Rising Temperatures Lead to Rise in Insurance Claims
As insurance companies face increasing claims due to natural disasters, they must take action to mitigate these risk if they hope to remain profitable.
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Climate change is clearly causing a dramatic increase in natural disasters. When thinking about effects of climate change we often think of hits to agriculture, travel, energy, mining, and other industries facing a direct impact from rising temperatures. One that is sometimes overlooked is the insurance industry, yet it faces compounded risks from all industries. Allianz, the largest insurer in Europe, expects climate change to “increase insured losses from extreme events in an average year by 37% within just a decade” [1]. In fact, “Munich Re has done studies estimating that […] extreme weather events led to more than $500 billion in covered losses between 1980 and 2011 “[2]. What is difficult about the threats insurance companies face versus those faced by companies in other industries is that solutions aren’t actually in their direct control—the companies and individuals they insure need to take actions to combat climate change.
Common solutions for combatting these risks focus on risk minimization, research on solutions, and loss prevention. With risk minimization, a focus of US insurance companies, companies stop insuring entities that are deemed too risky. For example, Allstate stopped renewing and even cancelled policies for many Gulf Coast states due to major losses (wiping out 75 years of profit) caused by recent hurricanes. They “cut the number of homeowners’ policies in Florida from 1.2 million to 400,000 with an ultimate target of no more than 100,000” [1]. In the Proactive approach, companies spend on clean energy opportunities like “AIG’s Global Alternative Energy Practice, Allianz’s Climate Solutions, Aon’s Agri-Fuels Group and Chubb’s Green Energy Team” [1]. Loss prevention is akin to a combination between risk minimization and the proactive research; it focuses on mitigating risks given our current situation and includes options from improving disaster resilience of entities, energy efficiency programs, green design of buildings, and trading of carbon emissions.
Allianz created Allianz Climate Solutions to deal with these changes. They address the three approaches mentioned above with their “Anticipate, Care, Enable” strategy.
To mitigate financial risks, they “anticipate” the increase in claims caused by climate change and adjust policies and investment decisions accordingly. Allianz plans to work with 37 environmental, social and corporate governance (ESG) criteria to make more informed decisions in addition to divesting from coal[3]. This will help in two ways : 1) Allianz’s financial investments will be diversified and therefore less at risk since they take climate change risk into consideration 2) divesting from investments that accelerate climate change will hopefully have a positive impact on the environment as those companies find it harder and harder to find funding due to companies like Allianz pulling out funds.
Additionally, Allianz “cares” about the environment and takes proactive steps to slow down climate change. Due to Allianz’s far reach of insurance policies, they have been able to gain insights from researching the businesses of their customers to better understand causes of and solutions to climate change. We can see a particular instance of this is in Brazil where Allianz conducts research on “the change of rainfall patterns and extreme weather events influence [on] crop yields” [3]. This research helps those Allianz insures and in turn Allianz themself.
Finally, they work to “enable” individuals and corporations to take actions to prevent losses that are a result of the climate changes we already face. Not only has Allianz made solutions available to lower emissions that other companies can take advantage of, but they have also put this into practice with their own business. Despite having been “carbon-neutral since 2012”, Allianz still strives to lower their carbon footprint [3].
No longer making money off of certain clients, insurance companies are highly incentivized to take action against climate change. While Allianz is making a lot of progress in combatting climate change, they can take their research a step further by incentivizing those they insure with lower rates if they follow certain guidelines. Similar to how car insurance companies like Progressive alter rates based on ones driving ability, Allianz can financially incentivize their clients to make changes they might not have otherwise. With climate change on the rise and profits of insurance companies dropping, they need to do everything within grasp to incentives companies to lower emissions.
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Sources
- http://evanmills.lbl.gov/pubs/pdf/climate-action-insurance.pdf
- http://www.rmmagazine.com/2015/02/03/climate-change-and-its-impact-on-the-insurance-industry/
- https://www.allianz.com/v_1462265985000/media/press/document/160425_Digital_AZ_ClimateSolution_A5_portrait.pdf
- https://climatecrocks.com/2012/02/14/insurance-companies-should-be-selling-the-public-on-climate-change/
This is a great example of how sustainable practices are aligned with the performance of a business. However, it is very worrying that insurance companies might have to raise their premiums in regions that are the most affected by climate change. At higher insurance prices, less percentage of the businesses in those regions will be able to get insurance, making them riskier investments. In consequence, funding will be harder to attain and investors will become more demanding in terms of ROI. This would generate an vicious cycle and these regions could undergo a serious economic downturn.
I really liked your post! I shows how a company traditionally assumed to be negatively exposed to climate change can turn this adversity into a business opportunity. Allianz has been widely regarded as a thought leader on climate change solutions, not least since they established their Munich think tank Allianz Climate Solutions. Furthermore, Allianz has been able to respond to the demand for climate change related insurance solutions very well. Their subsidiary AGCS offers consulting services and insurance coverage for renewable energy providers, e.g. wind and solar energy providers. Other climate change related products offerings would be crop insurance and micro insurance solutions for countries which will see a big impact in climate change related damages in the future.
Furthermore, it should be kept in mind that Allianz is also well positioned to change investment standards around ESG topics by being both a thought leader on environmental topics and a large investor in terms of assets under management. They were one of the first financial services providers who signed the UN Principles of Sustainable Investments and rank consistently high in sustainability driven indices, such as the Dow Jones Sustainable Index (where they are currently the leader in the insurance space). This shows how seriously the company has taken both the direct impact of climate change on their business and their societal responsibility as a large player in this market.
Riley, thank you for your fascinating post. It’s interesting to draw parallels with the natural disaster insurance industry and the US health insurance industry before the Affordable Care Act (‘Obamacare’) came into effect: namely, that insurance companies can simply deny coverage to residents who are in disaster-prone areas. This has always been the case to some extent (e.g. if you live in a low-lying floodplain, you’re unlikely to get flood insurance), but my question is twofold:
(1) To what extent is the issue for insurance companies just the fact that their actuarial models are ‘out-of-whack’ with the effect that climate change has on increasing the frequency of natural disasters? Currently they would be based on historical data, but if (hypothetically) they were accurate, then insurance companies should be able to manage the risk by either increasing premiums or denying coverage (as the US health insurance industry did for many years before the ACA). Accurately predicting the frequency of natural disasters (e.g. with best-in-class climate modelling) could become a source of competitive advantage for insurance companies who crack this, and even allow them to increase their profitability over time.
(2) Given the possibility for (1), do you see a role for regulation (similar to the ACA) for natural disaster relief? Is it appropriate for governments to mandate coverage for at-risk individuals (even though doing so would risk making the insurance company insolvent)? Similar to arguments made about the ACA and healthy people cross-subsidizing the healthcare cost of unhealthy people, would maintaining equitable coverage for insurance risk of people living in low-risk areas subsidizing others’ choice to live in high risk areas?
Thanks for the post Riley. It is interesting to see insurance companies are also taking action against climate change. I assumed they “just” adjusted their models and margin pricing to compensate for the uncertainty. I believe the future for insurance companies will rely on more and more sharing of risk to prevent cases in which a sequence of natural disasters take these companies out of business.