Climate Change Concerns Require a New Look at Property Insurance on a Macro Scale

Climate change is no longer just the concern of flood-exposed coastal residents, or those who inhabit potential wildfire areas; there is growing indication from insurance companies that the cost of events related to climate change will spill over in significant ways to property insurance in total.  Global insurer Munich Re’s Chief Climatologist, Ernst Rauch, recently discussed the issue with The Guardian, “Climate change could make insurance too expensive for ordinary people”, indicating that the rising financial effect of catastrophes could spill over into rates being taken across the  spectrum of property insurance policies. 

“If the risk from wildfires, flooding, storms or hail is increasing then the only sustainable option we have is to adjust our risk prices accordingly. In the long run it might become a social issue,” he said after Munich Re published a report into climate change’s impact on wildfires. “Affordability is so critical because some people on low and average incomes in some regions will no longer be able to buy insurance.”

Low and average incomes?  If one agrees that Munich Re’s outlook is correct it might be said that affordability will be an issue for ALL incomes in some regions if no carrier makes insurance available due to excessive risk;  if there is no property insurance available (or it’s not purchased by customers- interesting perspective on earthquake insurance here) this problem spills over to financial markets in terms of loss of mortgagee casualty protection for real property loans.  Take the spillway further, and riskier areas become less viable for economic activity in the big picture.  Consider even further- reduction in occupied properties, reduction in property tax revenues, public revenue… now there’s trouble.

What’s to do?  Wring hands, rend garments, wail and gnash teeth?  How about some real change of thought for property insurance?  Let’s look at coverage, coverage amounts, indemnity, parametric options, and connected properties (IoT).

If property insurance policies covered just fires or probable maximum loss (PML) perils, insurance would be significantly less costly.   Correspondingly, if those PML perils had a ‘floor’ severity amount beneath which the customer held responsibility (not unlike windstorm or earthquake perils in the US), insurance would be less costly.  If policy coverage for frequent claims, e.g., water losses, was capped at a known amount, insurance would be less costly.  Continuing, if frequent insurance claims were payable essentially on demand (no claim inspection needed), insurance would be less costly.  Even further- if insurance products were more available with less cost of acquisition (customer or company cost), premium volume would rise, making insurance less costly.  Customers have become accustomed to the granular indemnity response that today’s policies provide, and that may need to change.

So what’s the point?  Again, the industry is at a potential tipping point- natural and manmade losses are growing faster than expected ($500 billion in 2017-18 alone, per insurer Swiss Re , estimated $200 Bn insured), and the purpose of this article is not to focus on what is a given- increasing cost of insurance due to the expectation that the pattern continues.  Of course absent the presence of insurance to indemnify at a time of loss, what matters the cost?

What if:

  • Connected devices became ubiquitous, not just as features in devices, but as data collectors?  Simple, inexpensive moisture sensors for example that not only serve to turn off water supply, but also as aggregators of damage information.   A leak occurs, triggers a parametric cover response from the property owner’s policy.  Sensors that recognize material obsolescence, prompting maintenance by the property owner.  Roof sensing that anticipates not only wear, but damage due to sudden perils.
  • Property insurance policies became hybrid indemnity/parametric risk management vehicles, with higher frequency, lower severity claims paid upon occurrence, at a predetermined coverage limit with no need (other than fraud vetting) for expensive claim investigation?
  • Mortgage holders held part of the risk for major losses in areas where climate risk perils, e.g., coastal flooding, wildfire, etc., are known elevated risks?  Mortgagees do this now to an extent as those property owners without adequate risk cover will walk away, and the mortgagees are left with the property.  Change the mortgage payment risk from an upfront portfolio percentage to anticipate walkways, to a loan ‘premium’ to help cover the elevated insurance policy premiums.
  • Governments held parametric disaster response insurance policies that triggered when events occurred, jump-starting financial response to community-wide disasters?
  • There was an acceptance that pollution is contributing to climate change, and pollution tax paid by firms was used to fund disaster recovery efforts?

Just some thoughts, but holding key ideas- broadening responsibility for risk management beyond just the individual property owner and changing the expectation of property insurance from a full indemnity model to one that recognizes a loss but doesn’t hold one party to the contract (the insurer) solely responsible for determining the amount of loss and working to identify every detail of the financial loss.

If property insurance is to remain viable from an industry basis it seems the product needs to be considered from a loss/disaster perspective backwards, from a who is at risk from a ‘no recovery’ aspect, and then from a who benefits from helping fund risk management efforts.  There are plenty of data available to the industry to calculate the probable cost of individual high-frequency claims, and by extension the premiums needed for a parametric basis for settling that nature of claims.  Individual investigation of smaller claims is simply not a highest and best use of expensive human capital, and if AI is to be applied to those claims, why not carry the knowledge to preemptive claim resolution (loss is detected, payment is made?)  Sure, the policy forms that exist today would need rework (as would customer expectations), but in the face of pricing risk sharing beyond many property owners isn’t radical thinking needed?

Wildfire losses like those experienced in California or Greece exposed the nature of who and what is insured, the haves and have nots, and also the difficulty in rebuilding (or not) areas that have had regional destruction ( see Paradise California’s wildfire recovery challenges.)  Significant wind and flooding damage in Hong Kong, Japan, southeast US, and southern Africa produce ripples that extend materially well beyond those regions.  Confidence that risk is being apportioned and shared will serve to stabilize capital that is being made available as a backstop for significant risk (catastrophe bonds, insurance linked securities, and traditional reinsurance- with an interesting ECIS regional perspective Seeking Alpha view here ).

Climate change effects highlight the big responses to big events, but whether there’s a clear bread crumb trail between change in climate and change in property insurance the anticipated path is clear- the cost of insurance is rising along with global tides.  And the effect that all benefit from a viable, affordable insurance industry is also clear- risk management is a keystone factor that if absent ripples through economies on a macro scale, and as such needs a unique macro approach to ensure we are all not insurance poor.

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Patrick Kelahan is a CX, engineering & insurance professional, working with Insurers, Attorneys & Owners. He also serves the insurance and Fintech world as the ‘Insurance Elephant’.

I have no positions or commercial relationships with the companies or people mentioned. I am not receiving compensation for this post.

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  1. I agree with your perspective Pat. IoT has tremendous potential to help insurance companies learn more about risk and to mitigate it. Insurance companies are struggling with IoT. In my opinion they need to update their stand on data. They need to look at data not from the perspective of owning it but of having access to it. Consumers and insurers will enter a new relationship. Consumers will own their IoT data and will share it with insurers for them to bid on personalized quotes. The era of mass-customization based on risk profiles owned by consumers is coming.

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