Threats and Opportunities for Insurance Companies
Climate change has become one of the most important aspects of our daily lives as it has a deep impact on our systems and the general well being of humanity. Such unprecedented change in the climate has resulted in extreme catastrophes such as hurricanes, floods, wild fires, etc. The loss caused by such accidents is not limited to the general public, but is further passed on to industry, which thrives on the concept of underwriting assets.
The industries core belief is to quantify the uncertainty of an unforeseen event. But as these events are growing in frequency and size, it will continue to challenge the sustainability of insurance companies. Inevitably, it will transfer the burden to the insurance purchaser, as insurance companies will seek higher premiums for their products, which will only make it less affordable for the masses to afford essential insurance coverage. In this essay we will discuss the various challenges that the industry faces due to climate change, the possible ways to mitigate the threats, and then the scope of more opportunities arising out of the given change.
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Climate change can be seen as a threat to many insurance companies in the long term as well as the short term. IPCC (2007) has confirmed an increase in the frequency of the catastrophe in the recent years. Insurance claims running into billions of dollars can cause a huge dent in this industry, which makes up up-to 10% of the US economy. It is only natural for insurance companies to charge higher premium for those asserts. Which are exposed to high risks, making it less affordable to the market. The chairman of Lloyd's of London quoted that "climate change is the number- one issue for that massive insurance group". And also Europe's largest insurer, Allianz, stated "climate change stands to increase insured losses from extreme events in an average year by 37% within just a decade" (Hawker, 2007,p.28).
In the past, insurance companies have relied on previous data to formulate policies. But such a practice has only caused high losses as the climate is changing in a rapid way. Warren buffet pointed out "insurance companies cant simply extrapolate past experience. If there is a is truly global warming, for example, the odds would shift, since tiny changes in atmospheric conditions can produce momentous changes in weather patterns'".
Therefore new techniques such as risk management system (RMS) are used extensively by insurance industry for assessing and managing risks.
Hurricane Andrew caused a loss of $23 billion to insurers as they based their policies after relying on past data. However, the same industry had a much smaller impact when hurricane hit the US coast in 20004 and 2005, as they used future risk models such as RMS to formulate policies (Herweiger et. al., 2009).
Climate change leads to increase damage and costs as ever increasing level and long lasting wildfires are causing more claims and property damages. Such frequency and magnitude of potential losses can jeopardize the solvency of insurance and reinsurance companies.
Sustainability can be insured if the given threats are dealt with adequately. Insurance industries have a history of fostering practices and technologies to reduce risks. Some of the possible and effective ways to mitigate risks are, firstly, a lesser premium can be charged from customers of motor insurance who drive hybrid cars or use "pay as you drive" scheme. Special benefits can be given to customers who buy vehicles jointly to use them under car pool system. Secondly, a close association with government agencies to improve land use planning, better management of forestry agriculture and wet lands can help in having a well balanced growth that does not put to much pressure on natural resources. Collaboration with private builders to promote, improved building codes, which insure minimum damage to the environment, lower energy requirements and long-term durability. Thirdly, building awareness amongst clients and formulation of public policy. Companies can provide information and education to customers about the harmful effects of violating laws of nature. Consultation should be given to primary and secondary industry to reduce their impact on their immediate environment. .
Many insurers have already made investments in green projects like renewable energy, energy efficiency, forestry projects and green funds to ensure that their customers receive protection and also saving them from large claims (Mills, 2007,p.7). Promotion of voluntary energy saving and energy efficient codes can help reduce our dependence on state electrical supply.
Active participation from insurers such as AIG offer its Private Client Group a service in which crews are deployed to apply fire retardant in areas such as Colorado which are threatened by wildfire.
Climate change can prove as a very big opportunity for insurers as the unpredictable climate can threaten their customers and lead them to insuring their assets. However they must adapt timely & successfully.
Responding to change is important as it brings opportunities. Insurance companies should develop new solutions and introduce insurance of new assets and risks for their customers changing needs. It is also seen that the Insurance industry is in constant search of better returns for its vast investments. In this regard it could take advantage of the opportunities available in alternative energy sources as it is a good investment as constant technological developments make this it more affordable and attractive for the public.
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Introducing new products such as risk based pricing under which insurance premiums are charged as per their risk exposure. For normal policies, premium is charged by keeping various factors in hand, but the premium is standard for all, & no consideration is given to a policy holders risk exposure. For example- buying car insurance in UK, Any individual above the age of 21 is charged a basic insurance premium which is more or less standard. However when it comes to providing insurance cover to an individual below the age of 21, the policy premium is charged at a much higher rate, as the possibility of an accident is much higher as these new drivers are mostly inexperienced.
Another opportunity comes from state help, in form of promotion, because If the majority of the population do not insure their properties then in case of a catastrophe, the financial burden will fall on the state insurers, so to save from this burden, governments promote and favour private insurance companies. Thus making it profitable for private insurers as well as the government.
Some of the possible ways to tap the available opportunity are firstly by energy saving insurance, which is given to promoters of energy efficient projects to protect them from loss due to underachievement of predicted energy efficiency. Secondly by motor insurance where packages such as 'pay as you drive' insurance are given, in which cover is given for the miles driven. This helps to reduce miles driven by 10 % to 15 % and also reduces accidents. Thirdly by green building insurance, insurance schemes for buildings that comply with green, eco friendly codes. Fourthly by micro insurance, where the majority of the population living below poverty line, cannot afford insurance of any sort. Therefore new packages for this section of the society can help to capture a very large customer base. Fifthly by investing in alternate energy sources
As they can help to get a much higher returns to the surplus investable capital of insurance companies, as this sector holds great promise for better, cleaner & greener energy, through technological innovations. And lastly by improved identification of flood plains will help to promote insurance purchasing in the marked areas.
After exploring the implications of climate change on the insurance industry, I have shown above, the threats & opportunities that the insurance companies face.
By comparing both sides of the argument, I believe that the insurance industry faces more threats than opportunities due to climate change. An ever-increasing catastrophe rate, sparked by excessive climate change has lead to increased financial losses, reduced customer base & in some case cases complete wipe out of companies. Therefore it is only right for these companies to mitigate these risks in order to insure sustainability.
In the given scenario, there also exist enough opportunities to develop new business models and increase revenue through new policies, revised & competitive rates. Many untapped market segments, which remain untouched by industry, can provide high revenues. Adequate investments in research and technology will be beneficial for the industry. Above all, a close association with the general public, government agencies & private sector enterprise will help the insurance industry to protect itself from the dangers of climate change and provide sufficient opportunity to grow in size.
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