As the climate crisis worsens, risks grow for insurers around the world

The role of the insurance industry on the road to net zero

All areas of the economy share a common concern with regard to climate change. Globally, financial services regulators are taking action to ensure that banks, insurers, and asset managers recognise the risks of climate change, develop plans to manage those risks and modify their business models accordingly. Because climate change risk affects both the asset and liability sides of the insurance balance sheet, unlike any other industry, insurers, with their frequently longer-term time horizons, have a special role in the discussion about climate change. Additionally, insurers have developed decades' worth of experience in managing and pooling high risks. Therefore, insurers are in a unique position to control the effects that climate change will have on society while also being more exposed to financial risks from those hazards than many other financial institutions.[i] Insurance companies may have exposures to climate change risk that are less evident and hence more challenging to detect and manage, even if some of these exposures are well-established and understood. For instance, as extreme weather events increase in frequency and severity, liability insurers may see an increase in claims expenses across a variety of insurance products. This encompasses both general liability insurance policies and more conventional catastrophe risk insurance products.[ii]

Risks for experts on risk

The rise of climate litigation

A quarter of all climate cases to date have been filed in the last three years; however, the practice of climate litigation dates back to the 1980s. Among the factors influencing this expansion are the increasingly visible physical impacts of climate change and the belief that governments and businesses are not moving quickly enough towards net-zero energy or are not upholding their climate obligations. Investors and other interested parties are also concerned that some businesses may not be doing enough to recognise, quantify, report, and address the climate risks they face or may be giving false information.[iii] The risk of climate litigation has significant financial repercussions. In addition to losses and transition-related expenses, the company's share price, creditworthiness, and financing costs could decline, which could, for instance, result in the stranding of important assets. This would significantly affect financial institutions' assets (investees' market values would decline) and liabilities (more claim payouts).[iv]

Source: Bank of England [v]

Anthropogenic climate change or act of God?

The Association of British Employers defines an Act of God as ‘An event that is not the fault of any individual, such as a natural disaster.’ They add that Acts of God are not generally excluded from insurance coverage. What is insured and the principal exclusions are specified in the policy. If a loss results from a covered incident, the insurer will make a payment in line with the terms and conditions of the policy.[vi] With natural disasters considered acts of god, and with the increased frequency of such events related to the climate crisis, insurers could see an increase in payouts. Global insurance losses from floods totalled roughly $30 billion between 1991 and 2000. According to Swiss Re, global insured losses from floods reached $40 billion in the following decade and $80 billion from 2011 to 2020. According to the same research, insured losses totalled $20 billion in 2021, the first year of the following decade.[vii] Research from the University of Arizona suggests that by 2030, 172.9 million more people could be at risk from flooding due to global temperature increase; this represents a 20% to 24% increase.[viii] Such an increase would mean billions of extra spent on payouts. To manage and limit customers' exposure to climate risks and enable more efficient responses to climate-related losses, insurers and other industry participants may offer advising and risk-engineering services. Examples of these services include engineering and risk assessments for natural disasters, risk advising prior to construction, and post-loss incentives to rebuild more resiliently or in less risky areas. McKinsey suggests that the sector could do a lot more to lower risk and losses and that climate-focused risk engineering offers an appealing entry point for insurers to boost their relevance and support ongoing accessibility and affordability. Partnerships with third-party data and analytics providers and providers of value-added services (such as risk modelling for physical assets with an eye towards the future, for example) can enhance and distinguish carrier offers. Taking such steps now could have an impact towards the mitigation of the climate crisis and thus work towards preventing climate payouts from spiralling.[ix]