How Climate Change Impacts Severe Weather and Role of Insurers

Although it’s hard to pinpoint whether climate change intensified a particular weather event, the trajectory is clear — we’re experiencing hotter heat waves, drier droughts, and bigger storm surges – with scientists detecting a strong link between the planet’s warming and its changing weather patterns. With record-setting temperatures year after year, it’s likely that global warming is making extreme heat events more frequent. Most recently, for example, wildfires in the Western U.S. have led to over four million acres burned so far (2.5 million in Northern California and over 1.5 million in Oregon and Washington) and over 13,500 structures damaged or destroyed as of September 20. Climate change has also led to more hurricanes, with rising sea levels that are leading to higher storm surges and more floods.

Insured Losses from Recent Wildfires, Hurricanes

The cost of extreme weather events to federal and state governments, businesses, and insurers is astronomical. Most recently, leading catastrophe risk company, RMS, estimated that insured losses alone for the Western U.S. wildfires will be between $4 billion and $8 billion. These estimates include losses from property damage, including evacuation and smoke damage, business interruption across residential, commercial, industrial lines, and additional living expenses. Estimates for insured losses from various industry sources have indicated that wind and storm surge damage to residential, commercial, and industrial properties from Hurricane Sally is between $2 billion and $4 billion.

In fact, a report released by Aon, “Reinsurance Market Outlook – September 2020,” indicates that secondary perils, exacerbated by climate change, are also driving catastrophe insurance losses. Secondary perils are generally defined as secondary effects that follow a primary peril, and can include hurricane-induced flooding, storm surges, hailstorms, tsunamis, and fire after an earthquake. More than 50% of the $152 billion in insured losses from 2017 to 2019 can be attributed to the accumulation of losses from secondary natural catastrophes perils, according to reinsurer Swiss Re.

The Call for Insurers to Better Manage Risks from Climate Change

A letter from the New York State Department of Financial Services (DFS) urged New York-based insurers to better manage the risks they face from climate change, joining other regulators worldwide in raising alarms about the shocks severe weather could cause the financial system. The DFS regulates nearly 1,800 insurers with assets totaling more than $4.7 trillion. Its warning comes amid fears of severe weather fueled by climate change spurring more losses for insurers and recommends steps be taken across their governance, risk management, and business strategy to better prepare for climate change. These steps include putting a board member or committee and a senior official in charge of reviewing financial risks from climate change, addressing climate change in internal risk and solvency assessments and disclosing related data through frameworks like the Michael Bloomberg-backed “Task Force on Climate-related Financial Disclosures,” which has been cited by other regulators.

Why Tackle Climate Change

The unprecedented catastrophic property losses from wildfires, hurricanes, flooding, and droughts that insurers have experienced over the last several years have led to underwriting unprofitability and deterioration in certain insurance lines. In addition, a large portion of assets that carriers hold in certain industries may become “stranded,” with no value or ability to produce income, particularly if countries around the world adhere to the Paris Agreement. For instance, it’s expected that by 2030 between $1 trillion and $4 trillion in assets in the energy (oil and gas) sector will become stranded, as a shift to a low-carbon economy takes place. This could have a significant impact on an insurer’s financial performance, with a loss of premiums from those assets. Also, if an insurer is a stockholder in companies with stranded assets, these holdings could impact investment returns and balance sheets. On the flip side, those insurers that factor climate and environmental, social, and governance (ESG) issues in their stock holdings are likely to see an improvement in their investment performance.

A sound climate strategy can bolster new business developments and products and targeted customers. Global electricity demand, according to Boston Consulting Group (BCG), is projected to increase 30% by 2030, spurring $23 trillion in renewable energy investments in emerging markets over the next decade. This market could mean sizable and growing underwriting opportunities for insurers.

Insurers taking the lead in tackling climate change, integrating climate risk into their investment processes, will also be more competitive in winning third-party investment mandates, particularly from institutional investors, such as pension funds, says BCG. In addition, insurers with ambitious climate strategies will bolster their brand reputation and ability to attract and retain talent. Millennials and Generation Z factor in how companies approach climate change in their career choices.

Insurers Redoubling Efforts on Climate Change

Insurance industry groups have been studying the effects of climate change. The Geneva Association, comprised of the world’s largest insurers and reinsurers, conducts research focused on building resilience to extreme weather events and climate risk, as well as the transition to a low-carbon economy. The Munich Climate Insurance Initiative (MCII) was launched by insurers, climate research organizations, the World Bank and agencies associated with the United Nations, among others in response to the growing realization that insurance-related solutions can play a role in adapting to climate change.

In addition, some insurers are stepping up efforts to raise awareness of extreme weather events and how potential damage can be limited through more prudent land use, stronger building codes, and better planning. Some large companies have launched innovative projects to help developing countries adapt, or have invested in renewable energy. Many insurers are committed to reducing their greenhouse gas emissions and offsetting the remainder through contributions to reforestation and renewable energy projects. Addressing climate change is a critical component in establishing a stronger insurance industry and a healthier and safer world for future generations