Home People & Planet What is the impact of climate change on insurers

What is the impact of climate change on insurers

Arup Chatterjee
The climate crisis will have dramatic impacts on economies and business communities, but the insurance industry could change the narrative through an innovative attitude to coverage
Principal Financial Sector Specialist, Sustainable Development and Climate Change Department at Asian Development Bank

As time wears on, it’s becoming clear that failure to address the climate crisis will result in significant socioeconomic risks to our entire society. However, where there is risk there is also opportunity. Today, Asia-Pacific’s insurance industry has an unprecedented chance to position itself as a lynchpin in the region’s transition to a sustainable economy by reducing the protection gap and building resilience to climate-related risk.

The economic risks of climate change

A climate-focused approach is especially important in Asia-Pacific, where temperatures are rising twice as fast as the global average, leading to more frequent and severe weather-related disasters. Home to five of the world’s largest greenhouse-gas emitters, the region produces about half of all global emissions.

As climate change progresses, the adverse consequences of disaster events are mounting and actions needed to mitigate them are getting more demanding. However, the costs of doing nothing are also high as the physical and transition risks will impact economies and individual entities differently. Damaged properties and disrupted supply chains will cause enormous losses to businesses and economies, which is further exacerbated by the lack of adaptive capacity such as climate risk mitigation infrastructure.

If no action is taken to address climate change, Asia’s economy could be on the line. The Climate Economics Index developed by the Swiss Re Institute predicts that the region’s current GDP may shrink 26.5% by 2048, compared to 18.1% in the global economy. It’s clear that governments and businesses must factor climate risks into their decision-making, especially as changing markets, rising costs, declining incomes and assets stranded due to transition requirements create new, unheard of challenges.

In light of this troubling present, it is surprising that the insurance industry has yet to catch up. A large segment of anticipated climate change-related losses is not covered by insurance; instead, the lion’s share of these costs is being borne by the public sector. This is particularly true in developing Asia where private insurance is less prevalent and covers about 9% of regional economic losses compared to the global average (38%).

Asia’s insurance protection gap—the difference between total and insured loss costs—is estimated at about 90%, varying in line with each country’s income levels. If these gaps persist, they may create long-term fiscal instability for governments, businesses, and households, especially as the worst of climate change’s impacts bear down on the region.

Insurers aren’t immune to climate change

Despite lagging behind on these issues, insurers must recognise the imminent threats posed by climate-related risks to their short- and long-term stability and operations. Not to mention the impacts that will undoubtedly complicate the insurability of policyholders’ property and assets as well as their own investments.

Increased exposure to natural catastrophes can lead to higher capital requirements or premium loading by insurance providers to accommodate surges in more frequent and severe catastrophe-related losses. We may even see lower risk-mitigation benefits during capital planning due to providers’ reduced reinsurance capacity. There may even be the risk of financial exclusion of policyholders who are especially vulnerable to certain natural catastrophes that insurers’ have little to no appetite for, even if they are the ones who are most in need of coverage.

The impact of climate change on population demographics and mortality or morbidity characteristics will introduce more uncertainty for life insurers as they grapple with accumulating risk of large epidemics and pandemics and the mass loss of life inherent to increased natural catastrophes. This is all compounded by the potential secondary impacts on investments due to greater financial market volatility. Insurers could see their portfolios and valuations diminished as financial markets rapidly reprice assets exposed to climate risk.

Building society-wide resilience

From its vantage point at the forefront of the climate crisis, the insurance industry is uniquely qualified to support society-wide efforts to build resilience by leveraging their wealth of data about the changing risk environment and vulnerability across Asia’s sub-regions at the sectoral and institutional levels.

Insurers’ impact may be especially sizeable in countries that lack the social safety nets, public insurance schemes, and countercyclical financing mechanisms that ensure some degree of support for all citizens regardless of income level. Amidst an environment characterised by frequent and intense shocks, all cascading in succession, governments may find themselves vulnerable to sizeable and implicit contingent liabilities.

Insurance can help absorb some of these shocks and support economic activity by protecting their debt-service exposure against climate change-induced events, which could help reduce default rates and maintain customers’ creditworthiness after a catastrophe. Collaborations with government will be key to bring affordable coverage to some of the most vulnerable groups. This could be done by pre-arranged risk pooling through sovereign climate risk financing and insurance. With the help of differentiated trigger mechanisms, pay out conditions and timescales – it can ensure essential public finance liquidity post-disaster. Additionally, blended finance structures, guarantee schemes or other de-risking solutions can unlock private sector financing from life insurers and pension funds to scale up new climate technologies in the transition to a low carbon and resilient economy.

Pivot to climate adaptation infrastructure

Insurers could even play a role as an engine for positive outcomes by shifting their traditional business models away from risk-transfer and indemnity payments, and towards mitigating physical climate risks with innovative solutions. These could be rebates on sustainable construction materials, partnerships with government, and a commitment to clean energy.

Already we’ve seen some examples of insurance industry players partnering with multilateral development banks to recommend public investments in climate adaptation infrastructure that reduce the residual risks and increase insurability. For example, there are innovative risk transfer schemes targeted at conserving and restoring natural ecosystems like mangroves and coral reefs that are cost-effective solutions to coastal flooding. Insurers and reinsurers are already transferring the risk of this type of insurance to capital markets by selling securities that mirror underwritten insurance obligations.

Renewable energy sources, particularly solar, wind, hydro, and biomass, will be key to the achievement of net-zero goals, and their relevance will only grow with time—it’s estimated that 49% of global electricity generation will be provided by renewables by 2050. However, while renewable energy technologies, distribution methods, and business models evolve, the risks keep growing too and affect the energy infrastructure across all stages of the supply chain. By 2050, 61% of hydroelectric power will be at high risk for droughts or flooding. Insurance undergirds the entire industry by offering coverage opportunities for the full life cycle of renewable energy projects, while also making them more bankable with the help of risk screening, vulnerability assessments, and hedging the risk.

Accelerating green and resilient investments

There are trillions worth of new climate investments waiting to be unlocked, especially if Asian governments are able to institute the appropriate reforms and incentives to drive green investments and projects. Insurance markets will be critical to mobilising more green investments, especially given that environmental, social, and governance (ESG) issues are gaining traction among the investor community.

By placing a price on climate risks, insurers are helping translate ESG issues into a language understood by boardroom executives and shareholders. This has led to more and more companies integrating climate risks exposure into their broader risk management processes.

As institutional investors, insurers are beginning to exert their influence to channel more funding into projects that deliver measurable non-financial benefits while improving long-term financial returns. There are also significant non-financial returns such as reduced carbon footprints, clean and affordable energy, efficient resource utilisation, enhanced productivity, and improved overall climate resilience.

The costs of complacency become more evident every day, but the insurance industry can no longer afford to shy away from the reality of rising risks. Insurance leaders who pursue active climate-related initiatives and establish themselves as part of the solution have the potential to not only secure our future but also capitalise on the financial rewards of a healthier planet.

* This article has been adapted from the official keynote address given by Arup Chatterjee at the Asia Nat CAT and Climate Change Conference — Unmask the Possibility, organised by Asia Insurance Review, Singapore, 26-27 September 2022.

Print Friendly, PDF & Email
Arup Chatterjee
Principal Financial Sector Specialist, Sustainable Development and Climate Change Department at Asian Development Bank

Arup Chatterjee is Principal Financial Sector Specialist, Sustainable Development and Climate Change Department, Asian Development Bank. His current work involves financial, governance, risk management, and regulatory reforms across different industries. He has held stints with the Bank for International Settlements in Switzerland, and Insurance Regulatory and Development Authority of India.

You may also like