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How insurance companies can prepare for risk from climate change

Industry regulators sharpen their focus

Insurance companies face the dual challenge of addressing escalating climate change risks and shifting industry regulations. See why climate change insurance risk is intensifying, examine the insurance industry’s response to climate change, and explore action items insurers should consider to address risks and achieve greater resilience.

The escalating frequency and severity of extreme weather-related events—from wildfires in the US, to record heat waves in Europe, to floods in Japan—have shone a brighter regulatory spotlight on insurance risk and climate change. One federal regulator in the US went so far as to suggest that the potential damage from climate change could end up being as severe as the fallout from the mortgage crisis triggering the 2008 financial crisis.

In fact, the Insurance Regulator State of Climate Risks Survey, conducted by the Deloitte Center for Financial Services, found:

A majority of US state insurance regulators expect all types of insurance companies’ climate change risks to increase over the medium to long term—including physical risks, liability risks, and transition risks. 
More than half of the regulators surveyed also indicated that climate change was likely to have a high impact or an extremely high impact on coverage availability and underwriting assumptions.

US state regulators and lawmakers are watching the implications of climate-related risks very carefully and are becoming increasingly concerned about the insurance industry’s response to climate change.
With losses mounting, insurers can no longer avoid or postpone addressing the impact of changing climate on their underwriting, pricing, and investment decisions, as well as their bottom lines.

There’s no doubt that more information—through more effective disclosure—would help regulators assess the effectiveness of insurer actions to mitigate insurance risk due to climate change. And that could very well be the starting point of increased climate risk regulations.

As rising climate-related losses threaten the viability of insurers’ books of businesses and investment portfolios, many regulators either aren’t aware of how prepared carriers are to deal with this threat or they aren’t fully confident that carriers are indeed prepared.

Information on insurer preparedness to deal with climate-related risks is considered vital by regulators in upholding their mandates. Yet according to our survey:

  • One-third of responding regulators said they didn’t know how well the insurers are prepared to deal with the potential impacts of climate-related risks on financial stability.
  • Among those who were aware, only up to four respondents answered that insurers were largely or fully prepared.
  • One-third of the regulators surveyed didn’t know whether current insurer risk models were up to the challenge of capturing and testing climate-related risks.

Level of insurer preparedness to respond to the potential impacts of climate-related risks

Clearly, there’s room for insurers to better disclose and showcase the efficacy of any activities and actions they may be taking to assess and mitigate climate-related risks. This could help reassure regulators about insurers’ ability to withstand extreme weather events, defend underwriting and pricing decisions made in response, and possibly head off more onerous mandatory disclosures down the road.

It’s likely that regulators will at some point start requiring more of insurers in the way of disclosure and its components and assumptions—including stress tests of a wide range of plausible climate-change scenarios and a determination of how climate data is used in risk modeling for pricing and underwriting decisions.

At the same time, more may be asked of insurers in terms of steps taken to prevent worsening climate-related losses, including adaptation activities to mitigate the impact of such risks.

 Insurance industry response to climate change

The regulator survey helped uncover several possible actions that carriers could implement—both within and outside the organization—to boost their climate readiness over the long term. The survey results were supplemented by interviews with rating agencies and leading environmental and risk management experts. They identified opportunities for insurers to become more resilient to climate-related risks in five key areas:

Raise the profile of climate risk in the organization.

An engaged board working closely with senior management on climate issues can help focus the entire organization on the risks involved, while assuring that adequate resources are allocated to accurately assess and mitigate them. Carriers should look to bring oversight of climate-related risks directly under the board of directors or executive committee if they aren’t already doing so.Companies should establish a clear governance structure, including the creation or assignment of dedicated roles, at executive as well as staff levels, to evaluate the potential impacts of climate-related risks. They should also embed ongoing climate risk assessment and mitigation efforts across the company, including underwriting, pricing, reserving, investing, and even in new product development.

Improve assessment of climate risk using advanced analytics

The inherent uncertainty of a changing climate, combined with the diversity and rising frequency of perils, may render the historical loss data that catastrophe models rely on less useful for future loss projections. A number of insurers and reinsurers are already actively engaging with the climate science community to remain current about the latest data and loss control advances.Advanced analytics could further help companies assess historical weather records, insured property data, and assumptions regarding future climate conditions to improve risk selection and pricing. Augmenting climate change models with big data/social media information and predictive analytics also has a huge potential to significantly broaden risk assessment considerations.

Take an enterprise-wide view while managing climate risks

Companies should include climate risk assessment more consistently in their broader enterprise risk management (ERM) framework, which can help in identifying and correlating impacts across different lines of business as well as investments. This would give carriers a holistic view of climate risk exposure, thereby helping top management with decision making.At the same time, such an approach could include organization-wide stress tests of a broad range of plausible climate change scenarios to determine capital and liquidity implications and prepare for any eventuality.

Work with policyholders and policymakers to alleviate climate risk exposure

Taking lessons from usage-based insurance in the auto business, carriers can incentivize policyholders who invest in mitigating climate-related risks and containing related claims through adaptation measures. Incentives can include discounts in premiums or financial assistance to policyholders to help finance mitigation efforts.Individual insurers can also leverage and support industry-wide efforts to educate policyholders and lawmakers about how to fortify properties against severe weather events.

Work with administrative agencies to develope climate-resilient public policies

Insurers could work with administrative agencies and builder associations more closely to discourage development in high-risk zones. Similarly, building design and materials used for development should be able to withstand the climatic threats in that region. Retrofitting homes to make them more resilient to natural catastrophes could be incentivized through government programs.In short, rather than making premiums unaffordable, which can lead to a rise in the number of uninsured, insurers could work proactively with administrative agencies to develop preventive and adaptive public policies supporting a climate-resilient future.

Climate change, insurance company change

Finding a balance between ensuring affordability and availability and managing financial stability may get tougher for insurers if extreme weather conditions continue to escalate. Insurers should focus on:

  • Fortifying their assessment of climate-related risks while taking long-term actions to alleviate and mitigate such exposures.
  • Using a holistic approach toward managing climate-related risks by integrating them as a part of their enterprise risk management efforts.
  • Taking steps to better demonstrate their climate readiness to regulators, analysts, and customers.

These actions can help both insurers and regulators create a more level playing field and a stable market for all stakeholders involved.

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