Hurricane Irma's huge toll will test how ready insurance companies are for climate change's new normal. Photo credit: Sean Rayford/Getty Images

By Ucilia Wang

The insurance industry is facing a staggering set of numbers from the country’s two latest disasters. Hurricane Irma will likely cause $20 billion to $40 billion in insured losses for homes, businesses and industrial properties, according to the risk modeling firm AIR Worldwide. Hurricane Harvey left behind an estimated $10 billion in insured losses from wind, flood and storm surge in Texas, AIR said, but estimates including uninsured losses reach as high as $75 billion in property destroyed.  

The overall economic damages are even higher. AccuWeather founder Dr. Joel N. Myers said Harvey will become the costliest U.S. weather disaster with a $190 billion price tag and Irma could top $100 billion.

The two hurricanes aren’t just drawing attention for their devastating financial toll. Irma and Harvey highlight a Category 5 problem slamming the insurance industry: how to manage the emerging climate-related risks for homes, businesses and governments as global warming fuels bigger and more costly catastrophes.  

The insurance industry, which is responsible for managing society’s risks, has been vocal in acknowledging the threat of climate change. But two reports issued last December by a group of the world’s largest insurers also concede that they remain largely unprepared to address climate risks in the communities they serve.  

The annual difference between the economic losses and the insured portion, dubbed “protection gap,” has ballooned from $23 billion to $100 billion since the 1980s, according to insurance giant Swiss Re. The losses connected to natural disasters have grown five-folds to about $170 billion worldwide during the same period. Most of the flood-prone properties in Texas and Florida aren’t insured, the Associated Press reported.

“There’s an enormous disjoint between what the industry acknowledges at the white paper levels (about a need for flood insurance) and what it in fact offers on the ground,” said Don Hornstein, a professor of insurance and environmental law at the University of North Carolina School of Law. “The insurance industry can be a real hero on this, but it has to get engaged.”

The insurance industry is made up of the companies that write the policies covering homes and businesses, and reinsurance, which provide protection policies for the insurance companies so they don’t go bankrupt when a disaster strikes and they have to pay out millions in claims at once. The reinsurance companies, including Swiss Re, do extensive research on climate risks, but their knowledge has not translated into meaningful climate adaptation strategies on the ground. Those shortcomings, along with the “protection gap,” means billions in losses end up as part of federally funded disaster relief.

The industry’s approaches to tackling the problem have varied widely, including lobbying for better city planning and advising their corporate clients in designing and building factories and building supply chains that reduce emissions and withstand natural disasters. One company, Farmers Insurance, even sued cities in the Chicago area in 2014 for what it said was a costly failure to prepare for severe flooding. Farmers said it filed the suits as a public warning and later withdrew them.

But the industry has largely struggled to figure out how to underwrite policies that cover big financial losses. Historically, it would impose significantly higher premiums or decline coverage when the risks were great. But other factors often interfere. After a string of costly disasters in 2004-05 (including Hurricane Katrina, the most expensive storm in U.S. history), many major insurers pulled out of high-risk places like Florida when regulators and lawmakers blocked them from raising rates to the levels they said were necessary to cover their exposure.

And climate risks are not limited to natural disasters. They include health risks, which could increase mortality rates and force insurers to retool life insurance coverage. The risks also involve lawsuits that seek damage from businesses and government agencies for contributing to climate change or failing to minimizing the resulting impact. Litigation is already growing in cases against fossil fuel companies.

Experts say insurance companies will also likely face more legal fights. Robert M. Horkovich, managing partner at the law firm Anderson Kill in New York City, said he went to court to prove that the damage to his clients’ properties from Katrina came from the lashing wind, not flooding, which wasn’t covered by homeowners policies.

“With the Millennial generation everyone has cell phones to take selfies and videos. I had video evidence that their buildings were blown down, and the roofs were blown off prior to flooding,” Horkovich said. “We had to fight very hard to get that coverage.”

Hornstein and other legal experts cite several reasons for the widening protection gap, including  government intervention and inadequate data collection and analysis to model and price climate risks. He said little has been done to improve the design and building of homes and businesses to withstand extreme events.

Insurers know they need better data and analyses to quantify risks in order to draw up policies. While science shows how a warmer climate leads to heat and moisture buildup that create bigger storms, it’s not yet able to draw a direct connection on how climate change affects the number and behavior of hurricanes each year.

Efforts to create better models and forecasts are underway, and have attracted startup companies such as RisQ, which spun out from the Sustainability and Data Sciences Lab at Northeastern University in Massachusetts last year. London-based Oasis Loss Modelling Framework, which is backed by insurers and brokers including Lloyd’s, launched open-source software in 2014 encourage more modeling of catastrophes.

“The models influence the development of new products, and are used to quantify risk exposures, so getting the data side right could help drive future climate adaptation and product innovations,” said Max Messervy, manager of the insurance team at Ceres, a business consortium that promotes sustainable environmental and social practices.

Government will also need to play a larger and more effective role in promoting a marketplace for insuring against climate risks, legal experts said.

Historically, state or federal agencies step in to provide coverage of certain types of disasters when private insurers gave up because they couldn’t make money. State insurance commissioners also typically regulate certain types of coverage and rate-setting. While the intention is good, the government involvement has in some cases led to poor coverage and prevented private insurance companies from re-entering the market.

The National Flood Insurance Program has been held up as an ugly example. Created in 1968 — long before climate change became an issue — the program offers policies to renters, homeowners and businesses in high-risk regions. The fact that it runs at a  deficit is not surprising given that it was designed to offer below-market rates, Hornstein said, but this leaves  taxpayers to subsidize a program that is nearly $25 billion in debt.

Many property owners who need flood insurance or are required to get it as a condition of securing federally-backed loans never bought it or let their policies lapse. Half of the 10 million properties nationwide that should buy flood insurance don’t have it.

Meanwhile, the program’s subsidized rates make it impossible for private insurance companies to compete against the government program. The solution, according to Hornstein, is to allow insurance companies to charge market rates while offering alternatives for low-income residents who can’t afford those policies.  

“The status quo is we are still in 1968,” he said. “The government needs to slowly extricate itself so that you can get the private insurers back into the marketplace. People who have money should pay fair rates — millionaires shouldn’t be subsidized for their second homes on the coast.”

Florida, which is covered mostly by the federal flood insurance program, has changed its regulations in recent years to lure back some private insurers that  offer flood policies. It’s also managed to do the same for covering hurricanes (wind damage). But whether those companies could survive a storm as destructive as Irma remains to be seen since the state hadn’t seen a big storm for a dozen years. A finance professor at Florida International University’s International Hurricane Research Center told The New York Times that a stress-test of Florida’s major insurers showed they could withstand another disaster the size of Hurricane Andrew, but that hurricane caused $47 billion in damage in today’s dollars. Irma may surpass that.  

Allowing private insurers to charge equitable rates also could reduce the public cost for disaster relief by discouraging people from rebuilding in areas prone to flood and other catastrophes, said Victor Flatt, faculty director Environment, Energy and Natural Resources Center at the University of Houston Law Center. Flatt pointed to the United Kingdom as a good example: the government stopped subsidizing flood insurance in the 1950s because it became too expensive.

“The developments that followed didn’t happen in floodplains, and they started to have less damage because they kept a lot of physical investments out of obvious harms’ way,” Flatt added.

While the insurance industry overall isn’t moving fast to underwrite climate risks, some firms are experimenting with new approaches, said Allie Goldstein, a scientist at Conservation International, an environmental organization.

She pointed to a novel policy that Swiss Re created with Nature Conservancy and launched in July this year to insure a stretch of coral reefs off the Yucatan Peninsula in Mexico. Swiss Re issues the policy to hotel owners along the coast and promises to a quick payoff for repairing the coral reefs when a particular event, in this case a hurricane, arrives (it doesn’t cover property losses after the hurricane has moved on). Coral reefs can reduce storm damage by absorbing wave energy during a tidal surge, Goldstein noted.

“The role that ecosystems play in climate change adaptation is a bit of a blind spot,” Goldstein said. “There are only a handful of companies using ecosystems in their climate risk management strategies.”