The climate is forcing the most risk-conscious industry to reinvent itself


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When it comes to climate impacts, insurance is at the forefront of the financial industry. The payout for damage caused by extreme weather events totaled $120 billion last year, about as much as Kenya’s economic output. And that’s a 50% increase over the average of the previous decade.

It’s going to be a big problem. Insurance offers companies and individuals the peace of mind that, for a small premium paid regularly, they are covered for disasters such as floods or wildfires. However, if payouts increase because more customers file claims, the insurance industry either makes lower profits or has to increase the regular premiums customers pay.

The damage is so great that the insurance industry is forced to do both. Insurance companies’ annual profit margins are under pressure, even as premiums for products such as home insurance are rising. “The insurance industry is head-and-shoulders facing the climate challenge,” said Nina Seega, research director of sustainable finance at the Cambridge Institute for Sustainable Leadership.

When the insurance industry goes bad, it relies on the reinsurance industry to help. Companies like Swiss Re and Munich Re provide cover for insurers hit with much higher payouts than before. Reinsurers have fared worse, according to a Moody’s report released earlier this month, with profits lagging those of insurers. That is causing reinsurers to increase premiums, limit the types of coverage they offer, and even exit some markets.

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Now even the investors in reinsurers are dissatisfied with their investments because they are getting lower returns than expected. After Hurricane Ian that hit Florida last year, investors aren’t putting as much new money into reinsurers, said Charles Graham, senior insurance analyst at Bloomberg Intelligence. Climate effects lead to “a domino effect,” he said.

For example, in an ideal world, if premiums rise, market signals should force developers and buyers to move to places with lower climate risk. But the insurance market doesn’t always work well.

“Our price signal should imply that you need to change your behavior,” Christian Mumenthaler, group chief executive officer of Swiss Re, said in an interview at the World Economic Forum in Davos last week. “But people generally don’t like to change their behavior.”

Take the case of Florida. After Hurricane Andrew hit in 1992, the damage was so extreme that it led to the bankruptcy of at least 16 insurers. So the state stepped in and created a fund that lowers insurance premiums.

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That may seem like a good thing, but Florida’s vulnerability to extreme weather events has only increased. Since 2020, 15 real estate insurers have gone bankrupt. And the state has stepped in with a $1 billion fund to ensure more regional insurers don’t run out of reserves as Floridians are hit by more climate impacts.

The difficulties force the insurance sector to be creative. There are three levers the company can use to mitigate climate risks: reducing its own emissions, forcing the companies it invests in to reduce their greenhouse gases, and creating products that help its customers reduce their carbon footprint .

NN Group NV, one of the largest insurers in the Netherlands, now has an insurance product that does not just replace a cracked smartphone screen, but has it repaired. Currently, the product is the more environmentally friendly option, but it costs the company more than simply buying a new phone. However, Chief Executive Officer David Knibbe is confident that it will also be more economical in the long run.

“We have a lot more to do,” Knibbe said during an interview in Davos. “I have more examples, but it’s not a list of 20.”

The ultimate weapon that the insurance industry can use is to stop insuring certain things altogether. Reinsurers Swiss Re and Munich Re have reduced their capacity in Florida by as much as 80% as the state is battered by more extreme weather events. Swiss Re’s Mumenthaler says it has a policy of not insuring new fossil fuel projects, though he would not say which customers he had to say no to as a result of the policy.

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Seega says the insurance industry has come a long way from its early days when it used intuitions to make risk decisions. The industry has become more data-driven, relying on history as a way to understand the future. The problem now is that climate change is making historical data a less reliable guide, meaning more innovation is needed to ensure the company’s survival.

Climate risks “offer an opportunity for the insurance industry to reinvent itself,” Seega said.

Photo: A flooded trailer park after Hurricane Ian in Fort Myers, Florida, US, on Thursday, September 29, 2022. Hurricane Ian, one of the strongest hurricanes to hit the US, weakened to a tropical storm but continues to rain on the state as it makes its way through the southeastern US./(Bloomberg)

Copyright 2023 Bloomberg.

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