Insuring against climate change: how companies can improve their risk assessments
Climate change is altering the way in which insurers offer their services. Higher premiums and lack of affordable coverage in disaster prone areas are highlighting the need for novel ways of insuring against climate change related risks.
From wildfires in California and hurricanes in Florida, to flooding in the United Kingdom and heatwaves in Southern Europe, insurance companies in western nations are struggling to keep up with the pace of climate change and the rising frequency of extreme weather events.
“Insurers employ empirical data and advanced risk modeling instruments to assess risks and set premium rates,” says Jaroslav Mysiak, director of the Risk assessment and adaptation strategies research division at the CMCC. “However, climate change is making gudiance based on past records less reliable. If insurers continue to rely past events for direction, their risk assessments may turn out flawed .”
The failure of insurance companies to factor extreme climate events into their risk assessments famously came to the foreground in the early 90s, when hurricane Andrew struck the east coast of the United States with almost unprecedented force, causing an estimated USD 15.5 billion (1992 dollars) in total insured losses and dragging at least 16 insurance companies into insolvency.
“In the aftermath of hurricane Andrew, insurance companies made significant efforts to enhance sectoral risk assessments,” says Mysiak. However, the growing impacts of climate change, including increased frequency of extreme events, are providing ever greater challenges to the industry, leading many to revise their policies and investments, and in some cases even withdraw from at-risk areas.
Eric Andersen, president of Aon PLC insurance company, told the Scientific American that climate change is creating uncertainty in an industry built on risk prediction and has created “a crisis of confidence around the ability to predict loss,” which some fear may have far ranging consequences on both local and even global economies.
Should I stay or should I go?
A recent report from the First Street Foundation, a non-profit research group, reveals how the insurance landscape in the United States has altered significantly in the last decade. For example, over the last five years average costs of wildfire events have skyrocketed from approximately 1 billion USD per year in 2016 to over 17 billion USD in 2021.
The consequence is that many private insurers are either raising premiums significantly or ceasing to operate in these at risk areas.
According to Nancy Watkins, principal and consulting actuary at insurance company Milliman, one of the worries is that when insurance companies stop selling policies in an area, it “can cause ripple effects that endanger entire communities and create a downward spiral that’s difficult to emerge from.”
The First Street Foundation report also reveals that if climate risk is properly accounted for approximately one in four United States properties — around 39 million properties — are currently overvalued, raising fears of a “climate-insurance bubble”.
So, is the solution for governments to simply subsidize insurance premiums in at risk areas? According to The Economist the subsidy approach is leading to cascading issues in the US property market. The article argues that the actions of state-backed insurers — that are increasingly stepping in to replace the private insurers who are abandoning risky markets — is inflating property values and creating incentives for property development in at risk areas.
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Climate Foresight is published by the CMCC Foundation , a research center that develops models and predictions to study the interaction between changes in the climate system and social, economic and environmental changes. Climate Foresight is an observatory on tomorrow, a digital magazine that collects ideas, interviews, articles, art performances, and multimedia to tell the stories of the future.
