Due to climate change, insurers are confronting increased operating uncertainty that has them reconsidering their risk management and underwriting approaches.
An increasing number of companies are including environmental, social, and governance (ESG) considerations into insurance underwriting and investing strategies as they focus on risk prevention. Furthermore, regulatory and industry bodies are increasing expectations on climate risk disclosure.
Risk Assessment
Climate change will increase insured losses caused by floods, droughts, heat waves, severe storms, tropical cyclones and wildfires – with major financial implications for insurers. Climate change also poses systemic risk by straining local economies and increasing the probability of market failures that affect both consumers and companies (see sidebar “Florida flooding and insurance market failures”).
Many insurance executives have realized the necessity of revising their business models to adapt to climate change, with several taking immediate steps: reviewing catastrophe modeling techniques – taking sea-level rise into account; studying climate change’s potential effects on future losses trends; considering climate risks when making product decisions; and considering any possible shift in consumer demand as a result of climate-related impacts.
But the P&C industry must take additional steps, collaborating with governments and other stakeholders to promote long-term policies limiting greenhouse gas emissions. Such steps will help ensure insurability for increased risks caused by climate change; over time this will serve to protect customers while furthering economic security for society as a whole. They will also facilitate data sharing about climate-related loss information while raising awareness of its significance.
Policy and Program Management
Climate change has already had an enormous effect on insurance and risk management worldwide, especially its impacts on climate hazards – like floods, storms, and wildfires – and on people and communities prone to them. Insurance premiums also reflect these increased risks by reflecting them with premium adjustments that reflect them as future losses increase.
One major worry related to rising premiums is their impact on affordability of homeowner policies in vulnerable communities, leading to what’s known as a “protection gap,” in which lower and middle-income homeowners cannot afford insurance or choose not to purchase it, leading to lower property values as a result and thus decreased tax revenue for schools, fire departments and other municipal services.
Insurers should implement new risk management protocols to address climate change’s effects, including revisiting catastrophe modeling techniques and taking account of any new threats as it continues to affect climate conditions. To meet this need, insurers can employ strategies like adopting new protocols for risk mitigation. These may include revising catastrophe modeling methodologies as climate patterns shift or adapt.
Transformation also necessitates shifting business models away from transactional risk transfer and indemnity payments towards mitigating and even preventing physical climate risks – for instance, offering home owners rebates when building homes using climate-resilient materials. To do this effectively will require greater investments in direct partnerships with end customers as well as scaling up incentives like providing access to wildfire defense services.
Underwriting
Climate change is increasingly being recognized by insurers in their investment portfolios and property and casualty underwriting practices, and as such insurers need to adapt their business models in response to climate risk in order to provide customers with better services over time.
Insurance companies can assist clients in transitioning to net zero carbon emissions by aligning knowledge about risks with investments, and working closely with clients to reduce risks and build resilience. Failure to do this could result in substantial liability risks as well as growing physical risks that threaten business models, investment portfolios and even insurability down the line.
Failing to address climate change can also have detrimental social repercussions, including redlining and exclusion of low-income communities. Banks or mortgage lenders may identify vulnerable neighborhoods or communities more susceptible to climate impacts as higher insurance premiums or refusal of coverage is then offered; this forms of discrimination has detrimental health implications, including infrastructure deterioration that makes these communities more prone to disasters.
Insurers can play an essential leadership role in their communities by working closely with local governments and other stakeholders to increase resilience to climate impacts, including offering discounted policies or tax credits to people who take steps to safeguard their homes from extreme weather events.
Claims Management
Insurance plays a central role in global finance, so it is vital that insurers recognize and address their impact on climate change. Many are including ESG/climate change principles into their business models while some have pledged to limit exposures to carbon intensive industries by setting an annual or other deadlines.
This work will have implications for their underwriting, reserving, coverage and pricing decisions as well as asset management practices. These concerns are especially pertinent to property and casualty (P&C) insurers that face potential losses from climate-related events that are either new or increasing in frequency and severity.
Research demonstrates how climate change is increasing the chances of floods in areas not historically susceptible to them, while also altering hurricane, typhoon, and tropical storm risk characteristics. There is also evidence suggesting climate change influences wildfires, droughts, and heat waves.
As such, companies must assess whether traditional insurance products and policy stipulations are appropriate or feasible in light of climate change-related losses and damages. They should also evaluate liability risks such as lawsuits that might arise due to failure to take steps that reduce or mitigate climate-change-related damage or loss.
