“Neither insurers nor governments are prepared for the exponential increase in climate-related losses”

2023-07-09 10:00:23

In 2015, on the eve of the opening of COP21, Henri de Castries, CEO of Axa, said that“a two degree increase in the average temperature in the world [pouvait] still be insurable, but what [était] certain is that a rise of four degrees does the[était] not “. Eight years later, the Minister for Ecological Transition announces that “France will prepare for a rise of 4°C. Should we then prepare for a world without insurance?

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Insurance works by pooling risk among large groups of people who pay premiums and then paying out that money to people who have suffered a claim. This vision, certainly a little simplistic, corresponds to the functioning of a mutual insurance company, the contributions being used to compensate the most unlucky. Given the inherently random nature of insurance contracts, it is hoped (in a mathematical sense) that premiums will cover losses. With this reasoning “on average”, one year out of two, the insurers would make a profit and, one year out of two, they would not have enough money to compensate the victims. To avoid this kind of inconvenience, the legislation requires insurers to have sufficient capital to guarantee their solvency. This protects policyholders who have purchased the promise of compensation in several months if a mishap occurs.

This mechanism works in car insurance or home insurance when it is necessary to compensate for a fire in the kitchen or following an accident, but it is undermined when climatic disasters occur. The insurability of risks is in fact characterized by three factors: the insurable risk must be quantifiable and distributed among a large number of policyholders, the insurable population must be aware of the risk and be ready to pay the insurance premium, and a solvent insurer must be prepared to bear the risk.

Panic in the market

Unfortunately, climate change threatens all three conditions: physical risks can combine or accelerate in unprecedented ways; their long-term horizons can blur consumers’ understanding of the risks; potentially massive and long-lasting losses can exceed the capacity of insurers to cover.

The California wildfires in 2017 and 2018 led insurers to pay nearly $29 billion (26 billion euros) in damage, while they collected only $15 billion in premiums. And, since 2020, eight disasters caused between 20 billion and 50 billion dollars of damage. California has a hundred companies offering home insurance contracts. In late May, the biggest of them, State Farm, sent the market into a panic by saying it would halt all new underwriting in the state, due to rising construction costs, growing risk of wildfires of forest and the increase in the cost of reinsurance [garantie échangée entre différents assureurs].

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