Photo: Insurance companies have the experience necessary to play a more prominent role in the face of climate change. Credit: Lina Trochez/Unsplash.
By Isabel Reviejo
“I ask private insurance companies at this critical time not to hide behind fine print and technicalities. They must do their job and live up to the commitments they made to the communities they insured.” The President of the United States, Joe Biden, made this public plea for the nation’s leading insurers to finally cover the additional expenses of those who left their homes in the face of the threat of Hurricane Ida, despite not having official evacuation orders.
The strong winds and floods triggered by climate change, especially in Louisiana and Mississippi, but also in other states on the east coast of the country, have left damages that could mean, for the insurance industry, an impact of $18 billion in the US and the Caribbean, according to the firm Karen Clark & Co, although other expert predictions point to a figure that could reach $30 billion.
The passage of Hurricane Ida is one of the latest examples highlighting the need for insurance companies to be prepared for the increase in extreme weather events as a result of climate change. In the face of a global emergency, insurance companies cannot limit themselves to responding to natural catastrophes, but rather they must take an increasingly active role in preventing risk.
Extreme weather events: What is to come
If greenhouse gas emissions are not reduced “immediately, rapidly and on a large scale,” “limiting warming to around 1.5°C or even 2°C will be an unattainable goal.” This is the conclusion that the experts of the Intergovernmental Panel on Climate Change (IPCC) have reflected in their latest report, in which they indicate that an increase of 1.5°C will be accompanied by an increase in heat waves and longer warm seasons, while with a rise of 2 degrees “extreme heat episodes would more often reach critical tolerance thresholds for agriculture and health.”
And these are not the only consequences: the scenarios forecast by the IPCC also take into account other extreme weather events, such as the intensification of droughts and rainfall, which would also become more irregular, as well as a continuous rise in sea levels in coastal areas.
Today, natural disasters are getting worse, and this is already posing a challenge for insurers. In the first half of the year alone, insured losses from natural catastrophes amounted to $40 billion, which is the highest figure for this period since 2011, according to initial estimates from the Swiss Re Institute.
In Spain, where floods are the most common and costly natural disaster, – causing more than 800 million euros a year in damage-, losses are partially compensated by the Insurance Compensation Consortium (ICC), affiliated to the Ministry of Economic Affairs and Digital Transformation, as long as a property or personal insurance policy has been taken out. According to the organization’s calculations, the current Extraordinary Risks System could assume an increase of between 15% and 20% of the accident rate linked to the direct risks of climate change – floods and strong winds – if the current market conditions were maintained.
Photo: Floods, the deadliest natural disaster in Spain, will be more frequent as a consequence of global warming. Credit: Jo-Anne McArthur Unsplash
A preventive approach to mitigate the impact
In this context, marked by uncertainty, the insurance industry faces the challenge of evolving its risk assessment system to include the new threats that the future may bring, which will have a particular impact on areas such as livestock or property.
“Insurers have a great deal of experience in effectively managing risks and identifying possible solutions to adapt and improve. It is their core business and they have been doing risk modeling for decades,’ says Patricia O’Donnell, People Advisor at Opinno.
These companies, he argues, “should be considered when designing how to adapt to what is going to happen with climate change,” given that they have “privileged information on what is happening, what threats there are and how the level of vulnerability correlates with the subsequent impact.” In addition to having “a privileged position to improve the collective understanding of risk” and promoting more sustainable behaviours, insurers can play an active role in preventing and mitigating the impact, he stresses.
According to O’Donnell, a certain parallel could be drawn in this area with the change that the health sector has undergone: “Allocating part of the resources to a preventive medicine strategy had a direct impact on the use of health policies being lower. This is the same thing: if insurers make that transition to being an agent that helps in prevention and awareness, the impact will be much less.”
An example of these preventive actions would be the study on the risk of flooding of Spanish coastal populations produced by the Sustainability Observatory in collaboration with the General Council of Insurance Mediators, which identifies the areas most vulnerable to this problem, which will affect some 977,000 people in the coming years.
The industry’s commitment to the environment has also involved supporting sustainable projects and disassociating itself from activities that do not meet the goal of achieving a low-carbon economy. Last June, the International Institute of Law and Environment (IIDMA) recommended insurers to restrict their investments in companies with “carbon-intensive activities,” as well as to stop insuring companies in the coal, oil and gas sectors that are not aligned with the goals of the Paris Agreement.
In general terms, the industry has already made these commitments. For example, Mapfre has committed to not invest in companies whose revenues – 30% or more – come from energy produced from coal, and to not build new power plants from this resource. Even so, the industry may have difficulties in complying with the legal requirements of this change. In addition, getting rid of assets that are not in line with decarbonization will result in an increase in their supply which will result in a sharp drop in their value, leading to large financial losses if the transition to sustainable assets is delayed, explains O’Donnell, who stresses that “policy support and public financing for this transition is essential.”
Another key to addressing the risks posed by climate change, especially in the most vulnerable countries, is to increase insurance penetration among the population. “Countries with strong insurance markets recover faster from the financial impacts of extreme natural disasters, while countries with low insurance penetration face slower economic growth and fiscal losses,” says the Access to Insurance Initiative (A2ii). One of the solutions proposed to serve low-income populations is microinsurance, with proposals such as the one implemented by the Munich Climate Insurance Initiative (MCII) in the Caribbean region to respond to potential environmental catastrophes.
Photo: Taking a preventive approach will help insurance companies mitigate the negative impact of climate change. Credit: Markus Spiske/Unsplash.
Quality data, allies
In this preventive approach, and as in other challenges facing the sector, technology will play a very important role, although by itself it is not enough, but it is necessary to consider “how it serves the interests of clients, obtaining a return in return,” O’Donnell remarked. The use of advanced analytics and artificial intelligence, with insurtechs as key partners, will experience an ever-increasing boom, but will in turn imply making a “strong commitment” to data governance maturity and quality.
One of the tools being developed by insurance companies is parametric insurance, whereby policyholders receive compensation automatically if previously agreed parameters are met. For example, a farmer could sign a policy that includes his right to receive compensation if the amount of rainfall on his crops exceeds a certain amount. Although the agricultural sector is the one that can benefit most obviously from this advance, which is being applied by companies such as Axa or the insurtech Arbol, this solution can also be applied to other areas such as energy, transport and construction.
Some firms, such as Grupo Catalana Occidente, offer weather alert services to warn their clients of the risk of heavy rains or strong winds. However, to develop predictive models, improve measure vulnerability indexes and develop appropriate preventive products and services, the industry faces the challenge of making the data on which they are based increasingly diverse and of higher quality, says O’Donnell. In this regard, he adds, insurers have the option of using an advanced analytical tool that is still far from being exploited, although it is already being used by part of the industry: European Earth Observation Program, which provide more comprehensive information than mere meteorological data.
This is the case of Copernicus, which has a big data service on climate change with an open data policy to make it available to all companies and sectors. This makes it possible to identify emerging risks and new potential vulnerabilities due to changing weather conditions and changing patterns in natural catastrophes, although “not everything is predictable and there isn’t the economic capacity to make policies for everything,” says Ricardo Gonzáles, director of Analysis, Sectoral Research and Regulation at Mapfre Economics.
Although insurance companies are already taking steps to build a more sustainable business, there is still some way to go so that, putting innovation at the service of customers, they can play an even more prominent role in the strategy of adapting to climate change and be useful to society.