"Insurance can save the planet"
Not a phrase often repeated by climate evangelists nor insurers, but one which, after months of research, represents a core element of our financial markets’ climate thesis.
At Deep Science Ventures portfolio company Malachite, we are using socio-urban data to incentivise risk-reducing behaviour. Rather than pricing risk as effectively as possible, we want to reduce risk as much as possible and then price that reduced risk, giving the consumer lower premiums and better protection. This article explains why.
Although often overlooked in climate circles, the insurance industry is the most advanced societal mechanism available for evaluating likely climate costs. Worth $1.6 trillion annually and employing more than one million people, the property and casualty insurance industry is dedicated to quantifying potential risks to property. Within this, climate events are a priority, with natural disasters accounting for 90% of insured losses (source)
While the resources are there, the strategy is not. To date, the insurance industry’s climate strategy has focused almost entirely on modelling the events themselves (hazards such as floods, wildfires), rather than the cost of those events (the value at risk, the level of resilience and the cost of repairs). We have a very good idea of the maximum severity of a hurricane that is likely to hit Louisiana, but much less certainty about the likely cost if a category 5 hurricane were to occur. In addition, due to annual renewals, we’ve tended to favour short-term cost savings over longer-term strategic plays. Combined, this failure to accurately estimate costs and short-term bias has led to high market disaggregation and, ultimately, lower value capture for the insurer. This is only getting worse with time: customer acquisition costs rose from 15.8% of premium in 2018 to 17.9% in 2022. (source).
Negative externalities drive poor climate outcomes
How does this relate to saving the planet? Viewed from an environmental angle, the major failure of our economy is a systematic inability to include the cost of pollution in the price of our goods and services, resulting in sub-optimal climate outcomes. To resolve this, we must determine: “How can pricing be modified to optimise for climate outcomes?”
Applying our knowledge of insurance to the quandary above and employing a venture lens, the question “How can pricing be modified to optimise for climate outcomes?” then becomes a series of questions:
”How can insurance risk frameworks be modified to make adaptation overwhelmingly attractive in the short term and stem increasing losses?”
“How can short term adaptation be made consistent with long-term climate change mitigation?”
“How can modifications be done in a way which creates more value for insurers?”
Answering these questions is as important for the future health of our planet as it is for the future of the insurance industry.
Our growing inability to price risk
We’re actually getting worse at pricing risk: while economic losses from natural catastrophes have decreased by 16% over the last ten years (once normalised), insured losses have increased by 2% (source). Some of this is due to a changing climate - temperatures have increased and there is a high degree of confidence that rising temperatures will continue to increase the frequency and severity of extreme heat, flooding, and wildfire events. However, the much more certain driver of risk, and that which is having a greater impact on losses today (surpassing climate impacts), is the dramatic increase in the number and value of properties over the past decades, especially in areas of high risk.
The surprising and comforting insight driving our optimism is that this risk can be managed. The majority of rising losses from natural perils can be attributed to where and how people choose to live and build their homes (source). This means that although climate impacts are significant, through better preparation, planning and adaptation we can improve outcomes. Rather than focusing solely on how to quantify our risk, by focusing on mechanisms for risk reduction, we can minimise human suffering.
Building the future of climate insurance
Unfortunately, our current insurance system is not optimised for risk reduction. Instead of working with customers when damage is suffered to help them build back better and minimise future losses, insurers tend to penalise claimants with higher premium fees. They do not reward risk-reducing behaviour and little consideration is given to how improved adaptive capacity could reduce premiums. A failure to optimise for risk reduction also leads to a lower uptake of insurance: 38% of those in the UK without insurance say it is too expensive and a further 20% say they don’t see a need (source).
This is a missed opportunity for both climate and insurance. Last year, natural catastrophes resulted in economic losses of USD 270 billion, insured losses of USD 111 billion and 11,880 fatalities (source). Amongst this, floods have caused more than a third of natural catastrophe related fatalities since 2011 and affect nearly a third of the world population – more than any other peril. It is expected that by 2030, floods will cause US$700 billion in annual damages (source). From a commercial perspective, an inability to proactively protect customers is leading to uninsurable market segments, lower customer retention and higher claims as laggards get stuck with ‘bad risks.’
We believe there is a better way. We are building a next-generation insurance company optimised for adaptation to a new climate and are actively recruiting for the founding team. If you are interested, you can find out more from this job description, get in touch with Lydia Maher directly or contact us through the form in the footer.