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The insurance industry is at a critical juncture as it faces the harsh realities of climate change. A comprehensive report from the International Association of Insurance Supervisors (IAIS) underscores the substantial financial risks posed by climate change to the global insurance sector. The report reveals that climate-related risks could potentially erode up to 50% of insurers' available capital under the ‘too little, too late’ scenario the planet is rotating towards.
The Mechanics of Capital Loss
Climate change impacts insurers through both physical and transition risks. Physical risks include increased damage from natural catastrophes and extreme weather events. Transition risks involve the economic and regulatory shifts necessary to move towards a low-carbon economy, affecting asset values and business operations.
One of the primary ways insurers could lose capital is through asset devaluation. Investments in properties and sectors vulnerable to climate change, such as fossil fuels and high-risk real estate, can lose significant value as these assets become less viable or desirable. More frequent and severe climate-related disasters lead to higher claims, which in turn strain insurers' financial resources and reduce their available capital.
In addition to these risks, insurers face significant challenges related to regulatory changes. Sudden changes in regulations aimed at curbing emissions can devalue assets tied to high-carbon industries. This regulatory uncertainty can lead to abrupt market reactions, further impacting asset values. Furthermore, legal liabilities pose significant risks. Insurers might face lawsuits related to insufficient climate risk disclosures or the environmental impacts of their investments, adding legal costs and potential settlements to their financial burdens.
Operational disruptions caused by climate events can directly impact insurers' ability to process claims and maintain normal business operations. This can lead to delays and increased operational costs, further straining financial resources. Lastly, liquidity strains are a critical concern. Forced liquidation of assets to cover claims can lead to selling at unfavourable prices, further depleting capital reserves and exacerbating financial instability. As highlighted by IBM, climate events can significantly disrupt financial services, including devaluing properties accepted as loan security, due to threats like sea level rise and flooding. In 2021, large-scale floods in European countries such as Austria, Germany, Belgium, the Netherlands, and Luxembourg caused €40 billion worth of damage and led to insurance claims totalling approximately €280 million per company, with reinsurance losses estimated between €1.8 billion and €2.7 billion.
Local natural disasters like floods and wildfires are on the rise. Above, a picture taken by Chris Gallagher of the Bingley Floods on Boxing Day in 2015 illustrates this.
Industry Response and Recommendations
The IAIS report aligns with insights from a recent Forbes article by Nina Seega, emphasising the urgent need for the insurance industry to adopt more rigorous climate risk management practices. One key recommendation is enhancing data and analytics to better assess and manage climate-related risks. Regular stress testing and scenario analysis help insurers prepare and adjust their strategies. Regulatory coordination ensures a consistent approach to climate risk supervision.
Insurers should also adjust investment strategies to include more sustainable assets, reducing exposure to high-risk sectors and aligning with environmental goals. Increased transparency through better climate risk disclosures is crucial, aligning with frameworks like the Task Force on Climate-related Financial Disclosures (TCFD).
Additionally, insurance companies can monitor their carbon emissions and actively reduce their carbon footprint to help combat climate change. By addressing their own environmental impact, insurers contribute to sustainability and demonstrate leadership in environmental responsibility.
To Sum up
The insurance industry will be more impacted by climate change than anticipated, with estimates suggesting up to 50% of their available capital could be at risk due to rising temperatures. These rising temperatures are causing more local natural disasters and forcing regulatory changes, thus reshaping the industry's landscape. While it’s not too late to act, the industry must take a stand and actively combat these threats to prevent a potential downfall. Swift and decisive actions are essential for the industry to adapt to these changes and maintain stability.
For more detailed insights, refer to the IAIS Global Insurance Market Report, Dan Mishra’s article on IBM and Nina Seega’s article on Forbes.
Sources:
- Dan Mishra, “Mitigating the impact of climate change in insurance and other financial services”, IBM
- Nina Seega, "Why the Insurance Industry Must Wake Up to the Harsh Reality of Climate Change," Forbes.
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