The Impact of Climate Change on Insurance and the Role of Insurers and Insurance Distribution Networks

George Natar – B.Sc, M.Sc, MCyHRMA – Certified Business and Insurance Trainer

Climate change = insurance risk

The US regulator said the potential damage from climate change could be as severe as the impact of the mortgage crisis that sparked the 2008 financial crisis. A Climate Risk Survey, conducted by the Deloitte Financial Services Center, found that climate change risks of all types will increase in the medium to long term, including natural, liability and transition risks, and that climate change coverage and issues related to risk assessment and selection (underwriting).

The strongest natural disasters and the global average annual damage

Hurricane Harvey caused $ 125 billion in financial damage in 2017. Fires in Australia (2019-2020) burned more than one billion animals and caused more than $ 4 billion in damage.

CNBC on November 9, 2021 reported that the British Insurers Association said that an extreme frost in the UK, in 2018 led to pipe breakage claims, totaling £ 194 million (€ 260 million) over three months. That same year, an extreme heat wave saw more than 10,000 homes in the UK claim damages caused by subsidence. That exceeded £ 64 million, according to ABI.

AIR and L.S. Howard on October 26, 2021 – said the global insurance industry expects an average annual loss of $ 106 billion and a 40% chance of an annual loss of more than $ 200 billion over the next decade. The average annual loss of $ 106 billion “significantly exceeds the actual [annual] average of $ 75 billion a year, and we were fortunate not to have a major tropical cyclone or earthquake in a densely populated area,” said Bill Cherny, president of AIR Worldwide.

Reports from organizations such as the World Economic Forum analyze climate-related issues and report that they are numerous, some of which include extreme heat, natural disasters, and biodiversity loss. Consequently, however, is the failure to respond in a timely manner to all these challenges that make insurers’ concerns no longer isolated catastrophic events, but interactions between the global climate and human systems.

McKinsey’s research clearly shows that the value of climate risk could, conservatively, increase from 2% of world GDP to more than 4% of world GDP by 2050. The risks associated with climate change are multiplying.  A small physical displacement can change entire systems irreversibly, and vulnerable populations could be disproportionately affected.

Insurers’ level of preparedness and impact of climate-related risks

Many in the property and casualty insurance industry have underestimated the immediate physical and systemic effects of climate change. A serious systemic impact could be the “transition risk”, ie those risks associated with companies pursuing social and economic change towards a future of low carbon and more climate-friendly. These risks may include regulatory and technological risks, market risks, reputational risks, and legal risks. The Property and Casualty (P&C) industry needs to change its business model. This prevention can not only better protect customers in the long run but can also help safeguard society’s interests and serve the fundamental purpose of the insurance industry. What is certain is that insurers must act immediately and quickly. The window for effective response is limited (McKinsey & Company – Nov2020).

  1. Daprile in March 2018 stated that relationships become more important when decisions become more complex. Insurance decisions are one of the most complex that a consumer will encounter in his life. The executives who understand this and have achieved this shift in other areas may be the ones who adapt appropriate insurance distribution models. But just as important is that “we cannot solve problems with the same way of thinking we used when we created them,” said Albert Einstein.

In every crisis there is a hidden opportunity

The climate is the “greatest unique opportunity” the insurance industry has ever seen, says Lloyd’s CEO. “There is a risk that if there is an erratic transition to a low-carbon economy, the value of many of insurers’ investments will decline, with minimal warning.” ABI argues that this is also an opportunity for companies to make an early shift to “more sustainable assets”.

Readiness, it seems, is the key. Many insurance companies still have a long way to go to understand how climate change will affect their business models in the medium to long term. Business Model Review helps support customers, and the insurance industry can create financial security by providing reliable protection. “To use their experiences of risk and climate science to mitigate the systemic effects of natural climate risk on themselves and their customers,” said N.P. Simpson in 2021.

Completing insurance work involves five steps:

  1. Climate Risk Resistance Test – Climate-related losses spread to different types of coverage such as floods, property damage and business downtime. The risk of aggregation, ie the risk of multiple claims in relation to a single event, will extend beyond the geographical boundaries. An increase in average temperatures increases the likelihood of floods and fires, regardless of location.
  2. Creating investment resilience and balance – In the broader financial services sector, many institutions, from banks to asset managers, have begun to incorporate climate risk into their investment allocation, credit risk and financial assessments.
  3. Supporting organizations to mitigate climate risk – Insurers should focus on mitigation, even natural climate risk prevention, risk management and prevention. E.g. an insurance company provides its customers with access to fire protection services to assist them with prevention and mitigation measures. Services include relocating valuables and sending certified firefighters at insureds’ home, if a fire is imminent. Insurance companies will have to work with governments to provide affordable coverage and adapt to evolving risks, as some insurance companies, especially in the UK, have begun to do, can suggest boundaries in construction, in areas prone to flooding.
  4. Creating innovative products for climate-related risks – Solutions should be as simple as parametric pricing, e.g. limited liability insurance instead of value insurance. Insurers should explore ways to better protect businesses from heat waves that reduce crop yields, kill animals, or reduce outdoor working hours.
  5. Review of investment strategies – Insurers should evaluate their investment allocation strategies as the economy shifts to long-term carbon offsets, which can cause rapid asset revaluation and portfolio volatility, especially for coal investments.

Distribution insurance networks against climate change

The Climate Change Promotion Plans that insurance distribution networks can deal with zeal are:

  1. Loss of property: Scientists agree that rainfall is becoming more intense and unstable, leading to warmer, drier environments that increase the risk of fire, as well as catastrophic storms that increase the risk of flooding. Studies have shown that hurricanes are expected to intensify in the future. Property losses can include not only claims for structural damage (broken windows, holes in the roof and water damage) but also additional living expenses. The commercial side of the business must also be considered. Losses for the commercial side of the business may include loss of revenue and additional costs during remodeling or relocation.
  2. Disasters: Disasters are more severe, and losses are also increasing due to inflation and increasing growth, where natural disasters occur. Developing countries are more vulnerable to extremes and will be disproportionately affected, if global warming results in more frequent and catastrophic windstorms, floods and droughts. These countries have fewer resources for mitigation before disaster, fewer resources to promote economic recovery after lower insurance penetration rates, ie the percentage of individuals and businesses that have insurance
  3. Liability damages: Most companies buy liability insurance to protect themselves from negligence resulting in bodily injury, property damage and loss of reputation. Companies can also protect their managers and executives from liability for overheating. Shareholders or consumers may sue a company for actions that could harm the environment. In addition, the lawsuits may aim at withholding important information that could materially affect the financial and, therefore, influence shareholder investment decisions.

Areas where distribution networks can benefit

In August 2020, Rebecca Waddell, Douglas Beal, and David Cockerill, in their study, identified areas of work where insurance distribution networks could benefit most from focusing on climate change and the effects of natural disasters on life. These can be summarized as:

  1. Portfolio (evaluation and selection). Guiding change through their customer base and adapting the insurance products and services offered to support climate action.
  2. Portfolio (Business). Adoption of business practices and tactics leading to climate change. These may include partnering with companies, integrating environmental, social and governance (ESG) factors, such as carbon emissions, corporate investment decisions and targets, and investing in specific areas, such as renewable energy sources.
  3. Internal Emissions. Measurement and active participation to reduce emissions with internal operations of the company, including those concerning suppliers.
  4. Procedures and Reports. Provide transparency on corporate climate-related risk, carbon footprint and the company’s efforts to support climate action.
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