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Is the World Headed for an Uninsurable Future?

The growing trend of insurers exiting high-risk markets due to climate change threatens to upset the delicate balance of financial ecosystems. 

A core function of any insurance firm is the ability to identify, manage and price long-term risks. 

With extreme weather events like flooding, hurricanes, droughts, and wildfires on the rise, climate change is one of the biggest risks facing the insurance sector.  

“In many regions, we’re seeing very real changes in the intensity and/or frequency of extreme weather events,” Ernst Rauch, Chief Meteorologist at insurance firm Munich Re, tells ESG Investor. 

“For the insurance industry, this in turn changes the probabilities of losses already today, as well as what we can expect in the years to come.”  

A 2021 BlackRock study found that 95% of insurers representing US$27 trillion in assets believe climate change will have a significant impact on portfolio construction in the near term. Additional McKinsey research noted that the value at stake from climate-induced hazards could increase from around 2% of global GDP to over 4% by 2050. 

In May, US insurance giant State Farm announced it would be halting the sale of new home insurance policies in California, citing “rapidly growing catastrophe exposure” as one of its main reasons for stepping back from the market.  

State Farm – which has not responded to a request for comment – isn’t the only insurer to have made such a decision, with a number of firms pulling back from regions that are already seeing the negative effects of a rapidly warming planet. 

Experts speaking to ESG Investor are concerned this growing trend will upset the balance of financial ecosystems, posing detrimental knock-on effects for banks, investors, policymakers, companies and citizens.  

“Climate change is a huge financial risk to insurers,” says Steven Rothstein, Founding Managing Director of the Ceres Accelerator for Sustainable Capital Markets.  

“It used to be the case that pretty much everywhere was insurable, but that’s no longer true.” 

The irony is that, despite wanting to protect themselves from climate-related financial risks, many insurers continue to underwrite fossil fuel production and other carbon-intensive activities, thus further contributing to global warming. 

“But the future is looking very different from the past that is reflected in [insurers’] risk models,” says Peter Bosshard, Global Coordinator for the Insure Our Future Campaign. 

“The climate crisis is posing obvious, inherent challenges to the insurance industry; they can’t bury their heads in the sand any longer.” 

Walking a tightrope  

Honouring their net zero commitments while mitigating climate-related financial risks is not an easy tightrope for insurers to walk. 

“The insurance industry possesses both a curse and a blessing,” says Sylvain Vanston, Executive Director of Climate Investment Research at MSCI.  

“It allows for annual repricing of premiums and reinsurance markets, which enables risk re-assessments based on recent events. Unfortunately, this can sometimes limit the industry’s long-term perspective.  

“With the ability to adjust course each year, the incentive to integrate risks that may emerge in 20 years diminishes,” he says.  

Earlier this year, Eric Andersen, President at Aon, told a US Senate committee that climate change has created a crisis of confidence around the ability of insurers to predict loss. Just as the US economy was overexposed to mortgage risk in 2008, so too is the economy to climate risk today, he warned. 

And the increasing rate of natural disasters is already taking its toll.  

A 2020 report published by Aon noted that natural disasters caused US$3 trillion in economic damages between 2009-2019, costing insurers US$845 billion – well above levels seen a decade prior. Swiss Re said that insured natural catastrophe losses hit US$110 billion in 2021. Research also shows that limiting global warming to 1.5°C has the potential to save upwards of US$20 trillion in damages globally, whereas exceeding 2°C could lead to hundreds of trillions.   

These costs are having a huge impact on regional insurers’ balance sheets.  

In Florida alone, 15 property insurers have gone insolvent since 2020, due to running out of reserves following massive natural disaster-related claims and struggling to find enough reinsurance cover, with reinsurers like AIG and Swiss Re also reducing their exposures to the state. It’s a similar story for eight other insurance companies in Louisiana. 

Against this bleak backdrop, the decision made by insurers like State Farm and Allstate to step back from high-risk markets makes clear business sense.  

“The industry’s reliance on one-year contracts to recklessly procrastinate on managing climate risks underestimates not only the transition risks from fossil fuels, but also the devastating impact of withdrawals on insurance markets, local and regional economies, and ultimately the financial system as a whole,” warns Carly Fabian, Policy Advocate for the Climate Programme at US-based consumer rights advocacy group and think tank Public Citizen.  

The availability of insurance is typically a “decisive factor” in determining whether investments are made or not, Rauch from Munich Re acknowledges.  

“When buying a house and securing a mortgage, obtaining insurance that protects against fire and elemental perils is necessary to avoid financial ruin in case of incidents,” he says. “The same principle applies to institutional investors in infrastructure or industrial projects. Without insurance, these investments would be deemed too risky to pursue.” 

Without insurers, responsibility to plug the gaps will first fall on governments. 

Only around a quarter of climate-related catastrophe losses in the EU are currently insured, according to a discussion paper published by the European Insurance and Occupational Pensions Authority (EIOPA). EIOPA noted this gap could widen in the medium to long term because of climate change, with increasingly frequent and intense events leading to insurance becoming unaffordable.  

“This would further increase the burden on governments, both in terms of macroeconomic risks and in terms of fiscal spending to cover uninsured losses,” the paper said, adding this “may raise government debt burdens and increase economic divergence” and “pose financial stability risks and reduce credit provision in countries with large banking sector exposures to catastrophe risk events”.  

There is also the risk of creating “poverty traps”, where segments of the population are simply unable to secure insurance and, therefore, exposed to huge risks, according to MSCI’s Vanston.  

For insurers to manage climate-related risks sustainably and be able to offer coverage in the long term, they “need to understand the probability of current and future risks at a local level”, says Rauch from Munich Re. 

Modelling these risks on the basis of state-of-the-art scientific knowledge, especially regarding climate change, is the best way to help insurers avoid unexpected surprises that could otherwise result in a withdrawal from high-risk markets.” 

Empty words?  

It’s crucial that insurers, as one of the cornerstones of the finance sector, are supporting the global transition to net zero greenhouse gas (GHG) emissions by setting ambitious decarbonisation targets and following through. This appears to be happening on the investment side, at least. 

Hanna Kaskela, Senior Vice President of Sustainability and Communications at Finland-based Varma Pension Insurance Company, says that, as an investor, the firm has identified industries that offer both “the greatest opportunities” for emissions reductions through their business and are “significantly exposed” to risks caused by climate change mitigation with a “strong willingness” to change and an ability to adapt to climate change. These companies span oil and gas, electricity and heat production, metals and mining, construction materials, transportation, paper and forest products, and chemicals.  

Varma further plans to reduce its investment portfolio emissions by 25% by 2025 across all asset classes, and 50% by 2030 compared to 2021 levels.  

However, the 2023 annual general meeting (AGM) season left much to be desired, when it comes to whole-company net zero strategies, with many large US insurers failing this proxy season’s climate test.  

Proposals filed at firms received less support from shareholders compared to previous years, which is arguably a reflection of the growing influence of the anti-ESG movement.  

One such proposal filed by As You Sow asked Chubb to publish a report disclosing 1.5°C-aligned medium- and long-term decarbonisation targets for its underwriting, insuring and investment activities. It received 28.9% of the shareholder vote, yet a similar proposal received a 72.2% majority the previous year.   

The break-up of the Net Zero Insurance Alliance (NZIA) has also raised concerns that the sector’s climate resolve can be shaken. 

Earlier this month, NZIA rules faced a major re-write, with members no longer required to set or publish GHG decarbonisation targets, following a mass exodus of members earlier this year. Remaining NZIA members are now individually responsible and publicly accountable for any targets they set, the methodologies they use to set them, and their timelines for disclosing targets and progress. 

“The NZIA has allowed the insurance industry to pretend it’s at the forefront of the fight against climate change,” says Ariel Le Bourdonnec, Insurers and Reinsurers Campaigner and Analyst at Reclaim Finance. 

Andrea Ranger, Shareholder Advocate at Green Century Capital Management, says the firm “is doing its utmost to highlight the business risks to [insurance firms such as] The Hartford, Travelers and Chubb that are attributable to enabling more carbon pollution into the atmosphere”. 

She adds that it is the job of investors to “hold [insurers’] feet to the fire so they’ll keep their [net zero] commitments”.  

Untangling from fossil fuels 

For climate-focused investors, experts and NGOs speaking to ESG Investor, the way forward for the insurance sector is clear: the industry must end its support of fossil fuel production and throw its weight behind renewable energy and other low-carbon projects.  

This will be quite the undertaking. The US insurance industry alone had US$582 billion invested in some combination of oil, gas, coal, utilities and other fossil fuel-related activities as of year-end 2019.  

“Insurers have made climate risks challenging for themselves and have continually undermined their own markets by investing in and underwriting fossil fuels,” says Fabian from Public Citizen.  

“To meet the unique challenges of climate risks, insurers should adopt a precautionary approach that requires a large margin of error, and they should start by reducing their financed and insured emissions in line with science-based targets.”  

If more insurers refuse to cover fossil fuel projects, it will become much harder for companies to “build their climate bombs”, notes Le Bourdonnec from Reclaim Finance, as this will mean higher prices and more risks to cover for those insurers choosing to continue business with fossil fuel firms. 

“Without insurers and their ‘construction all risks’ coverage (CAR), a fossil fuel project cannot be built. It requires massive amounts of insurance capacity that only some of the largest insurers can provide,” adds Le Bourdonnec.  

The good news is that a growing number of insurance firms are making public commitments to no longer cover new upstream oil and gas projects, including Munich Re, Swiss Re and SCOR. AXA noted in its most recent climate and biodiversity report that it will be updating its oil and gas policy before the end of this year.  

Insurance firms are also increasingly offering products to support the growth of low-carbon industries, such as renewable energy.

Earlier this month, Australian insurer QBE launched its first renewable energy insurance offering for Australia-based projects, including solar and wind farms, as well as battery storage. QBE has plans for expansion into emerging technologies like hydrogen.

In a bid to become the UK’s biggest renewable energy insurer by 2027, Aviva now offers insurance for offshore and onshore wind, solar power, electric vehicle charging points, and battery energy storage systems across the UK, US and Europe.

These kinds of solutions encourage investment and accelerate market entry for new technologies,” says Rauch, noting that Munich Re offers performance guarantees to PV module manufacturers, allowing them to enter the market with a “competitive advantage”. 

“This solution can also provide buyers and investors with a safety net in case of warranty issues or insolvency on the side of the original equipment manufacturer,” he says. 

Staying out of court 

Another incentive for insurers to untangle themselves from fossil fuels is growing climate litigation risk, according to Bosshard from Insure Our Future.  

“If insurers aren’t going to be taking on the costs of climate catastrophes in high-risk markets, then who should pay alongside governments? The answer is the polluters should pay,” he says, pointing to the growing number of climate lawsuits filed against fossil fuel companies.  

Insurers may feel increasingly inclined to take fossil fuel companies to court to cover the mounting costs of climate-related catastrophes, but Bosshard warns that insurance firms continuing to support the fossil fuel industry are at risk of becoming exposed to litigation themselves.  

“If a firm is insuring the liabilities of a fossil fuel company that has been taken to court over its contribution to climate change, the insurer may need to pay up for the damages and political costs,” he says.  

Last year, Aloha Petroleum, a subsidiary of US-based Sunoco, filed a claim against AIG’s National Union Fire Insurance Company, arguing that the insurer had failed to protect Aloha from the costs of defending against climate-related claims made by local governments in Hawaii. 

The UN Environment Programme has previously said that insurance firms are not being rigorous enough in their assessments of exposure to climate litigation risks. The US Department of the Treasury has also warned that insurers face significant litigation risks due to the climate policies they issue, as well as failure to address exposure to climate calamities.  

“It’s clear that we have missed the opportunity for an orderly transition to net zero,” says Bosshard. 

“The longer we allow the fossil fuel industry and its supporters in the insurance sector to delay the transition, the more painful and chaotic global decarbonisation will become.  

“If we continue the way that we are, then the world will become uninsurable; we’re closer to that reality than the insurance industry acknowledges.” 

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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