How does the insurance industry manage a climate in crisis?

Following the UN Climate Change Conference (COP27) in November – a summit where political decision makers across the globe attend to discuss current environmental risks – climate change is once again at the top of everyone’s mind.

It’s a well-established fact that weather patterns are changing. More than ever, people are being caught off-guard by severe events at a magnitude not previously experienced. So, how does the insurance industry, whose entire model runs on detecting and reducing risk, manage the burden of climate instability? What problems do insurers face, what are they doing, and what more needs to be done?

How is climate change affecting insurance?

In recent years, cyclones have left thousands of Africans displaced. Rising temperatures have caused some of Australia’s worst-ever bushfires, destroying millions of hectares of natural habitats and homes. Droughts and floods have affected areas that were woefully underprepared. These are all events that require quick payouts from the insurance sector – and this is just the tip of the iceberg.

Under old insurance models, the impact of these sudden and catastrophic incidents would eventually render some areas uninsurable, increasing animosity between consumers and insurers while heavily impacting the economy, leaving devastated businesses unable to recover.

Insurers are not only affected by the physical risk (weather effects), they are also dealing with transitional risks (policy enacted by governments to combat these risks). While physical risk poses the most direct threat to insurers, transitional risk is the most tricky, as it has the greatest potential to destabilise investments that affect the insurer's portfolio: just the announcement of an energy price cap in the UK caused the value of sterling to fall against the euro.

There is an outcry for financial institutions to take an active stance on climate change; it’s no longer something that the insurance sector can ignore.

How are insurers currently managing climate risk?

• Reinsurance and catastrophe bonds are used to protect and safeguard funds for specific incidences. By partnering with reinsurers who specialise in certain climate events and have a higher appetite for risk, insurance brokers can provide their customers with appropriate policies at more affordable prices. Catastrophe bonds allow funds to be locked away, accruing high-interest only to be released under certain circumstances, such as hurricanes. Not only does this provide insurers with immediate access to funds, but obligations to pay interest or repay principal is either deferred or forgiven, massively reducing the monetary burden on the broker.
• Parametric insurance creates more affordable products as, similar to catastrophe bonds, these only trigger a payout if customers experience events of a set magnitude, rather than just covering losses. “It’s a win-win,” says Adam Rimmer, CEO of parametric insurance broker FloodFlash, “parametric insurance is the best and most efficient way to cover these low-frequency, high-severity events.” Parametric insurance removes the need for insurers to continually assess the risk every year, which somewhat alleviates dependence on unpredictable data.
• Making smart IoT tools and funding climate technology help contribute to climate research and improve predictions. One insurer using technology to battle climate change is Reask. “We now have improvements in seasonal weather prediction [showing] 1-6 months ahead what the global state of the climate will be,” says CEO Jamie Rodney. “These are things that are evolving over the last 5-10 years at a rate of speed that allows us to do what we do.” The more insurers use monitoring tools, the cheaper and better-available they become.
• Enforcing change at a policy level by leveraging products such as more preferable premiums for policyholders who use resilient construction materials that can better withstand a climate emergency. This can also include developing products that support and encourage policyholders while they transition their operations to low- or no-carbon solutions, moving insurance from ‘detect and repair’ to a ‘predict and prevent’ model that will help to increase climate resilience globally.
• Providing warnings ahead of events is achieved by insurers using parametric devices as well as foresights from new forecasting technologies to raise the alarm on imminent climate emergencies.  “We have a forecasting model that lets our customers know up to two days in advance when a flash flood is going to hit a property of theirs,” says Johnny Stubbs, Head of Partnerships at Previsico. This gives customers time to “put in place their action plan, they can move stocks and assets, their cars”. Stubbs continues: “We’re going to reduce any claim that they might make, and it also means they can get back on their feet more quickly… that’s hugely beneficial from the insurer perspective. It means reduced claims [and] reduced exposure.”
• Helping to educate customers and influence policy regarding the risks and what steps can be taken to prevent potential damages. Though many consumers still see insurers as the enemy, a major function of the industry is to educate consumers about how to reduce their personal risk, as well as influence government policy to ensure that public exposure is minimised. It’s the responsibility of the industry not only to adhere to policy, but to drive it.

There’s still more to do…

Insurers need to look into methods that protect against chronic climate issues – like heat waves and soil degradation reducing crop yields, affecting safe working hours, or making livestock rearing more challenging.

They also need to build more in-depth weather forecasting tools that find patterns in unpredictable data to better predict what events could take place and where. This is not only to help indemnify themselves, but to warn their customers and reduce the damage of these catastrophic events as much as possible.

Insurers must review their investments to ensure that their portfolios are protected from climate risk such as changes in energy prices, the housing market, supply chain disruptions, political uncertainty, and fluctuations in stock prices that are indirectly impacted by climate change.

The insurance sector has the potential to be at the forefront of the world’s climate change response, creating products, influencing policy and innovating with new technologies that could help to protect and shape the future of society. Not only will this impact their bottom line, but it could be the way to bridge the gap between insurers and customers.