Greater access to real-time environmental data, better predicting and pricing for extreme weather risks needs to be part of the solution.

Currently countries throughout the world are coping with the health impacts of COVID-19, along with the wide-ranging societal and economic impact.

However, with the current focus rightfully on addressing COVID-19, it remains important not to lose sight of the long-term challenge of climate change. In recent years we have experienced a marked increase in the frequency and severity of natural disasters, including fires, floods, hurricanes and typhoons. These events have become increasingly damaging, in part due to a greater concentration of people and property in and near disaster-prone areas. But more critically, climate change is creating conditions where natural disasters tend to be more intense, widespread and destructive.

The result is that individuals, businesses and governments are faced with the reality that dealing with the effects of climate change can’t wait for some time in the future — better solutions for coping with the new reality are needed today. Insurance companies in particular are facing pressure to rethink traditional models that are often not measuring up in this new environment.

No recent natural disaster has captured more global attention than the devastating bushfires in Australia. Dozens of people and an estimated one billion animals died in the horrific fires1. Australia is no stranger to fires in the dry season, but the intensity and magnitude of the 2019 fires was more severe than any experienced before.

Australia's costliest disaster of past two decades

The scale alone of the fires was unprecedented. Beginning off the back of severe drought conditions in June of 2019, the fires numbered well over 100 by November, burning an area of more than 100,000 square kilometres, the size of South Korea2. Even heavy rains at the start of 2020 failed to extinguish all of the blazes, and as of February, 50 or more continued to burn in New South Wales3.

The Australian fires came a year after northern California experienced its own once-in-a-lifetime natural disaster, 2018’s Camp Fire, reported to be the most destructive fire in the state’s history. In fact, November 2018 was the most destructive wildfire month in California’s history, with insurance claims exceeding US$12 billion4.

The scale and intensity of the Australia and California fires were an in-your-face demonstration of the impact of climate change. Due to climate change, wildfires are becoming larger, more intense, and faster moving and more difficult to control. Where the dry season and related bushfires have historically lasted a period of weeks in Australia, the intense fires of the past year were unprecedented, lasting months as they spread up and down Australia’s east coast.

Amazingly, as destructive as the bushfires in Australia were to the natural environment and its wildlife population, they were actually less damaging in terms of insured losses than other natural disasters. In recent years the greatest damage has come from hail storms, floods and cyclones. In fact, in terms of cost, the bushfires, with current losses at AUD1.65 billion will fall well short of Australia’s costliest event for the past 20 years5. The bushfires were strongest in less populated areas, while more populated major cities have been hammered in the past 3 years with severe hail storms, floods and cyclones. For the insurance industry, the impact of climate change with more frequent, intense and destructive events is upending many of the conventional assumptions about the role of insurance in addressing natural disasters and causing the industry and governments to rethink the ways that persons and property are protected.

Insurance companies in particular are facing pressure to rethink traditional models that are often not measuring up in this new environment.

The increased damage resulting from disasters has enlarged tension in the system, as insurers work to properly price risk, while political pressure ramps up with allegations of price gouging and demands to reduce premiums.

In many affected areas, there are increasing numbers of people who don’t have insurance or adequate insurance to address their loss or damage. Already, there are parts of Australia where the cost of insurance is so high that many people can’t afford it6. In California, a moratorium was instituted preventing the cancelling of policies in areas in and around the wildfire damage7.

In Australia, major insurers maintain a natural hazard allowance to ensure they have the resources to respond to natural disasters. But even these reserves are being underestimated in the face of climate change. In 2019, at least two of Australia’s leading insurers used up their full-year allowance in just 6 months. And this isn’t the first time the natural hazard allowance has been underestimated. Over the past 10 years, it has become an increasingly rare case where insurers’ predictions of their natural hazard allowance have proven to be adequate8. While comprehensive reinsurance arrangements have absorbed much of those losses, the price and availability of reinsurance coverage will eventually come under pressure in a world of increased frequency and severity of natural disasters.

It is a strong reflection that the increasing size and frequency of natural disasters; hail storms, cyclones, flooding, to the bushfires that we’ve just seen implies that the models for predicting these events are obsolete or at a minimum in need of a major recalibration.

What does this mean for insurers and their policy holders?

Greater access to real-time environmental data, better predicting and pricing for extreme weather risks is part of the solution. There is also a greater burden on individuals and businesses who want to locate in areas more exposed to climate-based events, and the municipalities who encourage the development. Insurers would argue that for those who choose to live in a place that is prone to natural disasters, an appropriate rate has to be charged to provide the protection that is needed.

In the US, insurers learned lessons about the unpredictability of damage from natural disasters going back to the early 20th century. Damage from flooding along the Mississippi River in the 1920’s overwhelmed private flood insurance and caused the collapse of a number of insurers. Many insurers stopped writing flood policies as a result, leading to a range of government efforts to mitigate flooding with dams and levies and establishment of programs such as the National Flood Insurance Program (NFIP) to help protect homes and businesses in flood-prone areas. Extensive flood mapping was done to help manage risks, but the historical data used became outdated with increasing development in areas susceptible to floods and hurricanes9.

Fast forward to today, where mapping is used to identify particularly fire prone areas. As with the flood maps, insurance companies became very disciplined about writing policies in the ‘green’ areas and not in the ‘red’ areas but as with the flood mapping, fire maps have been made obsolete with the scale and intensity of fires in the past 2 years. Combinations of historically dry conditions and near hurricane force winds, caused intensity, speed and spread of fires beyond the old predictive models.

What more can be done?

The insurance industry and policy makers are increasingly recognising that while historically the insurance model has been built around protecting policy holders from loss, going forward the new business model will have to rely much more on preventing the loss in the first place.

As the California fires spread, insurance companies reacted quickly to help policy holders, even working to help prevent the spread of the fires. They sent teams to join in local efforts to cut forestation back. They sprayed flame retardant foam around policyholder homes10. And as losses occurred, they took aerial photos of damaged property so that they could more quickly pay out a portion of insurance proceeds to people who needed them.

The question is, could more be done to better prepare in advance? Better monitoring using drones and advanced sensors are already playing a role. Advanced technologies like artificial intelligence will undoubtedly be used to better predict where and when events could occur. There are also more practical steps that can be taken, from helping ensure policyholders have the right roof shingle and building design for the exposure that they have, to making sure brush is cut back from structures.

Extreme weather: Prevention and protection

There is also a massive public policy piece that needs to be addressed to get alignment on preventative measures. Building codes and environmental matters are two significant areas that require attention. There needs to be the right balance between environmental regulation to preserve trees and green space but also allow for a certain amount of hazard reduction to manage the risk of wild fires. A coordinated, targeted approach to forest management is essential to help manage and reduce fire risks. Building codes also need to be reviewed. More stringent building codes unquestionably bolster resistance to natural hazards. They also increase the replacement cost for homes and businesses, so an appropriate policy response from government and industry is needed to support this transition while maintaining affordable insurance coverage.

For insurers it is a challenging dynamic — adapting to a more uncertain and rapidly changing environment, pricing products properly, while avoiding losses and remaining capitally sound. It will require shifting the traditional focus on protection more to prevention. This means the insurance sector working closely together with government, communities and policyholders to better prevent, as well as protect against damage from natural disasters.

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