If there is one thing the recent insurer retreats have taught, it is the fact that the world we live in is precarious. The effects of climate change across the industry cannot be understated, and heightened weather threats in every region of the insured world equates to pricier premiums, coverage uncertainty, and in some extreme cases, market exits for those who decided that the risks now outweigh the rewards.
However, these extreme cases should also present as a perfect opportunity for those looking to capitalize on the uninsured market. MSCI ESG and climate research senior associate Cody Dong (pictured above) said that those in the business of pricing risks should know this but are held back by several factors.
“Like any business, I think [the] number-one priority is always to make profits. That's the essence of any company, insurance companies included,” Dong said in conversation with Insurance Business’ Corporate Risk channel. “That being said, generating profits doesn't necessarily lead to simple exits from high-risk markets. Insurance companies are in the business of pricing risks. For insurance companies, it's about rising to the challenges and finding their own climate-related competitive edges versus competitors.”
These insights follow a study from Dong that looked at the recent insurer retreats in California following the wildfires, and the possible threat of it spreading to Asia under certain circumstances. However, while his research shows that certain areas in the region have reached a threshold similar to what is happening in the US, there is still a bit of leeway involved because of Asia’s bigger gap.
“Asia is very different from North America or Europe. It’s less likely to see insurance pulling away in Asia from high-catastrophe-risk regions. This is because insurance companies haven't even entered much of the catastrophe market in APAC yet,” he said.
Research from MSCI ESG found that only 14% of economic losses in the APAC region stemming from natural disasters were insured, while the global average hovers around 40%. This gap, Dong emphasizes, is the differentiator; however, he still cautions that extreme weather events could still make carriers think twice about their coverage.
“With climate change increasing the frequencies and intensities of different physical hazards, the end results globally would be similar around the world. This means that in high insurance penetration regions like North America and Europe, you'll see more insurance scaling back from certain regions due to high catastrophe risk. But in Asia, you see insurance companies are more hesitant to provide protection and grow business in catastrophe risk space. Globally and across regions, the protection gap problem will be exacerbated by climate change,” he said.
Dong also emphasized short-sightedness as an issue that needs to be addressed. In essence, those who exited certain markets because of the heightened risks may find another hurdle once they enter another. This also, in turn, presents a unique opportunity for those who elected to hold their ground.
“If every insurance company flees from high-risk markets and go to the so-called lower risk regions, I think the concentration of competition will hurt them in a different way than climate change,” he said. “So, for insurance companies who are better equipped with climate risk management tools, more sophisticated pricing capacities and more innovative products, they can not only withstand this challenge brought up by the climate change, but also benefit from other competitors’ retreat.”
Retreats and scale-backs aside, Dong said that there is a lot that insurers can do besides just sitting back and simply reacting to heightened risks in their respective markets.
“The first is about pricing risks more appropriately. Generally, if the risk is high, insurance can charge higher premiums. However, things aren't that simple because there are other factors at play. One is regulation; in California's case, there are regulations in place that limit insurers’ abilities to raise their premiums. Basically, in terms of repricing, their hands are tied,” Dong said.
While it is not as simple in practice as Dong made it out to be, he said regulator engagement should be the priority for any carrier to address the current climate risks. Dong believes that the government could share some of the burden from these risks, including by subsidizing households or policyholders, either corporate or individuals. It all comes down to making sure to keep the market profitable and sustainable in the face of growing climate threats.
“The second, which relates to my research, is longer term underwriting strategies and pricing strategies. P&C insurers are both blessed and cursed in that they can basically reprice and renew their policy every year. It is a luxury because they enjoy the annual underwriting adjustments,” Dong said.
“However, this often leads to short-sighted underwriting strategies. If any major catastrophe event happens, policies tend to become more expensive and less affordable in the following year. And yet, this kind of annual pricing doesn't necessarily reflect the longer term view, or the real climate risk we will be facing for a few decades to come,” he said.
Finally, there are also sophisticated risk mitigation measures like catastrophe models and climate models, the latter of which are more innovative and cutting-edge for insurers who know how to utilize them. Scenario analysis, stress tests, early warning calls to policyholders – there is a plethora of solutions, Dong stressed, before one could consider the ultimatum that is the retreat.
Product innovation also comes in handy, he added, in that incentivizing policyholders to reduce the risks themselves is a great way to lessen the burden. It also goes into the realm of parametric insurance, where payouts are dependent on certain thresholds rather than losses, a mechanism that is becoming fast popular in the agriculture industry.
“There are a lot of things insurance companies can do besides exiting,” Dong said. “You also have examples of catastrophe bonds, a financial tool that can transfer risks from insurance companies. All these risk mitigation measures are helpful and should be explored by insurance companies.”
Despite the many challenges present in the industry, and all of it coming without geopolitical tensions taken into account, Dong believes that there will still be an insurance market. The question of its viability, however, is another issue entirely.
“There will be extreme cases in regions where a viable insurance market is not possible,” Dong said. “The policies will get so expensive to an extent that they are not affordable at all. But like I said, the risk appetite for different insurance companies varies. This is due to the fact that their cost of capital is different. Therefore, their break-even points are different.”
For these risk takers in a riskier world, it will not just be on them to keep the engine running, but on everyone as well. On the government’s side, it means protecting households and individuals through better legislation. On the insurance side, it’s about offering robust propositions that will ensure that these households and individuals are protected, all the while keeping operations sustainable and profitable.
“Keep in mind, you have all of these risk mitigation measures underexplored by insurance companies, in addition to public-private partnership or government support. This will incentivize at least some high-risk appetite insurers to stay in or get in these markets,” Dong said.
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