Are Japanese insurers ready to put a price on climate change?

AM Best associate director Jason Shum said they still have a long way to go.

Some argue that climate change may not be detrimental to the insurance industry, particularly to the property and casualty (P&C) insurance segment because insurers can use the annual policy cycle and their understanding of evolving risk to reprice and rearrange portfolios to avoid long-term exposure. Recent occurrences, however, prove otherwise.

In July, the insured losses due to the Henan flood in China nearly reached $2b. In the same month, a storm in New Zealand, which saw a rare red weather warning from the state’s weather authority Metservice, reported over $86m in insured losses.

Mckinsey & Company warned that insurers must be careful not to underestimate the true threat of climate change. Because its effects are systemic, climate risk is likely to stress local economies and cause market failures that affect both consumers and insurers. 

“More frequent catastrophic events, in combination with the need to meet evolving regulatory requirements, can threaten company business models—and make insuring some risk unaffordable for customers or unfeasible for insurers,” Mckinsey wrote.

Japan’s readiness

Toshio Koshiba, the manager and senior consultant of the risk assessment section and corporate planning department of MS&AD InterRisk Research & Consulting, Inc., said that major disasters resulting from massive typhoons and heavy rains in 2018 and 2019 and record-high temperatures over the past several years have made the Japanese public increasingly concerned about and aware of the realities of climate change.

Koshiba highlighted that claims in the non-life insurance industry in the country will continue to increase if climate change intensifies.

In an interview with Insurance Asia, Jason Shum, associate director of ratings firm A.M. Best Rating Services, said that for Japanese insurers, climate risk has been influencing the society in which they operate, as well as the financial risks of their assets and liabilities that might be subject to climate risk.

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AM Best associate director Jason Shum

“Similar to their regional peers, a number of Japanese insurers have already announced that they will not invest in or insure any new risks associated with carbon-intensive industries, such as coal-fired plants,” Shum said.

One such example is how multinational insurance holdings company, Tokio Marine Holdings, Inc., revised its climate strategy by adding key changes in its insurance underwriting and investment and lending policies.

It now added ‘thermal coal mining projects’ as restricted transactions.

“We will make more careful consideration for granting coal exclusion exceptions on insurance underwriting and investment and lending by limiting the scope of the projects to those with innovative technologies and approaches aiming to achieve the goals of the Paris Agreement,” Tokio Marine said in a statement.

The insurance firms enacting such policies is just one of the key areas that AM Best said that Japanese companies are making progress.

Shum added the key areas that Japanese insurers are excelling to help address climate risk are in research on the impacts of climate change, partnerships, product developments, and investments.

Climate risk cost

Allison Martin, CEO Europe, Middle East & Africa and Bank Distribution, pointed out how the risk managers and insurers have an important role to play in raising awareness of climate change risk and mitigating the impacts, particularly in demonstrating the cost of climate change.

“Attribution of climate change is difficult but it would be useful for businesses if insurers were able to say what proportion of insurance premium represents the cost of climate change; in other words, to put a price on climate change risk,” Martin said.

But why has it been difficult to put a price on climate change?

According to Sompo Japan Insurance Inc., there are several factors.

First is that the analysis of the impact on typhoons and floods when the atmosphere and oceans rise in temperature due to climate change will require advanced analytical methods including meteorology and oceanography.

There are also instances of varying degrees of temperature increase depending on future carbon dioxide emissions and other factors, hence a large degree of uncertainty. 

Additionally, the medium-to-long-term changes in river embankments and building structures will also have a large impact, however, these changes are difficult to predict.

Sompo Japan also added challenges such as inadequate disclosure of information on climate change by investment and financing partners and risk in transition and its impact on stock and bond prices.

Commenting on the difficulties of Japanese insurers, AM Best’s Shum added there is still a long way to go before companies can put a price on climate risk and precisely incorporate climate risk into their strategic risk management.

“Climate risk is a good example of grey rhino problems—it is a highly probable, high impact, yet a neglected threat. Similar to many grey rhino risks, like Japan’s ageing population, the long-term negative impact is usually hard to estimate precisely, as these problems usually exist in complex systems—whose behaviour is intrinsically difficult to model due to factors such as the presence of many variables and multiple stakeholders, as well as the potential interactions amongst these variables and stakeholders within a given system,” Shum said.

Shum added that insurance companies might be able to see this coming and analyse in which direction these grey rhino problems are leading us toward, but coming up with a precise estimate—without a wide confidence interval—for the potential effect is nearly impossible.

Meeting halfway

Shum enumerated some observable changes in various financial aspects of insurers that may or may not change over the years.

AM Best predicts insurers to shift towards a higher proportion of risk related to renewable energy as Japanese insurers' commitment to reducing carbon emissions strengthens. Additionally, public perception of climate change could see the rise in demand for electric vehicles that would potentially lead towards a higher proportion of insured risks related to more environmentally-friendly vehicles.

Shum said that the potential impact on overall premium revenue is unlikely to be that material, despite some gradual shifts in the segment mix within the fire and automobile insurance portfolios.

There also might be an increase in claim payments related to natural catastrophes as a result of climate risk, but as always, it is difficult to identify all the underlying causal relationships and determine precisely how significant all these complex relationships are.

Shum added that to estimate precisely how climate could change is difficult therefore it is also difficult to predict it could directly or indirectly affect insurers’ underwriting decisions and claims experience. The impact of climate risk, Shum said, will likely take a longer time to manifest material financial impacts.