Climate Change Looms Large Over the Property and Casualty Insurance Market

Between widespread flooding and landslides in California and multiple earthquakes in Indonesia it feels like the world barely has time to catch its breath before the next climate disaster wreaks havoc and devastates another community. With these disasters come a lot of loss. It’s impossible to ignore the fact that stronger and more frequent climate related catastrophes are killing our loved ones, wiping out our biodiversity, and destroying our homes and businesses at alarming rates. 

Over the last five years, we’ve seen a significant jump in the amount of annual insured losses due to natural disasters. Meaning it’s time for the insurance industry—which plays a crucial role in helping individuals and businesses recover after these kinds of catastrophic events— to stop underestimating the true threat climate change poses to the global economy and its role within it.

Could climate change topple the Property & Casualty insurance market?

P&C insurance is built on the idea of risk sharing. When a misfortune, like a wildfire, hurricane, or flood, causes property damage, an insurance policy ensures individuals in the affected community don’t have to bear the full weight of their loss alone. After a natural disaster occurs, P&C insurers can use their newfound understanding of evolving risks in that area to reprice their policies and rearrange their risk portfolios as needed. 

At first glance it almost seems like an increase in natural disasters would benefit the P&C insurance market. An increase in risk should increase consumer demand for insurance solutions to protect against said risks, increasing P&C insurance market opportunity. This would be true if everyone purchased every type of insurance they needed to protect against increasing natural disaster threats. For example, we’ve written about the potential upside for the industry of a universal flood insurance requirement. 

Unfortunately, we don’t live in an ideal world where every consumer has access to, and chooses to, purchase as much insurance as they would need to create a net positive effect on the industry. The stress of frequent and devastating climate related disasters like the ones we’re already seeing could create situations in which premiums become too expensive for customers, or too risky for insurers to take on. This is already happening in some states, resulting in solutions like the establishment of new insurers of last resort. Without viable long term solutions, this could lead to a significant increase in the amount of underinsured or even uninsured individuals and businesses.

As for insurers, refusing to take on business because it’s too risky doesn’t lead to business growth. To continue as a profitable industry into the future, P&C insurers need to find new ways to proactively and profitably manage the growing threat of climate change.

Innovative approaches to funding

Reinsurance

Typically, when catastrophic events cause large scale losses, insurers turn to reinsurance to help cover claims. While reinsurance can serve as a safety net for insurers, there are still limitations to its coverage. Reinsurance works because of the underlying principle that risk is often limited to one geographic area. If a hurricane causes massive property damage on the east coast of the United States, it’s unlikely that an insurer operating out of the midwest would be dealing with similar losses. 

But the surge in natural disasters across the U.S. brought on by climate change could put even reinsurance companies in a bind. Multiple catastrophes occuring back-to-back across multiple geographic regions could push reinsurance to its limits and create compounding losses that are just too high.

CAT Bonds

Catastrophe (CAT) bonds can also be used as a financial safety net for insurers after a natural disaster causes major losses. Like reinsurance, CAT bonds allow insurers to transfer risk, only this time it’s to investors. By opening investments to the financial markets, CAT bonds expand an insurer’s potential risk-taking capacity.

While CAT bonds have been successful at mitigating the economic consequences of natural disasters in the past, the increased frequency of these climate related catastrophes could spell trouble. As climate change risk increases so does the cost of insuring against it. Investors who typically buy CAT bonds because they see the risk as being overpriced might look to invest their capital elsewhere after they lose their principle due to severely underpriced risk. 

Solutions beyond insurance

The insurance industry may play a big role in curbing the economic impacts of climate change, but avoiding a total breakdown is going to take some more comprehensive help. The following solutions go beyond insurance (and reinsurance) to decrease the loss caused by natural disasters and give insurers a greater appetite for controlled risk. 

Climate resilient infrastructure

Coastal cities may boast growing populations and thriving economies, but when it comes to climate change, they are among the most dangerous places to live. Disastrous hurricanes and rising sea levels haunt coastal communities causing massive losses and higher insurance premiums. 

To protect their citizens and land, some coastal cities are investing in climate resilient infrastructure. The Dutch coast hasn’t flooded in years thanks to wave blocking infrastructure built in the 90s. In Boston, a system of floating wetlands designed to reduce coastal flooding and offset rising ocean levels is in the works. 

Reexamined zoning laws

Planning and zoning ordinances could reduce the amount of lives lost, properties damaged, and land destroyed in disaster-prone areas. After Hurricane Sandy caused major flooding in New York, the city developed new zoning rules to help buildings better withstand and communities quickly rebuild after natural disasters.

However, many communities are resistant to reexamining zoning laws and land-use practices for various economical, social, and political reasons. Progress will require community support and innovative solutions. 

Controlled fires

The idea that purposefully starting a fire can help reduce the risk of a wildfire might seem a little backwards at first, but controlled fires are actually extremely effective for wildfire suppression. Controlled burns rid forested areas of dead leaves and debris without posing a threat to the public. 

While controlled fires remain an essential tool in preventing destructive wildfires, climate change is making the practice riskier. The hotter, drier conditions brought about by climate change increases the chance for controlled fires to spread outside of planned areas. In 2022, the federal government inadvertently started New Mexico’s largest wildfire when a controlled burn got out of control. 

Climate change is no longer a matter of when 

The effects of climate change are already here and with the long-term viability of the P&C insurance industry at stake, insurers need to act now. Response – both in and outside of the industry – will take time, but with no action the problem will only get worse. 

With the looming threat of climate change also comes an opportunity for the insurance industry to create more economic security in the face of more frequent natural disasters. By changing their business models to better predict climate risk, creating innovative solutions to cover emerging and more frequent hazards, and reevaluating investments to support a more sustainable economy, insurers have the chance to create positive change.

As climate change continues to reshape the insurance industry you can bet AgentSync will be here to report on any new developments. In the meantime, check out what our producer licensing compliance software can do for you.