Felicia Khoo and Jeffery Yong from the Bank for International Settlements published a report in November on the impact of climate on the insurance industry. It seems to be a good summary of the issue that many insurers are facing. At the same time, the impact of climate on insurers is obviously complex and varies according to product and market. I'm interested in people's views on this from their perspective in the industry.
The other reason for this article was to test out generative AI, in this case Afforai 3.5, as a research assistant. The summaries are AI generated, with some minor editing on my part for continuity. I'm also interested in your thoughts on the quality of the summaries.
Executive summary
The report provides a comprehensive analysis of the challenges and recommendations for the insurance industry and government in the context of climate change. It emphasizes the accelerating impact of climate change on the insurance sector and the urgent need for proactive measures to address climate-related risks.
The report highlights the role of insurance supervisors in addressing natural catastrophe protection gaps and the importance of incorporating climate-related risks into pricing and underwriting processes. It also discusses the impact of climate change on insurance coverage, including the withdrawal of insurance cover from critical economic sectors and the potential implications for systemic risk.
Furthermore, the report emphasizes the need for insurers to support climate risk mitigation efforts and incentivize risk adaptation measures through their pricing and underwriting policies. It also addresses the challenges faced by insurers in fully addressing climate-related risks and recognizing adaptation measures in their pricing and underwriting processes.
The report underscores the importance of capacity building for insurers and the public to enhance their understanding of climate-related risks. It also emphasizes the need for coordinated efforts from insurers, regulators, and governments to mitigate and address the climate challenge.
In conclusion, the report emphasizes that insurance alone is not sufficient to protect society at large from climate change impacts and calls for close cooperation between regulators and other governmental and non-governmental agencies to address the disproportionate impact of climate change on emerging markets and developing economies. It also highlights the need for an orderly transition to avoid economic disruptions and financial instability.
Summary of impact of climate change on insurers
The report highlights several issues facing the insurance industry as a result of climate change:
- Inter-relationships between Climate-related Risks and Insurance Product Pricing and Underwriting: Climate-related risks, including physical, transition, and liability risks, can significantly impact the pricing and underwriting of insurance products. Physical risks, such as increased insurance claims due to property damage or loss of lives from climate-related events, can lead to premium increases and/or withdrawal of coverage. Transition risks, arising from disruptions associated with the transition to a low-carbon economy, and liability risks, including climate-related claims under liability insurance policies, also affect insurance product pricing and underwriting.
- Implicit Consideration of Climate-related Risks in Pricing: Many insurers rely on regular pricing processes that prompt revisions of premium rates based on actual loss experience, assuming that any climate change impact is reflected in the claims data. However, this approach may not explicitly account for climate-related risks, and it may miss changes over the long term, such as chronic physical risks. Additionally, historical data may not fully capture emerging climate trends, posing limitations to repricing possibilities.
- Challenges in Incorporating Climate-related Risks into Pricing and Underwriting: Product design and practical challenges make it difficult for insurers to fully address climate-related risks and recognize adaptation measures in their pricing and underwriting processes. Legislation may restrict risk-based pricing, and the mixing of climate- and non-climate-related risks makes it difficult to price for climate change impacts. Furthermore, insurers may find the cost of verifying risk adaptation measures to be too high and may face difficulties in engaging with high-risk customers to encourage them to take risk adaptation or mitigation measures.
- Insufficient Technical Capacity: Insufficient technical capacity of both insurers and supervisors is a challenge to adequately minimize insurance claim payouts. This lack of technical capacity may hinder the effective incorporation of climate-related risks into pricing and underwriting processes.
- Impact on Premiums and Coverage: Property losses from natural disasters due to climate change are projected to increase, leading to higher homeowner policy premiums. Health insurers have also increased premiums for more frequent claims resulting from climate change-related events. Non-life insurers have been adjusting their product offerings via deductibles, coverage limits, and outright exclusions to mitigate physical risk impacts. This has led to premium increases for insurance products exposed to climate-related risks.
- Role of Insurers in Climate Risk Mitigation and Adaptation: Insurers play an important role in supporting climate risk mitigation efforts to transition to net zero and incentivizing risk adaptation measures. However, challenges exist in encouraging policyholders to take climate adaptation measures due to a lack of appreciation of their climate-related risk exposures and the high cost of verifying risk adaptation measures.
These issues collectively underscore the complex and multifaceted challenges that the insurance industry faces in addressing climate-related risks in their pricing and underwriting processes, as well as the broader implications for premiums, coverage, and risk management.
Summary of recommendation for insurers
These recommendations emphasize the importance of proactive measures to address the impact of climate change on insurance coverage, the need for proper oversight and governance, and the consideration of broader financial implications. Insurance companies are encouraged to take a holistic approach to ensure the long-term availability and affordability of insurance products in the face of climate-related risks. The recommendations for insurance companies are:
- Addressing Protection Gaps: Insurance companies are advised to address protection gaps as a priority in their broader work programs on sustainable finance. This involves taking measures to maintain the long-term availability and affordability of non-life insurance products in the light of climate change.
- Risk Adaptation Measures: It is crucial for insurance companies to implement risk adaptation measures to mitigate the impact of climate change on the availability and affordability of insurance products. This includes considering the needs and characteristics of the target market and striking an appropriate balance between limiting losses and aligning products with the market's needs and objectives.
- Justifying Premium Increases and Exclusions: Regulators are putting in place requirements for insurers to justify any premium increase or new exclusion for climate-related insurance coverage. Insurers are expected to follow proper oversight and governance rules, disclose information to customers, and consider the needs of the target market when making such changes.
- Minimizing Financial Instability: Insurance companies should be cautious about collective industry underwriting or pricing approaches that could lead to financial instability in the event of major or multiple simultaneous climate-related disasters. Insurers are advised to consider repricing policies upon renewal and covering unexpected losses using capital to minimize risk.
- Consideration of Cross-Sectoral Implications: Increasing premium rates and/or reducing insurance coverage could have adverse implications for other parts of the financial system. For example, corporate borrowers could become more exposed to business interruptions, and lenders may face cross-sectoral disruptions from uninsurable mortgage portfolios in certain geographical locations.
- Contribution to Combating Climate Change: While the insurance industry can contribute to combating climate change through favorable pricing and underwriting conditions to support climate risk mitigation and adaptation, it is acknowledged that other policies beyond the remit of insurance supervisors may be needed to decelerate reductions in the availability and affordability of insurance coverage.
