How insurance companies can prepare for risk from climate change

Climate change = insurance risk

The escalating frequency and severity of extreme weather-related events—from wildfires in the US, to record heat waves in Europe, to floods in Japan—have shone a brighter regulatory spotlight on insurance risk and climate change. One federal regulator in the US went so far as to suggest that the potential damage from climate change could end up being as severe as the fallout from the mortgage crisis triggering the 2008 financial crisis.

In fact, the Insurance Regulator State of Climate Risks Survey, conducted by the Deloitte Center for Financial Services, found:

• A majority of US state insurance regulators expect all types of insurance companies’ climate change risks to increase over the medium to long term—including physical risks, liability risks, and transition risks. 
• More than half of the regulators surveyed also indicated that climate change was likely to have a high impact or an extremely high impact on coverage availability and underwriting assumptions.

US state regulators and lawmakers are watching the implications of climate-related risks very carefully and are becoming increasingly concerned about the insurance industry’s response to climate change.

With losses mounting, insurers can no longer avoid or postpone addressing the impact of changing climate on their underwriting, pricing, and investment decisions, as well as their bottom lines.

There’s no doubt that more information—through more effective disclosure—would help regulators assess the effectiveness of insurer actions to mitigate insurance risk due to climate change. And that could very well be the starting point of increased climate risk regulations.

Insurance companies’ climate change preparedness

As rising climate-related losses threaten the viability of insurers’ books of businesses and investment portfolios, many regulators either aren’t aware of how prepared carriers are to deal with this threat or they aren’t fully confident that carriers are indeed prepared.

Information on insurer preparedness to deal with climate-related risks is considered vital by regulators in upholding their mandates. Yet according to our survey:

• One-third of responding regulators said they didn’t know how well the insurers are prepared to deal with the potential impacts of climate-related risks on financial stability.
• Among those who were aware, only up to four respondents answered that insurers were largely or fully prepared.
• One-third of the regulators surveyed didn’t know whether current insurer risk models were up to the challenge of capturing and testing climate-related risks.

Level of insurer preparedness to respond to the potential impacts of climate-related risks

Source: Insurance Regulator State of Climate Risks Survey, Deloitte Center for Financial Services, 2019.

Clearly, there’s room for insurers to better disclose and showcase the efficacy of any activities and actions they may be taking to assess and mitigate climate-related risks. This could help reassure regulators about insurers’ ability to withstand extreme weather events, defend underwriting and pricing decisions made in response, and possibly head off more onerous mandatory disclosures down the road.

It’s likely that regulators will at some point start requiring more of insurers in the way of disclosure and its components and assumptions—including stress tests of a wide range of plausible climate-change scenarios and a determination of how climate data is used in risk modeling for pricing and underwriting decisions.

At the same time, more may be asked of insurers in terms of steps taken to prevent worsening climate-related losses, including adaptation activities to mitigate the impact of such risks.

Climate change, insurance company change

Finding a balance between ensuring affordability and availability and managing financial stability may get tougher for insurers if extreme weather conditions continue to escalate. Insurers should focus on:

• Fortifying their assessment of climate-related risks while taking long-term actions to alleviate and mitigate such exposures.
• Using a holistic approach toward managing climate-related risks by integrating them as a part of their enterprise risk management efforts.
• Taking steps to better demonstrate their climate readiness to regulators, analysts, and customers.

These actions can help both insurers and regulators create a more level playing field and a stable market for all stakeholders involved.