Insurance innovation needed to offset the rising risks of climate change
The climate crisis is set to be one of the greatest challenges humanity will face, a watershed moment with protracted effects whether we overcome this predicament or not. Not only will climate change have a significant impact on our current environment and the world around us but the way we address this issue will define the lives of future generations for years to come.
While people, leaders, organisations and industries across the globe have been galvanised to do their part to mitigate the impact of climate change and enable more sustainable development, human activity is producing greenhouse emissions at record levels. Although lower than anticipated, global carbon dioxide emissions from both energy combustion and industrial processes grew by to a new record high of 36.8 Gigatonnes in 2022. Meanwhile, the average global surface temperature has been steadily rising with the hottest ten years since records began in 1880 all falling in the last decade.
This has meant that both the frequency and intensity of extreme weather events such as heatwaves, soaking rains, severe floods, years-long droughts and extreme wildfires are increasing. In 2022 there were at least 28 significant climate events, including damaging wildfires across the contiguous United States, record-breaking rainfall in Pakistan which affected 30 million people, destructive typhoons in the Western Pacific and devastating hurricanes in the Eastern North Pacific. In South Africa we recently saw the Western Cape face an intense storm which caused intense flooding and significant damage, leading to the South African Weather Service declaring a level nine extreme weather warning - the highest level ever issued for the region. This followed close after the extensive 2022 flooding in KZN which was evaluated by Wits University as the most catastrophic disaster recorded in the province's history.
The growing trend of extreme events is leading to an increasing exposure to weather risks which in turn has seen a marked rise in insurance claims. As a result, we can expect to see risk-based premiums rise over time, potentially impairing the affordability and availability of insurance protection - particularly in regard to coverage against climate-related hazards.
The unavoidable impact on insurance
The insurance industry is required, by regulation and good practice, to build the cost of expected losses into their capital and pricing models using known historical data such as, for example, the fact that once every five years there will be a major hailstorm in a region or that there will be one major flood every 50 years in a particular area.
However, the rising climate risk is injecting uncertainty into an industry that is built on predicting risk. With the changing weather patterns, we are seeing unexpected frequencies such as say two 50-year events happening in 5 years. This is a dilemma for insurers and we can soon expect to see climate change drive up prices considerably and possibly even push insurers out of high-risk markets.
In agriculture, one of the industries most vulnerable to climate change, the adverse effects of floods, drought and fires have meant that crop and livestock insurance for farmers is becoming costly or unavailable and will have knock-on effects on critical sustainability factors such as global food security.
We've also seen some large insurers draw hard lines in the sand to not insure properties susceptible to the impact of climate change, for example, those that are close to a shoreline (like along the Atlantic Seaboard), within a flood basin (as in the KZN South Coast), or in areas that are at high risk of veld and forest fires, such as in Knysna. It's likely that this is a trend that will continue, with the eventual outcome being that it will be impossible or extremely expensive for consumers to insure certain properties or goods that are most vulnerable to the negative impacts of climate change. The other trend we are seeing is that insurers may agree to insure the property but exclude cover for the specific perils such as flood.
This approach of not offering cover against high-risk perils will be detrimental to insurers too as they are walking away from significant revenue, and this shrinking premium pool might result in further increases in prices, creating a vicious cycle of premium inflation leading to unaffordability.
Adopting a new approach to insurance
Unfortunately, insurance is a zero-sum game in the long run, so if the severity and likelihood of claims are rising, then so too must premiums. Traditional models of insurance just don't apply in a future filled with uncertainty, and it is clear then that what the insurance industry desperately needs is innovation in order to reduce exposure to climate risk and increase climate resilience.
One way to inject much-needed innovation into the industry is by adopting digital technologies such as Satellite Imaging, Artificial Intelligence and Machine Learning to predict, detect, monitor and forecast extreme weather events and automatically alert consumers ahead of time to mitigate the risk of loss or damages. Additionally, digital and self-service technologies are being used to improve efficiencies and reduce or remove administrative costs of insurance, which in turn reduces premiums and can make insurance more affordable and accessible.
Besides technological interventions, we need new capital models and a more proactive approach to developing new and targeted products that specifically cover climate-related risks. Enter parametric insurance. Unlike traditional indemnity-based insurance, which pays out a claim after a rigorous process involving the client proving the loss event and an assessor establishing the quantum of the claim, Parametric insurance insures a policyholder against the occurrence of a specific (weather) event and pays out a claim in relation to the magnitude of the event without the client having to prove or substantiate his loss. For example, a policy which pays out an amount if a storm of more than 150 mm of rainfall or winds in excess of 100 km/h occurs with the payout amount based on a sliding scale linked to the severity of the event. One of the benefits of Parametric insurance models is that it brings in new players prepared to inject fresh capital into the industry. These new entrants don't have the legacy systems, processes and infrastructure built over decades that the incumbents have so they are generally more left-field and open to innovation.
Another positive trend we are seeing is that insurers are embracing the various climate accords and are investing in or incentivizing renewable energy technologies while turning away from insuring fossil-fuel based industries in the expectation that this will help the climate crisis.
Non-traditional insurance strategies such as above are offering consumers greater choice, flexibility, and increased customisation and at the same time are enabling a more robust and resilient insurance industry better equipped to weather the climate change challenges.
In such an uncertain and dynamic climate environment, it is encouraging to see that the insurance industry is relinquishing its traditionally staid posture and embracing innovation.
*Vis Govender is Co-founder of Everything.Insure and Group CEO of FirstEquity Group.