Insurance industry can find economic opportunity in climate change
The insurance industry should take changing climate risks into consideration when making financial decisions and seizing opportunities.
May is Hurricane Preparedness Month, reminding us to be sure we’re mitigating risks as the start of the Atlantic hurricane season approaches on June 1. In the 2020 season, in addition to dealing with the COVID-19 pandemic, insurers and policyholders should consider the effects of climate change on potential losses from storms that have increased in frequency and severity in recent years.
The stable climate created a predictable physical climate, which contributed to the emergence of the modern economy, says Arturo Brandt, environmental lawyer, sustainability consultant, and senior broker and Latin American representative for Tradition Green, the environmental markets brand of Tradition, one of the world’s largest brokerage firms.
Much of the economic and financial activity, particularly for the long-term ― including buying, selling, investing, borrowing and lending ― requires a degree of confidence that tomorrow will be similar to today. “But this premise is changing; we do not have a stable climate anymore,” he adds, noting that such changes are not occurring uniformly, and the risk varies across countries.
The key issue is how to engage the private sector, which is focused on making a profit. “Insurance is ahead of most industries,” Brandt explains, “because the biggest losers in the battle with climate change are insurers and utilities.” He advises the financial sector ― including the insurance industry ― to take risks from the continually changing climate into consideration when making investment decisions such as capital allocation, development of products and services, and supply chain management, among others.
Larger impact
Brandt has found five major components of the economy that are impacted the most by climate change. He shared the following impact framework in a recent presentation to students and the public at Fairfield University in Fairfield, Conn.
- Livability and workability: The ability of human beings to work outdoors in extreme weather is diminished. For example, high heat reduces labor productivity. Workers must take more breaks to avoid heat strokes, and a construction job that should take only two weeks might take three or more.
- Food systems: Food production could be disrupted or destroyed by extreme temperatures or floods that affect land and crops. The colder than usual temperatures in recent years have destroyed citrus crops in Florida, driving up prices and limiting supplies.
- Physical assets: Risks that arise from the interaction of climate-related hazards demonstrate the vulnerability of exposure. Buildings could be damaged or destroyed by extreme precipitations, tidal flooding and forest fires, as seen in lower Manhattan after powerful storm surges from Super Storm Sandy in October 2012.
- Infrastructure services: Power systems, airports and highways can all be impacted by severe flooding. This was most notable in Texas and Louisiana after the catastrophic rainfall from Hurricane Harvey in 2017.
- Natural capital: Glaciers are melting, and the loss of land-based ice contributes to global sea-level rise, which impacts shipping. Oceans are warming, which changes fishing patterns and affects the global food supply.
Where are the risks?
The insurance industry faces risks related to climate change from a variety of fronts, Brandt says. Some are within the industry’s control, while others are not. But if the insurance industry delays dealing with climate change on its own, the industry should be prepared to manage the following risks:
- Regulatory: The focus is on government action, for example, carbon pricing, renewable energy mandates, electric vehicles support, and tax subsidies or penalties.
- Litigation: The threat is of excessive verdicts, injunctions and punitive damages.
- Reputational: Brand market value can be severely damaged as BP Oil learned after the Deep Water Horizon disaster, and it is now exacerbated by social media.
- Transitional: Insurers face the risk of losses from covering business or assets that will not adapt to the new low carbon economy, for example, coal mines or other fossil fuel companies.
- Physical: Due to extreme events such as flooding, hurricanes, drought, diminished fresh water supply, or lethal heat waves, damages could create “stranded assets,” for instance, airport runways that remain under water for days or telecommunications systems that lose power for a sustained length of time.
In other countries, the financial sector is beginning to respond. Brandt says. The Bank of England, for the first time, is asking British insurers to gauge how global warming might impact the value of the stocks and bonds they hold ― and its potential to upend financial markets. He explains that the exercise, which started in June 2019, is part of a broader effort by former BOE Governor Mark Carney to focus the attention of investors both on environmental issues and on the ways in which they are creating new risks for the financial system.
Insurance and reinsurance companies are the most careful in the world because of climate change, he adds. They have done studies and mapping, they have the risk models, and they’re pushing things to change because the increasing risk increases the value of the loss.
According to a recent report from the McKinsey Global Institute titled “Will mortgages and markets stay afloat in Florida,” one example of emerging risk from climate change is the impact on residential real estate in Florida. “Today, average annual losses for residential real estate due to storm surge damage in Florida are $2 billion and could increase to about $2.5 billion to $3 billion by 2030 and $3 billion to $4.5 billion by 2050, in our inherent risk assessment, absent adaptation and mitigation action,” the report says.
Brandt suggests that insurers offer advisory services to complement standard insurance products, including educating target communities on the present and future risks from climate change.
Climate change is about changing weather patterns, Brandt stresses, not only about increasing temperatures. One positive aspect of the coronavirus lockdown around the world is the largest annual fall in CO2 emissions. But levels are likely to increase as businesses open up and travel picks up.
Brandt’s message: Weather is changing, we don’t know what’s going to happen, and the insurance industry needs to be prepared. “This is an opportunity to be smart,” he emphasizes. “Let’s grab the opportunities.”
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