Climate change: key considerations for general insurers

Rising claim costs and reduced insurance access and affordability

Worldwide, climate change is already increasing the risk of extreme weather events, though impacts vary by region and by type of peril. In February 2022, the Intergovernmental Panel on Climate Change (IPCC) released its alarming Sixth Assessment Report, a “dire warning” that climate change is a “grave and mounting threat to our wellbeing and a healthy planet”. In emphasising the urgent need to adapt to a warming Earth, the IPCC explains that a certain amount of climate change is ‘baked in’, so even if we immediately reduce emissions significantly (which isn’t happening), significant climate impacts will still take place.

Climate change has, and will continue to, increase the frequency and severity of catastrophic losses in future, placing pressure on premium rates, and on insurance access and affordability in some market segments. New South Wales, in particular, has suffered through the 2021 floods, then the even worse and more extensive 2022 flood events. As the climate warms, heavy rainfall events are expected to become more intense, causing increased potential for flooding. Solutions that reduce loss of lives, livelihoods and property in a flood-prone future are complex and involve multiple parties. These include local, state and Commonwealth governments, as well as insurers, banks, builders, developers and communities. Insurance is a vital part of the solution. For example, insurance pricing, terms and conditions can provide incentives for the construction of more safely situated and resilient buildings.

One response of the government to this issue in Australia has been the introduction of a reinsurance pool for cyclones and related flood damage, which began operations on 1 July 2022. The pool is aimed at reducing the cost of home insurance for households in cyclone-prone parts of the country.

Insurance affordability for flood-prone areas was also on the mind of the New Zealand government well in advance of the recent events in the North Island, with New Zealand’s first national climate adaptation plan released in August 2022 listing “develop options for home flood insurance” as a key action to address inequity. This action notes that work is underway to determine the impact of risk-based pricing on insurance and explore options to support access to and affordability of flood insurance. Possible options range from doing nothing through to some form of government action, as in Australia, the UK and other countries.

Climate risk management, adaptation and mitigation will be increasingly critical for insurers, customers and regulators into the future. This is likely to require a forward-looking approach, new capabilities and a broader range of partnerships.

Standardised disclosure of climate risks

With growing risk of climate related risks comes a growing global momentum toward standardised disclosure. The Task Force on Climate-related Financial Disclosures (TCFD) issued voluntary guidelines that 2,600 companies around the world endorsed in 2021. The recently created International Sustainability Standards Board has also released draft International Financial Reporting Standards on Climate-related Disclosures, which builds on the recommendations of the TCFD. The message for insurers is that investors and regulators will expect increasing maturity and quality of disclosures.

In New Zealand climate related disclosures are now mandatory for accounting periods that start on or after 1 January 2023 for:

• Large, listed companies with a market capitalisation of more than $60 million
• Large-licensed insurers (with greater than $1 billion in total assets under management or annual gross premium income greater than $250 million)
• Registered banks, credit unions, building societies and managers of investment schemes with more than $1 billion in assets and some Crown financial institutions.

Given the global momentum towards standardised closures, smaller NZ insurers should get on the front foot and start thinking about how to identify, quantify and report on their climate-related risks.

In December 2022,  the Australian Treasury released a consultation paper on Climate-related financial disclosures, which commits to introducing standardised, internationally-aligned reporting requirements for Australian businesses to make disclosures. The consultation paper proposes that large financial institutions – including insurers – should be the first cabs off the rank for mandatory disclosure requirements. The consultation period closed in February, and insurers will be keeping a keen eye on what size thresholds will be put in place to determine this initial requirement. Next steps involve further consultation on a specific design proposal which will provide more detail of the new reporting requirements, their implementation and sequencing.

Australian insurers of all sizes should be preparing for eventual mandatory disclosures, building off the considerations they have made applying APRA’s Prudential Practice Guide CPG 299 – Climate Change Financial Risks which reflects the TCFD’s framework for considering and managing climate risks.

A move towards net zero

While climate-related disclosures focus on the risk that climate change poses to a business’s operations and profitability – companies, investors, regulators and other stakeholders are also looking to understand the direct impact a company’s operations and products have on the climate and environment.

Joining the global momentum towards insurers making net-zero emissions targets, in November 2022, the Insurance Council of Australia released its Climate Change Roadmap Towards a Net-Zero and Resilient Future. This roadmap reflects the commitment of the Australian general insurance sector to achieving net-zero by 2050, and provides guidance for the Insurance Council members on the role they can play in the decarbonisation of the Australian economy.

Further, at least 39 major insurance companies have adopted policies to no longer insure new coal projects and, in many cases, to phase out their cover for existing coal operations. In a similar way, net-zero commitments are likely to continue to impact underwriting standards in future, particularly for high-emissions industries, such as transport and agriculture.

Opportunities for innovation

As economies transition towards lower emissions, opportunities will emerge for industries that can demonstrate more emissions-efficient systems, or even carbon neutrality. Leading insurers will be on the lookout for ways in which they can develop new products and services, access new markets and build resilience along their supply chain. Examples already exist of banks and insurers offering better rates to businesses with lower emissions relative to their sector peers – partly because these companies are deemed better risks. An Australian insurer, for example, currently offers a low emissions car discount, where customers can save up to 25% off comprehensive car insurance if their car is recognised as having low emissions.

How can Taylor Fry help

With more than 20 years’ experience partnering with the insurance industry, and a team of climate risk specialists, Taylor Fry can help insurers think strategically about their response to climate change. For more information on the services we offer, visit our Climate and Sustainability page.