Those familiar with the insurance industry will know that it can sometimes be resistant to change. For example, the insurance business was slower to adapt to the digital arena than some other industries. But the rising insurance-related costs associated with climate change have gotten underwriters' attention.
The number of major annual natural catastrophe events in the United States alone tripled between 2010 and 2020 (from 7 to 21), and the 5-yearly average cost of such events more than quadrupled (from US $30.5 billion in 2015 to US $126 billion in 20200). 1 As we have seen this year, many other locations around the world are experiencing extreme weather events, causing enormous harm and costing insurers hundreds of billions of dollars in claims.
In addition, enormous business interruption claims caused by the COVID-19 pandemic have prompted the industry to focus more intently on the clash between natural and man-made risks. The difficulty in predicting when disasters and pandemics will strike, and what their ultimate costs will be, has made it doubly difficult for insurers to allocate adequate reserves for future losses. It also makes providing affordable insurance rates a real challenge. This has become a vicious circle for all involved, so there are a variety of incentives to find a reasonable solution.
In response, insurers around the world are starting to do their part by increasingly embracing the concept of carbon neutrality (achieving net-zero carbon dioxide emissions)—adapting their operations to be more climate-friendly. In 2017, MetLife became the first US insurer to achieve carbon neutrality—just 2 years after declaring its intention to do so. 2 However, other insurers, such as the UK's Aviva, have somewhat less ambitious time lines, not intending to become carbon neutral until 2040. 3 And, this year, broker Marsh said it would reduce its emissions by a modest 15 percent by 2025. 4 So, the absence of ambition in achieving carbon neutrality in a timely manner by some in the industry is as noteworthy as MetLife's noteworthy example.
That said, some insurers are to be commended for taking a stand against climate change and reorienting their underwriting policies to reflect an anti-fossil-fuel orientation. For example, Allianz announced in 2018 that it would stop selling insurance policies to coal-fired power plants and coal mines. Consistent with the previously mentioned unambitious time lines of some insurers toward achieving carbon neutrality, it announced a "climate protection package" as the first step toward a complete withdrawal from the coal business—by 2040. At the same time, it stopped investing in companies that failed to reduce their carbon emission in line with the 2-degree objective agreed upon under the Paris Agreement. Other insurers—such as AXA, Generali, and Lloyd's—have similarly shifted their investment portfolios away from coal companies and into green businesses. 5
That is a good and welcome start, but insurers more generally have been too slow to get on the "green" bandwagon. Life insurers, in particular, have tremendous amounts of money to invest but have invested relatively little in green investments until recently. A report by the Insurance Association of China 6 noted that China's life insurers plan to greatly increase the portion of their investment portfolio in green investments while the country's largest insurer—Ping An—plans to invest at least 20 percent of its investment portfolio in green investments, targeting approximately $62 billion in the sector by 2025. 7
Some ethical questions naturally arise. For example, how much should insurers incentivize individuals to engage in behavior that runs contrary to what a prudent investor should be doing in the face of climate change by extending coverage to them? Some public sector insurers provide flood insurance in geographic locations that are prone to repetitive flooding, which makes little sense to the insurer or the homeowner. America's National Flood Insurance Program—operated and funded by the US government—is a good example. The program charges premium rates that do not vary with the replacement cost of houses, so expensive houses end up paying below-market rates. In effect, taxpayers provide subsidies for owners of luxury beach homes so that they can rebuild in the same place until the next flood occurs. 8
Private insurers are smart enough not to issue policies where losses have previously occurred and will likely occur again. Yet, governments around the world have chosen to foot the bill, knowing its taxpayers will lose money in doing so and generating clearly unfair benefits to some flood insurance recipients. Now that floods (and droughts and fires) are becoming more frequent in places that never had them before, insurers need to think about creative solutions that address climate-change-related problems without incentivizing individuals and businesses to take unreasonable risks.
These changes in climate point to some of the near- and longer-term challenges to the insurance industry. As the frequency and severity of tail events—formerly thought to be low probability—increase, so do changes to insurers' balance sheets. This will have impacts not only on future capital requirements but their ability to obtain critical reinsurance. Some of the traditionally stable and profitable sources of premium will shrink or possibly even disappear as insureds' assets that are exposed to climate risk become harder to insure. 9
The insurance industry is neither a polluter nor the decider of climate policy, but it plays a critical role in helping societies to establish socioeconomic resilience while simultaneously promoting economic development. It has a significant role to play in building financial resilience to extreme climate events by providing risk-related information and risk pricing expertise and offering innovative risk transfer products. The insurance industry should, therefore, do the following.
The insurance industry has no choice but to modify its business model to get out ahead of climate risk—sooner rather than later. Not doing so could ultimately imperil numerous sectors of the industry—from property and casualty to business insurance. Being responsive to climate change is no longer enough; insurers should become more proactive to help safeguard their interests as well as societies at large. Few industries are so influential or stand to lose so much by failing to act decisively and quickly.
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