Global Insurance Markets Under Pressure from Climate Change

A new report released by the Stockholm Environment Institute (SEI) indicates that the global insurance and reinsurance markets are undergoing dramatic transformations due to climate change-related threats. The report highlights how current risk management practices face increasing limitations, along with growing systemic climate pressures on insurers. These two factors create a new context for insurers to assess losses to their insureds, with potential impacts on policyholders, supply chains, and public finances.

Increasing Losses and Risk Retreat

According to an analysis conducted by the SEI, insurers are experiencing an annual increase of about 5–7% (depending on the source), in “real” terms (inflation-adjusted). In response to this increase in catastrophic loss exposure, many insurance companies have begun to retreat from insuring markets or industries that they no longer consider to be good risks, as indicated in this report.

As noted in numerous news articles published by leading news outlets, many parts of the globe are experiencing extreme weather events at a frequency and magnitude that creates significant financial pressure on the normal operations of insurance companies.

The SEI report contains many findings regarding the notion that “traditional” diversification strategies for risk management in the insurance industry are becoming increasingly ineffective, due to heightened hazard intensity from climate change. Consequently, many insurers are now reviewing their policies on how to underwrite policies and allocating their capital to balance between remaining solvent, while being profitable.

Industry data from other sources confirm what the SEI analysis indicates: that the financial pressures on insurers in high-risk markets are mounting, as evidenced by tens of billions of dollars in insured catastrophe losses reported recently by a leading media organization due to increases in losses associated with natural disasters, such as wildfires and storms.

Climate Risk and Global Supply Chain Disruptions

The interrelatedness of climate change risk with global supply chains is becoming more pronounced. The ability for weather extremes to disrupt the global economic system, thereby resulting in shortages of goods, delays in production, and increased financial pressures on businesses and insurers alike, adds to the complexity of assessing risk for insurers.

The historical events of droughts in southern regions and flooding in parts of Europe show how a series of climate shocks can lead to widespread halting of manufacturing processes, disrupted logistics, and decreased output of agricultural products — all of which are indicative of systemic vulnerability. The subsequent cascading effects of these events create greater complexity for insurers as they now are required to assess not only physical damage to their assets, but also the economic implications of climate events.

Traditional insurance models are built upon the ability to pool and diversify risk across geographic areas and risk types. The increasing systemic risk associated with the climate crisis means that traditional insurance methodologies can no longer absorb this level of systemic risk without passing on sizeable amounts of financial risk to individuals, businesses and governments.

Traditional Risk Modelling Limitations

Industry research and experts have identified that relying on historical data and fragmented risk metrics has severely impaired insurers’ ability to predict what their exposures will be going forward. This is compounded by climate change, which is changing the historical patterns of disasters occurring around the globe and making it increasingly difficult to use past losses as a forecast for what will occur in the future.

In addition to the SEI report, multiple academic studies, as well as several industries, have identified that climate risk is multidimensional, including physical exposure to extreme weather events, transition risk associated with the decarbonisation of economies, and liability risk arising from legal and regulatory frameworks. Therefore, all of these multiple dimensions of risk require insurers to both re-evaluate their underwriting frameworks and pricing approaches based on the realities of climate change, rather than continuing to rely exclusively on traditional actuarial methodologies.

There are efforts currently underway to incorporate future-oriented climate scenarios into existing risk models. However, this process poses a challenge not just to insurers, but also to regulators as well. If insurers do not update their methods of evaluating long-term climate exposures, they will likely continue to limit their coverage in high-risk areas. As a result, this will create even greater protection gaps in society and within businesses.

Public-Private Partnerships and Market Adaptation

Many of the respondents of the various industry research surveys that have taken place indicate the need for more inclusive and cooperative efforts between the private sector and government agencies. The growing awareness of the responsibility of all stakeholders — including governments, insurers, regulators and others — to address systematic climate risk is driving initiatives aimed at enhancing resilience and closing the gap in insurance protection.

Examples of the recommended initiatives are the creation of policies, improving climate data collection, investing in measures to adapt to climate change, etc. Implementing such initiatives will require greater public-private cooperation and developing stronger governance frameworks between both sectors, to ensure that risk transfer mechanisms are aligned with the needs of society, especially in those geographical regions where insurance markets are either declining in strength, or where insurance coverage has become too costly to obtain.

Insurance companies can have a direct influence on climate resilience developments through innovative insurance products that provide financial incentives to clients to mitigate their risks from climate events and adapt, such as charging lower premiums for those properties with improved flood protection and/or other measures to protect themselves against potential loss. Even though these innovations may offer an opportunity to reduce clients’ risk exposure over the long term, these new products still require accurate, reliable data and appropriate regulatory pathways to achieve maximum benefit across many different markets.

Broader Implications for Insurers and Society

The changes to the climate risk and insurance markets raise challenges for both insurers and insureds in a time of increasing uncertainty caused by climate change or other environmental pressures. In addition to the challenges for insurers and insureds, there are additional broader-reaching implications of climate change for the economy, investment choices, and community resilience due to rapidly shifting boundaries for the climate risk and insurance markets.

Insurers will need to assess their entire risk portfolio under a new climate impact lens and develop a comprehensive approach to pricing, business strategy and long-term planning. Similarly, businesses and individuals will need to be aware of these changing insurance conditions in order to effectively manage their risk exposure and maintain continuity during disruption events related to climate change.

This report emphasises that climate risk is now an integral part of the insurance landscape and impacts how markets behave and how risk is distributed around the world. Continued innovation, collaboration and the use of data to inform decision-making are critical to ensuring that the insurance industry can continue to be a viable tool for managing risk as the impacts of climate change continue to evolve.