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Nothing grows in the Desert

HIGHLIGHT /
Climate change should not be treated as a business-as-usual insurance case. In order to align with climate goals, the insurance industry requires a significant transformation. Currently, the current role of insurance is under discussion in terms of advanced risk modeling and parametric insurance. It is imperative that the industry adapts to the changing demands of the climate and adopts more innovative and effective approaches to mitigate risks associated with climate change.

The concept of insurance is typically associated with risk management, a system designed to provide financial protection against unforeseen events. It's a well-established industry, and for many, the role of insurance seems to have remained constant over the years. However, as we navigate the challenges posed by climate change, it becomes evident that this industry needs a substantial transformation.

Historical Perspective

The discussion surrounding climate change is not a recent development. It dates back to the 19th century when scientists and thinkers began to recognize the potential risks and impacts associated with changing climate patterns. A significant milestone in this journey was Carl Sagan's testimony before Congress in 1985. His warning about the potential consequences of climate change served as an early alarm bell.

Despite the long history of climate change discussions, the world has struggled to find a market equilibrium to address this existential threat effectively. The assumption that the free market, driven by the expectation of alternative energy sources, could compensate for the use of fossil fuels has not materialized to the extent necessary to meet climate goals.

The implications of climate change have become undeniable in recent years. We find ourselves in 2023, facing the reality that climate change has a direct and immediate impact on all life on Earth. These effects have been witnessed across the globe. From the massive wildfires in California to the scorching temperatures that broke records in South Spain, these are not isolated incidents but symptoms of a much broader issue.

In an insurance context, the urgency of addressing the protection gap is becoming more apparent. Home insurers abandoning certain areas due to increasing risks, such as wildfires or flooding, underscore the industry's immediate challenges. The protection gap, which refers to the difference between insured and uninsured losses in the wake of natural disasters, surpassed a staggering $200 billion in 2020, as reported by Swiss Re. It's a clear indication of the scale of the issue we're grappling with.

The Current Role of Insurance

In this rapidly changing landscape, the insurance sector has tried to adapt. The current role of insurance is being discussed in terms of advanced risk modeling and parametric insurance.

Advanced risk modeling involves the development of new climate risk models and better climate predictions. These models aim to provide insurers with more accurate data to assess and manage climate-related risks. This is a crucial aspect of the industry's adaptation to the changing climate landscape.

Parametric insurance is another innovative approach. It involves using predefined parameters to determine when insurance payouts are triggered. This allows for quicker and more straightforward claims processing in the event of a covered event. This kind of insurance can be particularly useful in situations where the loss can be easily quantified and attributed to specific parameters, such as wind speed or rainfall.

The drive to enhance customer experience in insurance is also notable. The industry is working to create a frictionless claims process, utilizing technology to streamline interactions between policyholders and insurers. While these advancements are commendable, there is an underlying issue that cannot be ignored.

Despite these innovations, the metrics used to evaluate the performance of these advancements are essentially the same as those that have left millions of customers underinsured or, in some cases, without coverage at all. The very principles that the insurance industry has relied on for decades may not be sufficient to address the magnitude of the climate crisis.

Climate Change as Systematic Risk

Climate change is a systematic risk, which means it has the potential to affect all assets and cannot be mitigated through traditional diversification strategies. Much like other systematic risks, such as political or macroeconomic uncertainties, insurance plays a crucial role in managing and mitigating these challenges.

But climate change is unique in its scale and complexity. It's a risk that is challenging to predict, model, and price accurately. Unlike more traditional risks, climate change doesn't fit neatly into existing insurance frameworks. It demands a more comprehensive approach.

Insurtech Models and Investments

In the Insurtech landscape, we can observe three main models related to climate change:

  1. Climate Data and Analytics: This model involves the collection and analysis of vast amounts of data related to climate and environmental conditions. It provides insurers with valuable insights into emerging risks and trends.

  2. Parametric Insurance: This model, as previously mentioned, uses predefined parameters to trigger insurance payouts. It's an innovation that aims to simplify and expedite the claims process.

  3. Clean Energy: Insurers are investing in clean energy initiatives as a way to reduce carbon footprints and promote sustainability. This not only helps address climate change but also aligns with the broader environmental goals of society.

These models have received significant investments from major insurers, reflecting the industry's recognition of the need to adapt to a changing world. They enable insurers to be more intelligent and enhance customer experiences through automatic triggers and preventive climate alerts.

However, as promising as these models are, they represent only a fraction of the potential of the insurance sector in addressing climate change.

Redefining the Mission

It's evident that the current role of insurance, as discussed in the market, falls short of what is needed to tackle the climate crisis effectively. The climate crisis is not just another business line; it's a global challenge that transcends conventional metrics and models.

The traditional mission of insurance, which is often centered around protecting against possible disasters, enhancing customer experience, and achieving specific business metrics, may no longer be sufficient in the face of the climate crisis.

A New Mission Emerges

A new mission is emerging, one that calls for a complete rethinking of the insurance industry's role in the context of climate change. It goes beyond merely providing coverage and managing risk. It's about embracing a more comprehensive perspective.

The ultimate mission for insurers, banks, governments, retailers, tech companies, and individuals is clear: to stop climate change. The focus should be on cooperation and collaboration, not just within the insurance industry but across all sectors of society. This mission is singular in its objective - to halt climate change, nothing less.

It's about redefining the insurance industry's role from a business-as-usual model to a model that actively contributes to the collective effort to combat climate change. The emphasis is on cooperation, innovation, and holistic thinking.

In conclusion, the role of insurance in addressing climate change cannot be business as usual. The urgency of the climate crisis demands a fundamental shift in perspective. It's not just about protecting against climate-related risks; it's about actively participating in the global effort to combat climate change.

Header photo by Keith Hardy on Unsplash

Authors
Richard Calvo, Alvaro Takashi Yamashiro
Richard Calvo
Author
Richard Calvo
Head of Insurtech at NTT DATA Insurance EMEAL
Alvaro  Takashi Yamashiro
Author
Alvaro Takashi Yamashiro
Analyst Digital Insurance at NTT DATA EMEAL
Published on 30/11/2023
~ 5 minutes
Business Transformation
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