Insurers Are Underestimating the Financial Impact of Climate Change - ESG Considerations You Should Make

Property & Casualty

Insurers Are Underestimating the Financial Impact of Climate Change - ESG Considerations You Should Make

As the world and insurance marketplace continues to change, non-financial factors such as the environment, ethics and governance issues are emerging as new pillars for analyzing and making financial investments.

What is ESG? 

ESG stands for environmental, social and governance. Environmental considerations could include carbon footprint, greenhouse gas emissions, waste reduction practices or other sustainable regulations. Social factors may include breaches of human rights or labor laws or health and safety concerns. Governance describes the understanding of the responsibilities different stakeholders hold in a company.

The Emergence and Importance of ESG 

Throughout the years, businesses have focused on short-term issues and putting the environment, energy, global health and climate change issues further down on their list of top concerns. However, failing to adapt business operations towards an ESG-focused agenda could increase overall long-term risk.  

Reinsurers could be underestimating their exposure to climate change and natural catastrophe risks by up to 50%. Carriers have begun to reflect the dynamic nature of climate-related risks, which is contributing to some of the volatility in the marketplace.     

As the frequency and severity of natural disasters have increased due to climate change and populations continue to grow in areas affected by these catastrophes, insurance costs are increasing. 

Failing to adapt business operations towards an ESG-focused agenda could increase overall risk. Developing ESG guidelines for your company may make it possible to find favorable terms and additional capacity.

According to research by Swiss Re, the gap between incurred losses and insured losses due to natural catastrophes has steadily increased in the last 30 years1. This is likely due to a combination of the following: 

  • Carriers restricting capacity in exposed areas 
  • Higher catastrophe deductibles  
  • Lower catastrophe limits 
  • Insureds purchasing less coverage due to elevated premiums 
  • Increased rate and high severity of natural catastrophes, hurricanes, floods, wildfires, and severe convective storms2 

Additionally, the United States is experiencing a rapid transformation toward clean energy. There is a robust pipeline of renewables projects under development, and further investments remain likely, especially following the recent progress of the Inflation Reduction Act of 2022. However, insurers see challenges with these projects. 

Many of these projects are in regions susceptible to catastrophes. For example, solar projects take advantage of weather conditions in places like Texas, Florida and Arizona. However, those geographies are prone to hailstorms, hurricanes and wildfires. This has translated to higher premiums, narrower policy terms, lower limits and higher deductibles. The technology employed in renewables projects is also rapidly changing, which has given some carriers pause over insuring equipment without a significant operating history. 

How Can Organizations Prepare?

Organizations can start by gaining a firm grasp on their exposure, including maintaining and actively reviewing statements of values. Begin by asking the following questions: 

  • How were values developed? Are they adequate in today’s current inflationary environment?  
  • Have you completed any recent appraisals or other work to develop values? 
  • Are any company locations in a region susceptible to catastrophes, such as on a flood plain or earthquake zone? 
  • Where are your key customers and suppliers located?  
  • What is their exposure to natural catastrophe risk? 

Modeling and Analysis

Organizations may consider modeling their exposure of all assets on an aggregate basis. Modeling can provide anticipated loss projections for various perils (flood, earthquake, named storm, severe convective storm, etc.) These models benefit large organizations with multiple locations that may be exposed in a singular area-wide event. This analysis also provides a baseline for evaluating the adequacy of any catastrophe-related limits within an organization’s policy. Analyses can lead to action items, for example: 

  • Investigate whether any tools exist to harden your facility, like flood barriers. 
  • Develop an emergency response plan for natural catastrophes.  
  • Test the emergency action plan or mitigation efforts regularly. For example, the emergency plan may be ineffective if personnel are unfamiliar with deploying flood barriers or parts have been damaged/lost in storage over time. 
  • Develop a business continuity plan if a loss occurs at one facility. 
  • Evaluate the business continuity plan if a critical customer/supplier cannot continue operations. 
  • Ask carriers if any loss control resources and engineering information can be leveraged. 

Select insurance carriers are becoming actively involved in incentivizing resiliency. FM Global has approved approximately $300 million for a first-of-its-kind resilience credit for eligible FM Global policyholders to invest in climate risk improvements. This initial resilience credit is intended to provide additional financial means to invest in climate resilience. 

ESG Guidelines from Underwriters 

Some carriers are requesting ESG information from prospective insureds as part of the underwriting process. Some of the parameters surveyed include details on tracking emissions, greenhouse gas mitigation efforts, determining whether ESG is an ongoing board-level agenda item and the scope of capital expenditures dedicated to ESG improvement. Prospective insureds that meet a carrier’s ESG guidelines may be offered additional capacity at competitive rates. Alternatively, some markets may be unavailable to an insured if their ESG profile is insufficient in the eyes of the carrier. This can lead to a shrinking market of carriers, impacting pricing and available capacity. 

In the public’s perception, there is heightened scrutiny on companies’ ESG activities, with increasing interest from investors and pressure on companies to provide ESG disclosures. The SEC has proposed rules for companies to disclose ”climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements.” The Insurance Information Institute is opposed to the rule, taking the position that “introducing a new layer of federal oversight would neither enhance nor standardize the climate-related disclosures US insurers make to their investors.”   

Climate change affects all businesses, some more directly than others. These impacts have only increased in recent years and show no signs of subsiding. Businesses can help protect themselves by having an emergency response plan, physically hardening facilities and developing proper risk transfer mechanisms. Organizations that are not proactive may be surprised by damage to a facility with a previously unforeseen exposure or by the potential scope (or limitation) of insurance coverage. 

ESG and Risk Management

Understanding your company’s ESG position and stance can inform your risk management strategy. Knowing your risks and having an action plan to mitigate them may not only help you in the event of a potential claim, but it could also assist your organization in taking a proactive stance toward improving your overall ESG position. As you evaluate your ESG and risk management strategy, Brown & Brown is equipped to help you navigate this evolving priority.

Blake Berscheid

Assistant Vice President | Senior Property Claims Director