Partner Emmanuèle Lutfalla and Associate Tara Farasat explore the impact of climate change on insurance

The scientific consensus is clear: the number and frequency of severe weather events will continue to increase steadily as a result of climate change. Over 5 years after the adoption of the Paris Agreement at COP21, the objectives laid down therein are still far from being attained.

The 2021 statistics clearly reflect this trend. This past year has been marked by the highest number of insurance claims related to environmental occurrences and the highest rise in the cost of “secondary risks”, e.g. heat waves, forest fires or major floods. As such, there is little doubt that the increasing number of intense weather events will continue to drive up the cost of the associated losses and of the policies designed to cover them.

It is likely that insurance premiums could be multiplied by two or three times the current figures, by 2050. Some insurers are also becoming reluctant to cover risks that will certainly occur. For instance, between 2015 and 2019, 350,000 California policyholders were denied renewal of their insurance policies in high fire risk areas. This is hardly surprising when you consider that between 2017 and 2018, the cost of these contracts for insurers amounted to USD 24 billion.

In this respect, the shortcomings of the coverage provided by the French “CatNat” (short for “natural catastrophes” regime are obvious and the increasing need for reform is glaring. Under Articles L. 125-1 and L. 125-2 of the French Insurance Code, when a property damage policy covers property located in France, the coverage provided by said policy automatically extends to any losses imputable to natural disasters.However, this mandatory coverage extension only applies if the occurrence has been formally categorised as a natural disaster by inter-ministerial decree.

In order to benefit from this statutory policy extension, the determinant factor of losses incurred must be the “abnormal intensity of a natural event”, but if formerly “abnormal events” are bound to be “normalized” as a direct result of climate change, doesn’t the “CatNat” regime become devoid of purpose? Bertrand Labilloy, General Manager of the CCR, confirmed in an interview that “the increase in the overall cost of claims and mostly related to events that occur on a recurring basis.”, Even though the need to rethink and rebuild a more adequate system is obvious, the recent reform undertaken by the Government remains superficial and does not clarify the way this legal regime can be articulated with the provisions of policies covering the same risks.

Considering the economic and social implications of climate associated risks, both corporations and individuals must anticipate and mitigate the consequences of climate change on their property and day-to-day activities. Currently, they remain mostly dependent on the classic insurance mechanism to cover environmental risks and will face an increase in the cost of underwriting. We must urge them to actively explore other ways to protect themselves against climate-related losses.

For instance, companies may subscribe to parametric insurance in place or in conjunction with a regular insurance policy to cover environmental risks. Today, historical insurers (such as Axa Global Parametrics) and insurtechs (such as Descartes) have already entered the parametric insurance market. This other type of policy guarantees the automatic payment of a lump sum to the insured when the policy’s index or indices are reached. Parametric insurance allows for a direct correlation between the payment issued and the losses incurred and ensures the prompt delivery of an indemnity to the insured. Commonly used in emerging countries, this type of policy is more affordable and, therefore, more accessible to companies who may not be able to afford other types of insurance.

Other tools also allow companies to assess the degree of resilience of their operations in the face of climate change and guide them on the path to climate-resilience. A prevention tool named Ocara has been developed by HDI Global France and Carbone 4 and uses public data related to climate change, and information specific to the company, in order to evaluate their physical and financial exposure to climate related risks. The tool then generates a tailormade guide to ensure that the company’s infrastructure and business model become increasingly resilient, therefore mitigating the costs related to climate change.

Ocara could become the reference tool for analysing the resilience of companies with respect to climate related contingencies, thus enabling them to take the proactive measures to combat the impact of climate change on their operations.

In conclusion, there is no doubt that climate change will have a considerable impact on the insurability of environmental risks, especially in regions particularly exposed to such risks, and on the structure of the insurance market as a whole. We are clearly witnessing a paradigm shift: both insurers and policyholders pay attention to the climate resilience of the insured infrastructure to ensure the economic viability of their respective businesses.