Why the Insurance Market Must Prioritize Commercial Lines Sustainability

The insurance industry faces immense pressure to embrace sustainability across all lines of business. However, commercial lines stand out as an area of particular urgency and opportunity for specialty lines and commercial lines insurance with big ticket clientèle located around the globe.

So, here's why the insurance market needs to prioritize commercial lines sustainability when it comes to weather-related losses, including flooding or wildfires, among others. Such environmental risks affect commercial properties and physical assets. With the support of algorithmic underwriting, computable contracts and advanced technologies, insurers, reinsurers and brokers can start building more dynamic operations while closing the $1.8 Trillion protection gap.

We will gather at ITC Vegas on 31 October.

I am thrilled to bring a panel of experts who will dive deep into our current sustainability in commercial lines' reality and share examples of how insurers across the globe are addressing the issue with high purpose and responsibility.

Make sure to pre-register here.?

The Staggering Costs of Climate Change Drive the Need for Action

Climate change is drastically increasing the frequency and severity of catastrophic flooding worldwide. In 2021 alone, natural disasters caused over $313 billion in economic losses, of which only 50% was insured.?In 2022, Losses from natural catastrophes covered by the insurance sector amounted to $132 billion, 57% above the 21st-century average, it added, leaving a global 'protection gap' of 58%.

By 2026, companies are projected to face up to $120 billion per year in losses from supply chain disruptions caused by climate change and extreme weather.

For over 50 years, the average number of climate-related disasters has risen from fewer than 50 per year in the 1970s to well over 300 per year in the 2010s.

This massive and growing protection gap exposes communities, businesses, and insurers to unacceptable levels of risk. Insurers are responsible for building resilience and closing this gap through sustainable underwriting practices and risk management.?

Flooding Represents an Existential Threat for Commercial Insurers

?Flooding is perhaps the clearest example of how climate change threatens the commercial insurance sector. Historically, most flooding risk has been uninsured. European Central Bank states that only a quarter of climate-related catastrophe losses are insured in the EU, leaving a protection gap in the billions.

In the US, only 20% of flooding damage is covered by insurance. However, we are now seeing a rapid rise in extreme flooding events that cause massive insured losses. The European floods in July 2021 resulted in $12 billion in insured damages across Germany, Belgium, and the Netherlands. Hurricane Ida caused up to $95 billion in total economic damage in 2021, of which $32 billion was insured.

As flood risk grows, many insurers respond by excluding flood coverage, raising premiums, or avoiding high-risk areas altogether. But this narrow approach leaves communities and businesses dangerously exposed. Insurers must take a more holistic and sustainable view towards insuring flood risk.

Computable Contracts Enable Responsible Underwriting of Climate Risks

One of the biggest obstacles to sustainable underwriting is the use of rigid, outdated policy structures. Most commercial property policies use fixed terms that fail to account for rapidly evolving climate risk factors.

?Computable contracts offer a solution. These are digital, modular policies that use external data feeds to automatically adjust coverage and pricing based on changing risk profiles. For example, wildfire risk could be dynamically priced using real-time data on vegetation dryness and wind patterns.

?By adopting computable contracts connected to environmental data, insurers can accurately price climate-related risks as they emerge. This facilitates underwriting in high-risk areas instead of avoiding them altogether.

Algorithmic Underwriting Makes Sustainable Pricing Scalable

Sophisticated risk pricing is also essential for insurers to profitably underwrite climate risks across large portfolios. But manual underwriting processes make this nearly impossible.

?Algorithmic underwriting automates risk assessment using predictive analytics. This allows insurers to rapidly incorporate new data sources, such as satellite imagery and sensor data, to price climate risk at scale. With large commercial portfolios featuring thousands of locations, algorithmic underwriting is the only feasible way to develop risk-based pricing aligned with climate exposure. It also reduces frictional underwriting costs compared to manual processes.

Embedding Insurance in Commercial Properties Boosts Sustainable Resilience

Beyond risk pricing, insurers also need new commercial products that incentivize climate resilience. Embedding insurance directly into commercial properties, such as offices, warehouses, and retail stores, helps accomplish this goal.

Embedded insurance uses IoT sensors to monitor a building's risk profile, automatically adjust coverage, and even initiate preventative measures. For example, flood sensors could trigger automated flood barriers while also notifying the insurer to dispatch first responders.

This real-time connection between risk mitigation and coverage provides financial incentives for policyholders to invest in loss prevention and business continuity. Embedding insurance into the commercial built environment is a powerful catalyst for climate adaptation.

Business Model Innovation in Commercial Insurance

?The commercial insurance industry is ripe for business model innovation to drive sustainability. Some emerging approaches include:

1. 1.??Platform business models: Insurers can leverage digital platforms to expand distribution channels, enable usage-based insurance models, and integrate with partners to provide value-added services. For example, they are creating an online platform for small businesses to compare and purchase customized policies easily.
2. 2.??Ecosystem orchestration: Insurers can collaborate with industry partners to co-create prevention-as-a-service offerings. This could involve working with IoT partners to provide real-time risk monitoring and prevention for commercial properties.
3. 3.?As-a-Service models: New pay-per-use insurance models like Insurance-as-a-Service allow businesses to only pay for the coverage they need when needed. This provides flexibility and aligns insurer incentives with risk prevention.
4. 4.?Data monetization: Insurers can monetize data insights through value-added services like real-time risk alerts, predictive analytics, and loss prevention recommendations for commercial clients.

Parametric Insurance for Cloud Downtime and Supply Chain Management

Parametric insurance is emerging as an innovative solution to cover risks like cloud downtime and supply chain management:

Parametric policies for cloud services pay out quickly based on easily triggered events like downtime exceeding a duration threshold without needing claims adjustment. For example, a policy could pay $10,000 per hour of downtime after the initial 2 hours. This provides rapid liquidity to an insured to address business interruption losses.

The predefined payout structure reduces ambiguity and basis risk for the insured compared to traditional indemnity policies. Real-time monitoring data can act as a transparent, automated trigger for parametric cloud downtime policies, as well as supply chain disruption affecting the delivery of products around the globe.?

Key benefits include faster payouts, lower administrative costs, and alignment of interests between insurers and insured to prevent downtime. Challenges include essential risk if the payouts do not fully cover losses. Insurers also take on more risk exposure with parametric structures.

Only Holistic Risk Management Can Close the Protection Gap

Insurers have a pivotal role to play in closing the $1.8 trillion global protection gap that leaves people and businesses dangerously exposed. But this can only be achieved through a holistic approach to risk management.

Pricing risks in isolation incentivizes policyholders to under-invest in resilience and transfer more exposure to insurers. But a holistic view aligns underwriting with risk prevention, for instance, by offering premium discounts for investments in resilience.

Insurers must also close data gaps by generating and sharing risk insights with policyholders. And they need to support resilience across the entire economic ecosystem, not just individual policyholders.

Only by advancing integrated risk management will insurers constructively close the protection gap rather than simply transferring unsustainable levels of risk.

The Time for Action is Now

Climate change poses an existential threat to the commercial insurance sector. But it also presents an unprecedented opportunity to catalyze sustainability across the global economy.

By embracing new technologies, collaborating across the industry, and innovating products that embed resilience, insurers can lead the transition to a sustainable future. The insurance industry cannot wait any longer - the time for action is now. The future of our communities, businesses, and planet depends on the choices we make today.

Make sure to sign-up for the pre-event on 31 October. Places are, as always, limited.?

References:

Swiss Re Institute. "Sigma 2/2022: Stagflation: the risk is back, but not 1970s style.

Swiss Re Institute. Sigma 1/2022: Natural catastrophes in 2021: the floodgates are open.

Moody’s European Flood and Climate Change.

Commercial Risk, 2022. "Floor risks grow in Europe."

FloodLisk, 2021. "Only 46 Percent of German Households Have Flood Insurance."

Aon, 2020 - "Weather, Climate & Catastrophe Insight: 2019 Annual Report."

Reuters, 2023 - "Natural disasters caused $313 bln economic loss in 2022 - Aon"

European Central Bank, 2023 - "What to do about Europe’s climate insurance gap."

Willis Towers Watson, 2021 - "July floods in Europe."

Swiss Re Institute, 2021 - “Preliminary sigma estimates for 2021: global insured losses from disaster events were USD 112 billion.”

McKinsey & Company, 2020. “Climate risk and response in insurance.”

Hartford Steam Boiler, 2019. “The computable policy: Insurance evolution for the digital age.”

The Geneva Association. “Insurance in the Digital Age.”

AXA, 2022. “Can the insurance industry afford to ignore computable contracts?”

Stanford, 2021. “Computable Contracts and Insurance: An Introduction.”

Insurance Thought Leadership, 2023. “AI's Role in Commercial Underwriting.”

Swiss Re Institute, 2023. “Going Digital: Embedded insurance.”

Hurricane Ida: a storm of two acts

Swiss Re Institute, 2022. “Parametric Products.”

EY, 2020. “Seven business models of the future for the insurance sector.”

McKinsey, 2018. “Insurance beyond digital the rise of ecosystems and platforms.”

Qover, 2022. “How insurance-as-a-service can transform your business model.”

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