Insurers Face Mounting Climate Costs

Disasters both globally and in Australia are “significantly underinsured,” while disaster relief provided by governments is often inadequate and underfunded.

This blog has been adapted from an article written by Christine St Anne, titled ‘Insurers face mounting climate costs,’ featured by Australian Banking and Finance, AB+F, published by RFi Group.

This article features SEI key researcher, Rosemary Lyster, Professor of Climate and Environmental Law at the Sydney Law School.

Geoff Summerhayes, executive board member of the Australian Prudential Regulation Authority (APRA) recently delivered an address to the Insurance Council of Australia’s (ICA) annual forum on climate change and prudential risk, said the industry can no longer ignore the threats posed by a changing climate.

Risks, Summerhayes said, that pose “system-wide implications that APRA and other regulators here and abroad are paying much closer attention to.”

“Like all risks, it is better they are explicitly considered and managed as appropriate, rather than simply ignored or neglected,” he said.

Rosemary Lyster, Professor of Climate and Environmental Law at the Sydney Law School and Sydney Environment Institute, who works closely with insurers on climate risk issues, welcomed the caution as timely.

“His warnings that directors could be found personally liable for breach of their duties under the Corporations Act is salutary at this time, as is his view that investors need to assess the climate risks and make investment decisions accordingly,” Lyster told AB+F.

Lyster said the industry also confronts huge costs from the “risks of extreme weather events, influenced and intensified by climate change.

For example, the bill for Hurricane Sandy which devastated the Caribbean and east cost of the United States, was put at an estimated US$75 billion.

“Australia is no stranger to the extraordinary economic costs of extreme weather events and disasters,” Lyster said.

Quoting figures from the Australian Business Roundtable for Disaster Resilience and Safer Communities, Lyster put the economic costs of natural disasters in an average year to now exceed $9 billion (in 2015) or 0.6 per cent of GDP.

“These tangible and intangible costs are expected to double by 2030 and average $33 billion by 2050, without even considering the likely impacts of climate change.”

According to Lyster, disasters both globally and in Australia are “significantly underinsured,” while disaster relief provided by governments is often inadequate and underfunded.

“This places the insurance industry in a predicament as a compensator of disaster losses given that disasters interfere with the traditional insurance practices of aggregating risks; segregating risks into separate risk pools; and the control of moral hazard,” she said.

In terms of solutions, Lyster argues that the traditional approach to pricing premiums will need a major rethink.

“When disaster strikes and the vast majority of those affected are uninsured, or underinsured, the call is for insurance premiums to better price and transfer the risk.”

“As experience in the United States has shown after Hurricane Sandy, actuarially fair premiums conflict with societal goals of insurance affordability and greater insurance penetration and so reforms to better price the risk had to be revised and amended.”

Echoing the comments made by Summerhayes, Lyster said insurers and reinsurers need to carefully consider climate change risks to their business as part of their risk management framework.

Insurers and reinsurers are already refusing to insure catastrophic climate risks, requiring innovative products to be developed.

For example, after Hurricane Sandy the first Catastrophe Bond that covers only storm surge, known as MetroCat Re, was established after the Metropolitan Transportation Authority had difficulty obtaining insurance and reinsurance.

Other strategies for insurers include “withholding insurance until conditions have been attached to developments in ‘at risk’ areas and appropriate building codes have been established.”

Lyster also urges insurers to have emergency plans in place to deal with burdens placed on staff such as claims managers. Insures also have a role to play in addressing information irregularities in underinsurance.

“For example, the government has accepted the Productivity Commission’s recommendation that the insurance industry develop guidelines for standardising the information for households on insurance policy coverage, natural hazard risk and the indicative costs of rebuilding,” Lyster said.

“The insurance industry could also consider entering into collaborative partnerships with government as a risk transfer mechanism such as had occurred in the UK with the establishment of Flood Re.”

To access the original article, click here.