How is insurance underwriting impacted by climate change?
Insurance, the law, risk and climate change
Insurers trade in risk; insurance is, at its heart, a financial risk transfer mechanism. An insurer agrees to bear the financial risk of a specific event occurring. These events – such as a flood – are referred to in insurance as ‘perils’. In return for taking on this risk, in the practice known as ‘underwriting’, the insurer receives a monetary payment or ‘premium’ to cover the cost of potential losses resulting from the insured perils.
Insurance law governs the terms on which risk is traded and managed. An insurance contract, with its legally binding terms and conditions, underpins this exchange. As a risk multiplier, climate change makes risk more unpredictable and therefore harder to trade and manage, challenging established legal principles.
Insurers usually run their business through two main functions: underwriting and investment. Through underwriting, they earn primary income from insurance premiums. The premiums collected are generally invested, chiefly to make sure the insurer has enough capital available to pay policyholders’ claims if insured perils materialise. This generates secondary income for the insurer, in the form of dividends, interest and capital gains.
In this Explainer, we focus on the role of insurers as underwriters and how this is affected by climate change.
What do insurers cover?
Underwriters generally specialise in a particular ‘line of business’ or type of risk. Insurance is widespread and can cover a huge range of commercial and non-commercial activities and actors. Often insurance markets are broadly split between ‘life’ (health and life insurance) and ‘non-life’ (property, etc.) insurance; consumer/personal or commercial insurance; and first-party or third-party insurance.
First-party insurers provide cover to policyholders for losses that the policyholders suffer directly due to a peril – such as injury or property damage. Third-party insurers (also known as ‘liability insurers’) cover losses that policyholders suffer because of a third party claiming against them to recover a loss that they suffered as a result of the policyholder’s activity.
What are the impacts of climate change on underwriting?
Climate change challenges the traditional roles of different actors involved in insurance underwriting (see the table below), as climate-driven changes make perils non-linear, more severe and less predictable. This impacts their capacity to predict and respond to events.
| Actors involved in insurance underwriting | What role do they play? |
| Underwriters | Serve as the frontline decision-makers in insurance, assessing individual risks against insurers’ risk appetite. They blend actuarial forecasts with qualitative judgement to balance profitability and capacity, often negotiating with brokers on hard-to-place climate-related perils like flood-prone assets. |
| Brokers | Involved in ‘placing’ risks by acting as intermediaries between prospective policyholders and underwriters. |
| Actuaries | Involved in insurance underwriting through forecasting future losses via statistical models that analyse data on event frequency, severity and causality. |
| Claim handlers | Act as operational gatekeepers post-loss, investigating coverage, validating the amount and determining payouts under policy wordings, often assisted by loss adjusters and/or external legal counsel. |
Climate change is leading to some previously profitable markets becoming uninsurable based on existing business models (for instance, in the US, homeowner insurance in certain areas of California affected by wildfires, or flood-prone parts of Florida). This is leading underwriters to increase premiums, introduce more stringent policy terms, or withdraw coverage. Brokers may also face growing difficulty in ‘placing’ risks.
Insurers are also facing increasing regulatory scrutiny as climate impacts intensify. Regulatory intervention aims to protect policyholders and to ensure that insurers remain financially safe and sound. In the UK, for example, the Prudential Regulation Authority now explicitly requires that insurers account for climate risk in how they run their business.
How can insurers adapt to a world with climate change?
Insurers are employing new approaches including machine-learning-driven catastrophe models, climate scenario generators, and probabilistic attribution science, which integrate climate projections from the Intergovernmental Panel on Climate Change (IPCC), to refine risk pricing amid regulatory scrutiny. Pricing of insurance acts as a market signal for climate risk.
However, while advancements in technology and climate risk scenarios help the industry become familiar with longer-time horizons, it does not always follow that the insights drawn are integrated into pricing or contractual structures, which can remain backward-looking and often operate on short-term (12-month) horizons.
Some risks are becoming unavoidable as the climate changes. Pricing these risks may have unintended consequences, such as withdrawal of insurance from risky markets, with potentially deleterious consequences for uninsured communities and businesses, who would struggle to recover.
Finally, climate risk interacts systemically with other planetary risks, such as pollution and biodiversity loss, and could generate irreversible tipping points that could drastically change physical conditions on Earth, further complicating the assessment of future risks.
Risk reduction measures are therefore also needed (these are steps taken to lower the likelihood of a loss, or to reduce the severity of the loss were it to occur). Several regulatory and supervisory frameworks encourage incorporation of risk reduction measures into insurance policies and products, such as UK FloodRe (Build Back Better), the Strengthen Alabama Homes programme, and supervisory guidance like that issued by the European Insurance and Occupational Pensions Authority.
This Explainer was written by Tiffanie Chan, Zaneta Sedilekova and Lucia Williams, with review by Joana Setzer, Martina Menegat and Catherine Higham, and editing by Georgina Kyriacou.
Read our further Explainer on climate change and insurance: ‘How does the rise of climate change litigation impact insurers?’