Insurers warned to wake up to the risks from climate change

The magnitude and frequency of extreme weather events such as hurricanes, floods and wildfires, which could be set to rise further as a result of climate change, puts insurance firms in the eye of the storm according to a new report by F&C Asset Management, a investor and specialist in sustainable investment.

In its 20-page report, In the Front Line: The Insurance Industry’s Response to Climate Change, F&C warns that some insurance companies have been slow to act and urgently need to develop climate change strategies. The report also calls on insurers to engage with policy makers and regulators to bring about systemic changes.

The F&C report argues that a stable and efficient insurance sector provides a vital underpinning to society and economic growth by providing a social ‘safety net’ and incentivising individuals and businesses to take intelligent risks. To date, traditional risk models have relied on historic claims data to price forward-looking risk and determine underwriting requirements. But climate change means that the past is increasingly an unreliable guide to the future. To the extent that risk may be systematically under-priced, the report argues this could significantly impact the profitability of the sector, and have implications for capital adequacy requirements.

While the impact of climate change will primarily fall on property cover, F&C points out that there are implications for other areas of insurers’ businesses too: companies operating in vulnerable areas face the risk of having their operations interrupted; health and life insurance may be impacted by climate change increasing mortality and morbidity rates as diseases enter new territories and, additionally, both liability and professional indemnity insurance could suffer as companies find themselves facing law suits under changing legal regimes and customers sue property developers for damages not covered by policies.

While some insurers have been encouraging customers to reduce the risks they face, for example by reducing premiums for those who install flood defences on their homes, a more common response has been for insurers to withdraw from high risk areas forcing the state to step in. For instance, following numerous extreme hurricanes in the southern states of the US the State of Florida has become the number one provider of residential insurance as several firms have withdrawn from the market.

The report also notes that while the insurance industry is the single largest gatherer of capital in the global economy, with $16.6 trillion of assets under management, it concludes that “many insurers fail to see a link between climate change and the value of the assets they hold”.

While the report cites some excellent examples of good practice, including Munich Re and Swiss Re in the field of risk pricing, overall it assesses that the response of the industry to climate change has been patchy with European insurers much more active than their US counterparts. The lack of action in the US, with some notable exceptions such as AIG and Travellers, stems from a combination of weaker acceptance of climate science, limited public policy action, and state-based insurance regulatory regimes that limit the industry’s ability to respond as effectively as it should by, for example, putting pressure on insurers to keep pricing low.

In the Front Line: The Insurance Industry’s Response to Climate Change concludes with a call to action for individual companies, and for systemic change. It recommends that insurers adopt comprehensive climate change strategies that consider issues including whether the catastrophe models used reflect underlying climate risk; the scope for products which respond to the opportunities of climate change; the impact on their investment portfolios; and how they are working with public policy makers.

Vicki Bakhshi, Associate Director of Governance and Sustainable Investment at F&C, and co-author of In the Front Line: The Insurance Industry’s Response to Climate Change, concludes:

“F&C, as a major asset manager, has significant long-term investments in the insurance sector. We therefore have a very real interest in seeing insurance firms respond to both the opportunities and the threats of climate change. Insurers are currently standing at a crossroads. If they don’t act they are in real danger of becoming the victims of climate change, subject to ever increasing risks in their investment portfolios and claims that exceed their projections. However, it doesn’t have to be like that. By acting now the insurance industry can play a key role in shaping and financing the solutions to climate change. Insurers can work with governments and regulators to get the right conditions in place both to maintain a healthy insurance industry, and to help society cope as climate change hits home.”