Insuring the Future: How Climate Change is Reshaping Insurance Companies

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Overview

As the world grapples with the escalating consequences of a warming planet, the impact of climate change on insurance companies is a pressing concern. Climate change manifests in various ways and poses unique challenges to the insurance industry. The two main categories are physical risks and transition risks. One of the most pronounced impacts is the increased frequency and severity of natural disasters; this is physical risk which means direct impact by climate change on exposure. The transition risk means the decades long struggle by economies to transition to green economy like international goals by UN agencies like 2030 sustainable development goal or goals for achieving a net zero economy. The transition means forgoing a lot of currently economical way of doing business-as-usual and adopting newer innovative technologies, processes and methods that come up with their own challenges, such as higher cost, lack of experience, teething problems while implementing and so on.

Impact by type of insurer

Insurers, particularly in the Property & Casualty (P&C) sector, find themselves on the frontline, dealing with the financial fallout of extreme events like pandemics, earthquakes, hurricanes, floods, wildfires, and other extreme events. The surge in these disasters translates into higher claims payouts, straining the financial resilience of insurance companies. Moreover, climate change introduces a dynamic element to risk assessment for insurers. The traditional models may no longer suffice as the climate evolves, prompting the industry to invest in advanced risk modeling techniques. The integration of climate science into risk assessment allows insurers to better understand and quantify the potential impact on properties and infrastructure. This, in turn, enables more accurate underwriting decisions, helping insurers navigate the changing risk landscape associated with climate change.

In the Life insurance sector, climate change presents unique challenges tied to long-term health implications. Changes in climate patterns, extreme temperatures, and the spread of diseases can impact mortality rates and life expectancy. Life insurers are compelled to reassess their actuarial models and develop adaptive strategies to address these evolving risks. Collaborations with public health entities, incorporation of climate risk scenarios into planning, and the introduction of new insurance products are some of the measures undertaken to ensure the sector's resilience in the face of climate-related challenges.

The health insurance segment is indirectly affected by climate change through its influence on public health. Rising temperatures, increase in air pollution, changes in air quality, and the spread of vector-borne diseases contribute to increased health insurance claims and escalating healthcare costs. Insurers in this sector are responding with innovations in insurance products that specifically cover climate-related health risks. Emphasizing preventive measures and collaborating with healthcare providers, health insurance companies are actively working to enhance resilience and adaptability in the ever-changing climate landscape. Natural catastrophes also bring with them increase in localized health claims like spike in gastrointestinal diseases outbreak after floods and so on.

Regulatory pressures add another layer of complexity for insurance companies dealing with climate change. Governments and regulatory bodies are increasingly pushing for the integration of climate risk assessments into the operations of insurers. This includes stringent reporting requirements, compelling companies to disclose their exposure to climate-related risks. The evolving regulatory landscape underscores the importance of transparency and proactive risk management in the insurance industry. This leads to sizeable transition risks. Customers also put pressure on companies to make their processes, services, and products more climate friendly and are willing to pay a premium for those that do. Social policy making is changing now that focus on just increasing quantity via increase in GDP is not the only factor to consider. The objective is now to make growth more climate friendly, more inclusive of people instead of increasing economic inequality and more circular and focused on renewables and recycling as well as via focusing on other measures like the happiness index or Gini inequality index.

Certain regions becoming less habitable or inhabitable in the future due to extreme temperatures or rising sea levels, can impact mortality rates and life expectancy. For example, farmers in some rural areas being forced to become climate refugees due to soil degradation and frequent floods would now have a much lower life expectancy than before. Being uprooted from home and forced to scatter in difficult to access and over-populated cities can have a material impact towards reducing life expectancy.

Insurers often have substantial investment portfolios. De-carbonizing investment portfolio of insurers and pension schemes can mean decreasing or eliminating investment in coal, oil, and gas companies, fixing high quotas to invest in renewal companies and so on. Climate change can pose risks to these investments, especially if they include assets that are vulnerable to climate-related shifts, such as real estate in high-risk areas. While there are challenges, climate change also presents opportunities for insurers to innovate. Developing new insurance products, risk modeling techniques, and partnerships with climate-related organizations can help insurers adapt to the changing landscape. Insurers are increasingly using scenario analysis and stress testing to assess their vulnerability to climate-related risks. This allows them to evaluate their resilience and develop strategies to navigate potential challenges.

Time for action

Given all this, here are key areas where actuaries can contribute and take ‘climate action’, rather than being overwhelmed by ‘climate anxiety’ and feeling helpless about it:

  • Scenario and stress testing; This can get quite imaginative as chaos theory or butterfly effect applies here which means that one small change can lead to huge changes in the future which we fail to anticipate. For example, developing countries can see a lot of climate refugees who must migrate because climate change has made their native lands unlivable. The melting of Artic, Antarctic, and Siberian ice and tundra might unleash millennia old viruses against which only ice-age humans had any immunity and these can lead to new pandemics. Earth is also one major catastrophe away from a full-blown disaster as we are always ‘standing on the edge of chaos’. For example, volcano eruptions in Iceland had led to 536 A.D being labelled as the ‘worst year to be alive’. Large parts of the world faced eternal nights, crop failures, pestilence, wars, winters in summers and start of bubonic plague. Still, our scenarios need to be research based, and the impact needs to be quantified in some way by narrowing the scope of impact.

  • Actuarial pricing for Carbon credits which is expected to have vibrant carbon markets soon. Carbon markets are where companies can earn credits which can be redeemed for money by shifting to climate friendly policies. Again, we have other specialists working on qualitative areas of climate change such as ESG disclosures but the unique value to hire an actuary comes from requiring quantitative analysis and hence, we should focus our efforts on that.

  • Making insurance products that increase climate change risk resilience especially for vulnerable communities. Index products require utilizing satellite data, carrying out simulations and applying risk metrics on simulated data to create triggers and premium and payout levels. Index insurance products are those based on pre-defined triggers that if crossed, claims are paid automatically without any claims investigations like done in indemnity insurance. This is not something that a marketing person in an insurer can devise on their own. These products introduce social risk protection where there is none because infrastructure for implementing indemnity-based insurance products does not exist there. Index products also enable automatic fast payouts without requiring expensive and time-consuming claim settlement processes. Other products can be increasing focus on covering solar panels, electric vehicles, insurance against vector-borne diseases, smog in winters, wildfire insurance and so on.

  • Research activities in actuarial societies via collaboration with other professionals like weather scientists. The Actuaries Climate Risk Index (ACRI) is a key example of such research where ACRI illustrates the impact of climate risk and its evolution over time in North America1. There has been an explosion of research in actuarial societies in the past 10 years over the topic of climate change as well. We also have professional certificates in climate change from various actuarial societies now. So upskilling can be the first step towards taking climate action by actuaries as we will then be more informed in knowing the context behind our actions.

Conclusion

Climate change has such a profound impact on almost everywhere that it is hard to see any area where it does not have impact directly or indirectly. While each Insurance segment (Life, Property & Casualty, and Health) faces distinct challenges, there are also opportunities for innovation and adaptation. Insurers must navigate the evolving landscape by incorporating climate considerations into their risk models, exploring new financial instruments, and collaborating with other sectors to build resilience. As the industry continues to grapple with these challenges, proactive measures and strategic planning will be crucial for ensuring a sustainable future in the face of climate change before it is too late.