United States of America

Insurance Law and Climate Change

Contents

    This section was last reviewed in February 2024.


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    Introduction

    In recent years, the intersection of insurance law and climate change has emerged as a critical and dynamic area of legal concern. Climate change, driven primarily by human activities such as the burning of fossil fuels and deforestation, has led to a range of environmental consequences, including more frequent and severe natural disasters like hurricanes, wildfires, floods, and droughts. These events have had a profound impact on the insurance industry, forcing it to adapt and evolve in response to the changing risk landscape.

    Insurance, at its core, is designed to provide financial protection and risk mitigation for individuals, businesses, and communities. It operates on the premise of assessing and pricing risk accurately to ensure that policyholders receive compensation when they experience losses covered by their policies. However, the increasing frequency and severity of climate-related events have challenged traditional notions of risk assessment and management within the insurance sector.

    • Climate change is significantly impacting the insurance industry, leading to increased frequency and severity of extreme weather events and challenging traditional risk assessment models.
    • Insurers are grappling with the financial strain of paying out climate-related claims, potentially affecting the affordability and availability of insurance.
    • Reinsurance companies are also facing pressure due to climate-related claims, which could lead to rising costs throughout the insurance ecosystem.
    • Insurance companies are taking proactive measures, such as developing innovative insurance products like parametric insurance and refining risk assessment models to better incorporate climate-related data.
    • Regulatory authorities are pushing for greater oversight of climate-related risks in the insurance industry, leading to standardized reporting and stress testing.
    • Climate-related litigation related to insurance claims may increase as damages from climate events rise.
    • Emerging insurance products, such as green building insurance, climate liability insurance, and microinsurance, are addressing specific climate-related risks and needs.

    This interplay of insurance law and climate change raises a multitude of complex legal and ethical questions. Insurers must grapple with issues such as how to underwrite policies in an era of heightened climate risk, how to fairly allocate costs among policyholders, and how to incentivize climate-conscious behavior among their insureds. Conversely, policyholders may find themselves in disputes with insurers over claims related to climate-related damage, leading to legal battles over policy interpretation and coverage.

    Moreover, governments and regulatory bodies worldwide are beginning to play a more active role in addressing climate change through legislation and regulation. This involvement adds another layer of complexity to insurance law, as insurers must navigate evolving legal frameworks and compliance requirements related to climate risk disclosure, green insurance products, and sustainable practices.

    In this evolving landscape, insurance law and climate change are inextricably linked, influencing one another in profound ways. As climate change continues to exert its influence on our world, the role of insurance and the legal frameworks governing it will undoubtedly remain at the forefront of efforts to mitigate the risks and impacts associated with a changing climate.

    Risks associated with climate change

    Climate change, driven by the relentless increase in greenhouse gas emissions, has ushered in an era of heightened environmental volatility. For the insurance industry, this translates into a complex landscape riddled with challenges and uncertainties. The most immediate and noticeable impact is the surge in the frequency and intensity of extreme weather events. Hurricanes, wildfires, floods, and droughts are now occurring with alarming regularity, resulting in an upsurge in insurance claims related to property damage, business disruption, and personal losses. The scale and unpredictability of these events have shaken the foundations of traditional risk assessment models employed by insurers. In 2022 alone, the cumulative cost of extreme weather-related damages soared to exceed $165 billion.

    Looking forward to 2050, Swiss Re, a major player in the reinsurance industry, projects a potentially stark scenario: even if global temperatures rise by a seemingly modest 2°C (3.6°F) above preindustrial levels, the repercussions could reverberate through the United States’ economy, potentially precipitating a nearly 7 percent reduction in GDP. The White House Office of Management and Budget (OMB) offers an even more sobering assessment for the longer term, predicting that the adverse effects of climate change could cast a shadow over the U.S. economy, potentially slashing GDP by as much as 10 percent by the close of the century. This economic gloom isn’t confined to American shores; it extends globally, with OMB estimating that worldwide GDP could plummet by a substantial 14 percent if nations manage to keep temperature increases within the 2.6°C (4.7°F) range — an outcome aligned with current policy trajectories[1].

    As insurers grapple with this new normal, they are confronted with the mounting financial strain of paying out claims from climate-related disasters. The sheer magnitude of these payouts has raised concerns about the financial stability of insurance companies. To mitigate these risks, insurers may resort to increasing premiums for policyholders or limiting coverage in high-risk regions, such as coastal areas. This, however, can lead to questions of affordability and availability of insurance.

    Reinsurance companies, which serve as the insurance industry’s safety net by providing insurance to primary insurers, are not immune to these challenges. The increasing frequency and severity of climate-related claims are putting pressure on the reinsurance market, potentially leading to rising reinsurance costs that reverberate throughout the entire insurance ecosystem.

    Measures undertaken by insurers to overcome challenges posed by climate change

    In the face of mounting climate change-related risks, insurance companies are taking proactive steps to mitigate their exposure and contribute to the broader effort of combatting climate change. Insurance companies are actively engaged in the development of innovative insurance products that cater to the specific needs of climate-vulnerable regions and industries. This includes parametric insurance[2], which pays out based on predefined triggers such as wind speed or rainfall, providing rapid financial relief to policyholders in the aftermath of climate-related events. Such innovations are designed to enhance resilience and reduce the financial impact of climate disasters.

    Another and more fundamental approach is through the refinement of risk assessment models. These models, once solely based on historical data, are now being adapted to incorporate climate-related data and projections. By integrating climate science into their risk assessment, insurers aim to gain a more accurate understanding of the evolving threat landscape, thereby enabling better risk pricing and management.

    The challenges posed by climate change may also force private insurance companies to reassess the insurance premiums and payouts. For example, in California, the worsening impact of climate-driven wildfires has prompted insurers to request rate hikes totaling $8.5 billion since the year 2015[3]. Starting in January 2022, a total of 31 states have experienced double-digit rate hikes, while six states observed increases ranging from 20 to 30 percent[4]. In response to these challenges, some insurance providers have chosen not to offer insurance in certain areas. Notably, the two largest homeowners insurance companies in the United States, namely State Farm and Allstate, made announcements earlier this year indicating their temporary suspension of issuing new policies in California[5].

    According to reports, American International Group (AIG) has scaled back its property insurance coverage for homes situated along the eastern U.S. coast, which are vulnerable to flooding, and for properties in the western United States, which face a heightened risk of wildfires[6]. The surge in hurricane-related losses and mounting litigation expenses in Florida have resulted in nearly a dozen insurance companies declaring bankruptcy[7]. Meanwhile, other insurers like Farmers and AAA have imposed limitations on coverage[8]. Additionally, in parts of Louisiana susceptible to hurricanes, insurance companies have refrained from underwriting policies[9].

    Property losses resulting from the impacts of climate change-induced natural disasters are anticipated to surge by over 60 percent by the year 2040, as projected by Swiss Re, the world’s leading reinsurer[10]. Consequently, homeowner insurance policy premiums are expected to experience an annual increase of 5.3 percent[11]. It’s important to note that premiums have already seen a substantial rise, soaring by 12.1 percent across the entire United States from 2021 to 2022. This surge has been particularly pronounced in states that frequently bear the brunt of natural disasters, such as Arkansas, Washington, and Colorado according to Policygenius Home Insurance Pricing Report[12].

    Policy Recommendations on Gaps in Insurance Supervision

    On June 27, 2023, U.S. Department of the Treasury’s Federal Insurance Office (FIO), the only federal entity with a mandate focused on monitoring all aspects of the nation-wide insurance industry, released a report entitled Insurance Supervision and Regulation of Climate-Related Risk, whereby it assesses climate-related issues and gaps in the supervision and regulation of insurers[13]. The report contains 20 policy recommendations aimed at enhancing the oversight of climate-related risks, which include, but not limited to:

    • Encouraging insurers to collect precise, consistent, and comparable data on climate-related risks.
    • Identifying and addressing data gaps to help insurers quantify climate-related exposures.
    • Creating climate risk monitoring guidance by state insurance regulators tailored to their markets.
    • Insisting that insurers integrate climate-related risks into their financial planning and risk management.
    • Standardizing the definition of “materiality” for climate-related risks.
    • Implementing a uniform standard for “materiality” in the NAIC[14] Climate Risk Disclosure Survey.
    • Monitoring and publicly reporting on the impact of climate-related risks on residual and surplus lines markets.
    • Revising the NAIC Climate Risk Disclosure Survey to include quantitative impacts and scenario analysis.
    • Enhancing transparency on how insurers manage climate-related risks and identify best practices and vulnerabilities.
    • Assessing the impact of climate-related risks on the insurance industry[15].
    Emerging Insurance Products in Response to Climate Change

    In response to the increasing threats posed by climate change, the insurance industry has been at the forefront of innovation, developing novel products and coverage options. Among these offerings, parametric insurance has gained prominence, providing quick payouts based on specific climate triggers such as wind speed or temperature thresholds. Insurers are also offering climate risk assessment services, helping businesses evaluate and manage their vulnerability to climate-related risks.

    For property owners and developers with a focus on sustainability, green building insurance is becoming increasingly popular, incentivizing eco-friendly construction practices. Similarly, as the demand for renewable energy sources rises, insurers are creating specialized policies to protect wind farms, solar installations, and other clean energy projects from various risks.

    Climate liability insurance has emerged to address the growing risk of climate-related litigation, offering coverage for legal defense and settlement costs. Ecosystem services insurance is designed to protect against economic losses resulting from the degradation or loss of natural ecosystems, particularly relevant for businesses relying on services like water purification or pollination.

    Agriculture-dependent regions are benefiting from crop and livestock index insurance, which pays out based on predefined climate and weather indices, helping farmers withstand the financial impacts of extreme weather events. Companies engaged in carbon offset projects can purchase carbon offset insurance to protect against the risk of projects not delivering the expected carbon reductions, ensuring financial security for offset buyers and investors.

    Additionally, resilience bonds, although not traditional insurance, use insurance-like principles to raise capital for climate resilience projects, paying out when specific climate triggers are met.

    Lastly, microinsurance tailored to low-income and vulnerable populations in climate-prone regions is providing essential coverage for basic needs during and after climate events. These innovative insurance solutions underscore the industry’s commitment to addressing the challenges posed by climate change and providing adaptable tools for individuals, businesses, and governments.”

    Future Trends

    In the evolving landscape of insurance law and climate change, several prominent trends are emerging. Regulatory authorities are increasingly demanding comprehensive climate risk assessments and standardized reporting, driving greater transparency within the industry. Insurance companies are likely to face climate-related stress testing to gauge their resilience.

    As climate-related damages escalate, litigation surrounding insurers’ response to claims related to climate events may rise. Adjustments in pricing and coverage for climate risks are expected, with parametric insurance gaining popularity. Innovative climate-specific insurance products and international regulatory coordination are on the horizon.

    Additionally, sustainable and green insurance, coupled with potential tax incentives, may encourage insurers to actively engage in climate resilience efforts. These trends underscore the critical role of insurance law in addressing the challenges posed by climate change.


    [1] See Alice C. Hill, Climate Change and U.S. Property Insurance: A Stormy Mix, August 17, 2023. Available at: link.

    [2] See https://content.naic.org/cipr-topics/parametric-disaster-insurance.

    [3] Available at: link. Another survey has also shown that California wildfires in 2017 and 2018 resulted in insurers paying out $29 billion in claims while they only collected $15.6 billion in premiums. The estimated total insured losses from Hurricane Ian range from $53 to $74 billion, with flood-based losses projected to be another $10 billion. Available at: link.

    [4] Available at: link.

    [5] Alice C. Hill, supra note.

    [6] Available at: link.

    [7] Available at: link.

    [8] Id.

    [9] Available at: link.

    [10] See Renee Cho, With Climate Impacts Growing, Insurance Companies Face Big Challenges, November 3, 2022. Available at: link.

    [11] Id.

    [12] See Pat Howard, Home Insurance Prices Are Rising Even Faster Than Inflation. July 12, 2022. Available at: link

    [13] See Federal Insurance Office, U.S. Department of the Treasury, Insurance Supervision and Regulation of Climate-Related Risks. June, 2023. Available at: link.

    [14] NAIC is a 501(c)(3) organization established by the states and governed by their chief insurance regulators that provides guidance, data, tools, and other expertise and analysis for use by state insurance regulators. Id. at 12.

    [15] Id. at 18-55.