While a homesick Dorothea McKellar once romanticised notions of Australia as a "sunburnt country", the reality is that its "droughts and flooding rains" are increasing in ferocity.
Caught in the throes of an unrelenting El Nino/La Nina cycle, the Climate Council has warned that the mounting cost of natural disasters could leave 1 in every 25 properties in Australia high risk and uninsurable by 2030.
In this article we explore the costs of, possible responses to and exposure lines of insurance have to climate change.
How did we get here?
Australia in recent years has experienced various extreme weather events causing flood, fire and storm damage. It is estimated Australia's general insurers paid out $3.89 billion from over 300,000 claims related to the bushfires, floods and storms in the summer of 2019-20.
While 2022 was the year we all hoped for some level of reprieve and normal programming, the east coast of Australia has instead been felled by disaster upon disaster. It might only be July, but insurers have already suffered the following hits according to articles published by Insurance Business Australia:
- $4.8 billion in insured losses arising from flooding in Queensland and New South Wales during February/March;
- An estimated $97.9 million in claims so far from the July flooding event in the same regions; and
- Allianz Australia has already depleted 90% of is natural catastrophe budget.
Not only are costs mounting, but the forecast is foreboding; just when you thought it was safe to attempt any kind of dry weather pursuit, La Nina is tipped to return in summer 2022/2023. Third time is most certainly not a charm, particularly as the areas of high risk identified by the Climate Council as uninsurable fall beyond the traditional sphere of concern in northern Australia (few insurers offer property cover above the Tropic of Capricorn).
Climate change poses short term and long term risks to insurers and will result in additional costs as policyholders and insurers transition away from carbon-based economy and adapt to climate change, greater regulations and increased litigation, greater claims and increased losses.
What is the fall out?
Insurance affordability is not just an issue for policyholders. As identified by McKinsey in its report Climate change and P & C Insurance: The threat and opportunity "some historically stable premium and profit pools will shrink, and possibly disappear, in places and industries that are exposed to climate risk...". Currently premiums often do not adequately cover the level of risk that insurers are insuring resulting in large losses. It is inevitable, with the higher risk associated with increased frequency of the extreme weather events, premiums will increase and the question about insurability becomes more prevalent.
As such, with the uncertainty of the impact of climate change comes the issue of forecasting the risks associated with the extreme weather events. Insurers will need to look closely at their underwriting practices and exposure limits and develop sophisticated models to forecast and manage the risk. Miscalculating the extent of the impact of climate change to their pricing will cost insurers dearly.
The reinsurance sector will play a key part in particular in providing primary insurers with necessary protection as they seek to shift their risks whilst protecting themselves from catastrophic losses. Reinsurers in turn will also need to manage the tail risks and appropriately underwrite the risks linked to climate change to ensure that financial losses are absorbed.
Further, a failure to respond has the potential to "damage the industry's reputation and its credibility as a global economic citizen." The reputational risk is particularly acute when you consider research from the Actuarial Institute and Deloitte to the effect that a number of those faced with higher premiums and uninsurable homes are already considered vulnerable by virtue of their lower socio economic status.
What can be done to minimise insurers' contribution to climate change?
Curbing the affordability crisis cannot be achieved by insurers alone. The following steps proposed by the Climate Council will require action from governments and private enterprise:
- Enact swift and deep emission cuts across the Australian economy;
- Eliminate fossil fuel subsidies;
- Prioritise investments in resilience;
- Account for climate risks in land use planning;
- Improve building standards and compliance; and
- Support communities to 'build back better'.
Insurers can, however, assist by:
- Declining to cover activities that contribute to climate change such as coal and other fossil fuels;
- Working with governments and regulators on climate resistant policies and building codes ensuring buildings are more disaster resilient;
- Working with policy holders to become more climate-resilient and encouraging sustainable methods and behaviours. This could be in the form of impact underwriting practices. For instance, Deloitte cites the work of insurers in the US who have offered premium discounts and practical assistance in fire proofing homes in wildfire prone states;
- Choosing to invest in sustainable and ESG conscious investments; and
- Becoming a member of the UN-convened Net-Zero Insurance Alliance (NZIA).
Many insurers are already taking proactive steps. For example, over 20 leading insurers have joined NZIA and committed to transition their insurance and reinsurance underwriting and investment portfolios to net-zero greenhouse gas emissions by 2050.
What can be done to minimise insurers' risk?
Climate change will require insurers to rethink their approach to underwriting with the main issue being the insurability of such risks as highlighted above or result in insurers excluding climate change liability generally. For example:
Property and casualty insurance
Property and casualty insurers are most vulnerable to climate change given the catastrophic effect an extreme climate event has, leaving insurers vulnerable to liability claims for property damage and personal injury. In response, insurers could rely on pollution exclusions which are broadly worded to argue that claims asserting damage or injury caused by greenhouse gases, for example, are excluded from coverage. However, climate change does not only impact property and casualty insurers. Insurers will also need to consider mitigation strategies for other lines.
Many sectors are and will be affected by climate change. Auditors and lawyers, for example, are exposed due to the increased regulation they and their clients must adhere to as well as the increase in climate change litigation. Insurers need to ensure that their assessment of these risks adequately factor in secondary climate change effects.
In the construction sector, it is not inconceivable that as regulations regarding building materials and land use are enacted, coverage is extended increasing the potential losses for insurers particularly as some design and construction professionals fall foul of the regulations. Insurers should, therefore, review the wording of their exclusion clauses and consider excluding cover where non-compliance is a causative factor or results in regulatory proceedings. Insurers might also choose to exclude cover for construction projects that take place in climate risk prone areas, or limiting the maximum payout for a claim or include clauses which encourage climate risk assessments.
Australia has recently seen a wider range of climate-focussed litigation. For example, where shareholders have sought disclosure from financial institutions regarding their lending activities. Companies in the fossil fuel sector are also being challenged for potential greenwashing claims as well as claims alleging that they are not properly disclosing their climate change related vulnerabilities to investors. Increased regulatory scrutiny is also occurring in Australia. For example, in November 2021 APRA released its prudential practice guide on managing climate change financial risks, providing greater clarity on APRA's expectations and best practice for managing such risks. ASIC is also stepping up action against ESG-washing and in particular 'net zero' statements in offering documents.
Climate change therefore presents a substantial risk for directors and officers. Accordingly, insurers should give careful consideration to:
- questions asked of financial institutions on proposal forms about their lending activities, particularly in light of director's duties, misleading or deceptive conduct and continuous disclosure obligations;
- whether the policies respond to climate related litigation; and
- should lower limits be imposed for climate related claims?
Insurers should also review their policy wording, in particular bespoke extensions (such as those relating to pollution or environmental mismanagement) as these could be wide enough to capture climate related claims which were not intended for cover.
Life insurance risks are also impacted by climate change; mortality rates are tied to natural disasters, which also have secondary effects through disruptions to critical infrastructure, affect air quality and increased vector-borne illnesses. Further, increased probability of both heat and cold related mortality are also a growing concern. Insurers need to review modelling of assessing the risks to ensure that they are adequately factoring in climate change impacts.
As climate change continues to ravage Australia, property insurance will become unaffordable and/or unavailable to many. Premiums will also increase across the sector to counter the increased risk. It will also impact claims handling and litigation management. Efforts to avoid these issues will require collaboration with governments and policyholders.
Whilst climate change is causing the insurance industry in Australia (and globally) to suffer increasing losses, there are many opportunities for insurers if they invest in data to enable them to adapt appropriately to the risks. It will enable them to expand into undeveloped insurance markets, offering new products for emerging climate risks. It is also an opportunity for insurers to help communities manage risk and recover from disaster.