Insurance Industry Struggles with Extreme Weather Phenomena and Climate Change

Extreme weather phenomena have steadily been increasing in recent decades. The cost of these natural disasters has increased by more than $870 billion (adjusted for inflation) since 1980. Many industries are affected by extreme weather, which can impact economic output. The bitter cold that held much of the U.S. in a firm grip this past winter lowered American output by as much as $3 billion (2014 USD) a week. Insurance companies face particularly challenging issues in the wake of climate change, including assessing risk and setting prices.

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Risk assessment has become difficult for insurance companies, who traditionally rely upon historical data to determine risks. Flooding and other disasters have grown more widespread since 1990, occurring in historically low-prone areas. As a result, the insurance industry has been faced with an increased demand for storm-related insurance. Some regions may become uninsurable due to high risk relating to the frequency of extreme weather phenomena (e.g. wind-damage insurance along gulf coast states).

Flooding from Hurricane Katrina

Flooding from Hurricane Katrina.

Additionally, pricing policies are becoming more uncertain for insurance agencies. Setting a reasonable price for weather-related insurance has become problematic as the frequency and intensity of natural disasters are hard to predict. Setting prices too low risks huge losses in the wake of an extreme weather phenomenon (e.g. extra-tropical cyclone Sandy in the Northeast U.S.). On the other hand, setting prices too high for insurance policies will cause consumers to drop their protection policy. Finding an equilibrium in the insurance market is tough, but imperative for the survival of individual insurance agencies.

The insurance industry is working with other industries to curb the effects of climate change by reaching out to consumers and encouraging a drive toward renewable energy and use of sustainable products. Furthermore, insurance companies are pressuring businesses and individuals affected by natural disasters to rebuild in a sustainable manner (i.e. adhering to more strict building codes) so that disasters will not have as big of an impact in the future.

4 thoughts on “Insurance Industry Struggles with Extreme Weather Phenomena and Climate Change

  1. We expect that unusual losses will occur in groups … that’s basic probability, the more common the event, the less such sequences. So global warming? Or just that unusual events perforce aren’t evenly spaced? Then we have economic development: how much of the coast of NJ or Florida is empty of development? Hilton Head NC is an insurance disaster waiting to happen!!

    Both make an insurance company’s pricing harder – you tend not to have historic loss data from places where until recently few people lived. Firms rely upon reinsurance: it is not impossible for bad luck to break that bank. Lean years, fat years, it’s the number in a row that matters, not the average!

    Now … how does this affect the structure of the insurance industry? Primary policy writers vs reinsurers, capital structures should be debt-light? But then how can CEOs line their own pockets, er, earn a “competitive” bonus?

  2. As long as the actuaries are doing their risk valuations correctly shouldn’t this be profitable for the insurance firms? The fact that their is more of a risk than ever of people losing their things means that people will buy more insurance. It makes more sense financially for an individual to pay a higher insurance premium on an asset than risking losing all of the asset (which is why their is insurance in the first place). I may be wrong but it seems like the threat of disaster (not disaster itself) is a firms dream.

  3. When the effects of climate change are discussed people rarely start to talk about how difficult it will become for their insurance company to set policies, so this was an interesting change of perspective. Modeling for future changes in climate is still far behind the rest of the field of climatology, which means if historical data won’t be of much use for insurance companies then neither will predictions from experts in the field.

    If the entire industry begins to suffer wouldn’t they all need to raise premiums to cover the increase in costs? It seems unlikely that consumers would begin to leave their policies in droves since one insurance company shouldn’t have to raise their prices more than the others.

  4. Why does since recently everyone hide behind that non-descript “climate change” vocabulary? Is it getting warmer (on average) or colder? The above refers to both, but that is nothing new, there have been weather extremes since there is weather. And most times these “extreme” weather situations are prefaced with something like “not since 1880 has …” or, in other words, there have as a rule been more “extreme” weather spikes on record. The reason the insurance industry struggles is likely twofold: humankind builds (and ventures into) in regions previously not used (sometimes exactly due to freak events like floods in the past) and … the investments in these areas increase in value thus leaving the insurances more exposed to costlier risks. This has nothing to do with climate change but with reckless risk-taking. Insurances have to learn to say no to signing policies in certain areas. There is such a thing as uninsurable risk!

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