UNCERTAIN FUTURE FOR CLIMATE RELATED RISKS – POSSIBILITY OF EXCLUSION BY REINSURERS LIKE TERRORISM

The insurance of climate risks is indeed under significant stress, largely because of the intensifying frequency and severity of climate-related events, such as floods, hurricanes, wildfires, and droughts. This strain has led to growing concerns about whether insurers can continue to cover these risks profitably and, in turn, whether reinsurers can support them. Like terrorism the reinsurers may either totally exclude climate related risks from the treaties or tighten the restrictions like ‘natural catastrophe event limit’ further.

Current Scenario

?In 2023, insured global natural catastrophe losses reached approximately $140 billion, marking it as one of the costliest years on record for insurers. Around 70% of these losses stemmed from weather-related events, especially floods, wildfires, and hurricanes. Economic losses (both insured and uninsured) from natural catastrophes have increased nearly fourfold over the last 40 years, now averaging around $200 billion annually, with climate-related events contributing the largest share.

In the United States, many property insurers experienced loss ratios over 100% in climate-sensitive regions like Florida, Louisiana, and California. Wildfires in California alone have led to cumulative losses exceeding $25 billion over the past five years, while hurricane-related losses in Florida have created a deficit in the state’s insurance market, pushing insurers to consider pulling back or exiting the market.

Swiss Re reported that severe flood events, a major climate risk, have increased by over 50% globally since 2000. These escalating numbers are also observed in the frequency and intensity of wildfires, which are up by about 70% since 1990, especially in regions such as California, Australia, and the Mediterranean.

India is no exception to the rising frequency and severity of flood events, which have been increasing year on year. The highly competitive insurance market, characterized by inadequate premium rates, combined with escalating claims costs, poses significant challenges to the profitability of direct insurers. These pressures are further impacting their solvency ratios, raising concerns about their financial resilience.

The strain is also evident in reinsurance treaties, where prolonged payback periods have become a growing concern, reflecting the cascading effects of unprofitable primary insurance operations on the broader risk transfer ecosystem.

?Reinsurance Capacity and Pricing Trends

Hardening Reinsurance Market:

Reinsurance pricing for catastrophe cover increased by approximately 30% globally in 2023, while climate-exposed regions saw increases of over 50% for certain coverages. This "hard market" phase is largely driven by reinsurers needing to build reserves against worsening losses and volatile climate risks.

Declining Capacity for Climate Risks:

According to Aon, global reinsurance capital declined by 8% in 2022 compared to the previous year, as reinsurers pulled back capacity for certain climate-related risks. Reinsurers have been reducing their catastrophe exposure by either tightening terms or exiting some markets, notably in high-risk zones.

Higher Capital Requirements:

In response to climate risks, regulators, especially in Europe and North America, have raised capital requirements for insurers underwriting these perils. For example, the EU Solvency II directive has recently increased capital charges for insurers with high exposure to climate-sensitive assets, impacting their profitability and forcing some insurers to restrict climate coverage to maintain capital adequacy ratios.

Trends Toward Exclusions and Shifting Policy Coverage

Some insurers are already starting to exclude specific climate-related perils, especially in high-risk areas. For instance, wildfire and flood coverage is being restricted in parts of the U.S., while insurers in Australia and Europe are reconsidering coastal and flood risk policies. Additionally, some insurers have started capping or excluding secondary perils, such as flash floods and storm surges, that are otherwise covered under primary catastrophe policies. The Indian Market has witnessed the reinsurers imposing in the past few years “natural catastrophe event limits” to restrict their exposure. The event limit is between 100% to 150% of the treaty capacity. This may get tightened further.

Rising Deductibles and Reduced Limits:

Reinsurers are facing similar issues and, in some cases, even higher exposure levels. In response, reinsurers are demanding higher premiums, reducing available capacity, or setting stricter terms on climate risk treaties. If climate risks are persistently unprofitable, reinsurers may pull back further, making it harder for primary insurers to maintain affordable coverage. The reinsurers may insist on increasing the deductible much higher. Besides, the pricing may go up unreasonable with ROL (Rate On Line) above 60%-70 with reinstatement @ 125% to 150%.

Emerging Solutions and Alternative Approaches

Risk Pooling and Public Support Solutions:

To mitigate these pressures, some regions are considering risk-pooling or government-supported reinsurance for climate risks, similar to terrorism pools. This approach would help spread the risk across broader pools or provide public reinsurance support to protect markets from collapse. It is high time for the Indian Market to start a “Cat Pool” before the reinsurers put pressure on the market. Though there were some attempt in the past to establish "Cat/Nat Pool" it did not take shape as at that time enough capacity was availble in the market.

Parametric Insurance:

As an alternative, parametric insurance, which triggers payouts based on predefined weather events rather than loss assessment, is gaining traction and could fill some gaps left by traditional policies.

Public-Private Partnerships:

Partnerships between governments, insurers, and reinsurers may become essential in providing sustainable climate coverage. Governments could act as reinsurers of last resort or subsidize premiums for climate risks.

ESG Investments: (Environmental, Social and Governance)

Insurers and reinsurers are increasingly investing in ESG-focused strategies, which include underwriting incentives for green projects and penalizing carbon-intensive ones. This approach aims to reduce future climate exposure indirectly by encouraging less risky environmental practices.

Conclusion

The situation is fluid, but climate risks face an uncertain future in the insurance market. Reinsurers, in particular, will play a critical role in determining the direction of this coverage based on capacity, pricing, and risk appetite. The increasing trend of climate related losses underscore that without significant changes, insurers and reinsurers will likely continue to restrict coverage or raise premiums for climate risks. However, the threat of withdrawing support for the climate risks is hanging over the insurance market like a Sword of Damocles.