Home Insurances Climate Change and Insurance: Navigating Risks in a Changing World

Climate Change and Insurance: Navigating Risks in a Changing World

by Charles Henderson

Climate change is one of the most significant challenges facing humanity in the 21st century. Its impacts are already being felt across the world through rising temperatures, changing weather patterns, and more frequent and severe extreme weather events. As climate change continues to intensify, it poses serious risks to communities, businesses, infrastructure and economic systems worldwide. The insurance sector, being in the business of managing risks, faces substantial challenges from climate change. Insurers are having to adapt to heightened physical risks from natural catastrophes as well as risks arising from the transition to a low-carbon economy. This article examines the multifaceted risks presented by climate change to the insurance industry, as well as the sector’s vital role in promoting climate resilience and supporting the transition to sustainability.

Climate change refers to long-term shifts in global or regional climate patterns, primarily attributed to increased levels of atmospheric carbon dioxide produced by the burning of fossil fuels. As per the Intergovernmental Panel on Climate Change (IPCC), human activities have already caused the earth’s temperature to rise by 1°C above pre-industrial levels. Under current projections, global temperatures could increase by 1.5°C between 2030 and 2052 if greenhouse gas emissions continue unabated.

For the insurance sector, climate change translates into escalating risks, uncertainties and liabilities. Insurers are exposed to increasing claims and losses as extreme weather becomes more frequent and intense. Moreover, climate risks are rendering many assets and regions practically uninsurable. As risk experts and managers, insurers have a crucial role to play in climate change mitigation and adaptation. The industry needs to assess exposures, engage with stakeholders, and develop innovative solutions to promote climate resilience and low-carbon growth.

Climate Change Risks to the Insurance Sector

Climate change is increasing insurers’ risks in two key ways:

Physical Risks from Extreme Weather

  • Rising global temperatures are linked to more frequent and severe weather events like floods, storms, heatwaves, and wildfires.
  • Such events cause substantial property damage, disruption of operations and loss of life. This leads to a spike in claims for insurers providing coverage against natural catastrophes.
  • Insured losses from natural disasters have increased five-fold in real terms since the 1980s. 2017 and 2018 saw record insured catastrophe losses of $219 billion globally.
  • Climate change impacts are rendering some regions practically uninsurable, like flood-prone areas or regions facing increased wildfire risks. This shrinks insurers’ market and premium base.

Transitional Risks from Decarbonization

  • The transition to a low-carbon economy also poses financial risks for insurers invested in carbon-intensive sectors.
  • Stranded asset risks arise as tougher climate policies make fossil fuel reserves unburnable, causing the value of carbon-intensive sectors to plummet.
  • Insurers also face liability risks if claims are made against fossil fuel companies for failing to mitigate climate change impacts.

Thus climate change threatens insurers through escalating extreme weather risks as well as financial and liability risks from the low-carbon transition. These challenges are existential for the insurance industry, necessitating urgent action.

The Role of Insurers in Tackling Climate Change

Challenges for the Insurance Industry

Climate change poses several key challenges for insurers:

  • Insurability – Some risks like coastal flooding threaten to become uninsurable due to increasing frequency and severity. This shrinks the market for insurance firms.
  • Risk pricing – The evolving nature of climate change risks makes pricing insurance premiums for perils like floods or wildfires more complex. Historical models can’t be relied upon to accurately predict future losses.
  • Capital uncertainty – The unpredictable and catastrophic nature of climate impacts makes estimating adequate capital reserves an uncertainty for insurers.
  • Regulation – Insurers face growing regulatory and disclosure requirements regarding the climate resilience of their business models and portfolios.

The Protection Gap

Consequently, climate change is leading to a substantial insurance protection gap as coverage shrinks for climate-vulnerable regions and communities worldwide:

  • The protection gap for weather-related events was around 70% in emerging markets and around 35% in advanced markets as per Swiss Re estimates.
  • Underinsurance is marked in regions facing new climate risks like wildfires or coastal flooding.
  • Low-income groups are especially vulnerable to the insurance gap due to rising premiums and lack of risk reduction options.

Opportunities for Insurers

However, climate change also offers new opportunities for innovative insurers:

  • New risk transfer products – Parametric insurance, resilience bonds, microinsurance – offer customized solutions for clients to transfer climate risks to capital markets.
  • Climate risk advisory – Leverage insurers’ risk expertise to provide consulting on climate resilience and adaptation for governments and businesses.
  • Investments – Insurers can align underwriting practices with sustainability goals and direct investments into green sectors and infrastructure.

Thus while climate change poses varied challenges, leading insurers are also harnessing opportunities by pioneering climate-resilient products and directing capital to support sustainability.

Regulatory Obligations and Key Considerations for Insurers

Climate change has significant regulatory implications for insurers worldwide:

Key Regulations

  • The EU Sustainable Finance Disclosure Regulation requires insurers to report on how they integrate climate risks beginning 2022.
  • The Task Force on Climate-Related Financial Disclosures (TCFD) provides voluntary guidelines for climate risk reporting.
  • In the UK, insurers must report to the Prudential Regulatory Authority on climate risk governance, risk management, scenario analysis and targets.

Key Considerations

Some key considerations on climate change for the insurance industry include:

  • Financial impact – Climate risks like stranded assets can adversely impact insurers’ solvency and investment portfolios. Scenario analysis helps ascertain exposures.
  • Varied claims risk – Risks differ across insurance lines – property, health, crops, marine, etc. Granular data analysis is vital to understand varied exposures.
  • Business interruption – Losses aren’t confined to physical damage but also arise from disruptions to supply chains and operations.
  • Legal liability – Changing legal interpretations around “Act of God” defenses against claims require attention.
  • Reputation – Insurers need to manage heightened public expectations regarding their climate responses.

Proactively addressing climate change helps insurers demonstrate leadership, manage their reputation, and comply with evolving regulatory responsibilities.

Enhancing the Insurance Sector’s Contribution to Climate Adaptation

The insurance industry has a vital role to play in adapting to climate change in a socially responsible manner. Some key measures in this direction are:

Promoting Risk Reduction

  • Work with stakeholders to improve building codes, infrastructure design and early warning systems to curb losses from extreme weather.
  • Offer premium discounts on buildings incorporating disaster resilience features like storm shutters or fire-resistant roofing.
  • Finance research into future implications of climate change on insurance risks and exposures.

Supporting Climate Resilience

  • Develop parametric insurance products with swift pay-outs to provide climate-vulnerable regions with rapid liquidity after disasters.
  • Offer comprehensive climate risk advisory services to governments and businesses based on insurers’ risk expertise.
  • Expand availability and affordability of microinsurance to benefit low-income groups.

Mainstreaming Climate Factors

  • Integrate climate risks into underwriting decisions and investment strategies.
  • Divest from carbon-intensive sectors to manage stranded asset risks.
  • Channel investments into green sectors like renewable energy to curb emissions.

Multi-stakeholder Collaboration

  • Partner with governments, communities, businesses, humanitarians and sustainability experts to devise inclusive and ethical climate solutions.
  • Support climate change research to improve predictive models and data analytics capabilities.
  • Promote insurance mechanisms like resilience bonds and catastrophe pools to spread risks.

The insurance industry has deep risk expertise that can help societies worldwide to understand, prevent and recover from climate change risks in an equitable manner.

Climate Change Risk Assessment and Insurance Industry

A robust climate risk assessment framework allows insurers to understand and mitigate their exposures across different insurance segments:

Climate Change Risk Assessment Approach

  • Identify physical and transition risks from climate change that can impact insurers’ underwriting, investments and reputation.
  • Measure the exposures by doing granular portfolio analysis, loss modelling and scenario planning.
  • Mitigate identified risks through underwriting limits, risk diversification, exclusions, etc.
  • Monitor and Report to keep track of evolving climate risks and demonstrate accountability.

Findings Across Insurance Lines

  • Property – Flood and hurricane risks need pricing adjustments. Coastal assets may become uninsurable.
  • Agriculture – Adverse weather impacts crop yields and food security. Parametric crop insurance helps farmers.
  • Health – Risks include mortality from heat stress, changing disease patterns and mental health issues.

Marine and Aviation – Risks include more frequent and severe storms, flooding of ports and airports and route disruptions.

Liability – Risk of litigation against carbon-emitters grows as climate attribution science advances. Litigation and compensation costs may rise.

Business Interruption – Increased disruption to operations and supply chains due to extreme weather events and other climate impacts.

Emerging Risks – New risks like infectious diseases, biodiversity loss, and population displacement also need monitoring.

Enhancing Climate Risk Assessment

Insurers need to continuously refine their climate risk assessment by:

  • Improving data collection and analytical capabilities
  • Advancing catastrophe models by integrating climate change projections
  • Conducting detailed analysis across insurance segments and geographical markets
  • Aligning with latest climate science and predictive insights
  • Tracking legal and regulatory developments related to climate change
  • Partnering with climate experts for sectoral analysis

A robust climate risk management strategy allows insurers to safeguard their financial viability and demonstrate climate leadership.

Conclusion

Climate change poses an existential threat to the insurance industry and the communities it serves worldwide. However, progressive insurers also have immense potential to drive positive change by directing investments into low-carbon sectors and developing innovative risk transfer solutions. Key imperatives for the industry include closing the protection gap, integrating climate risks within core business strategies, complying with heightened transparency regulations, and leveraging their expertise to promote climate resilience. The insurance sector must collaborate across stakeholders to equitably manage escalating climate risks, protect vulnerable groups, and accelerate the sustainability transition. The steps insurers take today will determine their competitive advantage in a climate-altered future.

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