Climate change risks and the future of insurance

When Storms Dud­ley, Eunice, and Franklin wrought chaos across the UK dur­ing a sin­gle week in Feb­ru­ary, insur­ers were left fac­ing a huge bill for the con­tents and prop­er­ty dam­age caused to home­own­ers and busi­ness­es.

Soon after, in ear­ly March, experts from the Inter­gov­ern­men­tal Pan­el on Cli­mate Change released their sixth assess­ment report, with IPCC chair Dr Hoe­sung Lee describ­ing the doc­u­ment as a “dire warn­ing about the con­se­quences of inac­tion”.

Dr Lee called cli­mate change “a grave and mount­ing threat to our well-being and a healthy plan­et”, adding the actions we all take today will shape how peo­ple adapt to this threat.

For the insur­ance indus­try, cli­mate change rep­re­sents a major chal­lenge. Flood­ing and high winds aren’t new, but the poten­tial for more fre­quent extreme weath­er events means they must be planned for and mit­i­gat­ed against through stress test­ing for expo­sure, a focus on pol­i­cy avail­abil­i­ty and exclu­sions, and the price of pre­mi­ums.

Chris Bow­den, man­ag­ing direc­tor of Squeaky, a B2B mar­ket­place for clean ener­gy, says: “The eco­nom­ic loss­es to cli­mate-relat­ed activ­i­ties are on track to become the biggest risk in the glob­al insur­ance indus­try and I don’t think the mar­ket is ready for the full con­se­quences that lie ahead.”

Bow­den cites the 2019 Cli­mate Dis­clo­sure Project report, which revealed the world’s largest 215 com­pa­nies poten­tial­ly face $1trn (£760bn) worth of finan­cial risks due to cli­mate change, from high­er oper­at­ing costs, asset write-offs and falls in demand. 

“Many organ­i­sa­tions will sim­ply become unin­sur­able. His­tor­i­cal­ly insur­ance mod­els were based on pay­ing out peri­od­i­cal­ly on extreme events,” he adds. “How­ev­er, giv­en extreme weath­er events are becom­ing more reg­u­lar, they are hav­ing to make more pay-outs. 

“To cov­er their loss­es, insur­ance pre­mi­ums are ris­ing to lev­els that many just can’t afford, and it’s only going to get worse.”

Investment in education and information

In the UK, work is under way to explore and counter the threat cli­mate change pos­es to insur­ance. For exam­ple, Flood Re sees gov­ern­ment and insur­ers work togeth­er to pro­vide flood insur­ance cov­er­age to domes­tic prop­er­ties deemed at sig­nif­i­cant risk of flood­ing.

The Asso­ci­a­tion of British Insur­ers has also launched its Cli­mate Change Roadmap to inform on ways the sec­tor can take col­lec­tive action on net zero while sup­port­ing pol­i­cy-hold­ers with their own resilience and risk man­age­ment.

Ben Howarth, the ABI’s cli­mate change man­ag­er, accepts cli­mate change will have “a major impact” on all parts of the insur­ance indus­try. But while he describes it as a top pri­or­i­ty issue with no room for com­pla­cen­cy, he also believes the sector’s unique role and sig­nif­i­cant invest­ment capac­i­ty allows it to play a key role in help­ing peo­ple adapt to future risks.

“The risks are very sig­nif­i­cant,” he says. “I think the indus­try is very aligned to that. But I think at this stage, it’s prob­a­bly too ear­ly to spec­u­late on at what point those risks would become unin­sur­able. The key thing is to do as much as we can to mit­i­gate the impacts of cli­mate change.”

Howarth sug­gests the insur­ance indus­try should work close­ly with gov­ern­ment, busi­ness­es, home­own­ers and motorists to find ways to encour­age them to reduce car­bon, take up elec­tric cars and make changes to prop­er­ties through an “edu­cat­ing and inform­ing role”.

How­ev­er, while he does not believe we are there yet, Howarth does admit insur­ers may one day have to state that cer­tain things will be expect­ed to make prop­er­ties and busi­ness­es “more resilient to the impacts of extreme weath­er and oth­er cli­mate change impacts”. This could include, for exam­ple, ensur­ing prop­er­ties meet ener­gy effi­cien­cy stan­dards, and that insur­ers are noti­fied of adap­ta­tions such as elec­tric vehi­cle charg­ers or heat pumps.

“That’s not a major change,” he explains. “In oth­er areas, when peo­ple are doing risky activ­i­ties, there will always be con­di­tions imposed.”

And he adds: “I don’t think we’re at the point yet where we could spec­u­late on whether there will be aspects that sim­ply become too big to insure, but I think if you look at com­ments indus­try lead­ers have made on cli­mate change, it’s clear that if we don’t do enough, then we will reach a point where cer­tain activ­i­ties are sim­ply unin­sur­able.”

Analysing the dangers in closer detail

A greater use of tech­nol­o­gy could be one way for­ward for cli­mate change mit­i­ga­tion. 

Shrop­shire-based GeoSmart Infor­ma­tion has launched Flood­S­mart Ana­lyt­ics, to enable insur­ers to accu­rate­ly assess flood risk depths, prob­a­bil­i­ties and the relat­ed costs, includ­ing cli­mate change impacts.

Mean­while Aspia Space offers satel­lite imag­ing that uses AI to help insur­ers iden­ti­fy and under­stand trends, pre­dict flood­ing risks and make faster, more informed deci­sions.

Simon Lan­cast­er is founder and CEO of SJL Insur­ance Ser­vices, a Lloyd’s bro­ker, which insures busi­ness­es from sole traders to cor­po­ra­tions across the world. He says more fre­quent storms and flash flood­ing has forced insur­ers to change how they view and under­write cer­tain things.

As a bro­ker and under­writer, SJL looks ahead at a short­er time peri­od than insur­ance com­pa­nies, which focus on trends 10 years into the future, Lan­cast­er explains. “What SJL does is fol­low the data, look for trends about one to two years ahead, analyse per­for­mance on sta­tis­tics and adjust our rates and accep­tance cri­te­ria accord­ing­ly.”

He cites the exam­ple of flood risk assess­ment, which pre­vi­ous­ly focused on a com­bined flood score – the result of riv­er and coastal flood­ing and sur­face water. Instead, a keen­er inter­est is now tak­en in the sur­face water score alone, as this is mak­ing a larg­er impact on flood claims.

Like the ABI, Lan­cast­er believes more can be done inter­nal­ly to fight cli­mate change by insur­ers them­selves. But he warns: “Ulti­mate­ly even with the best under­writ­ing and inter­pre­ta­tion of data, the sheer increase in storms and flood­ing will have one end result – claims increase and there­fore so will pre­mi­ums.”

The role of stress testing and regulation

Stress test­ing for cli­mate risks is set to become a key plank of the insur­ance industry’s response to cli­mate change. For exam­ple, France’s cen­tral bank found in 2021 that claims relat­ed to nat­ur­al dis­as­ters could rise five­fold in its most affect­ed regions, with pre­mi­ums rock­et­ing as much as 200% over 30 years.

The Bank of Eng­land is now under­tak­ing its own evi­dence gath­er­ing to inform future stress test­ing, with the results expect­ed in May 2022. This involves banks and some of the UK’s largest insur­ers and could pave the way for new reg­u­la­tion in the future.

Justin Elks, part­ner in risk con­sult­ing at advi­so­ry firm Crowe UK, believes 2022 will see the tran­si­tion to net zero take cen­tre stage for UK insur­ers, with reg­u­la­tion act­ing as a key dri­ver.

He says: “With so much reg­u­la­to­ry activ­i­ty, address­ing cli­mate change might appear to be a com­pli­ance activ­i­ty. Pro­gres­sive insur­ers are how­ev­er increas­ing­ly focused on sus­tain­abil­i­ty as a strate­gic goal – con­sid­er­ing and cap­tur­ing the com­mer­cial oppor­tu­ni­ty of the tran­si­tion to net zero. COP26 has shift­ed the empha­sis from ambi­tions and com­mit­ments to actions and account­abil­i­ty. 

“This cre­ates the con­text for insur­ers to make a dif­fer­ence to the world in address­ing cli­mate change and insur­ing the tran­si­tion – help­ing to build cus­tomer trust in finan­cial ser­vices.”

Simon Crowther, aka The Flood Guy, is an award-win­ning civ­il engi­neer who believes stress test­ing will become of “vital impor­tance to the insur­ance indus­try”. 

He warns: “Assess­ing the risks of future dis­rup­tion from envi­ron­men­tal fac­tors should not be ignored and left until it might be too late. The chang­ing cli­mate is warn­ing us on an ever-more reg­u­lar basis of what is to come, and the time to act is now.”