Abstract

Climate change is manifesting in the form of erratic weather patterns and recurring natural catastrophes (CAT).

This is leading to losses for property and casualty (P&C) insurers. A National Centers for Environmental Information (NCEI) report reveals that the U.S. alone has incurred costs of over $2.195 trillion on weather-related disasters since 1980. We discuss the impact of climate change on the P&C insurance industry and highlight opportunities for growth. Additionally, we propose a framework for P&C insurers to systematically analyze climate risks and opportunities and define a strategy for the future.

Risk to opportunity

In the recent past, the P&C industry has witnessed increasing CAT losses, and climate impact is one of the main reasons.

Frequent weather-related catastrophes, coupled with other challenges, can make covering climate risks unaffordable for customers and unviable for the industry. In fact, premiums charged do not match the actual risks covered as is evident from the unfavorable loss ratios (LR). The impact of climate change on the P&C industry has been largely detrimental. However, it also offers insurers an opportunity for transformational change, which could take the form of adapting business models to the new reality, introducing new climate-specific products and services, and re-examining carbon-intensive investment strategies. 

_{Figure 1: Five dimensions of climate change impact and opportunities}

Let us analyze the effects and opportunities related to climate change across five dimensions: value chain impacts, risk models, new opportunities, investment management, and compliance (see Figure 1).

Value chain impacts

Climate risks impact the overall value chain of a P&C policy, right from quote through claims across areas such as product modeling, pricing, sales teams, agents and brokers, renewal retentions, billing options, reinsurance criteria, green compliance, and insurer preparedness to deal with CAT events. Product conceptualization for emerging climate-related risks requires deep CAT modeling. Underwriting guidelines, reinsurance treaties management, third-party adjusters (TPAs) are other areas that will be impacted. Risk management needs to address prevailing deficiencies by building robust CAT models for the emerging reality.

Risk models

Insurers usually rely on past losses to project future losses, and unfortunately both the past and future losses are not symmetric. Risk models are not aligned with the changing climate reality. For example, the National Flood Insurance Program (NFIP) uses a 1970s risk model—over the last 50 years, NFIP premiums stood at $60 billion while payouts amounted to a whopping $96 billion. The industry is looking at embracing the Federal Emergency Management Agency’s (FEMA) Risk Rating 2.0  methodology to correct skewed risk models by factoring climate effects. 

Similarly, events such as the Uri winter storm in Texas and heatwaves in Canada have highlighted deficiencies in local building codes. The existing risk models are usually limited to territorial and time constraints, whereas climate change is a global phenomenon. To address these challenges, insurers must:

• Leverage emerging technologies such as quantum computing, artificial intelligence (AI), machine learning (ML), and the internet of things (IoT) to develop dynamic connected risk prediction models suitable for a connected world.

• Collaborate with ecosystem partners and leverage their collective knowledge to launch new and innovative insurance products to cover emerging risks at optimal prices and meet evolving market needs. 

New opportunities

While the negative impact of climate change on P&C insurance has been overwhelming, the shift to green energy offers opportunities for transformational growth. These opportunities include launching new green products to cover renewable energy operations, adding new endorsements to existing products, adjusting pricing models to encourage renewable energy usage, and introducing liability coverage for pricing adjustments. However, insurers must carefully study renewable energy transitions and associated technologies to fine-tune their portfolios of products, services, and investment options. Insurers must move quickly, as early adopters will gain significantly from the first-mover advantage. 

Investment management

Insurance is a low-margin business, and insurers rely heavily on investment income for improving operating ratios. A major share of insurers’ investments goes into bonds that support infrastructure development, especially in areas witnessing increased migration, and these projects may not always align with sustainability goals. As a result, insurers may be inadvertently supporting investment in non-green initiatives. Consequently, they are coming under societal and regulatory pressure to embrace green investment initiatives. Insurers must therefore divert investments to green and renewable energy projects and help drive a shift from fossil fuels to renewable energy sources such as solar and wind. Although the pace is slow, some insurers have already made the shift, but the industry as whole needs to do a lot more to make an impact.

Compliance

Recently, the U.S. Department of the Treasury emphasized the need to evaluate gaps in climate-related regulations, assess the potential for disruption in coverage and enhance resilience and mitigation, and leverage insurers’ ability to achieve climate goals. Clearly, the onus is on insurers to act. A recent U.S. government order requires insurers to declare their green investments and climate exposures to the Financial Stability Oversight Council (FSOC) and other regulatory agencies. Given climate-related adjustments have the potential to impact traditional compliance parameters such as solvency ratio and capacity ratio, insurers must take the lead by leveraging AI and ML technologies, data techniques, and predictive modelling techniques to ensure compliance.

Greening P&C insurance

How can P&C insurers capitalize on climate opportunities and position for future growth?

While the P&C industry has a significant role to play in the entire ecosystem, insurers need a robust framework to understand the specific actions necessary to enable them to achieve a leadership position. Leveraging a climate risks and opportunities management framework (see Figure 2) can help insurers systematically organize innovative ideas by leveraging the Clay Map framework. Insurers can create an innovation portfolio model based on the work of late Harvard Business School professor Clayton Christensen.

_{Figure 2: Climate risks and opportunities management framework}

Quadrant 1: Incremental enhancements to existing products and services

Climate change has an impact on insurance products and their profitability. To overcome profitability challenges and grab emerging growth opportunities, insurers must:

• Introduce new endorsements for improved policy coverage. 

• Improve risk prediction models.

• Incorporate climate impacts into rate indications.

• Introduce green discounts and incentives to encourage right behavior among clients. 

• Adjust reinsurance arrangements to improve operating ratios. 

Quadrant 2: Major product enhancements and new product introduction 

The market demands major product changes or new products to cover climate risk. For example, the introduction of solar panels to generate clean energy may require significant changes to existing liability products and new coverage and endorsements for property risks. Insurer action must center on: 

• Partnering with insurtechs to leverage niche technologies and introduce major product changes and new products.

• Predicting future losses and factoring them into product changes by leveraging industry data sources.  

Quadrant 3: Expansion into new territories

As insurers try to expand their footprint and introduce new products, they must consider multiple options, including leveraging partnerships with other experienced insurers (B2B relationships) and collaborating with insurtechs (ecosystem models) to introduce niche products in new regions. Similarly, insurers must leverage their experience and expertise in a particular area to expand into new territories. For example, an insurer may be experienced in dealing with wildfire coverage in California but not in Montana. This offers the firm an opportunity to expand into Montana by leveraging prior experience.

To expand into new territories, insurers can choose one of three options: 

• Model product pricing and underwriting based on industry or peer experience in the new region and/or their own experience in other regions. 

• Partner with other insurers with operations in the new region to help customers get the required coverage and earn brokerage and commission without bearing risk.

• Launch scalable, innovative solutions by leveraging cross-industry partner ecosystems to reduce time-to-market.

Quadrant 4: Design innovative, climate-friendly products

The market is witnessing the emergence of several new climate-friendly products such as solar powered products, rechargeable batteries, and electric vehicles. Going forward, this trend will gain momentum given the focus on sustainability. Insurers must design the right insurance products with appropriate coverage to cater to such emerging green sectors and incentivize their customers to use them by offering discounts or other offers, which, in turn, will help in preventing losses due to CAT events.  Unfortunately, sufficient data on emerging risks is not available, and collaboration among industry players is key to designing innovative products to encourage the use of climate-friendly products and services. Taking advantage of this opportunity will require insurers to:  

• Allocate budgets to craft innovative products and services for new sectors.

• Collaborate with peers and the insurtech ecosystem to launch new products to cover emerging risks. 

• Create collective knowledge hubs on new products and services to offer superior solutions.

   

Toward a greener future

Climate risk is real, and its impact on the P&C insurance industry is devastating.

At the same time, it offers insurers an opportunity to take the lead in ushering in real change by greening their operations. However, given the industry is treading unknown territory, meaningful progress will necessitate cross-industry collaboration to build data and knowledge hubs. That said, bold steps are the need of the hour, and insurance firms that respond quickly and decisively will lead the charge in the green battlefield.