The impact of climate change on insurance markets has been systematically underestimated, with profound implications for financial stability and the sustainability of the risk-sharing services insurance provides.
In my research on the economic impacts of climate change and other disasters, I’ve observed a persistent pattern: insurers treat climate change primarily as a future risk while failing to recognise how it has been transforming the risk landscape for some time now. This misunderstanding is now coming home to roost as insurers abruptly withdraw from markets or dramatically hike premiums, creating economic shockwaves which should concern those charged with maintaining stability in the insurance industry and financial system more broadly.
The situation is more precarious than many realise. As 2024 is set to become the first year to breach 1.5°C of warming – even temporarily – we are already within the uncertainty range for five major climate tipping points. These are thresholds such as the potential extinction of coral reefs or dramatic shrinking of the Amazon rainforest which, once crossed, trigger self-reinforcing cycles of irreversible change. The financial implications of crossing such tipping points are impossible to price, yet they depend directly on today’s emissions choices.
Even before these tipping points are crossed, the changes in the climate are creating turmoil in the insurance industry. A new analysis reveals that climate change accounts for approximately US$600bn in insured weather-related losses between 2002-2022. Even more alarmingly, climate-attributed losses are now growing at 6.5% annually compared to 4.9% for insured weather losses, rising from 31% to 38% of the total share over the last decade.
Climate red flags for insurance regulators
Consider how this dynamic is disrupting existing methods of calculating insurance risk: insurers typically price risk based on historical loss patterns and data, until a major event forces a dramatic reassessment. But climate change has already altered the frequency and severity of extreme weather, rendering historical data an increasingly unreliable guide. When insurers finally recognise this reality – often after suffering major losses in a catastrophic event – they tend to overcorrect, either by sharply increasing premiums or withdrawing coverage entirely.
This pattern is playing out in many places although in different ways. In highly insured economies, insurers retreat from climate-exposed regions and raise premiums at inflation-beating rates. In emerging and lower-income economies, the persistently high “protection gap” between insured and total losses continues to leave communities financially unprotected and governments exposed to devastating financial impacts.
For insurance regulators these dynamics should be a red flag, suggesting they should reassess how they oversee the industry because insurance companies are exposed to climate risks on two fronts.
First, from the financial impact of ever-increasing extreme weather risks (witness the recent devastating hurricanes in the Gulf of Mexico and floods in many parts of Europe). Second, from the investments these companies make in the fossil fuel industry, one of the principal drivers of climate change. In effect, insurance companies are amplifying those climate risks that are now bearing down on them; regulators should take steps to break this doom loop.
For central banks, these trends pose challenges to both core mandates: price stability and financial stability. The inflationary impact of insurance premium hikes is direct and measurable. Less visible but potentially more serious are the implications for financial stability – when insurance becomes unavailable or unaffordable, property values can plummet, businesses find it more costly to invest in new productive assets and infrastructure, and these changes can potentially trigger broader disruptions.
Outdated approaches to financial stability
But the deeper concern is what these market signals tell us about systemic risk. If insurers are already struggling to price and manage climate risk at today’s warming levels, how will they handle impacts as we approach irreversible tipping points? The insurance market’s current instability may be the canary of much larger economic dislocations to come.
This creates an imperative for financial regulators to better understand and act on climate-related risks in the insurance sector. Yet the climate crisis is not being treated as a systemic threat in the here and now. For instance, while many central banks have begun to incorporate climate considerations into their supervisory frameworks, most still treat it primarily as a long-term future threat rather than a possible immediate driver of financial instability.
The evidence suggests this approach is outdated. Climate change is already reshaping insurance markets in ways that directly affect central banks’ ability to maintain price and financial stability. Understanding these dynamics and their potential to trigger broader economic disruptions should be integral to monetary policy and financial supervision.
Moreover, central banks and regulators need to recognise that their traditional tools may be inadequate for managing climate-driven financial instability. When insurers withdraw from markets or dramatically raise prices, they’re signaling that certain risks have become unmanageable through conventional means. As we approach critical planetary thresholds, these challenges will only intensify without systemic and decisive interventions.
The accelerating pace of climate-attributed losses represents more than just striking numbers, it is evidence that our financial system is already straining to manage climate impacts. Unless we rapidly reduce emissions while building more resilient financial structures that steer us towards outcomes that benefit the climate, biodiversity, and society, we risk crossing tipping points that could fundamentally destabilise both ecological and economic systems.
For financial regulators, the message is clear: climate risk is no longer a future threat to be gradually incorporated into policy frameworks. It is a present reality demanding immediate attention and new approaches to maintaining economic stability.
This article draws on a report funded by the Sunrise Project, which also funds Green Central Banking.
This page was last updated December 10, 2024
Written by
Professor Ilan Noy is chair in the economics of disasters and climate change at Te Herenga Waka, Victoria University of Wellington, and author of the largest peer-reviewed climate attribution metastudy, published in Nature in 2023.
