Insured losses from natural catastrophes have increased 250% in the last 30 years, according to a report by consulting firm Capgemini and the European Financial Management Association (EFMA). Perils such as wildfires and storms, which are particularly impacted by climate change, are causing an even faster rise in insured losses, according to the report.
A survey of insurance regulators in the U.S. by the Deloitte Center for Financial Services found that the majority of respondents expect all types of insurance companies’ climate change risks to increase over the medium to long term. Additionally, more than 50% of regulators surveyed indicated that climate change was likely to have a high impact or an extremely high impact on coverage availability and underwriting assumptions.
The Perfect Storm: More Extreme Weather Events, Populated High-Risk Areas
Scientists say rising average temperatures are causing weather events to become more extreme, making floods, fires, and heat waves increasingly more damaging when they occur. Population growth in high-risk areas is also increasing, putting more people and property in danger. Major disasters such as hurricanes and catastrophic fires destroy entire towns and areas.
Most recently, for example, the storm surge from Hurricane Ian completely changed the landscape of Florida’s Sanibel and Captiva Islands. The downtown area of Fort Myers Beach was decimated, with several restaurants and shops completely wiped out.
A wildfire in 2018 leveled Paradise, California. The fire destroyed more than 18,000 structures, including about 14,000 homes, or 90% of those in the town.
Insured losses from Hurricane Ian’s destruction keep rising, with some estimates now at $75 billion. In 2021, insured damage from wildfires was $5 billion, according to Aon.
The Long-Term Risk of Climate Change on Insurance
In summary, insurance aims to spread risk. The insurance business model is effective when many people purchase coverage and only a small number of people suffer the type of damage that necessitates large payouts. However, the model breaks down when large claims are paid out across many insurance products to many people when hurricanes and catastrophic fires destroy entire towns. Climate change connects and exacerbates many disasters in ways that many insurers are unaware of.
“What the industry hasn’t figured out is how connected all of these events are,” said Kia Javanmardian, a McKinsey & Company partner who examines insurance. “Previously, events weren’t as related — the flood in Florida might not have been related to the fire in California — but if there’s an underlying driver called climate change driving both, then they do become related.”
Rising Premiums, Carrier Bankruptcies, Moratoriums
The combination of frequent and more severe disasters can cause insurance policies to become prohibitively expensive for most customers or make it impractical for insurers to provide coverage. Look at what is happening due to severe weather events in the Florida and Louisiana property insurance markets and California, for example.
Four Florida insurance companies have declared bankruptcy since April of this year, and others are canceling or not renewing policies (due to severe weather losses and the state’s litigation environment). About 1.3 million homeowners are now insured with the state’s last-resort insurer, Citizens. This number could reach 2 million by next year. At the same time, private-sector insurers have received rate increases of 30% to 50% (before Ian hit the Sunshine State).
In the last two years, storms Laura, Delta, and Zeta in Louisiana have cost insurers $10.6 billion, while Ida alone cost an estimated $40 billion. As a result, some carriers have been placed into liquidation.
In California, in 2020, insurers dropped about 212,000 California properties, and nearly 50,000 homeowners — many in the Sierra Nevada foothills on the eastern side of the state — couldn’t find another insurance option in the private market, according to Politico. Household names like Liberty Mutual, State Farm, and Nationwide have pulled back from writing homeowners insurance in certain areas.
According to a study by the think tank Next 10 and the University of California Berkeley, one in every 12 homes in California is at high risk of fire, and risk assessment maps haven’t been updated since 2007. Nevertheless, people continue to build in areas prone to climate-related disasters. According to one estimate, 645,000 homes in California will be built in “very high” wildfire severity zones by 2050. The value of these properties is likely to rise as well, increasing rebuilding costs when a disaster strikes.
The insurance industry wants rates to be based on estimates of future fire damages rather than actual damages from the previous 20 years. “Right now, our rules are just antiquated,” said Rex Frazier, president of the Personal Insurance Federation of California. “What’s going to give us long-term stability is a much more dependable method that can only be had by looking forward.”
The California insurance commissioner recently instituted another one-year ban on insurance companies canceling or non-renewing residential insurance policies in certain areas in the state affected by recent wildfires. However, many see this as a stop-gap solution that creates a scenario where insurers aren’t collecting enough premiums to cover their losses. When moratoriums expire, homeowners are left without insurance to cover a loss.
Insurance Industry Studying Climate Change Risk
Reinsurers are at the forefront of bearing the brunt of insured losses from climate change. As a result, they are investing time and money into studying climate change and what actions can be embedded in their decision-making process, including risk management. According to IRMI, reinsurers are putting more emphasis on modeling, particularly for secondary risks such as winter storms, heat waves, wildfires, and flooding. They are also developing new hurricane models in response to the recent hurricane behaviors caused by climate change.
For example, Munich Re is a pioneer in analyzing the effects of anthropogenic global warming and natural climatic variability on weather-related natural disaster losses. According to its website, the reinsurer has spent the last four decades researching risks, loss prevention measures, and new risk transfer solutions. Furthermore, it examines long-term data on meteorology and losses to better understand risk changes.
Swiss Re has developed a flood risk assessment tool called “FLOAT” to assess and manage a location’s flood risk. FLOAT uses drones to capture location-specific elevation data. The collected data set is transformed into a realistic visualization of the location, including a precise interactive simulation that shows potential vulnerabilities.
Reinsurers are also leading the way in resiliency efforts, pressing local governments to address building code and land-use planning issues in climate-affected areas. Frank Nutter, president of the Reinsurance Association of America (RAA), has called for a long-term investment in mitigating losses, better land use planning, better building codes, greater use of green infrastructure to protect properties, and a change in philosophy in government.
Sources: Deloitte, Vox, Reuters, McKinsey, Politico, IRMI, Munich Re, Swiss Re, RAA