EIOPA publishes Discussion Paper on European Insurers' Exposure to Physical Climate Change Risks
Analysis of EIOPA Discussion Paper assessing European insurers' exposure to physical climate change risks.

 

On 20 May 2022, EIOPA published its Discussion Paper on European insurers' exposure to physical climate change risks (the Paper). The Paper presents results, based on a large data collection exercise, which focused on property, content and business interruption insurance against windstorm, wildfire, river flood, and coastal flood risks.

The Paper provides a greater understanding of the insurance industry's exposure to extreme weather events. These weather events will likely increase in frequency and severity due to climate change.

EIOPA warns that a large proportion of the insurance industry remains unprepared for the increase of extreme weather events caused by climate change.

The impact of climate change and physical risks – EIOPA's views

The impact of physical risks posed by climate change can be categorised into acute and chronic impacts.

  • Acute impacts refer to damage to property, business disruption or reduced productivity.
  • Chronic impacts relate to increased sea levels, rising temperatures and precipitation.

In order to measure the potential consequences of these risks, (Re)insurers should:

  1. Estimate the expected frequency of climate change risks and convert these estimations into economic impacts on the underwriting portfolio in relevant geographical areas;
  2. Establish an accurate period over which these changes are expected to occur;
  3. Evolve their practices in the long term to better adapt to the risks and opportunities presented by climate change. 

For these reasons, an accurate assessment of physical climate-change related risks requires access to detailed data, scientific and actuarial expertise, new modelling methods as well as an understanding of the various business models employed in the (Re)insurance sector. 

When modelling physical climate-change risks, three key factors need to be considered: 

  1. The level of exposure, estimating the likely split and composition of the population or the value and properties of assets at risk;
  2. The hazard which describes the likelihood of incidence of weather-related events such as windstorms, floods or droughts at a given location as well as their physical intensity or severity;
  3. The vulnerability of the exposures to weather-related losses. This can be defined as the inclination of the exposed population or the physical assets to suffer damaging effects from the impact of natural occurrences.

Climate change and non-life insurance business  

The Paper highlights four potential liability side impacts that increased climate related physical risks may have on a non-life (Re)insurer's balance sheet. These include: 

Reserving risk – Direct consequences stemming from physical climate change risks may affect the liability side of non-life (re)insurance firms’ balance sheets through several lines of business (LoBs), such as fire and other damages to property, motor property damage, crop damage and marine, aviation and transport (MAT). In addition, natural catastrophes may lead to an increase in mortgage insurance claims.

Pricing Risk - Insurance companies may turn to re-pricing strategies to reduce increased exposure to climate risks. However, modelling projections may not fully capture emerging climate trends leading to unforeseen losses. In addition, even where re-pricing is possible, it could make insurance coverage unaffordable for policy holders causing reputational damage to the insurance sector.

Underwriting Risk - Changes to underwriting strategies might widen protection gaps or create new ones. These changes would expose those who are most at risk from climate change causing reputational damage to the insurance industry and broader macroeconomic consequences.

Reinsurance Risk - An increase in the frequency and severity of weather events worldwide will eventually affect the reinsurance premium, terms and conditions of reinsurance treaties. Consequently, insurance undertakings may see a drastic increase in their reinsurance cost and be forced to pass on these increased costs through higher premiums or reassess the areas and regions considered insurable. 

Background to the Paper

The Paper provides data from 44 large European groups and solo undertakings active in non-life business and with relevant exposure to fire and other damages to property business. The sample represents at least 50% coverage at national level for 24 European Economic Area jurisdictions.

The Paper specifically analyses the potential consequences of physical climate change on the property insurance business where extreme weather events will likely have its greatest impact. As they are typically sold together, property insurance includes: buildings, contents, and business interruption insurance. 

The Paper compiles data collected by EIOPA on the following: 

  1. Year-end data 2020 data on sum insured, number of buildings insured, number of contracts covering business interruption and content related losses, premiums, claims, and expenses related to insurance contracts covering for European wildfire, windstorm, coastal and river flood risks for residential and commercial buildings.
  2. Historical information in three European Natural disasters.
  3. Insurers' views and expectations for the next 10-20 years on the potential long-term physical risks on their business strategies.

Further Steps

The insurance sector will play a key role in reducing risk exposure, raising risk awareness, and adapting industry practice. EIOPA caution that non-life (Re)insurers must strike a balance in preparing for the increased frequency and severity of natural catastrophe claims, while also ensuring that financial protection remains affordable for policyholders. 

The insurance sector's ability to provide financial protection against the consequences of extreme weather events relies on their ability to assess and understand the likely impact of climate change and adapt their business strategies. However, the Paper indicates that more than half of the study's participants have not undertaken any climate analyses. 

It is important that insurers begin to prepare detailed physical climate risk exposure assessments to ensure that their practice is ready for the increased frequency and severity of extreme weather events. EIOPA state that they plan to continue their analytical work in this field with an overall aim of supporting further forward-looking views and analysis of physical risks in light of climate change. 

 

Key Contacts

Eoin Caulfield Partner

John Larkin Consultant

Ian Murray Partner

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