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While a homesick Dorothea McKellar once romanticized notions of Australia as “country burnt by the sun”,the reality is that his “droughts and torrential rains” are increasingly fierce.
Caught in the throes of a relentless El Nino/La Nina cycle, the Climate Council has warned that the rising cost of natural disasters could leave 1 in 25 properties in Australia high risk and uninsurable by 2030.
In this article, we explore the costs, possible responses and exposure of insurance lines to climate change.
How did we come here?
In recent years, Australia has experienced various extreme weather events causing floods, fires and storms. Australian general insurers are estimated to have paid out $3.89 billion on more than 300,000 claims related to bushfires, floods and storms in the summer of 2019-20.
While 2022 was the year we all hoped for some reprieve and normal programming, the east coast of Australia has instead been shot down from disaster to disaster. It may only be July, but insurers have already taken the following hits according to articles published by Insurance Business Australia:
Not only are the costs rising, but the forecasts are worrying; just when you thought it was safe to attempt any type of chase in dry weather, La Nina is set to return in the summer of 2022/2023. The third time is certainly no charm, especially since the high-risk areas identified by the Climate Council as uninsurable fall outside the traditional framework of concern in northern Australia (few insurers offer property cover above the Tropic of Capricorn).
Climate change poses short- and long-term risks for insurers and will lead to additional costs as policyholders and insurers move away from the carbon-based economy and adapt to climate change, regulations more stringent and to increased litigation, higher claims and increased losses.
What is the downfall?
Insurance affordability is not just an issue for policyholders. As identified by McKinsey in its report Climate change and P&C Insurance: The Threat and Opportunity “some historically stable premium and profit pools will shrink, or even disappear, in places and industries exposed to climate risk…”.Currently, premiums often do not adequately cover the level of risk insurers are insuring, resulting in significant losses. This is inevitable, with the higher risk associated with the increased frequency of extreme weather events, premiums will increase and the issue of insurability will become more prevalent.
Thus, with the uncertainty of the impact of climate change comes the question of predicting the risks associated with extreme weather events. Insurers will need to take a hard look at their underwriting practices and exposure limits and develop sophisticated models to forecast and manage risk. A miscalculation of the magnitude of the impact of climate change on their pricing will cost insurers dearly.
The reinsurance sector will play a key role in particular in providing primary insurers with the necessary protection as they seek to transfer their risks while protecting themselves against catastrophic losses. Reinsurers will also in turn need to manage tail risks and appropriately underwrite climate change risks to ensure that financial losses are absorbed.
Additionally, failure to respond may result in
“damage the reputation of the industry and its credibility as a global economic citizen.” The reputational risk is particularly acute when considering research from the Actuarial Institute and Deloitte that a number of people facing higher premiums and uninsurable homes are already considered vulnerable due to their lower socio-economic status.
What can be done to minimize the contribution of insurers to climate change?
Stemming the affordability crisis cannot be achieved by insurers alone. The next steps proposed by the Climate Council will require action by governments and private companies:
- Enact rapid and deep emission reductions in the Australian economy;
- Eliminate fossil fuel subsidies;
- Prioritize investments in resilience;
- Take climate risks into account in land use planning;
- Improve building standards and compliance; and
- Support communities to “build back better”.
However, insurers can help by:
- Refuse to cover activities that contribute to climate change such as coal and other fossil fuels;
- Work with governments and regulators on climate-resilient building policies and codes that ensure buildings are more resilient to disasters;
- Work with policy makers to become more resilient to climate change and encourage sustainable practices and behaviors. This could take the form of impact underwriting practices. For example, Deloitte cites the work of insurers in the United States that have offered premium discounts and practical assistance for fire protection in wildfire-prone states;
- Choosing to invest in sustainable and ESG-aware investments; and
- Become a member of the Net-Zero Insurance Alliance (NZIA) convened by the United Nations.
Many insurers are already taking proactive steps. For example, more than 20 leading insurers have joined NZIA and pledged to move their insurance and reinsurance underwriting and investment portfolios to net zero greenhouse gas emissions by 2050. .
What can be done to minimize insurers’ risk?
Climate change will force insurers to rethink their approach to underwriting, with the main issue being the insurability of these risks, as outlined above, or insurers will generally exclude liability related to climate change. For instance:
Property and accident insurance
P&C insurers are the most vulnerable to climate change given the catastrophic effect of an extreme weather event, leaving them vulnerable to property and personal injury liability claims. In response, insurers could rely on broadly worded pollution exclusions to argue that claims alleging damage or injury caused by greenhouse gases, for example, are excluded from coverage. However, climate change does not only impact P&C insurers. Insurers will also need to consider mitigation strategies for other lines.
Many sectors are and will be affected by climate change. Auditors and lawyers, for example, are at risk due to increased regulations they and their clients must comply with as well as increased litigation related to climate change. Insurers should ensure that their assessment of these risks adequately takes into account the secondary effects of climate change.
In the construction industry, it is not inconceivable that as regulations regarding building materials and land use are enacted, coverage will be extended, increasing potential losses for insurers, especially since some design and construction professionals violate regulations. Insurers should therefore review the wording of their exclusion clauses and consider excluding coverage where non-compliance is a causal factor or leads to regulatory action. Insurers may also choose to exclude coverage for construction projects that take place in areas prone to climate risks, or limit the maximum payout for a claim or include clauses that encourage climate risk assessments.
Australia has recently seen a wider range of climate-focused litigation. For example, when shareholders asked financial institutions to disclose their lending activities. Fossil fuel companies are also being challenged over possible greenwashing allegations as well as allegations that they are not properly disclosing their climate change vulnerabilities to investors. Increased regulatory scrutiny is also underway in Australia. For example, in November 2021, APRA released its Prudential Practice Guide on Managing Financial Risks Related to Climate Change, providing greater clarity on APRA’s expectations and best practices for managing these risks. ASIC is also stepping up its actions against ESG washout and in particular “net zero” statements in offering documents.
Climate change therefore presents a significant risk to directors and officers. Accordingly, insurers should pay particular attention to:
- questions posed to financial institutions on proposal forms regarding their lending activities, including in light of directors’ duties, misleading or deceptive conduct and continuous disclosure obligations;
- whether policies respond to climate-related disputes; and
- Should lower limits be imposed on weather-related claims?
Insurers should also review the wording of their policies, especially bespoke extensions (such as those related to pollution or environmental mismanagement), as these could be broad enough to cover claims related to climate that were not intended to be covered.
Life insurance risks are also impacted by climate change; death rates are linked to natural disasters, which also have secondary effects by disrupting critical infrastructure, affecting air quality and increasing vector-borne diseases. Additionally, the increased likelihood of mortality from both heat and cold is also a growing concern. Insurers need to review risk assessment modeling to ensure they adequately account for the impacts of climate change.
As climate change continues to ravage Australia, property insurance will become unaffordable and/or unavailable to many. Premiums will also rise across the sector to counter increased risk. This will also have an impact on the handling of complaints and the management of disputes. Efforts to avoid these problems will require collaboration with governments and policyholders.
As climate change causes increasing losses to the insurance industry in Australia (and globally), there are many opportunities for insurers if they invest in data to enable them to adapt appropriately. to risks. This will allow them to expand into underdeveloped insurance markets, offering new products for emerging climate risks. It is also an opportunity for insurers to help communities manage risk and recover from disaster.