How Climate Change Could Make Insurance Too Expensive

Imagine you’re a homeowner living in a coastal area that is prone to flooding. You’ve invested a lot of money and effort into your property, and you want to protect it from any potential damage caused by natural disasters. So you buy a home insurance policy that covers flood risk, paying a reasonable premium every year.

Now imagine that climate change is making floods more frequent and severe in your area. Your insurer, facing higher claims and lower profits, decides to raise your premium by 50%.

You can’t afford to pay that much, but you also can’t afford to lose your home. What do you do?

This scenario is not far-fetched. In fact, it’s already happening in some parts of the world, where climate change is testing the limits of insurability of climate-related risks. Insurability refers to the ability of insurers to provide affordable and adequate coverage against certain risks, while maintaining their financial soundness and profitability. If a risk becomes too costly or unpredictable to insure, it becomes uninsurable.

In this blog post, we’ll explore how climate change is affecting the pricing and underwriting of insurance products, and what this means for consumers, businesses, and society at large based on the publication from BIS. We’ll also look at some of the challenges and opportunities for insurers and regulators to address this issue, and how you can play your part in mitigating and adapting to climate change.

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How climate change impacts insurance pricing and underwriting

Insurance pricing and underwriting are the processes of determining how much to charge for an insurance policy, and which risks to accept or reject. These processes depend on several factors, such as the probability, severity, and exposure of the insured risk, as well as the cost of reinsurance, which is the insurance that insurers buy to transfer some of their risk to other insurers.

Climate change can affect all of these factors, making insurance more expensive and less available for certain risks. Here are some examples of how climate change can impact different types of insurance products:

Property insurance: Climate change can increase the frequency and severity of natural catastrophes, such as floods, storms, wildfires, and droughts, leading to higher property damage and losses. This can result in higher claims for insurers, and higher premiums or reduced coverage for policyholders. For example, according to the Bank of England, around four million households in the United Kingdom will become uninsurable against flood risk by 2030 if no further action is taken to stem climate change. In Australia, the Climate Council projects that one in 25 homes will be effectively uninsurable by 2030 due to climate impacts.
Liability insurance: Climate change can increase the risk of litigation against parties who are held responsible for causing or failing to prevent climate-related damages. For example, insurers may face claims from policyholders who suffer losses from physical or transition risks, or from investors who accuse them of mismanaging climate risks. Insurers may also face lawsuits for providing coverage to high-emitting sectors, or for withdrawing coverage from vulnerable sectors. These liability risks can increase the cost and complexity of underwriting and pricing for insurers, and may also affect their reputation and social license to operate.
Life and health insurance: Climate change can affect the mortality and morbidity rates of populations, especially among vulnerable groups such as the elderly, the poor, and those with pre-existing conditions. Climate change can also increase the risk of infectious diseases, heat stress, malnutrition, and mental health issues. These health impacts can affect the pricing and underwriting of life and health insurance products, as well as the demand and supply of these products. For example, a study by the Geneva Association found that climate change could increase global mortality rates by 1.4% by 2100, equivalent to 3.8 million additional deaths per year.

How insurers and regulators are responding to climate change

Insurers and regulators are aware of the challenges and opportunities posed by climate change, and are taking various actions to address them. Here are some of the initiatives and measures that they are implementing or considering:

Climate risk management: Insurers and regulators are increasingly integrating climate-related risks into their risk management frameworks, in line with the ISSB. This involves identifying, measuring, monitoring, and reporting on the physical, transition, and liability risks arising from climate change, and taking appropriate actions to mitigate or transfer these risks. For example, the Australian Prudential Regulation Authority (APRA) outlines supervisory expectations for financial institutions regarding how they consider climate-related risks in their risk management frameworks, including in their pricing and underwriting approaches.
Climate risk assessment: Insurers and regulators are conducting climate risk assessments to better understand the potential impacts of climate change on their portfolios and solvency positions. These assessments typically involve using scenario analysis to model the effects of different climate scenarios on the assets and liabilities of insurers, as well as on the availability and affordability of insurance coverage. For example, the Bank of England is conducting a climate stress test for the UK insurance sector, which will assess the resilience of insurers to three climate scenarios: early action, late action, and no action.
Climate risk disclosure: Insurers and regulators are enhancing their climate risk disclosure practices to improve the transparency and comparability of climate-related information. This can help inform the decision-making of various stakeholders, such as investors, customers, policymakers, and the public. It can also help incentivize insurers to align their business strategies and practices with the goals of the Paris Agreement, which aims to limit global warming to well below 2°C above pre-industrial levels. For example, the European Union has introduced a regulation that requires insurers to disclose how they integrate sustainability risks and opportunities into their governance, risk management, and investment decisions.
Climate risk adaptation: Insurers and regulators are supporting climate risk adaptation efforts, which aim to reduce the vulnerability and exposure of individuals, businesses, and society to the physical impacts of climate change. Insurers can play a key role in this regard, by providing risk transfer solutions, incentivizing risk reduction measures, and sharing their data and expertise. Regulators can also facilitate climate risk adaptation, by setting standards, providing guidance, and promoting collaboration among stakeholders. For example, the European Insurance and Occupational Pensions Authority (EIOPA) defines impact underwriting as the development of new insurance products, adjustments in the design and pricing of the products, and the engagement with public authorities to support climate adaptation and mitigation.
Climate risk mitigation: Insurers and regulators are contributing to climate risk mitigation efforts, which aim to reduce the GHG emissions that cause climate change. Insurers can do this by adjusting their underwriting and investment policies to support low-carbon sectors and activities, and to discourage high-carbon sectors and activities. Regulators can also encourage climate risk mitigation, by setting targets, providing incentives, and enforcing rules. For example, the Financial Services Agency in Japan states that addressing climate change is related to its supervisory activities, and notes that financial institutions need to ensure both sound climate-related risk management and financial intermediary functions to support the decarbonisation of their clients and industries.

How you can play your part in mitigating and adapting to climate change

As a consumer, investor, or citizen, you can also play your part in mitigating and adapting to climate change. Here are some of the actions you can take:

Reduce your carbon footprint: You can reduce your GHG emissions by adopting more sustainable lifestyles and consumption patterns, such as using public transport, switching to renewable energy, eating less meat, and recycling more. You can also offset your unavoidable emissions by supporting projects that reduce or remove GHG emissions elsewhere, such as forest conservation or restoration.
Increase your climate resilience: You can increase your resilience to the physical impacts of climate change by taking measures to protect yourself, your property, and your community from climate-related hazards, such as installing flood barriers, planting trees, or joining local adaptation initiatives. You can also ensure that you have adequate insurance coverage against climate-related risks, and that you understand the terms and conditions of your policy.
Support climate action: You can support climate action by engaging with and influencing various stakeholders, such as governments, businesses, and civil society, to take more ambitious and urgent actions to address climate change. You can do this by voting, campaigning, investing, donating, or volunteering for causes and organizations that promote climate action.

Summary

Climate change is affecting the pricing and underwriting of insurance products, making them more expensive and less available for certain risks.
Insurers and regulators are responding to climate change by integrating climate-related risks into their risk management, risk assessment, risk disclosure, risk adaptation, and risk mitigation practices.
You can play your part in mitigating and adapting to climate change by reducing your carbon footprint, increasing your climate resilience, and supporting climate action.

Disclaimer: The views expressed in this blog are not necessarily those of the blog writer and his affiliations and are for informational purposes only.

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