Climate crisis demands a new insurance industry
There remains an unspoken hope things will either return to normal or that the economy will naturally adapt to worsening weather events.
As debate continues over declined COVID-19 business interruption claims and the virus exclusion, the role of the insurance industry amid global disasters has come into question. The ubiquity of pandemic risk requires enormous, sometimes unaffordable premium reserves to cover damages, which is why insurers routinely carve it and other all-encompassing events out of coverage. Yet, the industry has not approached climate change with the same vigor. Although wildfires and storms accelerate in frequency and severity, they remain core covered perils. What happens when the scale of damages from climate change surpass that of COVID-19?
The next crisis
The industry is already experiencing the beginning of this disaster. Natural catastrophe losses in 2020 were up 26.5% from 2019, according to Investopedia, and over the last five years nearly doubled those of the prior five. Carbon emissions are creating a weather system fundamentally different from the one in which the insurance industry thrived, yet most insurers still rely on historical data to measure future risk. Among some corners of the industry, there remains an unspoken hope, disguised in the humility of having witnessed many market cycles, that things will either return to normal or that the economy will naturally adapt despite all evidence to the contrary.
Regulators have expressed concern over insurer preparedness for this new climate. The tried-and-true methods of risk diversification will no longer protect portfolios when damaging ecological feedback loops cascade into new geographies. For example, how many insurers anticipated a winter storm would cripple the Texas power grid? When trillions of dollars in economic damage are considered underestimated, standard coverages could be excluded, just like flood or pandemics after the 2002 SARS outbreak.
Widespread reformation in the insurance industry will be necessary to endure the crisis. Insurers must drive necessary change and acknowledge they can offer what the world needs: good data, risk management, and the financial mechanisms to build resiliency. Thankfully, well-researched solutions are available. I suggest three main strategies.
No. 1: Accurate data and disclosure
The most urgent need is for accurate data. Insurers must invest in better weather models incorporating the latest scientific research with a long-term view. Without knowing what resources will be needed in 10 years, how can underwriters appropriately fund for losses?
Some insurers already disclose their exposure to climate risk through voluntary ESG (environmental, social, & governance) reports, but the variance among frameworks makes meaningful analysis difficult for policymakers and investors. Insurer associations should collaborate with regulators to adopt and mandate a normalized disclosure framework that encourages resiliency targets in line with carbon neutrality by 2050. The Task Force on Climate-related Financial Disclosures (TCFD) offers such a framework.
No. 2: Adequate pricing and alternative funding
We cannot afford the hidden costs of climate change anymore. Insurance premiums need to adequately reflect risk, even if it hurts. This will be the hardest reform, but pricing signals are necessary to change attitude and influence actions. Imagine if at your next trip to the fuel pump, you were charged for your contribution to the global healthcare bills from pollution-induced asthma or reconstruction costs of wildfires and floods. If every transaction included the financial harm of its greenhouse gas by-product, the path to sustainable choices would be self-evident. Insurance is the business of pricing risk, so why should these costs remain hidden? Businesses and households that contribute to or are threatened by the climate crisis should have expensive insurance.
However, accurate carbon pricing could make insurance premiums unaffordable, especially for the disadvantaged communities more likely to live in areas prone to disaster. Rather than burdening them further with the costs largely generated by the wealthy, policymakers should create financial mechanisms to fund these premiums. While prioritizing affordable premiums alone encourages unsustainable development, as we’ve seen with the National Flood Insurance Program, reasonable premiums are possible when funded by the source of the risk itself. The insurance industry should therefore support federal carbon fee and dividend legislation to levy fees on the production of greenhouse gases and re-allocate those funds to insurance and mitigation.
No. 3: Changes to underwriting and divestment
As a whole, the insurance industry is the second-largest institutional investor, which gives it enormous financial power. It is counterproductive for insurers to fund fossil fuel projects and industries that have been among the poorest performers in the past decade, offer only modest returns in the short term and exacerbate claim expenses in the long term. Insurers also provide critical underwriting to the fossil fuel projects driving the climate crisis. Insurers should halt support — both in underwriting and investment — of the thermal coal value chain, oil and gas producers, and other primary carbon emitters.
Harsh reality
The truth about the climate crisis is that no one group can afford its costs. The economic toll will be unprecedented, and if the insurance industry continues to assume governments or the economy will solve the problem without their assistance, insurance markets will either retreat or crumble under the losses. Instead, we must act now to avoid the most painful iteration of the coming upheaval. The insurance industry may not be adequately prepared for climate change today, but that can change. It must if we want our industry to endure.
Based in the Los Angeles Metropolitan area, Preston Nanney, CPCU, (preston.nanney@gmail.com) is a senior life sciences underwriter with The Hanover Insurance Group. These opinions are his own and do not reflect The Hanover Insurance Group.
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