Is insurance the first climate domino to fall?

While most economists and much of the financial system is still living in la la land when it comes to failing to account for the climate emergency, one sector where the impacts are already piling up is the global insurance industry. It in turn underpins national and transnational commerce as well as being a vital component of the housing sector. No insurance, no mortgage, as I explored in the Irish Examiner in September.

FOR MOST OF us, most of the time, insurance is just another bill that drops on the mat once or twice a year for our home or car. And while sometimes it might be tempting not to bother renewing, the nagging possibility, however slight, of being financially wiped out by a catastrophe, such as a house fire or major flood damage, means we keep on paying those annoying annual premia.

Typically, it is assumed that in any given year, a small number of claims will be made per 1,000 vehicles or homes covered. The pooled income then allows a few big payouts to be made. What happens, however, if a city is hit by a storm or extreme flooding event that destroys thousands of cars and houses?

The home insurance market in particular is beginning to rapidly unravel in parts of the world as extreme weather events ratchet up. In the first eight months of 2023 in the US, there have been 23 ‘natural disasters’ where damage has exceeded $1bn, making it already the worst year on record, with almost four months remaining.

“Climate change is the number one long-term risk out there”, according to Jerome Haegeli, chief economist with re-insurance giant, Swiss Re.

Calculating insurable risk depends on complex mathematical modelling, but for all their sophistication, almost all models have a fundamental flaw in that they base current and future risk on what has happened in the past.

Accelerating climate change means the risks are increasing, in scale, frequency and in unpredictability. Last May, State Farm Insurance, the largest insurer in California halted all its new home policies in the state due to what it described as “growing catastrophic exposure” to wildfire risk in particular.

In the last six years, California alone has experienced more than $30bn in insurable losses as a direct result of wildfires fuelled by rising temperatures. In March, Eric Andersen, president of Aon PLC stated that climate change has created “a crisis of confidence around the ability to predict loss.”

Ominously, Anderson added that “just as the US economy was over-exposed to mortgage risk in 2008, the economy today is over-exposed to climate risk.” Hurricanes, wildfires and flooding disasters have pushed insurers into crisis and bankruptcy in several US states, with homeowners struggling to get cover at almost any price.

The situation in Europe is also growing critical. According to the European Commission, losses directly attributable to climate change cost EU states some €145bn over the last decade, with Ireland ranking the third-highest country in per-capita climate related losses. These losses are expected to rise exponentially in the years and decades ahead, with dire implications for the insurance industry.

In parts of Cork, including Glanmire, there are already households that are unable to get insurance dating back to a major flood in the area over a decade ago. The inability to get insurance means people cannot get mortgages, with obvious knock-on effects into the wider economy.

Climate risk

In August 2022, Ireland’s Central Bank launched a consultation on climate change risk for the insurance sector, upgrading climate from “emerging risk” to “key risk”, and advised all insurers to closely monitor their exposure to climate risks.

“The stakes are high, not just for the future viability of the insurance sector, but for society as a whole”, according to Central Bank governor, Gabriel Makhlouf. A survey it conducted in 2021 found that only one in five insurers fully integrate climate risk into their risk management frameworks, with less than half the firms surveyed having conducted stress testing around climate risks.

This laid-back attitude to emerging climate risk is by no means confined to Ireland. Research published earlier this year revealed shocking levels of ignorance and complacency across the financial sector.

The study, involving the University of Exeter and the Institute and Faculty of Actuaries, found that many leading financial institutions simply didn’t understand the models being used to project the economic cost of climate change.

Models developed by economists that fundamentally misunderstand climate risks, including tipping points and compound events, are being used by financial institutions to estimate their own exposure to climate risks, and these are in many cases profoundly inaccurate.

‘Hothouse world’

For instance, a number of major financial institutions in the UK bizarrely reported that they would be unaffected or even do better in “hothouse world” climate scenarios that will lay waste to civilisation.

The most egregious example of this occurred in 2018, when famed economist, William Nordhaus in his address on receiving the Nobel Prize in Economics stated that an average 4C global temperature rise would represent the “optimal” balance between costs of climate change versus climate action.

As climate science has long confirmed, a 4C world would in reality be a hellish dystopia of famines, desertification, forced migration, political and economic chaos, ecological collapse and global immiseration. Indeed, at just 1.2C, the world is already experiencing ever-worsening and increasingly dangerous extreme weather events, as the ferocious summer of 2023 has so forcefully underlined.

The notion that the world’s food production system alone could withstand 4C global temperature rise is considered wildly unrealistic by scientists, yet many economists and the financial institutions they influence often appear to exist in a parallel reality where the physical limits of Earth systems do not apply.

As a case in point, an assessment of likely impacts on global GDP in a “hothouse” world of +3C carried out by a group comprising 114 central banks and financial overseers somehow managed to entirely omit “impacts related to extreme weather, sea-level rise or wider societal impacts from migration or conflict”.

If at this point it seems fanciful that some of the world’s highest-paid and ostensibly smartest people could really have gotten something this big so completely wrong, cast your mind back to the financial collapse of 2008, where greed, self-delusion and magical thinking on the part of major banks and investment companies came within a hair’s-breadth of triggering a total collapse of the global economy.

If they were this unable to grasp financial risk back in the early 2000s, is it really so difficult to imagine that the same people and institutions are any less blinkered today on climate risks?

On a positive note, many major insurers are now refusing to provide cover to new oil and gas exploration, having finally twigged that the fossil fuel industry is destroying the stable climate system that the insurance industry’s business model depends on.

While the only effective long-term defence against climate change is to drastically cut carbon pollution, in the interim, we also have to spend heavily to strengthen our infrastructure against threats such as rising sea levels.

To get a sense of just how unprepared the Irish public is for what lies ahead, Dublin City Council spent half a million euros in 2018 to lower a newly constructed sea wall as it slightly obstructed the sea views of motorists.

This change was demanded by local residents, even though these same residents may well face having their homes inundated as sea-level rise continues. The penny may not yet have dropped for many, but that too will change as the climate crisis comes crashing against our shores.

ThinkOrSwim is a blog by journalist John Gibbons focusing on the inter-related crises involving climate change, sustainability, resource depletion, energy and biodiversity loss
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