Beyond premiums: Insurance's role in a climate-resilient future

In 2023, the EU and United States experienced record-breaking heatwaves, wildfires swept through Mediterranean nations, and East Africa faced severe flooding. The total loss and damage costs: $250 billion. 

Established during COP27 in 2022, the Loss and Damage Fund (L&D) aimed to assist developing countries in their recovery from climate-related disasters. However, by COP28 in 2023, only $700 million had been committed. With the accelerating pace of climate change, the L&D Fund is projected to face an annual shortfall of up to $400 billion by 2030 with pledges covering less than 0.2% of losses.

This underscores the urgency of establishing financial structures capable of investing in climate and disaster resilience that minimize the cost of recovery and the reliance on currently unfunded L&D structures.

However, there is currently a disconnect between today’s insurance frameworks and the financing needed to invest in adaptation and mitigation measures. The rise in premiums, driven by escalating climate-related risk, underscores the widespread need for heightened coverage across all sectors.

Home insurance

The departure of major home insurers such as Allstate and State Farm from California and Florida coincided with a nearly 24% surge in average home insurance premiums compared to the previous year.

Utilities wildfire insurance

During the peak of the 2019 wildfires, PG&E filed for bankruptcy protection as it could only cover $11 billion of the $30 billion in liability for damages. In response, the California Commission permitted PG&E to create two Risk Transfer Balancing Accounts: one for general liability and another for wildfire liability. To avert a recurrence of the financial instability of 2019, PG&E insured around 80% of its assets, with a value of up to $750 million, while Southern California Edison opted for self-insurance instead of renewing its typical $1 billion policy.

Maritime insurance

Despite the $5 billion expansion of the Panama Canal in 2016, droughts have significantly reduced the load capacity of Neopanamax ships. The reduction in capacity has caused a surge in container prices from $300 to $500 per container, diminishing the overall insured value of cargo passing through the canal. This has led to extended wait times and delays in transporting goods, causing knock-on impacts throughout the supply chain.

As the world deploys new sustainable technologies, countries urbanize rapidly, and climate impacts become more severe, both the nature of risk and what is insured will undergo significant change at the same time. Insurance companies have a unique opportunity to mobilize new and innovative financing mechanisms that incentivize investments in resilience, thus driving longer-term stability and diversified revenue streams.

How can insurers leverage digital strategies to enhance their own long-term resilience?

Solving problems at national scale

Major home insurers have withdrawn from both California and Florida due to climate-related risks, each facing distinct challenges. California’s risk primarily stems from wildfires, while Florida contends with flooding threats. Moreover, the specific risks and long-term returns from mitigation efforts can vary significantly at the local level, even within the same state. 

New AI-driven digital tools that provide a common toolbox of options facilitated by unique customization abilities at scale can assist insurers in identifying optimal and localized resilience options on a national scale. These digital tools enable insurers to identify risks and calculate acceptable and profitably insurable levels that align with hyper-local contexts. 

Additionally, digital Systems of Record play a critical role in maintaining these national-level plans as technology, regulations, and financial models evolve. Given the dramatic cost reductions of sustainable and resilience-enhancing technologies, investments can rapidly shift from unprofitable to highly rewarding.

Improving risk assessment

Because of the localized nature of climate risk, improved data collection tools can improve the precision of risk assessment. 

For example, current climate methodologies used in the maritime industry often underestimate risks and uncertainties in specific regions. The heightened occurrence and unpredictability of warmer temperatures during El Niño cycles introduce significant climate-related risks to shipping operations in the Panama Canal. Conversely, ports in Asia may experience fewer typhoon-related incidents, enabling insurance companies to adjust premiums in real-time to match elevated risks. 

Continuously gathering data and reevaluating risk models during seasonal cycles will enable insurers to account for regional variations in climate-related risks and adjust premiums as these risks change over time.

Mitigation and adaptation

Despite insurance companies choosing to withdraw from certain markets and regions, they have the potential to play a crucial role in transforming the resilience of assets in these areas. By investing in adaptation measures in markets they would otherwise exit, insurers can enhance long-term returns by safeguarding revenue from these assets and significantly cutting costs linked to climate disasters.

Innovative digital tools can also enable insurers to make impactful investments beyond their traditional coverage zones. For instance, wildfires can cause severe respiratory damage to people living hundreds of miles away, leading to substantial costs for health insurance providers. However, investing in wildfire mitigation, facilitated by detailed regional analysis made feasible through AI-driven geospatial tools, could yield significant returns for health insurers. 

These kinds of innovative investments require significant collaboration between organizations that traditionally operate in a siloed manner. Digital multi-player collaboration tools can break down these walls, allowing experts from a variety of domains to interact with financial and regulatory stakeholders around a shared plan and build consensus more rapidly.

Reshaping financial systems requires action from both private and public sectors to scale investment and foster collaboration that propels us toward a climate-resilient future. Insurers have a unique opportunity to create new financing structures that enable policyholders to adapt to risk and invest in resilience, enhancing long-term revenue streams and the viability of entire communities.