Climate risk and insurance: a small step forward, but is it enough?

Why does climate change matter for insurance?

A fundamental part of insurance is about forecasting and assessing risks – both to their investments and to the potential insured losses they cover. A successful insurer balances paying out claims with earning a good profit.  But climate change is making all of these risks harder to predict. More extreme weather events, like hurricanes, floods, and wildfires, are increasing in both frequency and severity, meaning insurance companies may face much bigger payouts than expected. Investments are also being exposed to longer term risks of potential devaluation and risks of economic disruption as the planned transition to a sustainable economy stalls.

But there’s another side to this issue: insurance companies don’t just react to climate change – they also influence it. Insurance companies play a role in shaping climate outcomes through their investment choices and the businesses they insure. For example, if insurers continue to support fossil fuel projects, they are accelerating climate change instead of reducing risks.

What are ICPs, and what has changed?

Insurance Core Principles, or ICPs, are global guidelines that set standards for how insurance companies should be supervised. They help supervisors to ensure that insurers are financially stable, manage risks properly and protect policyholders. The work on the ICPs is coordinated by the International Association of Insurance Supervisors (IAIS) –  a voluntary membership organisation of insurance supervisors and regulators from more than 200 jurisdictions. The IAIS has now added climate change considerations to some of the key Principles:

• Investments (ICP 15): Insurance companies must now explicitly assess how climate change affects their investments. While this is a positive step forward, insurers should not rely too heavily on historical data to assess climate change risks, as the data do not capture the rapidly changing and unprecedented nature of the risks.
• Risk Management (ICP 16): Insurers are now encouraged to consider climate change as a long-term, complex threat. They should use scenario analysis – testing different “what if” situations – to understand how extreme weather, changing regulations, or shifts in public opinion could impact them.

Why isn’t this enough?

While it’s good that climate risks are now officially recognized, these changes don’t go far enough. Climate change isn’t just another risk that insurers are exposed to (exogenous riskExogenous risk in finance refers to risks that come from outside the financial system and impact markets. These risks include events like economic downturns, natural disasters, political instability, or major policy changes. As they originate outside the market, investors and businesses often have little control over them but must react to their effects.) – it’s a fundamental shift in how the world works. The gravity of this shift will be determined by the actions of economic agents, including insurers themselves (endogenous riskAs opposed to exogenous risks (read supra), endogenous risks are originated from the internal workings of the overall financial system, and how all participants interact with each other.). Insurance companies need to do more than just acknowledge the problem; they need to rethink their entire approach to risk and responsibility.

This also means accepting that historical data and modeling climate risk with scenario analysis will not be enough.

To truly address climate risk, insurers need to consider both how climate change affects their business and how their business affects the climate. Insurance regulators need to help usher in this change by upgrading the existing rules to point to how insurers can capture these risks. There are many uncertainties over how climate change and the transition will unfold. A simple, clear and consistent approach is essential to provide clarity and certainty for insurers, align risk-mitigating actions towards a common objective and prevent underestimating the risk.  There are already key steps that can be taken on transition planning and adjusting pricing of risks that are growing due to climate change.

The big question

Will regulators and insurers move fast enough to tackle these quickly expanding risks? One thing is clear: the first step is to recognise the limits of existing rules, but the second step is to take action to change the rules!

What’s next?

The IAIS will release more detailed guidance in April 2025 to help insurers and regulators strengthen their response to climate risks. This could help close some of the gaps in the current framework, but it is still small, incremental progress. As climate change accelerates and threatens to create a major economic disruption, global and European insurance regulators need to pick up the pace significantly. They should act decisively to enforce their financial stability mandatesRegulators and supervisors have the mandate to ensure safety and soundness of individual financial institutions, as well as stability of the financial system as a whole. The division of these mandates and respective responsibilities of regulators and supervisors differ depending on the jurisdiction. and protect society from a looming collapse of the insurance sector. The clock is ticking and effective policy options are on the table.

Paul Fox, Finance Watch

• Learn more about Finance Watch’s policy work on insurance
• Reach out to contribute to civil society advocacy effort