More frequent catastrophes, in combination with increased regulatory requirements, raise serious questions about current business models in the insurance sector, and the systemic effect of climate risk is likely to increase pressure on local economies and cause market failures for both consumers and insurers. 

Will prices go up?

Climate change may mean an immediate hike in premiums for consumers. “The speed of this change and the ability of society to adopt mitigation strategies may impact our ability to profitably provide products for our customers at affordable levels over the longer term,” says Ben Carr, Analytics and Capital Modelling Director at Aviva.

Insurers will also need to explore how they will manage transition costs. Measuring is key, according to Kabari Bhattacharya, EY’s EMEIA Insurance Sustainable Finance Leader. “Insurers need to take action as soon as possible to start to understand their portfolio exposures to climate change and ensure that they have the metrics in place to measure and understand the scale of the impacts on their business.”

Insurers must also eye their portfolios with a view to avoiding clustered exposure. As Karl Mallon, director of science and engineering at XDI, bluntly says: “Insurers with less capacity are avoiding high-risk areas. Dumb insurers are pricing as if nothing has changed.”

Aligning the data

And while climate metrics will need to be incorporated into underwriting governance frameworks, so that insurers have a good understanding of their level of exposure to climate risk and aggregations in particularly at-risk geographies both today and out to 2050, the thorny issue of reinsurers needing to develop similar frameworks will remain crucial for the industry to align on the appropriate data and metrics to assess these issues so that it can respond most effectively.

The United Nations’ Intergovernmental Panel on Climate Change (IPCC) recently released its 2022 update on the state of the planet, and it made for worrying reading. The report reinforced previous conclusions with more discouraging data that shows the planet warming, biodiversity decreasing, sea levels rising, and extreme weather growing more common. Does this in turn mean that costs are becoming baked in and the insurance market will have to shrink its coverage and product range?

“The IPCC assessment of the impact of climate change provided further evidence of the need to both reduce emissions and invest in adaptation and resilience. The insurance sector recognises that the worst case scenario could present risks that may not be fully covered by insurance,” says Ben Howarth, ABI Manager, Climate Change and Open Policy Data.

Insurance at a crossroads

The insurance market stands at a crossroads, concludes Mallon: “Shrink away from increasing risks, which are hard to understand, or expand understanding and capture society’s increased need for risk management, while being vocal and assertive about adaptation.”

A longer article, Weathering the Losses, is available from the Financial Services Faculty.