The Management Series

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Oct 2017

Insurers’ Role in Responding to Climate Change

Can insurance companies help stop climate change? Probably not. But can they help mitigate the damage caused by climate change and influence local policies that take the effects of climate change into account? Yes—and make a profit, to boot.

The key, argues the Harvard Business Review article “How the Insurance Industry Can Push Us to Prepare for Climate Change,” is making use of  sophisticated data and improved geographic and weather information tools about areas more likely to face the dangers posed by rising oceans, intensifying weather patterns and wildfires to take steps to mitigate risk.

Discussion of the potential influence by the insurance industry comes as areas struck by hurricanes Harvey and Irma debate how and where to rebuild ruined homes and buildings and as the federal government is backing away from efforts to take climate change into account in zoning and planning.

For example, President Trump recently rolled back an Obama-era executive order that required cities to anticipate worse flooding and higher sea-level change when planning the construction of roads, bridges and other infrastructure. They could be placed in drier areas or built stronger to withstand effects of climate change.

But access to improved data raises the possibility of “the insurance industry introducing innovative pricing strategies that induce private real estate owners and local governments to take efforts that together yield a more resilient real estate capital stock,” wrote the chairman of the University of California economics department, along with two department students.

The article points out that while some forms of insurance have long used price differentiation to mitigate risk, property insurance has been slow to adopt the practice. But some innovators are now doing so, using “detailed topographical data to assess” flood risks for low-lying coastal regions, and making competing property insurers decide whether to “embrace individualized insurance or lose out on the low-risk insurance seekers.”

“Low-risk customers will seek insurers that recognize their risk levels and lower their premiums. And as more and more insurers appropriately price climate risk using more fine-grained data, individuals will face clear incentives to consider those risks when deciding where to live.”

Insurers also could offer price breaks to property owners that take steps to make their properties safer, such as hurricane resistant doors or creating brush-free buffer zones in areas susceptible to wildfires, the economists said.

Some reinsurance companies are issuing high-yield catastrophe bonds that are sponsored by municipalities. “Catastrophe bonds are triggered when specific parametric triggers are reached by a disaster, such as a specific storm surge height for a hurricane,” the article explained.

What policies and practices make some areas like Houston more prone to flooding in disasters and more likely to rebuild without taking strong steps to ensure new buildings are less vulnerable to flooding in the future?

Billy Fleming, a researcher who studies the role of politics, science and architectural and civil design in an age of changing climate, explains in detail in a Knowledge@Wharton podcast what factors he believes made the catastrophic flooding in Houston following Hurricane Harvey unavoidable.

“That’s one of the world’s most predictable disasters,” Fleming said. “When a storm like this comes through, and you’ve spent the better part of 20 years building highways and roads and low-density development to become one of the world’s geographically largest cities, there’s nowhere for that water to go.”

For a look into how members of the insurance industry are leading the push for catastrophe resilience globally, check out the Leader’s Edge October feature, “Stabilizing the World.”

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