What's the role of insurers in climate change risk?

What's the role of insurers in climate change risk?

Insurance companies are often on the losing end of climate change, paying out increasingly exorbitant sums as extreme weather such as tornadoes, floods and fires damage property, agriculture and businesses.

But flipping the perspective for a moment, can insurance companies take active measures to mitigate the risks of climate change? Insurance companies have the opportunity – and some may say responsibility — to combat the effects of climate change by activating their expertise through various initiatives to construct products that hedge risk for their clients.

Insurers, for example, are using their adroitness at risk management to help communities and governments develop plans to adapt to the effects of climate change, advocate for policymaking that promotes sustainability and provide financial and other incentives for individuals and businesses to adopt environmentally-friendly practices. 

Risk analysis
Insurers have deep expertise in risk analysis. Carriers, actuaries and underwriters are constantly updating complex algorithms composed of hundreds of changing variables that evaluate the financial and other risks associated with climate change. These proprietary models are some of the most sophisticated in the world and provide deep insight into decision-making for a whole host of other types of institutions through sharing best practices and identifying trends in the data. 

In parallel, the effects of climate change such as extreme weather indirectly influence other types of risk, which carriers also analyze. For example, there is a developing causal relationship between climate change and reputational risk for organizations, given that consumer or broader societal behavior could be influenced by climate change to prompt changes in customer preferences for products and services. 

Insurers are constantly on the lookout for new and developing spectrums of risk. Climate change threat is often classified around extreme weather, but additional worries such as seismic activity induced by the draining of a region’s subterranean aquifer to compensate for climate-induced drought can impact fault lines and lead to increased tectonic activity.

Promoting sustainable development
Insurers also have a central role to play in encouraging sustainable development by individuals, organizations and government entities.

Insurers, often charged with bearing the brunt of the economic price-tag when a cataclysmic climatic event occurs, can provide financial incentives for developers to build further away from an eroding coastline, outside of areas prone to forest fires or for using earthquake-proof construction designs and materials. 

By explaining to coastal communities that there is a potential future liability for credit rating downgrades due to rising sea levels, with a resulting increase in flood insurance premiums, insurers can help regions make informed decisions about how their development plans can benefit or hinder future prosperity. 

Community support

Insurers are an informed voice in climate change mitigation. Through their own influence across their platforms of consumers or even through public forums such as conferences, editorial pages and the like, insurers can extend thought leadership, shaping the climate conversation as active participants.

For example, many small communities struggle with the cost and complexity of sourcing, contracting and implementing the recommendations of outside experts, especially when it comes to topics such as investment decisions related to future climate change issues.

By stepping up and offering expertise, insurers create opportunities for both the communities and themselves to be seen as subject matter experts who can support the process of working through thorny climate issues. 

Government leadership

Through lobbying efforts, insurers can advocate for local, regional or even national government policies that promote sustainability and address the causes of climate change while attempting to minimize its human and financial impact. Climate change is a complicated, multifaceted constellation of issues, and with unsettled decisional law related to climate change few entities are as qualified to opine as insurers. 

Newer models of risk management such as weather derivatives and parametric insurance – where a payout depends on an agreed value of an asset and a predetermined event threshold intensity (such as high windspeed or low rainfall) vs. the traditional evaluation of damage to an asset – are also giving new flexibility to governments to manage potential climate change disasters. 

Participants in the insurance space are uniquely positioned to have a voice in the discussion around climate change. Insurers can and should use their expertise in risk management to provide support and assessment to organizations and government entities. As well, insurers can promote sustainable development in communities and provide expertise and support where needed. Finally, insurers can play an active role in shaping forward policy around climate change, helping governments create best-practice frameworks and decisions to benefit citizens and the planet.