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The Insurance Industry and Climate Change: Shifting the Cost to Policyholders

As stewards of transition, insurers can mitigate climate-related risks and preserve access to affordable insurance for policyholders.

A recent report published by Swiss Re Institute, the research arm of one of the world’s leading insurance and reinsurance providers, announced that if no action is taken on climate change, global temperatures could rise by more than 3℃ and 18% of global GDP would be lost by 2050.

The reality is Europeans do not need to wait for such a date – for a long time, they have already felt the social and economic consequences of a changing climate. Climate-change driven events have cost an estimated €11.9 billion in annual economic losses across the continent and have also claimed the lives of over 100,000 Europeans since 1980[1].

Insurers have been instrumental in helping businesses and households manage the growing risks of damage and loss that coincide with climate change. Yet, the majority of actual damages have been uninsured. Last year, the world experienced 12 billion USD in insured market losses as homes and businesses were damaged or destroyed[2]. When you consider that 76% of potential losses are uninsured worldwide, the total losses were likely much greater. Indirect economic losses caused by disruptions were magnitudes higher.

Reframing the concept of risk responsibility – how is climate change changing the insurance industry?

Insurers collect premiums, pool together and distribute more evenly the risks that might materialise for some among the many in a process called mutualisation. Some policyholders pay more and some make more claims, but all have insurance coverage if they need it. Where the risks are manageable and predictable, this model works well.

As the impacts of climate change increase, the role insurers play is put under pressure. According to the report by Swiss (re, secondary perils) – storms, floods, frost, hail, droughts and wildfires – are strongly linked to climate change and are increasing in both frequency and intensity. While these secondary perils have historically accounted for 50% of losses worldwide, they were responsible for 70% of losses in 2021. The Swiss Re Institute has also projected losses from secondary perils will double by 2040[3].

Mutualisation as a business model doesn’t function when too many damage claims have to be paid. To compensate, the extra costs caused by climate change-related events are put into premium increases for policyholders. Significant losses from European floods, for example, contributed to a 12% year-on-year pricing increase for property insurance in the third quarter of 2021[4]. This shift exacerbates the trend to move away from mutualisation and toward risk-reflective pricing or a privatisation of risk.

Sometimes the risk or expenses are deemed to be so great, insurers limit or refuse coverage entirely (pertaining to situations of individuals, households or businesses). As insurers are pressured to keep profit margins consistent or rising in the context of a changing climate, this means the risk sharing balance is tipping and policyholders potentially have to accept more risk, pay more, or be outright excluded from coverage.

Uninsured losses eventually add up to the social cost of climate disasters, as public budgets are held liable to cover the cost of damaged but uninsured private property and to save their citizens from financial malaise. After the 2021 German floods, the German Insurance Association (GDV) revealed 54% of properties in Germany lack any insurance coverage against weather phenomena[5].

Insurers as stewards of the transition

Insurers not only insure economic and social activities, but invest directly into them. They make sure the premiums they collect are invested to earn enough money to cover the current and future claims and to keep profit margins high enough to sustain their business models. These investment portfolios, alongside insurance coverage itself, are a powerful financing tool.

Financiers and businesses should be a driving force toward a net-zero future by 2050. Instead, Finance Watch’s report on net-zero shines a light on the truth: the same actors making net-zero pledges are simultaneously committing to continue or expand their production and exploration of fossil fuels.

Regrettably, insurers have also been among those helping to accelerate planetary warming – both through their insurance coverage of and direct investment into the fossil fuel industry. In turn, climate change will eventually impact insurers’ business model, threatening firms or even system level financial stability.

A sure-fire way to significantly mitigate climate change-related disruptions is for major investors to take on a stewardship role and push the economy to transition. For the fossil fuel industry, this would mean a profound transformation of their whole business.

Insurers can link continued insurance cover or investment to transition targets. This would incentivise their client and investee companies to transition their risky activities. It creates a win-win situation as these companies can continue to receive insurance, investment and underwriting risks for the insurer and stability risks for the financial sector overall are reduced.

More than this, insurance providers becoming involved in climate mitigation efforts is crucial to preventing further climate breakdown, which will in turn keep their service affordable for citizens and businesses and protect the homes and livelihoods of ordinary people.

Emily Glantz

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