What if insurers stopped paying the climate bill?

In August, California was hit by the hottest temperatures ever measured in the area and possibly on Earth (54°C in the Death Valley). More than 100 wildfires across 12 Western states incinerated more than 4.3m acres, pushing 500,000 people out of their homes in Oregon alone.

Overall, the United States has been hit hard by an accumulation of extreme events this year and insurers are struggling to cover the toll and have a hard time anticipating the spiralling costs of natural disasters. The probability of seeing insurers overwhelmed by the worsening effects of climate change is very high. Joëlle Noailly, professor of environmental economics at The Graduate Institute in Geneva:

“The latest prediction models developped this year show that the social cost of carbon (economic losses linked to global warming) is three times higher than what our current models predicted. Society is not prepared to include such costs.”

In the US, insurance companies have even refused to renew policies in fire-prone zones forcing the state of California to impose a one-year moratorium to protect 800,000 homes: an unprecedented and worrying move.

"It is logical for insurers to refuse to cover these costs which are difficult to quantify and which will become more and more frequent. A trend that, with the increase of extreme events linked to climate change, will continue. Insurers will have no choice but to increase their premiums.”

A financial burden on the rise. According to Swiss Re, natural disasters cost $219bn worldwide in 2017 and 2018. New research shows that the wildfires of 2017 and 2018 alone wiped out a full quarter-century of the industry’s profits. California’s homeowners’ insurers alone lost a total of $20bn, according to the American consulting firm Milliman, twice the industry’s cumulative profits since the major wildfires of 1991. This financial stress is all the more worrying as states find it increasingly difficult to release funds to assist the victims. Milliman:

“The number of annual homeowner complaints about non renewals in the highest-risk area codes rose 249% between 2010 and 2016.”

The devil biting its tail. The insurance industry that can heal the wounds of societies threatened by climate change is precisely the industry that is most destabilized by climate change. This creates a vicious circle:

• Vulnerable customers who live in the “wrong” areas have to pay increasingly high insurance rates when insurers don’t simply refuse to renew their policies. In areas considered high or very high wildfire-risk, the number of people on California’s higher cost insurance plan grew 177% between 2015 and 2018.

• Government regulators are under the difficult choice of protecting their citizens and making sure insurers that are vital for reconstruction don’t go bankrupt.

• Insurers are more and more overwhelmed by accelerating climate risks and unable to predict future losses jeopardizing people’s recovery.

Predicting the unpredictable. Despite their historical expertise in risk prediction, climate change proves to be a tough call for insurers. After Hurricane Andrew wiped Florida in 1992 causing $28bn in damage, far more robust catastrophe models grounded in science and engineering were developed to assist insurers in pricing and managing risk. But hurricanes are more predictable than wildfires, of which 84% are caused by human activity.

Plus, most of the climate models used so far for the Paris Agreements did not include very rare events. Noailly:

"The tipping points have been poorly anticipated so far. We just started to introduce extreme events in the new models that we are starting to develop this year. The economic losses that they will generate will be much greater than expected.”

This situation could very well lead to the destabilization of our economic systems and to a crisis as severe as the subprimes, according to Noailly.

Possible solutions:

• Reinsurance: an insurance company purchases from another insurance company to insulate itself (at least in part) from the risk of a major claims event. Problem: Reinsurance itself has become more expensive as climate change worsens.

• Higher insurance rates but insurers are only allowed to set prices based on prior losses.

• Exclude construction where risks are too high, such as flood or fire-prone areas.

• Better prediction with the improvement of catastrophe risk models. For example, Zurich Insurance Group launched their dedicated Climate Change Resilience Services this month to help businesses better prepare for current and future physical risks related to natural hazards and climate change. Amar Rahman, specialist in Natural Hazards Resilience, Zurich Insurance Group, said:

“We firmly believe in prevention as the best form of protection. Adaptation costs for climate change effects may be significantly lower than damage costs.

In 2019, Zurich was the first insurer to sign the Business Ambition for 1.5°C Pledge aimed at limiting average global temperature increases to 1.5°C above pre-industrial levels by 2030.

“As part of the pledge, Zurich is engaging businesses with high exposure to carbon-intense fossil fuels in a dialogue about climate change risks. We will continue to do business with those that have committed to a lower-carbon business model.”