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The concerning impacts of climate change on the insurance industry

January 02, 2020

In 2019, climate change was identified as the greatest risk of them all, ahead of the threats posed by cyber attacks and terrorism. The consequences of this for the insurance industry are undoubtedly significant and extensive.[1] Not only does an increase in frequency and severity of major weather events result in an increasing number of claims, but this will eventually create a surge in premium prices, making insurance less affordable for those who need it. As Denis Kessler (Chairman and CEO of SCOR SE) stressed, insurance should be used ‘not only as a means for providing financial resilience, but as an instrument for supporting risk reduction’,[2] and therefore, insurers should focus on mitigating the risks associated with climate change.

The unpredictable effects of climate change:

Due to unpredictable weather patterns, insurers have struggled to accurately predict the loses they will incur in a given year. For instance, in 2017, Swiss Re had estimated to incur $1.18bn in losses, but a rise in claims resulted in a staggering sum of $3.65bn.[3] For an industry that relies on predictions and previous loss records, accurately pricing risks is becoming increasingly difficult to do. Rather, insurers will need to ensure they have the correct talent on board with the skills required to use advanced analytics in order to assess weather records and assumptions regarding future climate predictions. Actuaries and underwriters will need to be able to competently detract information from catastrophe risk models to assist them with managing the likelihood of adverse events occurring.

Furthermore, with the rise of extreme weather events, it is possible that it may become too costly in the future to provide cover to high-risk areas. For example, over a three-month period in early 2018, the abnormally low weather temperatures resulted in insurers paying an excessive amount to cover the costs of burst pipes; this amounted to a total of £194 million.[4] As a consequence, premiums rose, and in some cases, became unaffordable for individuals. There are fears that if insurers withdraw from certain types of risks, consumers will have little choice but to cover the costs of damage themselves. However, as will be discussed below, insurance firms can adapt to support a more sustainable future, and as a result, avoid the prospect of premiums increasing to an unaffordable level.

How insurance companies can drive a greener future:

As Huw Evans explained, although the insurance sector has been harshly exposed to the costs of climate change, in the long-term, the industry has the ability to shape the future.[5]  There are concerns surrounding how the transition to a zero-carbon economy will impact those insurance firms invested in companies reliant on fossil fuels. Consequently, not only is it important for insurers to manage the physical risks involved with climate change, but it is also crucial that these organisations play an active role in moving away from investing in non-renewable energy. In recent years, several insurers have committed to no longer insure and invest in companies that generate more than 30% of their revenue from coal-related businesses.[6] Swiss Re initially made this move, and Munich Re, AXA and Zurich have followed suit in limiting their dealings with unsustainable firms.

Furthermore, insurance firms can act as ‘gatekeepers’ and participate in promoting the transition to a zero-carbon economy. Insurers can place increasing pressure on large companies, as by refusing to provide coverage for these firms, they will be compelled to move towards embracing renewable energy. Allianz made a statement in May 2018 pledging to remove its ‘coverage from single coal-fired power plants and coal plants, and that it would phase all coal risks out of its business by 2040’.[7] This movement away from a reliance on fossil fuels towards greener initiatives will consequently help mitigate the risks climate change pose to the insurance sector.

How is the industry preparing?

In addition to shifting towards a sustainable economy, a short-term solution to dealing with an increasing number of climate change related claims is necessary. Insurance companies can introduce parametric insurance policies which assess the possibility of an adverse event, and will automatically trigger a payment to the consumer if the event occurs.[8] For example, Swiss Re has developed a new product, known as FLOW, for companies that are unable to transport goods when water levels drop below a certain level.[9] As a result, accurate risk assessment will be more important than ever, and when weather-related disasters occur with little warning, quick payments can reduce the level of disruption that may otherwise arise.

Overall, it appears insurance firms will need to make a choice; either they face huge losses resulting in their inability to insure high-risk areas, or they must gradually move away from investing in and insuring large companies supporting the fossil fuel industry.

 

[1] The Ecologist, ‘Insurance and Climate Change’, 2019

[2] SCOR, ‘How Does Climate Change Affect the Insurance Sector? A Geneva Association Conference’.

[3] Fortune, ‘Climate Change Is Hitting the Insurance Industry Hard. Here’s How Swiss Re Is Adapting’, 2019

[4] ABI, ‘Climate Change’.

[5] ABI, ‘Can Insurance Help Drive a Greener Future?’, 2019

[6] KPMG, ‘Climate Change into the Boardroom’, 2019

[7] Financial Times, ‘Insurers Act on Climate Change Exposure’, 2018

[8] Marsh, ‘Parametric Insurance: A Tool to Increase Climate Resilience’.

[9] Swiss Re Corporate Solutions, ‘FLOW: Parametric Water-level Insurance’, 2019