Climate Risk: A Call to Action for The Industry

By: P. Vrinda, Mamta Patel & Bhavya Bapna

Background

Climate change is no longer a distant concern, it’s here, and it’s reshaping the world around us. Rising sea levels, extreme weather events, prolonged droughts, and devastating wildfires are just some of the ways climate change is impacting economies, communities, and ecosystems. For the insurance industry, these changes are both a challenge and an opportunity. As risk managers, underwriters, and investors, insurers are uniquely positioned to help society adapt to and mitigate the effects of climate change.

This article explores the many dimensions of climate risk and highlights how the insurance sector and actuaries can play a critical role in building resilience in the face of this global challenge.

Climate risk refers to the potential for harm caused by climate-related hazards. These risks fall into two main categories:

• Physical Risks: These are the direct impacts of climate change, such as hurricanes, floods, heatwaves, and wildfires. For example, the Atlantic hurricane season has become increasingly active, leading to record-breaking insured losses in recent years.
• Transition Risks: These arise from the societal and economic shifts needed to transition to a low-carbon economy. Regulatory changes, technological advancements, and shifts in consumer behaviour can disrupt industries and create financial risks for businesses.

For insurers, both types of risks are significant. Physical risks directly affect claims and underwriting, while transition risks impact investment portfolios and long-term planning. The insurance industry is on the front lines of climate risk. Here’s why:

• Claims and Underwriting: Insurers bear the financial burden of climate-related disasters. The increasing frequency and severity of these events are driving up claims, making it harder for insurers to maintain profitability and sustainability.
• Investment Portfolios: Insurers manage trillions of dollars in assets globally. Transition risks, such as the devaluation of carbon-intensive investments, pose challenges to maintaining resilient and sustainable portfolios.

How Can the Insurance Industry Can Address Climate Risk?

Despite the challenges, insurers have a unique opportunity to lead the charge in tackling climate risk. Here’s how:

• Risk Assessment and Pricing

Insurers are experts in understanding and quantifying risk. By incorporating climate risk into underwriting practices, they can encourage policyholders to adopt risk-reduction measures. For example, offering premium discounts for homes built to withstand extreme weather events can promote climate-resilient construction practices.

• Promoting Resilience

Insurance products can be designed to help communities recover faster from climate-related disasters. Parametric insurance, which provides payouts based on predefined triggers (like rainfall levels or wind speeds), offers quick financial relief, enabling affected communities to rebuild more efficiently.

• Advocacy and Collaboration

Insurers work with governments, businesses, and other stakeholders to shape policies that promote climate resilience. Public-private partnerships expand access to insurance in vulnerable regions, reducing the protection gap and enhancing societal resilience.

• Innovating for the Future

Advanced technologies like artificial intelligence, satellite imagery, and big data are helping insurers improve risk modelling and decision-making. These tools allow insurers to better understand and respond to the dynamic risks posed by climate change.

The Role of Actuaries

Actuaries are at the core of the insurance industry’s response to climate risk, leveraging their expertise in risk modelling, data analysis, and long-term forecasting to understand and address the financial impacts of climate change. They develop models to predict the frequency and severity of climate-related events, help insurers price policies that accurately reflect the true cost of climate risk, and assess the long-term sustainability of investment portfolios in the face of transition risks. By providing critical insights, actuaries guide strategic decision-making and enable insurers to adapt to a rapidly changing world.

To summarize, climate risk is one of the defining challenges of our time, and the insurance industry is uniquely positioned to lead the response. By assessing risks, promoting resilience, driving sustainable investments, and advocating for change, insurers can help mitigate the impacts of climate change while unlocking new opportunities for growth and innovation.

Actuaries, as the industry’s risk experts, have a critical role to play in this journey. Together, we can ensure that the insurance sector not only adapts to the realities of climate change but also leads the way in creating a safer, more sustainable world.

Note: The authors P. Vrinda, Mamta Patel and Bhavya Bapna work at Chubb India