A UN climate change report’s warnings are compounding alarm in the insurance industry and companies that pay premiums, as they eye increased risks from more frequent and more severe storms, wildfires, droughts, and rising sea levels threatening coastal cities.
The Intergovermental Panel on Climate Change report—which United Nations Secretary General Antonio Guterres branded a “code red for humanity”—only worsens fears of increasingly costly payouts for the insurance industry and concern that companies faced with pared-back coverage will opt to go without.
“This is by no means the end of insurance,” but it does represent a wake-up call for the industry, said David Bresch, former head of Swiss Re’s Sustainability & Political Risk Management Unit.
Reducing risks for companies and other policyholders won’t be easy. The big solutions are largely something insurers can’t do: rapidly reducing fossil fuel combustion and other emissions cuts while scaling up global resilience and adaptation efforts.
But improvements can be made, such as expanding the pool of those insured, said Bresch, now a professor for weather and climate risks at the Swiss Federal Institute of Technology, ETH Zurich and MeteoSwiss. The Swiss system provides expansive coverage for catastrophic losses and requires property owners to be covered—a key driver to spreading risk and keeping policies affordable, he said.
Climate risks have been “on insurers’ horizon for some time,” but the IPCC report “makes clear how widespread and destructive climate-related disasters already are and will continue to be in the near term,” said Shana Udvardy, a climate resilience analyst at the Union of Concerned Scientists.
“The insurance industry needs to shift its business model away from a status quo that simply transfers risk towards one that utilizes the latest science to help mitigate the risks and safeguard what people value most—their homes and businesses,” Udvardy said.
Tough Questions
Risks from what the report calls already irreversible sea level rise and increasing wildfires, heat waves, and a mix of drought in some regions with increased rainfall in others has insurance companies—and the reinsurers that essentially insure them—looking to better model likely impacts to come.
Expanding the use of parametric climate insurance, which triggers benefits based on measuring rainfall or wind speed, also speeds up payments to rebuild damaged areas.
But the latest report raises tough questions:
How do insurers, which historically have relied on past events to set coverage, accurately incorporate projections of climate risk which vary by region but also by how high global temperatures will soar?
At what point should companies opt to drop increasingly pricey coverage for such catastrophic events, the cost of which is driven up every time a disaster strikes?
Should national governments, at least those with big pockets, take a more direct role in insuring against climate risks?
Companies have few easy options today, said Jared Zola, a partner in Blank Rome’s policyholder-only insurance recovery practice. Wildfires, mudslides, and hurricanes particularly in 2017 and 2018 and the big payouts from insurers triggered big “portfolio-wide adjustments” as insurers increased rates and trimmed policy language on what could be covered.
“This has really made companies prioritize what is most important to them,” he said.
“If the business is thriving, the vast majority of its revenues come from its customers or suppliers,” so companies will often prioritize insurance covering business interruptions over blanket coverage of buildings and property, Zola said. He is seeing companies “drawing a line in the sand” on such coverage, essentially self-insuring risks to properties.
Trimming Coverage
The IPCC’s report notes that the world is already seeing significant impacts from warming many scientists had projected would be decades away. That already is obvious to insurers and areas ranging from California—where the ongoing Dixie Fire has claimed nearly half a million acres—to Germany, where massive flooding last month killed nearly 200.
Germany’s floods will likely require a huge government recovery package and illustrate how catastrophes can reveal holes in coverage that weren’t obvious before such catastrophes. Roughly half of property owners weren’t insured against such an event, Bresch said.
For commercial properties, carrying insurance can be an easier decision when economic times are good. But catastrophic insurance can also be one of the first big costs sacrificed in a downturn, said Tom Alleman, co-director of the Dykema law firm’s insurance industry group.
That tradeoff is likely to be more of a gamble in future downturns that will occur against a backdrop of increasingly severe climate impacts, he said.
“During a downturn, it’s very common in commercial areas for businesses to look at their insurance program, which is, after all, money they are spending, and to say ‘I want to downsize,’” Alleman said.
A central challenge for insurers is their historical reliance on past events in calculating future risks, he said. The uncertainty of future climate risks, including varying regional impacts, will require more precise modeling and projections that can only be so accurate, he said.
Given the global scale of increased risks from wildfires, rising sea level, flooding, and severe storms, some analysts argue that national governments will inevitably need to take a bigger role in assuming some of that risk.
Escalating Costs
Costs for insurers are escalating. In the U.S., insurance payout for natural catastrophes in 2017 and 2018 climbed to $291 billion total, the highest ever for any consecutive two-year period, according to Swiss Re.
In 2020, a record 22 U.S. weather and climate disasters cost at least $1 billion, according to the National Oceanic and Atmospheric Administration.
The National Flood Insurance Program provides many U.S. homeowners—those with federally regulated mortgages—the first line of defense against floods in high-risk areas, but it isn’t a panacea. Some floodplain maps, which can decide whether a property needs to be covered, remain outdated and most “do not reflect how climate change may affect flood risk,” the Government Accountability Office said in a July report.
Congress has for years debated—with little progress—how to revamp the NFIP amid concerns that its insurance rates are to too low to reflect the higher risk of flood damage for many homes and that pay-outs are too often used to simply rebuild homes in the same community without added flood protection measures.
Damages Don’t Lie
One way to fill the gap in coverage is parametric policies triggering payouts when a rainfall or wind speed hit a certain threshold. That’s the approach of the Caribbean Catastrophe Risk Insurance Facility, launched in 2007 as the world’s first multi-country risk pool, Alleman said.
The pool includes Caribbean and Central American nations and is supported by the World Bank and other nations, providing coverage for earthquakes, tropical cyclones, excess rainfall, and impacts on the fishing industry.
CCRIF has paid a total of roughly $203 million, including recent payments totaling $2.5 million to Barbados under its tropical cyclone and excess rainfall policies. Checks can go out in as little as 14 days, since they are triggered by storm measurements and not pegged to on-the-ground assessments of damages that can take months.
But even those policies have an obvious disadvantage, Alleman said. Benefits are modest, in part because they are not “designed to make an individual whole” by entirely rebuilding damaged businesses and homes, he said.