What is the meaning of climate insurance? : Unraveling the Battle Against Climate Change And An Imperative for the Insurance Industry

Climate Change Insurance Risk

The perilous specter of climate change once again takes center stage as a formidable heat wave engulfs Southern Europe and Northern Africa, triggering rampant wildfires and, tragically, loss of life. In recent years, the undeniable reality of our planet's shifting climate has unfolded before us, with ever-increasing frequency of extreme weather events and the mounting burden of associated secondary calamities.

Indeed, Swiss Re's research published in March 2023 ominously labeled the current situation as "a perfect storm," witnessing global economic losses from natural disasters soar to $275 billion in 2022, with insurance shouldering $125 billion of that sum.

2022 stands as the fourth-highest year for natural catastrophe insurance losses since records began in 1970, with losses surging 54% above the ten-year average. Moreover, it marks the first instance in history where costs have surpassed $100 billion for two consecutive years.

Despite being well aware of the imminent dangers posed by climate change, the insurance industry still has much ground to cover in its journey towards making a positive impact.

Media Backlash?

The insurance industry faced scathing media scrutiny earlier this year when numerous insurers withdrew from the Net-Zero Insurance Alliance—an UN-backed initiative aimed at decarbonizing insurance and reinsurance portfolios. Whatever their reasons for withdrawal, such commitments cannot remain unfulfilled, demanding renewed efforts to get the industry back on track.

Beyond the ethical imperative of safeguarding our planet and its inhabitants, the insurance industry also has a self-serving motive to combat climate change. Unchecked, it poses existential threats to various businesses worldwide, rendering assets uninsurable against the growing menace of extreme weather events.

This is an outcome that no one desires—the insurance companies that thrive on providing protection, nor the businesses, families, and individuals who rely on insurance for safeguarding their interests and homes from the impacts of climate change.

Climate Change Insurance

The time has come for the insurance industry to rise and act; procrastination might lead to irreversible consequences. Recent catastrophic climate-driven hurricanes and wildfires have exacerbated the issue, causing significant damage that forced many small insurance firms into bankruptcy while larger companies continued to retreat from high-risk areas. For instance, wildfires inflicted insured losses exceeding $30 billion in California since 2017, as per reinsurance company Munich Re.

In Florida, Citizens Property Insurance Corp., the state's insurer of last resort, anticipates increased activity in 2023 compared to the past two decades due to the continued instability within the Florida insurance market following the devastating Hurricane Ian's aftermath. States vulnerable to climate-driven disasters like wildfires and hurricanes have experienced even more pronounced premium hikes. Texas and Colorado witnessed home insurance costs surge by about 40% since 2015, and Florida's statewide average spiked by 57% compared to seven years ago. In the hardest-hit regions, premiums have doubled or even tripled following major storms and fires.

However, higher rates have failed to deter insurers from exiting the riskiest markets.

Seeking the Exit

The crux of the matter, according to insurance companies, is that they cannot charge adequately to cover their expenses post a major disaster.

In 2021, amid another relentless wildfire season in California, Evan Greenberg, Chubb's chief executive, announced the company's decision to shrink its home insurance business in moderately exposed regions. The previous year saw wildfires ravage a record 4.3 million acres in California.

Chubb blamed the state's restrictions, stating they couldn't charge customers an appropriate price for the risk, and as a result, others would have the privilege of writing that business. Subsequently, other major insurers like AIG, Allstate, and State Farm followed Chubb's lead. In fact, State Farm, Allstate, and Farmers accounted for over 20% of California's property and casualty insurance market last year.

California's wildfires have intensified due to soaring temperatures, resulting in severe droughts and vulnerable forests susceptible to large, perilous blazes. Insurers have begun discerning the direct correlation between climate change, the drought, bark beetle infestation, and the demise of 120 million trees, which has crystallized the reality of climate change's impact on their business, says Amy Bach, executive director of United Policyholders.

While the property and casualty insurance industry remains broadly profitable, companies worry about mounting disaster costs in certain markets, resulting from climate change, inflation, and escalating property values.

In California, the industry attributes a considerable part of the blame to the state's efforts to maintain low insurance rates. Since voters approved a ballot measure in 1988, insurers must undergo public hearings for rate increases of 7% or more—a costly process. Consequently, insurance companies often ask for less, even if it falls short of the required amount to cover their losses, explains Michael Young, vice president at Moody's RMS, which handles risk modeling for the insurance industry.

"Consumers feel like they're being protected," says Jim Tolliver, an insurance broker at Woodruff Sawyer. "But in reality, I'm not sure they are being protected. I think they're losing options on who can really write in the state."

Mark Friedlander, a spokesperson for the Insurance Information Institute, a representative group, warns that if state regulators don't permit insurers to charge customers enough to cover the risks they face, insurers will cease writing policies. As a result, it will be harder for policyholders to find affordable coverage.

When insurers depart, consumers face higher costs and reduced protection. The escalating risk, partly propelled by climate change, means that even dramatic rate increases won't necessarily result in ample or affordable options for homeowners.

This has become evident following recent major disasters. Even with the soaring cost of home insurance in Florida and Louisiana, the home insurance markets in these states have crumbled under the weight of hundreds of billions of dollars in hurricane damage. A survey of Louisiana residents showed that 17% of policyholders had their home insurance coverage canceled last year. Similarly, some insurers left Texas after Hurricane Harvey in 2017 and winter storm Uri in 2021. In Colorado, homeowners struggle to find insurance after a string of devastating wildfires.

As insurers depart regulated state markets, many homeowners turn to state-mandated plans that offer coverage to property owners who can't obtain insurance elsewhere. Colorado created its own backstop insurer this year, but such policies come at a higher cost and offer limited protection. Beth Pratt, a homeowner near Yosemite National Park, now pays twice the amount she did with Allstate.

"I love that California has a [state-mandated] plan, but it's a lot more expensive," Pratt laments. "I mean, I've heard from friends that it's, you know, their insurance double, triple, or quadruple."

Some states are exploring new regulatory approaches as the Earth heats up. New York and Connecticut, for example, urge insurers to devise strategies for managing climate change risks by considering present and future hazards. This marks a shift from the predominant backward-looking modeling used by most property insurers in the U.S., which relies heavily on historical data, despite the past increasingly deviating from the future shaped by global warming, according to the Treasury Department in June.

This reliance on antiquated data has led to a divide, with insurance companies and many parts of the U.S. business community diverging in their understanding of risk mitigation. Reinsurers, who essentially sell insurance to insurance companies, employ forward-looking climate modeling to set their rates. Since reinsurers aren't as heavily regulated as insurance companies, they can raise their rates more freely.

However, when reinsurance rates skyrocket, as they have lately, state regulators often restrict insurers from raising their prices based on the climate risks they foresee in the future, says Marlett of Appalachian State.

"And that's why you see the insurance companies kind of throw their hands up and say, 'Oh, fine, we're just not going to provide coverage here,'" he explains.

The reality is that insurance rates in vulnerable regions may need to surge significantly to reflect the actual risks faced by residents. "Rates increasing is not something that we are in favor of, but if the benefit of that is that people understand more about their risk, then there's some benefit to it," says Beth Dwyer, Rhode Island's insurance commissioner. These benefits could include investing in making homes more resilient to disasters or opting to relocate from harm's way altogether.

Solutions Exist, but They Aren't Simple

The most significant challenge facing U.S. insurance markets stems, in part, from the industry's own actions. As temperatures soar, climate impacts like storms and heat waves are becoming increasingly destructive. Despite criticism from lawmakers and activist shareholders, insurers continue to underwrite and invest in fossil fuel companies.

In June, Democrats on the Senate Budget Committee launched an investigation into the insurance industry's handling of climate change and its dealings with fossil fuel companies.

"It seems nonsensical at best—and complicit at worst—for State Farm to carefully factor climate risk from wildfires into its homeowner's insurance policies, refusing in some cases to provide such policies at all, while apparently ignoring the heightened climate risk that its investment portfolio is helping to create," wrote Democratic Sens. Sheldon Whitehouse, Ron Wyden, and Independent Sen. Bernie Sanders in a letter to the company.

Given the near-certainty that the impacts of climate change will worsen, it becomes imperative to build more resilient homes. Roofs can be designed to withstand hurricane-force winds and flying embers. Awnings can be modified to resist storms and avoid causing substantial damage. In regions prone to wildfires, fire-resistant materials can be used in home construction, and adjacent land can be cleared of flammable brush.

While the insurance industry and state regulators support efforts to fortify homes against physical threats, they lack the authority to enforce such changes. Instead, insurers incentivize more resilient buildings or retrofits by offering premium discounts to homeowners. Several states have programs to help fund retrofits, and the federal government is working to incentivize the construction of more resilient homes by making disaster-related funds more accessible to regions with robust building codes. For instance, an Alabama initiative to upgrade roofs resulted in significant hurricane damage prevention, inspiring Louisiana to consider emulating it.

Nevertheless, it will eventually become impossible to live safely in certain areas. This is already true for dozens of neighborhoods and towns relocating away from rising seas and storms, from Alaska to Staten Island to South Louisiana.

In the future, slowing down or halting development in the riskiest regions will be integral to addressing the escalating insurance losses, experts assert.

"There could be parts of states that are just not suitable for insurance, because really they're not suitable for home-building," says Hosfield of LexisNexis.

However, restricting development is currently unpopular among most politicians. "If you're looking at economic development and property taxes, the last thing you want to do is say, 'Well, don't build your multimillion-dollar house here on the coast or on the Outer Banks,'" says Marlett.

Dwyer, the Rhode Island insurance commissioner, urges everyone to take note of what's happening in states like Louisiana and Florida. These states may be viewed as outliers in terms of climate risk and insurance market dysfunction, but Dwyer believes that other states may soon encounter similar upheavals.

"If you're on the coast in Louisiana, you're on the coast of Florida, there's no question, you probably have some of the highest risk in the country," Dwyer observes. "But I hope that we've gotten to a point where it's not 'Hey, that's somebody else's problem.' Because it really isn't. It's gonna hit everybody in every part of the country."

For the millions already living in harm's way, this reality of facing risks like never before has become increasingly evident.

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