Insurance

The impact of climate change on the insurance industry

Life throws curveballs—an unexpected illness, a car accident or damage to your home.  Insurance acts as a safety net, offering financial protection against these potential misfortunes. In exchange for a regular payment (premium), insurers agree to cover specific losses or perils outlined in your policy. If you experience a covered event and file a claim, the insurance company will review it and, if approved, provide financial assistance to help you recover.

The power of many: Risk pooling

But how do insurers afford to pay out on these claims? They rely on a concept called risk pooling. By collecting premiums from a large group of people, they create a pool of funds. This allows them to pay claims to a smaller number of individuals who experience a covered event, spreading the financial burden and ensuring everyone has a chance to recover.

The challenge of the unexpected: When many are affected

How do insurance companies handle multiple individuals experiencing a covered event  simultaneously, such as the hurricanes of 2022 and 2023 in the US? Hurricane Ian in September 2022 was particularly destructive, with CoreLogic estimating insured losses to reach a staggering $70 billion—that was one of the costliest storms in US history.

The strategy of risk pooling that insurers use, is based on the assumption that claims will be spread out over time. A surge of claims significantly depletes the pool's resources. This burden is a growing concern for insurance industries.

Climate change and insurance: A shifting landscape

Insurance companies are adept at handling unforeseen events. However, the increasing frequency and severity of weather events due to climate change impacts the well-oiled machinery of the insurance industry. Here's how:

• Increased payouts and losses: Rising global temperatures lead to frequent extreme weather events like floods, wildfires and hurricanes. This translates to higher payouts for insurers due to property damage, infrastructure destruction and displacement costs.
• Difficulty in risk assessment: Erratic weather patterns make historical data less reliable for risk assessment. This makes it challenging for insurers to predict future risks and set appropriate premiums.
• Disappearing coverage: In high-risk areas, insurers may become more reluctant to offer coverage or may significantly increase premiums, making it unaffordable for some property owners.
• Resource strain and policy overhaul: Extreme weather events demand efficient resource allocation for a swift response. Delays due to stretched resources can damage customer trust. Additionally, existing policies may not reflect the changing risk landscape, requiring insurers to revamp their offerings. This could involve new coverage types or adjustments to existing ones, for example, higher deductibles in high-risk areas.
• Cost allocation challenges: Climate change brings increased business losses for insurers. Rising costs need to be effectively absorbed into the overall cost structure, demanding a critical review of current allocation practices.

When the premise on which insurance industries act—predicting and managing risk—is challenged by nature’s fury, it is time for them to think of innovative ways to adapt.

The future: Adapting to a new reality

Mark Carney, former governor of the Bank of England, emphasises, "Climate change is fundamentally changing the risk landscape, and the insurance industry needs to adapt its business models to reflect this new reality."

Here are some ways the insurance industry can act to manage these changing risks:

• Invest in new technologies and data analytics: Tech adoption wins! Technologies such as advanced data analysis and artificial intelligence (AI) help insurers better understand climate patterns and model future risks. This allows for more accurate pricing and risk assessment.
• Develop innovative insurance products: New insurance products tailored to address specific climate risks, like flood insurance in high-risk areas, can help both property owners and businesses manage their exposure.
• Promote risk mitigation and adaptation: The insurance industry can incentivise policyholders to take steps to mitigate their risk of climate-related damage. This could involve offering discounts for homes built with hurricane-resistant features or for businesses with robust disaster preparedness plans.
• Advocate for climate action: The insurance industry has a strong voice and can use it to advocate for policies that mitigate climate change. This could include supporting policies that promote renewable energy and sustainable development.

By taking proactive steps, the insurance industry can play a vital role in building a more resilient future in the face of climate change.

Conclusion

Climate change presents a complex challenge, but it's also an opportunity for the insurance industry to innovate and lead the way towards a more sustainable future. By working together—insurers adapting and individuals preparing—we can build a world where everyone has access to the financial security they need, even in the face of changing climate patterns.

How can Infosys BPM help?

Climate change necessitates innovative approaches from insurance firms to maintain operational efficiency and competitiveness. Insurers must tailor their strategies to this evolving landscape, a challenge where Infosys BPM’s Insurance Outsourcing Services can offer invaluable assistance.