What’s at stake for general and life insurers as the climate changes – and how can they best prepare their businesses for climate risk?

Louise McCabeThe November 2019 fires in New South Wales and Queensland are a harsh wake-up call about the dangers of climate change. Its impact has risks for our health, food, water, housing and the quality of air we breathe. It also has implications for the way we do business and invest – and the future of our industries.

All financial institutions will be (or are already) affected by climate change, but insurers are the ones most directly hit by its physical impact.[1] And it’s not only in obvious ways, like rising claims due to increasing extreme weather events and fires. Liability risk is also a major concern for the industry.

Companies across the globe face the threat of litigation for failing to mitigate or adapt to climate change, or for not disclosing climate-related risks to shareholders.[2] Landmark cases in Australia include the Rocky Hill coal Mine Project, where a mining company was refused development consent on the grounds of its contribution to climate change, and the ongoing case against REST Super, where member Mark McVeigh alleges the super fund breached its fiduciary duties by failing to consider climate change risk adequately.

Health and life insurers are not immune from climate risk either. They are likely to see more claims from increasing respiratory illnesses,[3] increased anxiety and depression, and illness and even death caused by heat waves.[4]

Insurance is a way to provide some certainty for an uncertain future, by studying past risk carefully and predicting future likelihoods. Climate change is creating scenarios for which we have no precedents – adding more layers of complexity for insurers to grapple with.

Pricing climate risk

A key issue for the insurance industry in this new landscape is how to accurately price premiums in a heating planet. Under-pricing could spell the end of their business, while over-pricing risk could make cover unaffordable for many Australians.

With the added risk that climate change brings, it seems inevitable that many premiums will rise. Climate risk analyst Karl Mallon estimates that in the next couple of decades, thousands of Australians’ premiums will double or triple. And if climate risk isn’t dealt with, he forecasts that one in 20 Australian addresses will be uninsurable by the year 2100.[5]  Rising premiums won’t do anything to endear insurers to customers, whose sense of trust in the industry is already damaged by the revelations of the Royal Commission.[6]

Insurers covering large businesses – especially those within the fossil fuel industry – may also have difficulty pricing liability risk. This issue could be further exacerbated if companies are unprepared to transition to a low-carbon economy, and as a result their assets lose value.[7]

Time to take steps

The Insurance Council of Australia (ICA) has begun taking action to help the industry prepare – starting by acknowledging the serious threats that human-induced climate change presents. It has also set up a Climate Change Action Committee (CCAC) to make sure insurers consider climate change issues in their decision making, and help stakeholders to manage risk and develop solutions. The committee is also taking steps to prevent any region in Australia from becoming uninsurable.[8]

Individually, insurers need to take internal action to guard against climate risk. This includes embedding climate risk considerations into their governance, reducing the carbon footprint of their own operations, and avoiding investing in carbon intensive industries in favour of low-carbon ones.  It should also include developing risk assessment tools and products to help mitigate the risk of climate change, and re-designing the way insurance products work – such as rewarding customers whose homes are better prepared for extreme events with lower premiums.[9]

According to a 2019 survey by APRA, many general insurers are already taking steps to deal with climate risk. However, far fewer life insurers are responding to the challenge. That’s because 80% think that climate risks aren’t relevant to them right now – although they acknowledge they may be in the future.[10]

If insurers can learn anything from the current climate emergency, it’s the importance of taking action immediately to avoid panicked, rushed responses down the track. Not doing so is putting companies in harm’s way as the impacts of climate change are felt. Those businesses who fail to act now also risk being left behind as the world inevitably transitions to a low-carbon economy.

[1] Reserve Bank of Australia, Financial Stability Review, October 2019

[2] Alison Garton, University of Cambridge, Climate change liability risk vastly underestimated by businesses, Cambridge Institute for Sustainability Leadership, 2018

[3] Gennaro D’Amato, Lorenzo Cecchi, Mariella D’Amato, Isabella Annesi-Maesano, Climate change and respiratory diseases, European Respiratory Review, 2014

[4] Paul J Beggs et al, The 2019 report of the MJA–Lancet Countdown on health and climate change: a turbulent year with mixed progress, The Medical Journal of Australia, 2019

[5] ABC News, The rise of red zones of risk, updated 19 November 2019

[6] KPMG, Rebuilding Trust, 2019

[7] KPMG, Combating climate risks: The future of insurance, 2018

[8] Insurance Council of Australia – Climate Change Action Committee website, 2019

[9] KPMG, Combating climate risks: The future of insurance, 2018

[10] Insurance News, Insurers raising their game on climate risks, 25 March 2019