More frequent and powerful natural disasters, extreme heat and biodiversity loss are destroying homes and businesses and putting entire food systems at risk. In 2019–20 Australian bushfires killed or displaced more than three billion animals. Insured losses for the Australian bushfires of 2019/2020 stands at an eye-watering $1.45bn, according to statistics from PERILS, the independent Zurich-based organisation that provides industry-wide catastrophe insurance data. Earlier this year - and closer to home - storm Eunice cost UK insurers more than £400m ($544.5m), according to Moody's.
As we face more frequent catastrophes, the fundamental question is whether current business and insurance models will remain appropriate. Climate risk is systemic; businesses, insurers and economies are all under threat. So what can be done?
A hike in premiums?
On face value, it could be argued that insurers are well positioned to use their sophisticated understanding of dynamic risks to constantly reprice and limit long-term exposure to climate events, and could even find opportunities. ‘We recognise that weather-related events may become more frequent, severe, clustered and persistent as a result of climate change,’ says Ben Carr, analytics and capital modelling director at Aviva. ‘We build the possibility of extreme weather events into our pricing to ensure it is adequate and monitor actual weather-related losses versus expected weather losses by business. Looking across all of our property insurance portfolios, the proportion of property insurance premiums attributable to weather-related losses is currently quite small, so the impact on premiums would be correspondingly low.’
However, Carr does admit that: ‘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.’
Industry analysts, though, are spotting big differences in the short term. Karl Mallon is director of science and systems at ClimateRisk, specialising in climate risk adaptation software, and director of science and engineering at XDI, which works on climate physical risk for commercial clients and government. ‘Flood risks are highly location specific,’ Mallon explains. ‘Premiums were already rising and many are now on a path towards being unaffordable or unavailable from some insurers. I’ve come across premiums up to 30k per year on a house worth 600k.’
Others point out the impact that swift action now - i.e, how rapidly we move to reduce emissions and move towards a low-carbon economy - will have on premiums going forward.
According to Kabari Bhattacharya, EY’s EMEIA Insurance Sustainable Finance Leader, insurers have a big role to play in supporting and encouraging the necessary steps. ‘If sufficient action is not taken in time, then the degree of insurance cost increases could be material and will impact firms and customers,’ she says. ‘However, actual impacts on insurance costs and premium will depend on how much progress the insurance industry - and society - makes in aligning to net-zero, including actions such as climate resilience.’
Managing transition costs
Measuring is key, according to Bhattacharya. ‘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,’ she says. ‘They need to continue developing the monitoring and governance frameworks around this so that they can make informed decisions around the transition costs and develop their climate strategy accordingly.’
Insurers must also eye their portfolios with a view to avoiding clustered exposure. As Mallon bluntly says: ‘Insurers with less capacity are avoiding high risk areas. Dumb insurers are pricing as if nothing has changed.’
Covering the losses
‘Naturally there are areas at higher risk, which would see proportionate increases in premiums,’ says Carr. ‘In those cases, we consider that the continued presence of industry-wide initiatives like FloodRe in the UK and development of risk mitigation techniques as well as public investment in flood defences would be vital in ensuring widespread access to insurance for all.”
Bhattacharya adds that where group fund mechanisms such as Flood Re exist, ‘insurers need to engage policymakers to ensure that they remain appropriate, and if they do not, to modify them, taking account of emerging climate risks. It will also be important to build resilience into insurance portfolios. An example of this could be insurers doing more to invest in climate risk mitigation for their customers.’
Mallon, however, believes the onus is on the property market rather than insurers: ‘The insurance market is working correctly, so a flood pool causes market distortion. The property market has the failure, because the wrong houses are in the wrong locations, and the solutions required are adaptation, including relocation in some cases. A better solution is for grants and concessional loans to cover these one-off costs and make sure emissions are kept low enough for adaptation to be effective.’
Open source data
Experts agree that data is critical. 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. Reinsurers will be developing similar frameworks and it will be important for the industry to align on the appropriate data and metrics to assess these issues so that it can respond most effectively.
There is also a recognition of the importance of worldwide collaboration. ‘Gaining country-driven views of risk is fundamental to constructing a responsive risk management system,’ says Sara Ahmed, financial adviser to the V20 Group of Ministers of Finance, which launched the Global Risk Modelling Alliance (GRMA) at the end of 2021 with the Insurance Development Forum. The GRMA is intended to help vulnerable countries access better risk information as a foundation for their national adaptation plans. The programme includes free-to-use risk technology, open data standards, and the support of a team of public and private sector risk experts.
‘Putting in place financial protection schemes when limits to [climate] adaptation are breached is vital, but insufficient,’ says Ahmed. ‘We need streamlined access to existing models and data and more granular regional and sectoral detail. We need people-centered metrics to create safety nets for the most vulnerable. This requires open access to risk and resilience planning analytics. We look forward to the GRMA making risk analytics accessible in order to drive and steer investments properly.’
What is clear is that the window for action is closing. ‘We're expecting a hard property correction for some parts of the property market as higher insurance costs are matched with reducing values,’ claims Mallon. ‘Some properties will…become unmortgageable - leading to 'Climate Ghettos', where property values spiral, and insurance is unreachable, attractive only to those who have no other options,’ he warns.
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 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. ‘However, in the short and medium term, the sector's focus is on helping customers adapt.’
Bhattacharya believes the report re-emphasises the need for urgent action, which will only be possible with the full support of the financial services industry, with insurers playing a key role in financing, supporting, accelerating and de-risking the action required. ‘The insurance industry will need to continue innovating to provide its customers with the protection they need, as well as developing new products to address changing needs as the whole economy transitions to net-zero,’ she says.
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.’