The insurance industry is susceptible to the impacts of climate change


In the future, climate change caused by humans is expected to have a fundamental effect on the activities of insurance companies. Due to increasing storm damage for example, companies are subject to a growing number of claims which will, most likely, also be seen as higher premiums and other changes in the insurance selection of companies. In addition to possibly encouraging adjustment measures, rising premiums have an impact on the operations of the financial sectors.

Insurance industry and climate change

Professionals in the insurance industry investigate risks, including climate change, as a part of their work. Already since the 1980s, large reinsurance companies have carefully followed the progress of climate change. In 2004, the insurance industry received a more severe wake up call when several storms upped the sum of damages paid for insured property to USD 49 billion. In 2005, these costs rose to USD 80 billion [1]. In Finland, the insurance industry employs approximately 11,000 people in approximately 60 companies. Some insurances are mandatory according to law [2].

The insurance industry spreads the costs of risks

In addition to securing the finances of the policyholders against unexpected losses, the main task of the insurance industry is to share risks both between individuals and companies. Climate change is feared to make the implementation of this task even more challenging. Although it can decrease some risks on a local level, climate change is likely to cause some new financial security needs through storms and floods, for example.

Resorting to reinsurance services is one way for the insurance companies to spread their own risk. The risks of an insurance company are spread to a wider economic area, when the companies insure their own operations usually through a large, international reinsurance company. This improves the possibilities to cover the costs of a catastrophe that has taken place on a limited area. In turn, reinsurance companies can spread their own risk by releasing various bonds on the market for investors to purchase. However, when the problem is an environmental problem with global-scale impacts such as climate change, possibilities for regional spread of risk are limited [3].

Climate change is allocated both at insurance companies' investments and life and non-life insurances

Climate change will influence matters covered by life and non-life insurances. In Finland, a warmer and more humid climate threatens to raise the costs of mould damage in buildings [4]. In addition to natural resources such as forests and farming lands, extreme weather phenomena and floods will damage material property and infrastructure. As hot weather becomes more common, mortalities related to it increase as well as health problems to the elderly and chronically ill. On the other hand, mortalities caused by cold will be reduced as a consequence of climate change.

Since it is not easy to change the terms of life insurance policies and other long-term insurance contracts as the weather conditions and risks change during a policy term, with respect to climate, such contracts may prove more problematic for insurance companies in the future. In addition, damage caused by climate change may weaken the capital funds of insurance companies by destroying the investment targets they own [3].

Climate change impedes anticipation of costs

Climate change will cause difficulties for the insurance industry in drafting suitable insurance terms and prices. In predicting accidents related to future weather, historical statistics are beginning to lose their relevance. Insurance companies must begin to use a range of simulations to an increasing extent to receive information regarding future events. In particular, uncertainty of local climate projections complicate the assessment of risk level [3].

Extreme weather events will cause major costs for the insurance industry

Losses caused by non-life insurance that are related to weather have caused particular trouble for insurance companies. According to a study by the German Münich Re reinsurance company, over the last fifty years, occurrence of major catastrophes has quadrupled. The amount of monetary costs has risen even faster than that. However, instead of climate change, the majority of the rise in the costs detected so far is believed to be caused by the increase in the value and amount of the insured property. In addition, housing centres and other buildings have been concentrated on areas that are prone to more risks [5]

In 2008, costs of damage related to weather totalled USD 130 billion of which 44 billion were insured property. In the future, in addition to financial costs rising, extreme weather events are predicted to become even more severe. According to British insurance researchers, climate change will double or even triple insurance companies' costs related to weather [4]. Although drawing up precise projections regarding property and its loss is difficult, in Finland, costs caused by floods and storm damage are estimated to increase [6].

Figure. Flood in Sipoo in the winter of 2005.

© Esa Nikunen

The USA's second largest provider of home insurance, Allstate, is an example of the effects of rising costs to insurance companies. In 2004, due to storm damage in Florida, the company lost USD 2 billion – a sum corresponding to all profits made by the company in that state since 1992. Since the company is of the opinion that climate change will aggravate the situation in the future, it stopped signing new insurance policies in the area. The next year, Allstate lost another USD 4.7 billion to the compensations of storm damage. This lead the company to cancel 200,000 insurance policies in Florida. In addition, Allstate also left the less risk-prone market areas, raised its insurance premiums all over the USA and terminated existing policies [1]. Although the spread of buildings to flood-risk areas and intensification of climate change are important elements for the entire insurance industry, the profitability of a single company is always underlain by several company-specific details.

Rising costs require higher premiums

Insurance companies' need for capital will increase in relation to the extent and versatility of the risks they are liable for. Climate change will have a negative impact on both these matters which forces insurance companies to gather even more capital to guarantee their operations [3]. To restore their solvency after large costs, insurance companies have been noted to regularly raise their premiums after a year that has included extreme weather events. When the reinsurance companies raise the charges they invoice from the insurance companies, premiums can also be raised elsewhere than in the disaster area. In such cases, also those insurance companies that have been saved from the damage have to adjust their prices if they wish to maintain their reinsurances [1].

In some countries, the USA for example, legislation may try to prevent companies from adjusting their premiums over a certain limit, in which case, adjusting to the costs caused by climate change may become impossible for the companies [1]. In addition, cancelling insurance policies may be prevented by law [7]. In exceptional situations, if no appropriate reinsurance is available, Finland has an insurance guarantee in force which is defined by legislation [8]. In such cases, the state can guarantee a non-life insurance security for Finnish nationals. This aims to guarantee the continuance of transports crucial to the population's livelihood, operation of economic life and national emergency supply in exceptional conditions and during major incidences.

Regional supply of insurances may change

If the legislation so allows, insurance companies can also refuse insurance in specific risk-prone areas. Natural catastrophes becoming more common in tightly constructed areas is particularly problematic for the insurance industry as these areas include amply of valuable infrastructure and insured property. On the other hand, in less insured areas that have a higher risk of facing strengthening disasters related to climate change, a problem may be created by the insurance companies' reluctance to grant insurances or by the higher prices of offered policies [3].

After major catastrophes, smaller insurance companies in particular, have sometimes decided to leave the market of a risky area altogether. This problem may also be faced by developed economies. For example, after the major disasters in the USA in 2004 and 2005, quickly risen reinsurance premiums forced many insurance companies to leave the east coast hurricane area states. Thus, in some areas, obtaining an insurance from private companies for a reasonable price can become very difficult. In some cases, a public insurance fund needs to be established to replace the private companies [1].

Legal action against polluters also pertain to insurance companies

First court cases regarding people suffering from climate change and oil companies that have been considered its cause have already been seen in the USA. Secondary obligations may become expensive for these companies if legislation and legal practice develop to a direction according to which companies and other corresponding operators that have produced greenhouse gas emissions can be considered responsible for the negative impacts of climate change. Those companies who have a legal expenses insurance will then transfer these costs to the insurance companies. In the future, insurance companies may have to consider what kind of companies they can provide legal expenses insurances for and invest their own money in [3] [4].

Insurance companies aim to return the risk to the policyholders

Risks increased by climate change cause pressures to both reinsurance companies and insurance companies to cut their own risks. In addition to higher premiums, for the policyholder, this may be visible as the lack of certain insurance policies, tighter contractual terms and more extensive demands to avoid damage [3]. If the policyholder's concept of the magnitude of the risk does not meet with the insurer's estimate and the pricing based on it, highly priced insurances available might not come to be sold. On the other hand, tightening conditions in insurances may motivate people to the adaptation measures needed due to climate change [9].

Higher premiums are suspected to lead to people of limited means moving away from certain risk areas because they cannot afford the insurance any longer. Alternatively, they may have to carry the risks related to the living area without the security provided by insurance [1]. In addition, there are fears that as the impacts of climate change become more evident with developments in science and experience, those people faced with less negative impacts in certain areas may not take out insurances related to weather. In such cases, the payment pressure for the phenomenon increases for those areas and people who often already are poorer [10].

Financial operations on other sectors, such as the construction industry are also influenced by the difficulties in obtaining insurance. For example, in the Virgin Islands, the USA, construction has occasionally been halted when creditors are reluctant to participate in projects that have no insurance. These impacts can spread and also weaken the financial activities in other sectors. On the other hand, insurance companies are believed to be facing bankruptcy due to the ever stronger storms if appropriate measures are not taken to prepare for this. [7]