Climate Risk is Shaping Insurance – Here’s How

This post is part of a series sponsored by CoreLogic.

As climate change alters the atmosphere and increases the frequency and severity of natural catastrophes, insurers must adapt to a shifting environment and industry regulations. Scientific understanding, investor goals and variables regarding climate risk modeling are evolving to meet the needs of the moment. This is putting even greater pressure on insurers to adhere to (and exceed) regulations and customer expectations.

To remain competitive in this new paradigm, it’s critical for insurers to keep abreast on the latest climate risk insights shaping the insurance space.

Much like a ship’s radar as it sails into a deep fog, these insights can help insurers identify and avoid risky regions and business lines while identifying safe waters. Below are four climate risk insights insurers should consider while serving customers — and navigating the often murky waters of the larger insurance industry:

Insurers need to stay on top of the latest emerging science and decide which climate models are the most accurate and applicable for them. The World Climate Research Programme’s Coupled Model Inter-comparison Project involves over 30 groups around the world. Each runs complex numerical climate models that couple the physics of the ocean and atmosphere together to produce climate projections based on different carbon dioxide emission scenarios.

Climate models are constantly improving, both in terms of increased spatial resolution and the physical processes included in simulations. These improvements result in more reliable estimates of how natural hazards will change at the regional level, ranging from the next few decades until the end of the century.

However, because climate change models have a relatively coarse resolution, projections must be downscaled to a finer resolution before becoming useful for a catastrophe risk model. CoreLogic aims to help insurers understand this methodology, how aspects of climate models are incorporated into catastrophe risk models, and to what degree.

There is always a degree of uncertainty in contemporary catastrophe models. Further complexity arises when disentangling climate change signals from the natural variability of the atmosphere, leading to changes in hazard on multi-decadal scales. Legacy catastrophe models use historical loss data to lend credibility to model outputs. But when it comes to climate, historical losses are not enough to fully understand future risk and evaluate the credibility of results.

To combat this uncertainty, mitigation takes effect in the form of hard measures and soft measures. Hard measures include physically engineered structures, such as flood defenses, and typically involve large capital expenditures to meet longer-term time horizons. Soft measures, usually driven by national or municipal policy such as the removal of combustible debris, are shorter term measures and much cheaper to implement.

With catastrophe models that account for both natural climate variability and physical mitigation measures, insurers are more likely to underwrite policies correctly and provide customers with the right level of protection.

While science lays the groundwork for shaping the future of insurance, regulatory guidelines also play a critical role. The current regulatory environment varies significantly by jurisdiction, complicating an already complex system. Regulation exists at different levels of complexity and maturity around the world, ranging from no regulatory position to highly prescribed tests. Thus, as a global industry, keeping track of what needs to be reported, and to which authority, is a major pain point for insurers.

That said, some regulatory bodies are leading the process of understanding the impact of climate change. The Intergovernmental Panel on Climate Change (IPCC) is widely considered the main authority in this area. While the IPCC does not conduct scientific research, it assesses the current state of scientific understanding related to climate change.

The IPCC also creates Representative Concentration Pathways (RCP), which describe four different 21^st century pathways of greenhouse gas (GHG) emissions and atmospheric concentrations, air pollutant emissions and land use. These scenarios range from business as usual (no mitigation) to strong mitigation where reductions lessen catastrophic effects. Given their acceptance as standard scenarios within the scientific, policy and regulatory spheres, RCPs will be relied on heavily when making changes to catastrophic risk models.

A final element to consider is the strong influence of investors. Investors are building sustainability into their investment strategies and demanding significant changes in the behavior of corporations. This includes the insurance industry and adjacent markets, such as real estate and mortgage lending, with respect to climate risk. This is currently managed via Environmental, Social and Corporate Governance (ESG) policy setting, monitoring and reporting. At least three credit ratings agencies (Standard & Poors, Moody’s and AM Best) have identified significant ESG factors, including climate risk for evaluation of insurers. Insurers must consider and implement these considerations as part of their holistic view on underwriting climate risk.

The effects of climate change are already here, and insurers that stall or ignore the pressing reality will risk losing business. By understanding the elements involved in climate risk, including the latest information on scientific understanding, regulations, investors and risk modeling variables, insurers can better serve their customers and improve their portfolios.

Learn more about catastrophe risk management solutions and stay up-to-date with the latest information from CoreLogic.