Over the last several years, there has been a considerable rise in public awareness on the impact of climate change, and it is no longer limited to environmental concerns. One of the most affected of these is the insurance industry. With shifting weather patterns and an increasing number of natural disasters, the phenomenon of climate change is now directly affecting insurers. Individuals, companies, and government institutions all have to adjust to this trend which is most notably seen in the increase in insurance costs.
The following post analyzes the ways in which climate change affects the cost of insurance premiums, its causes, and what should be expected in the future by both parties involved, insurers and policyholders.
How Climate Change Affects the Insurance Industry
Insurance companies use risk as a central theme in their business. The insurers determine the chance of a certain event occurring (e.g. fire, flooding, a car accident) and come up with a figure to charge as a premium which enables them to settle claims and also profit out of it. But climate change has disrupted this model by making extreme weather events more commonplace and unpredictable.
Increased Frequency of Natural Disasters
In the past decades, climate change has been trending due to an increase in natural disasters. World Meteorological Organization for instance, states that the climate has also increased in the last 50 years.Illustrative examples include storms, typhoons, droughts, and wildfires whose occurrence is changing in frequency and intensity.
Since losing over $125 billion, Hurricane Harvey in 2017 had one of the worst economic damages in US natural catastrophes. It follows that wildfires in California and Australia recently inflected billions of dollars’ loss and caused homeless thousands of people.
This means that for insurers, the claims made by the insured are more and the sum insured is higher. In turn, these costs compel insurance firms to raise premiums for those who have purchased insurance. To illustrate how bad the environment is getting, a tragic event occurred last year, in 2019 to be precise where approximately $268 billion worth secured damages in Economic loss occurred due to natural disasters. While losses of this magnitude rattled insurers, the industry has only begun raising premiums, limiting coverage, or withdrawing from those markets where the probability of loss is extremely high.
Regional Impact of Climate Change on Insurance Premiums
One of the key elements in determining insurance premiums is location. With climate change, regions that were once considered low-risk for certain types of natural disasters are now facing increasing threats. This shift is particularly noticeable in the following areas:
- Coastal Regions: Rising sea levels and more intense hurricanes have made coastal areas increasingly vulnerable. As a result, property insurance premiums in these areas have surged. In states like Florida, homeowners near the coast are experiencing premium hikes as insurers attempt to mitigate the risks posed by frequent storms and flooding.
- Wildfire-Prone Areas: In states like California, wildfires have become an annual occurrence, often with devastating consequences. Insurers have either drastically increased premiums in high-risk wildfire zones or have refused to offer coverage altogether. In 2019, the California Department of Insurance reported a 31% increase in homeowners’ insurance non-renewals in areas with high wildfire risk.
- Flood Zones: Flood insurance has also seen a significant spike in premiums. The National Flood Insurance Program (NFIP), which provides flood insurance in the U.S., has faced mounting pressure to adjust premiums as flooding events have intensified. Premiums under the NFIP are now being recalculated to reflect more accurate risk assessments, which could result in sharp increases for homeowners in flood-prone areas.
The Role of Reinsurance
Reinsurance, which is basically insurance of insurance firms, is a very useful tool for insurers in minimising the large scale risks. Quite simply, insurers transfer some of their risk to reinsurance companies to try to insulate themselves from potential catastrophic loss. Nonetheless, the reinsurance business has also greatly suffered due to climate change.
As reported by Munich Re, one of the leading reinsurance firms, the cost of claims related to the weather has increased threefold since the decade of the 1980s. Climate change has led the reinsurers to increase their rates as well. These high reinsurance rates are then further escalated to primary insurance firms and ultimately to the consumers.
The Growing Role of Climate Models and Data
As the climate becomes more unpredictable, the insurance field has had to change its way of assessing risks. In the past, insurance companies based their models on past experienced risks. But as climate change causes new risks to arise, such past models are becoming irrelevant. In order to solve this question, insurance companies are beginning to use advanced climate change models and analytics in order to add more value to understanding future risks.
Risk Management Solutions (RMS) and AIR Worldwide, among other firms, developed climate models designed to project the impact of various scenarios of climate change on different regions of the world. Some models include rising sea levels, changes in precipitation and temperature, which assist insurers in evaluating risk more accurately.
With this model, insurers can raise or lower premiums almost instantly to correspond with projected climate-related risks. On the downside, however, homeowners and businesses in high-risk areas would be charging premiums way above the average rate.
Government Intervention and Regulatory Changes
With climate change creating risks to the insurance market, governments are finding solutions to protect their citizens while allowing insurance services to be available in the market. In some instances, this has led to some form of regulatory intervention that would ensure policies are within the reach of many and there is coverage.
For instance, in America, FEMA has amended the NFIP to be more comprehensive and to deal with the worrying trend in flooding. Under FEMA’s Risk Rating 2.0 introduced in 2021, the rating system was meant to take into account how vulnerable a property is to flooding while determining the price of the premium. However, this has also resulted in skyrocketing premiums for properties located in high risk zones.
Some states, on the other hand, are launching state-sponsored insurance pools for those unable to locate coverage in the commercial sector. The typical example is the FAIR Plan in California which is a last resort to property insurance covering areas with high risk of wildfires.
There is increasing pressure on the government however from other governments and international bodies to deal with the issue of climate change as failure to address it could create certain uninsurable zones within the earth. The ever increasing costs of insurance if not checked would bring about an insurance gap in which homeowners and businesses would be left without protection against extreme losses.
What Does the Future Hold?
Looking forward, the extent of climate change impact towards the projected insurance figure is set to balloon. With global temperatures on the rise, there is a strong possibility that more severe weather events are going to be witnessed which will result to further increase in the insurance premiums.
The policyholders may understand it this way: climate change is no longer a theoretical problem and has real implications when it comes to cost. High risk home owners as well as those living in buoyant zones should not only prepare to pay higher insurance premium rates but in some cases may find it hard to get a reasonably priced insurance policy.
But there are also options which help to limit that loss. Such measures, however, could be taken, for instance, by insurers themselves: managing costs by enhancing climate risk models and broadening risk concentration. For consumers, lowering risk factors will automatically lead to lower premiums such as building stronger houses that can withstand storms or incorporating eco-friendly measures.
Conclusion
The influence of climate change on the liability to pay premiums is unjustifiable. Catastrophic weather events are now becoming more common resulting in an increasing number of claims which eventually pushes up the prices offered to the consumers. Forcing both governments and insurers to adjust to this change the coming years of insurance depend on how well climate risks will be defined and managed.
