Ready for anything: How the insurance industry is responding to the climate change crisis

It’s no secret that natural disasters are becoming more persistent and catastrophic with every passing year. The Institute for Economics and Peace reported that the frequency of natural disasters has increased tenfold over the past 60 years, rising from 39 disasters in 1960 to 396 in 2020. As a result, insurance companies have had to reckon with a growing demand for new types and levels of damage protection.

For Dr. Hong Li, an associate professor in the Department of Economics and Finance at the Gordon S. Lang School of Business & Economics, it’s crucial for the insurance industry to view climate change through a holistic lens. To that end, he says, there are two major actions that companies can take in the face of an uncertain and volatile future.

First, insurance agencies should continue planning for company-specific financial risks as the world transitions toward a low-carbon economy. For example, with heightened awareness surrounding environmental, social, and governance (ESG) standards, regulators may start requiring insurance agencies to disclose internal sustainability efforts. “The insurance industry does not merely depend on successfully innovating products to meet client needs, which most companies already do well,” Li notes. “Agencies also need to protect their own assets by withdrawing capital from carbon-intensive industries and investing in green energy development.”

Second, insurers should push for greater collaboration with local and federal governments. As disaster risks increase, so does the potential fallout if insurers don’t have enough available funding to protect their clients. Without government backing in the event of repeated catastrophes, many insurers may be forced to quit the market.

“The more insurance companies that quit, the more homeowners go uninsured,” Li explains. “We must find more efficient ways for insurers, regulators, and governments to work together when facing disaster.”

In his ongoing work on developing reliable models to predict environmental risk, Li recognizes the unique challenge insurance companies face in forecasting natural disasters. Most current prediction models were built using historical data that is no longer trustworthy considering how quickly the environmental patterns have changed. “Insurance companies are doing valuable work to develop and implement new products for their customers,” Li says. “But the types and amount of coverage they offer greatly depends on the climate risks of each geographical region. Moving forward, we have to develop models that can account for these differences and ensure people’s wellbeing no matter where they live.”

While there is certainly room for improvement, says Li, the insurance industry is making strides in adapting to a constantly evolving ecological and financial landscape. From his perspective, other industries would be wise to follow suit and develop a longer-term planning outlook. For example, land developers may jump at the short-term prospect of building cheaper, less-sustainable homes in rural areas. But this does not always account for the risk of forest fire destroying those homes several years down the line, limiting long-term profits. “Consumers are rethinking their choices in favor of more sustainable products,” says Li. “Whether they’re in insurance or real estate, every industry must become more nimble.”