While some of us may still be debating the causes of climate change, the insurance industry has been left to deal with its disturbing consequences. Climate change is estimated to cost the world economy over $1.2 trillion per year. The number of weather-related loss events in North America alone has nearly quintupled in the past three decades, which begs a very important question: how are we going to ensure that private and public assets remain insurable in the face of increasing climate volatility and extreme weather events? Join TSSS for a webcast and twitterchat on the topic of Cities and Climate Change with former Toronto Mayor, David Miller and Guelph Mayor, Karen farbridge (March 27th at 5PM EST) – register here.
How Insurance Works
To put it simply, insurance is a way of managing risk by transferring it to the insurer in exchange for a premium. Insurance companies need to have the financial resources to be able to pay for claims and make a profit, and as a result, they must charge sufficient premiums and invest sensibly if they want to remain solvent.
Companies base their premiums on perceived risk, which has traditionally been based on past experience. For example, a teenager in a sports coupe is likely to be charged a higher premium than a soccer mom who drives a minivan. Similarly, property owners in areas of high vulnerability to hurricanes or other extreme weather events are likely to pay more than their counterparts whose properties are in less vulnerable areas.
So what happens when the perceived risk increases?
In such an event, private insurers can choose to either raise premiums, cancel or renegotiate agreements, limit the types of coverage they provide, or in the worst case, withdraw from a market entirely.
Linking Climate Change and Insurance
According to Ceres, an advocate for sustainability leadership, “the insurance sector finds itself on the front lines of climate change, but the response of insurers to this challenge has varied enormously.” Because insurance companies base their policies on perceived risk, they might become more and more reluctant to insure markets that could potentially culminate in financial losses. To illustrate this, Ceres reported that Allstate was forced to cancel or forego the renewal of insurance policies in many Gulf Coast states, because claims from hurricane events dried up 75 years’ worth of company profits. But the problem doesn’t just concern the retreat of private insurance providers – coverage is also being “hollowed out“ through higher deductibles, lower limits, and increased exclusions.
If a large number of property owners become uninsured, or ‘barely’ insured, the economic impact on the state will be much greater in the event of a catastrophe, because it will be forced to pick up the slack. If state funding runs out, the burden will have to be borne by taxpayers. It is therefore in the interest of the public to have available and affordable insurance.
The insurance industry is a key part of our national (and the global) economy: it stimulates businesses to invest by ‘insuring their risk’; it provides a mechanism through which a range of losses can be recovered; it is necessary to secure financing (from homeowners and mortgages to businesses and lines of credit); and finally, it reinvests into the economy.
A Ceres report from earlier this month noted that insurance companies in the United States have full knowledge of the financial implications posed by the growing number of intense weather events. However, most are “ill-prepared and are only just beginning to address the effects climate change may have on their business.”
Given the sheer size of the industry – it’s the largest in the world – and its involvement in so many aspects of the global economy, it could potentially play a leading role in our efforts to tackle climate change.
The bottom line is that if climate change undermines the viability of the insurance industry, it’s bound to have a damaging impact on the economy as well. If the housing market, for instance, becomes uninsurable, then the mortgage market will be impacted because people can’t get a mortgage without home insurance.
Looking Forward: How Do We “Ensure Insurability”?
In essence, by lowering perceived risk through mitigation and adaptation. Our cities have to adopt a two-pronged approach: we must decrease CO2 emissions, and at the same time build ‘hard defenses’ against climate change. Being better prepared for the likely increases in extreme weather events will lead to a reduction in claims, in perceived risk, and 
ultimately, in premiums. As a result, there will also be less of a burden on the state and taxpayers in the event of a catastrophe.
The provision of affordable and available insurance will require the public sector to collaborate with insurers to enact legislation aimed at mitigating sources of climate change and adapting to its risks.
Such an approach would prove to be mutually beneficial to all stakeholders, and it would minimize societal uncertainty during our transition to a climate-safe economy.
Through a collaborative approach, insurers can influence public policy and address the issues of mitigation and adaptation simultaneously, by:
- Supporting national and regional initiatives to reduce greenhouse gas emissions
- Sharing knowledge with leaders, policyholders and the general public on the risks of climate change
- Advocating for more robust land use, building code, flood defense, and disaster plans
But insurers must also develop products that seek to address the same ends. They can provide:
- Coverage for new climate change technologies
- Price incentives to stimulate cuts in greenhouse gas reductions (discounts on green buildings and on policyholder investments in ‘weather-hardening’ measures like hurricane-proof roofs)
- Incorporate climate change into investment portfolio
“With core competencies in risk management and finance, the insurance industry is uniquely positioned to further society’s understanding of climate change and advance creative solutions to minimize impacts.” By joining forces with the public sector, the insurance industry can increase its ability to provide affordable and available insurance for the foreseeable future.