Climate change is set to touch every part of our lives – from the food we eat to how we heat our homes. But it’s also going to have a transformative effect on businesses, perhaps no more so than within the insurance industry. With climate change creating more extreme weather events, the world is becoming a more dangerous place.
Adam Podlaha, Global Head of Impact Forecasting at professional services firm Aon, is on the frontline of business and climate change, helping his firm to future-proof its risk transfer products so that customers are able to pick up the protection they need.
There is still a significant gap between the economic losses suffered by countries from natural disasters, and the pay-outs related to those losses. Advances in forecasting – modelling where and when catastrophes might hit and the associated potential loss – could potentially narrow that gap.
We spoke to Adam about what the future holds, and in the shadow of the Cop-26 event in Glasgow, how the world of insurance is changing to join the fight against climate change, and mitigate its impacts.
Has climate change always been on insurers’ radar – or have recent events pushed it on, or up, the agenda?
“Climate change has always been a topic that the re/insurance industry has followed, but it has taken on a rapidly accelerated level of importance in the past two to three years. The growth of loss costs has certainly contributed to this shift in attention, but the regulatory space has certainly played a major role as well,” Podlaha says.
“With various financial bodies requiring stress tests to highlight solvency in the face of these increased loss costs, this has forced more strategic planning on how companies are analysing their own investments and portfolios. Diversification of a portfolio through transition risk is a much more common theme observed today as companies try to meet defined “net zero” carbon emission commitments.”
Climate change is set to create more ‘weather events’ – the number is already on the rise. Indeed in the 21st century, more intense weather events have tallied nearly $5 trillion in economic damage, increasing by some 5 per cent each year. So what does that mean for the insurance and re-insurance industry?
Podlaha continues: “The trend of costlier weather and climate-related losses has become more pronounced in recent decades. The combination of more intense events with greater concentrations of population and exposure in what have been identified as the highest risk areas has driven these increased costs.
“Investing in tools to identify best-practice ways to mitigate risk and communicate the possible implications to a residential or commercial property owner can be an important first step to begin lowering future loss potential. The re/insurance industry has never been better prepared than it is today to take on the challenges being presented by climate change. Continued investment into tools such as catastrophe modelling remain important points of emphasis for the industry in terms of assessing volatility.”
It’s estimated that the so-called ‘protection gap’ on weather events now sits at 69 per cent – but what does that mean in layman’s terms?
“When a natural disaster event occurs, it results in damage or direct impacts with a subsequent financial cost,” highlights Podlaha.
“If a specific insurance policy in place covers the identified damage or direct impact, then it will result in a direct payment from an insurance company. The portion of the overall economic damage cost that is not covered by insurance highlights a “gap” in coverage.
“There are many reasons why such a large protection gap exists. The most obvious is that many high-risk and high-impact areas of the world have very low insurance take-up. Parts of Asia, Latin America, and Africa in particular are often impacted by high economic loss events – such as tropical cyclones, floods, earthquakes, severe convective storms, etc – that in many cases are mostly uninsured.
“However, even in regions with robust insurance coverage, such as the United States or parts of Europe, there can be gaps in coverage based on how various perils are bundled together or not covered by standard policies. The most known example is the flood peril in the United States, where a standard homeowner policy does not include flood coverage and a separate flood insurance purchase is required through the federal government.”
The latter is a particular problem: rainfall in the United States is increasing dramatically with each passing year, and with more properties being built on land more partial to flooding, that increases the danger of serious damage – with implications for insurers.
What are the implications of the protection gap – for industry and for the world at large?
“The protection gap is yet another tough reality that some of the poorest parts of the world are among the most vulnerable and least likely to obtain robust insurance coverage,” Podlaha says.
“There has been an increased focus with the private sector more directly engaging with governmental agencies and other public sector entities to develop new insurance programs that can ensure an influx of financial support in the aftermath of major events.”
People think of climate change as purely a physical phenomenon, but it has social consequences too. A UN report cited by Aon recently reckons that some 235m people across the world – one in 25 – needed assistance from some kind of crisis in 2020. What are insurers doing to future-proof their work against the second-order effects of climate change?
“There is increased focus on the interconnectedness of natural peril events that has shifted how we view risk. While the physical damage risk is the primary source of direct impact, the secondary and tertiary effects can be just as significant. This has had very real implications in the supply chain space, for example,” says Podlaha.
“Other topics gaining more attention with climate change include litigation and liability, reputational risk via inaction, the rise of the activist investor, food insecurity, and various geopolitical concerns. Climate change is a very complex subject with broad implications across most facets of our lives. Some implications are more obvious than others.
“The good news is that the insurance industry has never been in a better position to lead on this topic than it is today and is making strides to help reduce volatility and build resilience.”
Despite the increase in the number of disasters, the insurance industry managed to weather the storm in 2020 due to its strong capitalisation, which meant disasters could be comfortably managed where cover was in place.
But the industry is still committed to going further to ensure that it fulfils its purpose – stepping in to help when the worst happens.