due to climate change. 

In addition, economic threats may place insurers in jeopardy as events become too costly to cover and customers lose their ability to afford insurance for all possible climate damage. 

New regulations arise daily, meaning costs for compliance go up without notice. Fines may become enormous. Climate change and property insurance are under the microscope.

But higher risk means higher potential rewards. Insurance companies can take action now to prepare themselves for new realities. Coping with climate change risks and opportunities for insurers require full-time diligence and planning.

Known threats

The focus is shifting from weather to climate. Rather than focusing on isolated events, insurers must focus on chronic conditions that can cause ongoing losses.

  • Wildfires in the US and bushfires in Australia will continue to wreak havoc as long as extreme temperatures persist.
  • Europe has suffered heat waves, and extreme heat in other parts of the world appear to be a permanent feature of modern life.
  • “Flood zones” are no longer specific areas, as Japan has witnessed with its floods. The rise in average global temperatures increases the probability of floods — regardless of location.
  • Coastal properties may disappear with rising sea levels.

Hidden threats

The effects of climate change may seem relatively innocuous to insurers that deal with property and casualty (P&C). They can revise portfolios to reduce exposure to climate events.

However, insurers’ business models may be outdated. Because climate risk is systemic, it is likely to stress local economies and cause market failures that affect both consumers and insurers. This can make insuring some risks unaffordable for customers or unprofitable for insurance companies.

The increasing number of floods and wildfires may lead to underinsurance — or no insurance at all. Substantial market dislocation can include:

    • Premium losses
    • Higher rates of self-insurance
    • Increased demand for disaster relief from the public sector

Mark Carney, outgoing governor of the Bank of England, states, “Changes in climate policies, new technologies and growing physical risks will prompt reassessments of the values of virtually every financial asset.”

On top of that, the focus on P&C losses misses the big picture. Climate change may cost the world economy $23 trillion in 2050. That would make the fallout from climate change as severe as the 2008 mortgage crisis, while reducing insurability for companies and individuals. In particular, small and medium-sized enterprises are not prepared for the impacts of climate change, even though small businesses are more vulnerable to climate shocks.

Increased regulation costs loom as the Federal Insurance Office takes on greater influence on standards for insurance, especially in terms of climate risks. In addition, recommendations signal that the government wants insurers to reduce their ties to the fossil fuel industry. This could mean abandoning lines of business.

Insurance companies and climate change have both become headline topics, and the scrutiny increases daily. This means insurers must constantly innovate and anticipate.

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What are the opportunities for insurers?

Insurers can move now to mitigate risk and create profitable insurance products.

  1. Prepare for the rising demand for new insurance solutions.
    The increase in the number of assets at risk indicates a potential demand for innovative services, expanding the industry’s opportunities. Innovation can mean higher profits.
  2. Introduce parametric pricing.
    Insurers can pay an amount based on the size of the event rather than the dollar cost of the losses. Having a threshold for coverage reduces the amount of risk.
  3. Evaluate the complete range of potential losses. 
    These can include events such as floods following a hurricane, and crop losses during heat events. Climate-related damage rarely causes loss in a single category, so understanding the full potential impact of losses can inform premiums. This requires high-quality data.
  4. Anticipate ongoing severe events.
    Offer new solutions for chronic hazards such as reduced crop yields, and acute hazards like wildfires. The nature of climate change means risk events continue to grow in size and cost.
  5. Integrate environmental, social, and governance factors into targets. 
    Broaden the focus to include not only P&C but also cultural and environmental trends that affect the bottom line. Engender goodwill by actively working to address and reduce the impact of climate change.
  6. Invest in climate-related sectors.
    Consider solar and wind power, carbon offsets, electric vehicles, sustainable materials, meat substitutes, and low-carbon alternatives to existing technologies. Such investments can create more profits and positive publicity. 
  7. Utilise catastrophe bonds and weather derivatives.
    These alternative risk transfer (ART) products create new insurance markets associated with climate change. Look for more ART solutions as customers seek new ways to avoid losses.
  8. Responding efficiently with technology and data
    Successful companies gather constant data on customers and how climate change is affecting various regions. Leaders can make fast decisions as circumstances evolve. In addition, it is easier to price solutions accurately by using technology to evaluate and update information. This ensures affordable policies backed by solid underwriting. And, policies can be tailored to a customer based on their data.
  9. Analyse property exposures.
    Insurers can create new risk models by evaluating the geographic locations of property exposures to determine the amount of catastrophic risk in portfolios. The analysis should take into account the projected useful life of assets and compare time frames for asset expiration or replacement. Accurate and current climate data can improve this process.

Conclusion

Proactive insurers can help stakeholders adapt to climate change more effectively while reducing the risk of unexpected losses. By including considerations of the social climate and the environmental climate, insurers can prepare for large-scale economic events that can affect their customers and their business models. And with new regulations on the horizon, insurers can institute transparency and reporting procedures that will make them ready for doing business in a post-climate-change world. 

Technology can allow insurers to provide coverage in seconds, with data-driven pricing that reduces risks. Since climate change events are traditionally difficult to predict, technology can help make intuitive calculations. This allows insurers to be prepared when customers are not. Instant coverage provides protection and peace of mind.

How can insurers address climate change today?

Climate change and the insurance industry have captured the public’s attention. And, companies that demonstrate that they embrace the new climate realities now will win out over those that wait for forced change.

Discover how insurers can rethink their role and overcome challenges from rising risk, changing trends and competition in the roundtable discussion with some of the most prominent industry leaders. 

Ready to offer a new world of insurance?