As climate disasters become more volatile and costly, climate-related risks could have a material impact on the insurance sector in the near and long term. For the U.S., 15 climate disasters with losses over $1 billion each occurred in 2022. In turn, insurance becomes harder to find and even more expensive for entities as insurance payouts for climate-related catastrophes have "increased significantly" over the last ten years, a trend expected to continue.
To avoid financial risk, the U.S. Treasury's Federal Insurance Office (FIO) has launched a proposal to collect data from property and casualty insurers in all 50 U.S. states to help assess climate-related financial risks. However, the proposal has received some pushback after seeking comments during a feedback period of 60 days until 6th December since the proposal's announcement in mid-October. Why is the FIO pursuing improving data availability for the U.S. insurance sector to assess climate-related risks?
Economic losses caused by more frequent and more severe natural disasters are increasingly extensively experienced in the U.S. These include earthquakes, tornadoes, floods, storms and wildfires. Rising physical risk affects insurers' ability to account for climate-related risks through insurance products and solutions. This ability to enable more effective responses to climate-related losses remains limited. Such services include preconstruction risk advisory, risk assessments and engineering for natural hazards, and post-loss incentives to rebuild with improved resilience or in less vulnerable locations. The global insurance sector's limitations account for an estimated 60% of the economic costs of $280bn of natural disasters in 2021 were insured. However, the extent of insurance companies' exposure to physical risks is hard to quantify. In part because many U.S. insurance companies are not required to publicly disclose information about climate-related risks but also a need for more available data. Without robust data to understand climate risk vulnerabilities, insurers struggle to calculate risks accurately, making them reluctant to insure. For the U.S., insurance companies must overcome data collection challenges to address protection gaps and ensure affordable coverage for the country's public and private sectors continuously wrought by devastating natural disasters.
The New Abnormal
During 2022 in the U.S., 15 natural disasters invigorated losses of over $1bn each, shown below in figure 1. These disasters included: 10 severe storms, two tropical cyclones, one flooding event, one combined drought and heat wave and one regional wildfire event, including the mega-disaster of Hurricane Ian, which was the globe's costliest natural catastrophe with an estimated insurance loss of between $50–$65bn that may well top $100bn. Not every weather event is stimulated by climate change, but rising temperatures accelerate the climate in ways that amplify heat waves and droughts to supercharge storms. Since 1980, the U.S. has faced 338 weather and natural disasters exceeding $2.295tr in damages. However, these disaster costs are mounting every year. Over the last five years (2017 to 2021), 89 events inflicted over $788bn in damage, amounting to 35% of the $2.27tr in total costs of U.S. billion-dollar disasters from 1980-2021. 2022 is the eighth consecutive year with ten or more billion-dollar weather and climate-related disasters.
Martin Bertogg, Head of Catastrophe Perils at Swiss Re, added, "extreme weather events led to high insured losses in 2022, underpinning a risk on the rise and unfolding on every continent. Urban development, wealth accumulation in disaster-prone areas, inflation and climate change, are key factors, turning extreme weather into ever-rising natural catastrophe losses."
But not only is the total number of disasters putting pressure on insurers, but also how often disasters occur. Between 1980-2021, the time between billion-dollar disasters in a calendar year dropped steadily. According to NOAA applied meteorologist and economist Adam Smith, in the last five years (2017-2021), there have been just 18 days on average between billion-dollar disasters. "The important thing is that the disaster trend is increasing," Stanford University environment director Chris Field "And it will continue to increase until we halt the warming." Furthermore, another challenge is that climate change is expanding the areas at risk for various disasters. For example, flooding risk rises even in regions not on the coast or floodplains. Hurricane Ian recently flooded communities on the coast and in many areas of Central Florida, not designated flood zones. The unprecedented rise in U.S. natural disasters increasingly pressures the insurance sector, which acts as a front-line defence against climate risk.
Increasing natural disasters across the U.S. are pressuring insurers to abandon high-risk markets. Some smaller insurance companies are becoming insolvent in states more prone to natural catastrophes like wildfire-riven California with fewer coverage options.
One issue is raising premium rates. When insurance companies can't pay their bills, they draw on their reinsurance, which is insurance for insurance companies to deal with very high claims. But the reinsurance market is global, so if a natural disaster hits the other side of the world, the cost of a homeowner's insurance policy in Florida could increase as the reinsurance company raises its premiums. Premiums rose 12.1% across the U.S. from 2021 to 2022, with higher rates in states where natural disasters occur more frequently, like Arkansas, Washington, and Colorado.
In addition to increasing premiums, insurance companies are raising deductibles or establishing higher deductibles for natural disasters that are more likely in certain areas. As a result, insurance companies sometimes refuse to renew policies or deny coverage altogether. For example, the California wildfires of 2017-2018 resulted in 235,250 non-renewals, an increase of 31%. In 2019, however, California prohibited insurance companies from not renewing homes in declared disaster areas; this prohibition has been extended each year. If climate risks jeopardise insurance companies' stability, what would impact the financial markets and, consequently, the global economy?
FIO’s Data Remedy
The Treasury is "looking for a remedy for inadequate insurance for the poor and working-class individuals,", especially in high climate risk areas, Thomas Alleman, co-director of Dykema Gossett’s insurance practice.
It is the first-ever attempt by the U.S. Treasury Department to identify where the property is not insured against climate risk. In more detail, the FIO's proposal generally considers large property and casualty insurers in most states. It would require big property insurers, who write over $100 million in annual premiums except those in 10 particularly at-risk states, to submit claim data in every ZIP code for the last five years. The information collected would not include information on individual homeowners' policies. Distinct from other financial sectors, U.S. insurance is regulated at the state level. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act created the FIO under the U.S. Department of Treasury, tasked to monitor the stability of the insurance sector and spot problems that could lead to a broader financial crisis. The FIO has the authority to represent the U.S. on prudential aspects of insurance matters but has no power to regulate insurers. With that in mind, the FIO is limited in its ability. Still, its intention to help address the declining availability and affordability of home insurance that could put insurance out of reach for homeowners and entities due to worsening natural disasters across the U.S. is vital to strengthen insurers' ability to reduce climate-related risk.
Besides data collection, the FIO has other options to invigorate the insurance sector to reduce risk and losses, such as requesting status to set up their insurance funds for specific funds. This is exampled by the California Earthquake Authority, which has more than 1 million policyholders. FIO could also advocate that states bar insurers from reducing coverage. For example, earlier this year, AIG Inc. and Chubb Ltd. announced they would decrease offering homeowners insurance in California due to wildfires. However, the FIO's focus on data collection is compiled by the US Treasury Secretary believing "[the] FIO's data collection will add to the work of regulators and policymakers across the administration to assess climate-related risks to the financial system, the U.S. economy, and the American people." Platforms, including Spectra, support this type of data collection to help insurance companies attain the data they need to enable appropriate modelling.
It is well-known that the FIO would face criticism, having been criticised for overreach. Much criticism has succumbed from insurance industry associations representing the most prominent U.S. insurance companies that have actively engaged in efforts to delay emerging climate-related insurance regulation at the federal and state levels. These primary associations include the American Property Casualty Insurance Association (APCIA), the American Council of Life Insurers (ACLI), the National Association of Mutual Insurance Companies (NAMIC), and the Insurance Information Institute (Triple-I) have all criticised the FIO's data collection proposal. The National Association of Insurance Commissioners (NAIC) strongly advocated that it felt 'deep concern' for the bid. Disappointment in the bid originates from a lack of engagement between FIO and insurance associations to build greater collaboration to identify and collect accurate data. Furthermore, it is unclear how the data will coincide with other information to showcase climate risk, believed to be “incredibly broad”, as collected without a clear purpose. And that the FIO should leverage publicly available data and work directly with state regulators to better inform a data collection process to influence local policymakers to improve protection and preparation for U.S. entities for the next disaster.
FIO has estimated that the proposal would cost up to $4m for all required insurers to provide the data and that each insurer would spend 100 to 350 hours preparing it. Not only will it inflict implementation and time management costs, but if FIO calls for a federal climate insurance backstop, congress would have to write or amend a law that could take years. Therefore, although insurers may eventually welcome federal or state climate risk backup, the initial data request may seem like another obligation. In addition, if the U.S. federal government wants to get more involved in insurance regulation. In that case, there is potential political pushback with the risk of a future Republican administration dropping the FIO proposal.
Data is Paramount
As extreme weather events increase in frequency, insurers' risk models and premium assessments may become outdated, leading to increased volatility in insurers' business models and underinsurance for climate-vulnerable communities. However, compounded disaster losses over the previous decade showcase the need for insurance companies to embrace the upscaling of data availability for all perils of climate-related risk assessment. More than available data on insurance companies' exposure to climate risks is required. The insurance sector needs to make substantial changes to address climate risks. This includes data collection to enable more in-depth risk assessments, improved business decisions, disclosure into public filings, and running various climate scenario analyses statewide to determine whether and what further action may be needed to be more resilient.
Critically, the FIO and state insurance regulators must act now to develop strategies to prevent disruptions to the insurance sector, even if the FIO's data collection endeavour is a setback. If natural catastrophes increase in the U.S., insurance companies must be equipped with the best quality data that is paramount for all perils when assessing climate-related risk. Still, it remains a challenge for the entire insurance sector to prevent damage to the broader financial system while facing inevitable natural disasters.
- IPCC, 2022: Climate Change 2022: Impacts, Adaptation, and Vulnerability. Contribution of Working Group II to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change [H.-O. Pörtner, D.C. Roberts, M. Tignor, E.S. Poloczanska, K. Mintenbeck, A. Alegría, M. Craig, S. Langsdorf, S. Löschke, V. Möller, A. Okem, B. Rama (eds.)]. Cambridge University Press. Cambridge University Press, Cambridge, UK and New York, NY, USA, 3056 pp., doi:10.1017/9781009325844.
- NOAA National Centers for Environmental Information (NCEI) U.S. Billion-Dollar Weather and Climate Disasters (2022). https://www.ncei.noaa.gov/access/billions/, DOI: 10.25921/stkw-7w73