Re/insurers need to take a fresh look at risk for the sake of the climate

Climate scientists regard the 1.5°C threshold enshrined in the Paris Agreement as a key tipping point for the planet, beyond which extreme weather events will become more frequent and severe.

The physical risks of climate change in turn lead to water scarcity, crop failure, loss of infrastructure, conflict and migration. These have significant macroeconomic implications for governments, which have to provide relief or cover following losses after a catastrophe, but it is not only governments that are affected, according to Michelle Radcliffe, director of insurance consulting and technology at WTW.

“The affordability and insurability of natural catastrophe risk is increasingly becoming a concern,” she said.

Radcliffe moderated a panel discussion with climate experts from Munich Re, Zurich Insurance and Gallagher Re, in a webinar hosted recently by the Better Insurance Network.

In Europe, only one-quarter of total losses caused by climate-related extreme weather events were insured, while in other parts of the world that figure is a lot less. This brings with it the question of the insurance “protection gap” and there are increasing calls for the insurance industry to be more prepared to absorb such risks.

“We’re referring to adaptation and resilience in insurance more and more,” Radcliffe said.

Adaptation versus resilience

These two terms are often used interchangeably in policy and academic discourse but there are differences between them. Adaptation refers to the adjustments in ecological, social or economic systems in response to actual or expected climatic stimuli and their effects. Resilience is the capacity or ability to anticipate and cope with shocks and to recover from their impacts in a timely and efficient manner.

Adaptation and resilience is poorly understood as a joint concept, according to Antoine Bavandi, global head of public sector, parametric and climate resilience solutions at Gallagher Re.

“Adaptation includes specific risk reduction investments – for instance, by governments – and also, more globally, transformational shifts in economies towards more sustainable ways of operating. In terms of natural catastrophe risk, that means building flood defences, such as dykes, while keeping in mind whatever we do in adaptation can have positive and sometimes negative effects on resilience,” Bavandi said.

“You’re see an increasing number of insurers stepping back from writing property business, for example, because of the increase in acute and chronic hazards. How do you avoid essentially pricing people out the market while providing the protection, which I think we agree is needed?”
_{Michelle Radcliffe
WTW}

“Resilience would be any sort of measure, policy or instrument that looks at the ability to cope with events once they materialise, which is typically the role of insurance, but it’s also the role of contingency plans in general. Building dykes may have a negative effect on resilience in the sense they might not incentivise the use of insurance if they are poorly designed or poorly maintained,” he added.

In agriculture, adaptation measures would typically include things like drought-resistant crops, developments in irrigation or “climate smart” agriculture. Resilience measures would be parametric insurance, cash transfer and social protection programmes.

There is the need, therefore, for a more holistic approach to adaptation and resilience but adaptation is usually in the hands of ministries responsible for equipment, agriculture and the interior, which look at slow-onset risks. On the other hand, resilience normally falls to the insurance industry, insurance regulators and ministries of finance.

“There is clearly a gap between these different ministries and stakeholders and decision-makers. There’s also a lack of understanding and analytics that can really connect the two different dimensions of effective risk management. There are long-term and cross-sectoral investments with direct and indirect impacts on the economy: that’s adaptation. And there is the insurance industry, which looks at natural catastrophe models that cover geographic impact really well, but the time dimension much less so. The insurance industry has a key role to play in connecting the two agendas but there’s a long way to go,” Bavandi said.

Bouncing back

Julian Richardson, chief underwriting officer for green solutions at Munich Re, said resilience, in simple terms, is the ability to bounce back from an event.

“We know the genie is already out of the bottle on climate change. In the US alone in 2023, we’ve had more than 5,000 heat and rainfall records broken and around the world this year, we’ve had more than 10,000, heat and rainfall records broken, so climate change is here, it’s real, it’s happening and we can’t stop it. We can use engineering and science to mitigate some of those impacts, but it would be somewhat hubristic of us think we can stop climate change.

“So it is about our ability to bounce back from these events when they do happen. Fundamentally, insurance is what resilience finance is, and we’ve been bringing resilience to individuals and also to cor­porates for many years. That’s essentially what our industry does but we need to expand that through innovative schemes and approaches to make sure more people benefit from insurance or insurance-like solutions,” he said.

“What we have to remember is an insurance or risk-transfer transaction only happens after a long process of risk management. It’s really important to give sovereigns and sub-sovereigns, particularly in emerging and developing economies, ownership of their risks”
_{Julian Richardson
Munich Re}

Richardson highlighted a study by the Bank for International Settlements of the earthquake events that took place in New Zealand and Haiti and their very different capacities to deal with them because of the contrast in insurance penetration.

“If you’re in Haiti as opposed to Christchurch, you don’t have the ability to call the building contractor because you probably can’t afford it because you may not have an insurance payout. That means you’re rebuilding your own property, that means you can’t go to work and that reduces the economy,” he said.

“We need to be bolder about demonstrating the value of insurance because resilience finance is what insurance is. The more people we’re able to protect, the more communities we are able to support, the better chance they are going to have of long-term sustain­able development.”

Pointing out flooding affects people globally more than any other type of natural hazard and causes some of the largest economic, social and humanitarian losses, Radcliffe asked how insurers should respond when they are “ultimately answerable to numerous stakeholders and profit is on people’s minds”.

“You’re see an increasing number of insurers stepping back from writing property business, for example, because of the increase in acute and chronic hazards. How do you avoid essentially pricing people out the market while providing the protection, which I think we agree is needed?” she asked.

Adapt the business model

Michael Szönyi, flood resilience lead at Zurich Insurance, said insurers need to reassess their core business model and take the opportunity to “modify if not revolutionise” the market to participate more in adaptation and resilience.

“The things we do now are investments that are often seen as costs, with the benefits coming asymmetrically only in the future. That’s a challenge we need to break through,” Szönyi said. “There are different stakeholders to satisfy in the short term, meaning we need to be profitable, but we need to make sure, long term, we can still insure.”

Citing a statistic from the Swiss Re Institute that traditional insurance capacity in the natural hazard space is declining year-on-year and in 2022 had been reduced by up to one-quarter, he said: “That should send an alarm signal.”

“Risk management and protection is in the DNA of the insurance industry,” he said, adding Zurich’s own analysis showed every dollar invested in prevention and resilience building saves, on average, $5 in future losses. “The cost-benefit case, the economic case is really clear,” he said.

“Adaptation includes specific risk reduction investments and also transformational shifts in economies towards more sustainable ways of operating. That means building flood defences, such as dykes, while keeping in mind whatever we do in adaptation can have positive and sometimes negative effects on resilience”
_{Antoine Bavandi
Gallagher Re}

“Whenever we touch a risk, we should bring adaptation and resilience into the claims process. A great example of the key to resilient recovery, to building back better, is the UK’s Flood Re. With government-backed incentives, customers can invest in resilience measures, as the loss happens, to at least make sure the same loss doesn’t happen again. But that’s only the starting point, because we want to avoid the loss happening in the first place.”

That means looking at risk engineering as a service the insurance industry can provide to customers, he said, pointing out Zurich has built up its own climate resilience services.

“The trick is, we can’t just be a service provider, as an insurance industry within the climate space, if we only provide services but don’t in-house the risk any more. How do we avoid just being a service provider? By moving over to the underwriting side and really asking how we can incentivise risk reduction and adaptation more in our standard procedures. [Otherwise] there is a real risk of the core business model turning into an irrelevance for climate risk.”

Risk reduction benefits

Insurers must not simply exit markets and hazards, he said, but instead see the value risk reduction can bring to the underwriting process.

“How do we certify and standardise adaptation measures so they are actually visible in our underwriting process? Are they included in our insurance models? And then, thinking a step further, can you participate in the benefit of one dollar spent now, saves five dollars later? We should co-support adaptation measures together with our customers because the biggest value is not having the loss in the first place. Incentivising customers on prevention measures is something we need to bring through as our standard operating procedure,” Szönyi said.

“How do we avoid just being a service provider? By moving over to the underwriting side and really asking how we can incentivise risk reduction and adaptation more in our standard procedures. [Otherwise] there is a real risk of the core business model turning into an irrelevance for climate risk”
_{Michael Szönyi
Zurich Insurance}

Richardson said it is hard for underwriters to give customers a credit score because they are “pricing a basket of risks that may or may not occur”.

“To carve out very specific premium elements can be really difficult, so price signals are tough to give. What we have to remember is an insurance or risk-transfer transaction only happens after a long process of risk management. It’s really important to give sovereigns and sub-sovereigns, particularly in emerging and developing economies, ownership of their risks.

“By sharing data, by sharing insights, we can support them in understanding their risks better, and by having ownership of them, they can decide what they want to do with them. And when it comes to that final decision, sitting with an underwriter, whether it be a private sector entity or a multilateral, those sovereigns and sub-sovereigns become informed buyers who make informed purchases. It’s there they will see the value of the risk transfer at the end of the day.”

Protection gap education

The insurance industry is not doing enough to “educate and demonstrate” its potential value in helping to close the protection gap, Richardson added.

“We’re often criticised for how insurers ‘don’t pay out’ but, actually, we pay out an awful lot of money and we need to be demonstrating the efficacy of what we do and how we can help.” Insurance and risk transfer is a “complex transaction”, he added.

“I’ve been working in the insurance industry for more than 30 years and my heart still sinks when I have to renew my own home and car insurance. Imagine then if you’re a minister of finance and the very complex financial transactions they’re undertaking.”

Richardson participated in the Business of Resilience meetings hosted by the UK’s Department of Inter­national Trade, which brought together chief risk and resilience officers from around the world, insurers and multilateral organisations, to start building a “community of knowledge”.

“It’s about understanding what can and should be done in this interaction between the large pool of capital we have in the private sector insurance market – $3trn in the non-life insurance sector – and public sector entities to help them understand the risks and to build resilience.”

He also highlighted in April this year, Munich Re co-hosted with the Insurance Regulatory Authority of Kenya the Eastern and Southern Africa Regional Conference on Inclusive Insurance.

“Our programme in east Africa, concentrated on Kenya and Ethiopia, included a series of workshops with nine different government ministries represented. We talked about how they can use insurance to deliver the [UN] sustainable development goals and building resilient communities is one of those.

“And the lights went on with many of these people in the civil service, who had no idea this was even possible. So we as an industry need to be doing more outreach and more engagement in those parts of the world,” he said.

The value of risk prevention

Szönyl said there is the question of how to value the role of risk prevention.

“If I’m honest and play devil’s advocate, I feel there is a bit of a disconnect between what we as an insurance industry sometimes say, at the highest level, in terms of how we contribute to the closure of the protection gap, and then, that one of the key principles is risk-reflective pricing,” he said.

“Very often we say we price according to the level of risk, and that this sends the right signal to customers or to society to take action and reduce their risk. That inherently means, if society does act and does reduce their risk, then somehow we need to follow suit and provide something that is in line with that new level of risk in order to be in line with the principle of risk-reflective pricing.”

He referred to discounts on fire insurance from investment in water sprinklers.

“How did we get there? We were technologically involved knee-deep in the development, assessment and understanding of the risks and of the benefits of the protection against that risk. This means we could then underwrite it and actuarily better understand the pricing implications. Through certification, through research and development, I think the key word is underwriting laboratory, so bringing an industry-wide knowledge institute to the table to help us analyse what is a good risk, what is a bad risk and what are the pathways between them.

“Compared with the history of water sprinklers, the climate risk debate within the insurance industry is still emerging. We are still on a steep learning curve where we need to better understand what good protection means, and how we certify it and bring it into our underwriting models and actuarial calculations. That’s where I see an opportunity to make progress.”

Cop28

Richardson said Cop28 is “looming large on the horizon” and there are two things he is personally looking out for. The first is progress on the loss and damage fund, which was agreed at Cop27 to compensate vulnerable countries hit hard by climate disasters. The second is on Article Six of the Paris Agreement, which outlines market-based approaches to carbon reduction and removal targets.

“The genie is out of the bottle on climate change, and people are suffering the impacts of it now. So we have to ensure that they are protected from losses and damages that actually occur. And this is what we, as an insurance industry, have been doing for 300 years and so we need to be contributing to that conversation because we have the technology, skills, data, products and some of the solutions to solve the loss and damage debate. And if we are able to do that, it will unlock a lot more productive progress in other areas, because loss and damage is currently a huge source of political tension between negotiators,” he said.

“On the developed economy side, the big word no one wants to use is reparations. We know it’s off the table, politically, but we must support events where they do occur and help people be resilient and bounce back from these effects that the developed economies contributed to.”

Helping the developing world become informed buyers who understand their risks will enable underwriters to have a “completely different conversation” with them, he said.

Bavandi stressed the Covid pandemic and the Russia-Ukraine war had illustrated how extreme events “can make their way on to your asset or liability exposures”.

“I would really encourage the insurance community to go towards scenario-based risk assessments as a good climate stress test framework,” he said.

Parametric insurance has a key role to play, he said, in leveraging the wealth of data useful to future climate science and risk environments and because it is well suited to financing time sensitive expenses following a disaster.

“The parametric market is expanding massively and the consensus is it’s about $1bn of premium annually. It used to be in the remit of a few insurtechs and geeky underwriters up until about 10 years ago, but things have changed drastically.

“What’s probably lacking is a strong offering around flood risk, but for everything else – wind, drought, even hail – there are very strong models and basis risk is now much better understood.”

Richardson described parametrics as a “great way to simplify risk”, having a “certain elegance and speed to no-quibble settlement”.

He remains “unconvinced” about microinsurance, which has had “some great demonstration transactions”, but these are not enough. “We need 1,000 or even 10,000 of those transactions,” he added.

His message ahead of Cop28 is the insurance industry is “open for business and can help”.

“But we need partnership with multilateral development finance institutions. We need the sovereigns and sub-sovereigns to engage with us. And we really need to scale this up, and significantly, if we’re to contribute to the solution and if the potential beneficiaries are to capture the benefits we can offer.”