Climate change risks and the future of insurance

For the insurance industry, climate change represents a major and immediate challenge. With extreme weather events set to become more frequent, how will the sector adapt its policies, premiums and processes?

When Storms Dudley, Eunice, and Franklin wrought chaos across the UK during a single week in February, insurers were left facing a huge bill for the contents and property damage caused to homeowners and businesses.

Soon after, in early March, experts from the Intergovernmental Panel on Climate Change released their sixth assessment report, with IPCC chair Dr Hoesung Lee describing the document as a “dire warning about the consequences of inaction”.

Dr Lee called climate change “a grave and mounting threat to our well-being and a healthy planet”, adding the actions we all take today will shape how people adapt to this threat.

For the insurance industry, climate change represents a major challenge. Flooding and high winds aren’t new, but the potential for more frequent extreme weather events means they must be planned for and mitigated against through stress testing for exposure, a focus on policy availability and exclusions, and the price of premiums.

Chris Bowden, managing director of Squeaky, a B2B marketplace for clean energy, says: “The economic losses to climate-related activities are on track to become the biggest risk in the global insurance industry and I don’t think the market is ready for the full consequences that lie ahead.”

Bowden cites the 2019 Climate Disclosure Project report, which revealed the world’s largest 215 companies potentially face $1trn (£760bn) worth of financial risks due to climate change, from higher operating costs, asset write-offs and falls in demand. 

“Many organisations will simply become uninsurable. Historically insurance models were based on paying out periodically on extreme events,” he adds. “However, given extreme weather events are becoming more regular, they are having to make more pay-outs. 

“To cover their losses, insurance premiums are rising to levels that many just can’t afford, and it’s only going to get worse.”

Investment in education and information

In the UK, work is under way to explore and counter the threat climate change poses to insurance. For example, Flood Re sees government and insurers work together to provide flood insurance coverage to domestic properties deemed at significant risk of flooding.

The Association of British Insurers has also launched its Climate Change Roadmap to inform on ways the sector can take collective action on net zero while supporting policy-holders with their own resilience and risk management.

Ben Howarth, the ABI’s climate change manager, accepts climate change will have “a major impact” on all parts of the insurance industry. But while he describes it as a top priority issue with no room for complacency, he also believes the sector’s unique role and significant investment capacity allows it to play a key role in helping people adapt to future risks.

“The risks are very significant,” he says. “I think the industry is very aligned to that. But I think at this stage, it’s probably too early to speculate on at what point those risks would become uninsurable. The key thing is to do as much as we can to mitigate the impacts of climate change.”

Howarth suggests the insurance industry should work closely with government, businesses, homeowners and motorists to find ways to encourage them to reduce carbon, take up electric cars and make changes to properties through an “educating and informing role”.

However, while he does not believe we are there yet, Howarth does admit insurers may one day have to state that certain things will be expected to make properties and businesses “more resilient to the impacts of extreme weather and other climate change impacts”. This could include, for example, ensuring properties meet energy efficiency standards, and that insurers are notified of adaptations such as electric vehicle chargers or heat pumps.

“That’s not a major change,” he explains. “In other areas, when people are doing risky activities, there will always be conditions imposed.”

And he adds: “I don’t think we’re at the point yet where we could speculate on whether there will be aspects that simply become too big to insure, but I think if you look at comments industry leaders have made on climate change, it’s clear that if we don’t do enough, then we will reach a point where certain activities are simply uninsurable.”

Analysing the dangers in closer detail

A greater use of technology could be one way forward for climate change mitigation. 

Shropshire-based GeoSmart Information has launched FloodSmart Analytics, to enable insurers to accurately assess flood risk depths, probabilities and the related costs, including climate change impacts.

Meanwhile Aspia Space offers satellite imaging that uses AI to help insurers identify and understand trends, predict flooding risks and make faster, more informed decisions.

Simon Lancaster is founder and CEO of SJL Insurance Services, a Lloyd’s broker, which insures businesses from sole traders to corporations across the world. He says more frequent storms and flash flooding has forced insurers to change how they view and underwrite certain things.

As a broker and underwriter, SJL looks ahead at a shorter time period than insurance companies, which focus on trends 10 years into the future, Lancaster explains. “What SJL does is follow the data, look for trends about one to two years ahead, analyse performance on statistics and adjust our rates and acceptance criteria accordingly.”

He cites the example of flood risk assessment, which previously focused on a combined flood score – the result of river and coastal flooding and surface water. Instead, a keener interest is now taken in the surface water score alone, as this is making a larger impact on flood claims.

Like the ABI, Lancaster believes more can be done internally to fight climate change by insurers themselves. But he warns: “Ultimately even with the best underwriting and interpretation of data, the sheer increase in storms and flooding will have one end result – claims increase and therefore so will premiums.”

The role of stress testing and regulation

Stress testing for climate risks is set to become a key plank of the insurance industry’s response to climate change. For example, France’s central bank found in 2021 that claims related to natural disasters could rise fivefold in its most affected regions, with premiums rocketing as much as 200% over 30 years.

The Bank of England is now undertaking its own evidence gathering to inform future stress testing, with the results expected in May 2022. This involves banks and some of the UK’s largest insurers and could pave the way for new regulation in the future.

Justin Elks, partner in risk consulting at advisory firm Crowe UK, believes 2022 will see the transition to net zero take centre stage for UK insurers, with regulation acting as a key driver.

He says: “With so much regulatory activity, addressing climate change might appear to be a compliance activity. Progressive insurers are however increasingly focused on sustainability as a strategic goal – considering and capturing the commercial opportunity of the transition to net zero. COP26 has shifted the emphasis from ambitions and commitments to actions and accountability. 

“This creates the context for insurers to make a difference to the world in addressing climate change and insuring the transition – helping to build customer trust in financial services.”

Simon Crowther, aka The Flood Guy, is an award-winning civil engineer who believes stress testing will become of “vital importance to the insurance industry”. 

He warns: “Assessing the risks of future disruption from environmental factors should not be ignored and left until it might be too late. The changing climate is warning us on an ever-more regular basis of what is to come, and the time to act is now.”