Climate Change and Insurance: How Does Climate Change Impact the Insurance Industry?

Climate change is one of the most pressing challenges of our time, affecting every aspect of our lives and the planet. It poses significant risks to the insurance industry, which is exposed to both physical and transitional risks from climate change. 

Physical risks are the direct impacts of extreme weather events, such as floods, droughts, wildfires, and storms, that can damage property, disrupt business, and harm human health. Transition risks are the indirect impacts of the shift to a low-carbon economy, such as changes in regulation, technology, consumer behavior, and litigation, that can affect the value and performance of assets and liabilities.

The insurance industry has a dual role to play in addressing climate change: it can help protect society from the adverse effects of climate change by providing risk transfer and adaptation services, and it can also help accelerate the transition to a net-zero economy by supporting green investments and innovations. 

This article will explore how climate change affects insurance premiums, coverage, and the industry’s response to natural disasters, as well as what opportunities and challenges lie ahead for insurers.

What You Should Know About Climate Change and Insurance

Climate change impacts the insurance industry, primarily by altering the risk landscape. As extreme weather events become more frequent and severe, insurers face increased claims, leading to higher premiums and potentially reduced coverage availability. The industry must adapt by enhancing risk models, promoting sustainable practices, and developing innovative insurance products that address emerging risks associated with climate change. This adaptation not only helps manage financial risks but also supports broader efforts to mitigate the effects of climate change.

The Impact of Climate Change on Insurance Premiums

One of the most direct effects of climate change on the insurance industry is the increase in insurance premiums, especially for property and casualty insurance. This is because climate change increases the frequency, intensity, and unpredictability of natural disasters, such as hurricanes, floods, wildfires, droughts, and heat waves, which cause more damage and losses to insured assets and businesses.

According to a report by Swiss Re, the global insured losses from natural disasters in 2020 reached $83 billion, the fifth-highest on record, despite the lower economic activity due to the COVID-19 pandemic. The report also estimated that the global protection gap, or the difference between total economic losses and insured losses, would be $190 billion in 2020, indicating low insurance penetration and high growth potential.

The rising costs of natural disasters also put pressure on the reinsurance industry, which provides insurance for insurance companies. Reinsurers have to charge higher premiums to cover the increasing claims from primary insurers, which in turn pass on the costs to their customers. Moreover, reinsurers have to adjust their risk models and capital requirements to account for the uncertainty and variability of climate change.

The Impact of Climate Change on Insurance Coverage

Another effect of climate change on the insurance industry is the reduction or exclusion of insurance coverage for certain types of risks or regions. This is because some risks become too costly or too difficult to insure as they exceed the capacity or willingness of insurers to provide coverage.

For example, some insurers have stopped offering flood insurance or have increased the deductibles and exclusions for flood-prone areas, as the risk of flooding has increased due to climate change. Similarly, some insurers have withdrawn from the wildfire insurance market or have imposed stricter underwriting criteria for properties in high-risk zones as the frequency and severity of wildfires have increased due to climate change.

The lack of adequate insurance coverage for climate-related risks can have negative consequences for individuals, businesses, and communities, as they face higher financial burdens and lower resilience in the event of a disaster. This can also create a vicious cycle, as the lack of insurance can discourage investments in risk reduction and adaptation measures, which can further increase the exposure and vulnerability to climate change.

The Response of the Insurance Industry to Climate Change

Despite the challenges and threats posed by climate change, the insurance industry also has the opportunity and the responsibility to play a positive role in addressing and mitigating the effects of global warming. The insurance industry can leverage its expertise, data, and influence to promote risk awareness, prevention, and adaptation, as well as to support the transition to a low-carbon and resilient economy.

Some of the actions that the insurance industry can take to respond to climate change are:

• Developing new products and services that address the specific needs and preferences of customers in a changing climate, such as parametric insurance, resilience insurance, or green insurance.
• Improving their risk modeling and analytics to better understand and quantify the current and future impacts of climate change on their portfolios and operations and to inform their pricing, underwriting, and reserving decisions.
• Diversifying and rebalancing their portfolios to reduce their exposure and concentration in high-risk areas and sectors, and to increase their exposure and participation in low-risk and green areas and sectors.
• Enhancing their risk mitigation and adaptation measures to reduce their own and their customers’ vulnerability and losses from climate change, such as investing in resilient infrastructure, promoting energy efficiency, or supporting disaster preparedness and recovery.
• Aligning their investment and capital strategies with the goals and principles of the Paris Agreement and the Sustainable Development Goals, by divesting from carbon-intensive assets and sectors, and by investing in green and sustainable assets and sectors.
• Engage with their stakeholders, such as customers, regulators, policymakers, investors, and civil society, to raise awareness and advocacy on the risks and opportunities of climate change and to collaborate and partner on developing and implementing solutions.

Conclusion

Climate change is a reality that the insurance industry cannot ignore. It poses significant risks and challenges but also offers opportunities and benefits, for insurers and their customers. By taking proactive and innovative actions, insurers can not only protect their own business and reputation but also contribute to global efforts to combat and adapt to climate change. The insurance industry has the potential and the responsibility to be a leader and a catalyst in the transition to a net-zero and resilient economy and society.