How to Close the Protection Gap in a Changing Climate

Consider this alarming fact: The National Oceanic and Atmospheric Administration reports that as of May 9, 2023, the atmosphere contains 423.8 parts per million of CO2, which exceeds the recognized safe level by 68.8 parts per million. In the past decade, a staggering 23.6 parts per million of CO2 have been added to the atmosphere. These figures highlight the consequences of unhealthy levels of CO2 in the air, which translates to the exacerbation of climate change and the disruption of ecosystems worldwide. Given this ongoing situation, the insurance industry has been saddled with a widening protection gap. The uptick of weather-related catastrophes, not to mention the economic losses they leave in their wake, are leaving many businesses and property owners without adequate insurance coverage.

This protection gap has far-reaching implications for both insurers and policyholders. Indeed, according to the United Nations University’s Institute for the Environment and Economic Safety, climate risk insurance has both an economic and a (positive) political dimension to it as well insofar as it “allows countries which are affected by climate change to become more independent; rather than waiting for months, or even longer for international aid to arrive, they are able to manage disaster risk themselves.”

Unraveling the Complexity of the Protection Gap

The protection gap, the difference between the total economic losses from climate-related disasters and the amount covered by insurance, has been growing at a dizzying rate. Notably,  Gallagher Re's Q1 2023 report mentions that of the $77 billion in global natural catastrophe economic losses, a mere $22 billion was covered by insurance. This leaves a whopping $55 billion protection gap.

Such a gap reflects the multifaceted challenges faced by the insurance industry. These challenges include the unpredictability of weather events that defy historical trends, out-of-date  insurance models, as well as the lack of insurance penetration in certain markets.

An article published by KPMG entitled “Regulating for Climate Change in Insurance,” which cites the 2021 Global Insurance Market Report (GIMAR) stated that “more than 35% of insurers' investment assets (including equities and corporate debt, loans and mortgages, sovereign bonds and real estate) could be considered “climate-relevant,” i.e., exposed to climate risks. Within the equities, corporate debt, and loans and mortgage asset classes, most climate-relevant exposures relate to counterparties in the housing and energy-intensive sectors.”

The Challenges: Predictability, Traditional Models, and Market Penetration

Climate change adds an unprecedented layer of complexity to risk assessment. The unpredictability of climate events, their increased frequency and severity, and the long-term impacts of climate change are hard to quantify using traditional risk models, especially in regions undergoing drastic changes. This past April, for example, in Myanmar, Laos, Vietnam, Thailand and parts of China, daily temperatures soared to such levels that The Guardian quoted weather historian and climatologist Maximiliano Herrera's observation that the region had seen “endless record heat in Southeast Asia, with weeks of records falling every day.”

Another wrinkle that must be addressed is that there has been a significant lack of insurance penetration in certain markets, particularly in developing regions – such as southeast Asia and sub-Saharan Africa – that are highly vulnerable to climate risks. This lack of coverage exacerbates the protection gap, leaving communities and businesses exposed to potentially crippling financial losses and governments vulnerable to political instability.

Bridging the Gap: Strategies for the Future

To bridge this protection gap, insurers and reinsurers must adopt innovative strategies and leverage advanced technologies like parametric insurance, which can offer swift and transparent payouts tied to measurable weather events. Furthermore, advanced climate risk modeling can provide more accurate risk assessments by projecting future climate scenarios. This can help insurers better understand their exposure to climate risks and price their products accordingly. Finally, insurers need to focus on expanding their reach in underinsured markets. Doing so must entail the development of bespoke insurance solutions that are affordable and meet the needs of these markets. Accompanying such measures, insurers would also invest in awareness campaigns to educate potential policyholders about the importance of insurance coverage.

To learn more about Arbol’s bespoke climate change solutions and what they can do for your business, contact us here.  

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