- The glacial lake outburst in Sikkim, the impact by Cyclone Michuang and other extreme weather events this year have driven home the point that insurance cover can help in recovering some of the climate change-induced loss and damage.
- The insurance sector has for long relied upon historical data to assess weather risks, but the severity and frequency of climate-related disasters are upending previous calculations and require a reassessment of risk profiles.
- Low awareness and penetration of insurance to cover extreme weather events pose an additional challenge for insurance companies in a developing economy such as India.
India was hit by extreme weather events almost every day in the first nine months of 2023. Ranging from heat and cold waves, cyclones and lightning to heavy rain, floods and landslides, these events, brought on in part because of climate change, claimed nearly 3,000 lives. These extreme weather events have also affected 1.84 million hectares of crops, levelled over 80,563 houses and killed close to 92,519 livestock, according to the Climate India 2023: An assessment of extreme weather events report, recently released by the Centre for Science and Environment, an independent think tank.
In this period, from January to September 2023, Madhya Pradesh saw the highest number of days with extreme weather events and Bihar saw the highest number of human deaths at 642, followed by Himachal Pradesh (365) and Uttar Pradesh (341 deaths). Himachal Pradesh reported the highest number of damaged houses (15,407) and Punjab reported the highest number of animal deaths (63,649), the annual report, now in its second year, said.
This was before Cyclone Michaung hit Chennai and India’s east coast in early December. In Tamil Nadu alone, the state government estimated losses due to damage to roads and infrastructure at over Rs. 50 billion. The floods and landslides in Himachal Pradesh, due to extreme rainfall during this year’s monsoon, caused damages worth more than Rs. 100 billion.
Insuring against loss and damage
As elsewhere in the world, climate disasters are increasing in frequency in India and so is the damage to property, crops and human lives. In such a backdrop, the issue of insurance is gaining prominence to mitigate some of the worst impacts of extreme weather events.
There is an increasing realisation that insurance cover for climate risks cannot be business as usual. India’s insurance industry faces multiple challenges in grappling with these risks, which include affordability and availability of coverage, growing financial burden on insurers, limited historical data, uncertainty in risk assessment, long-term liabilities and the potential for moral hazard, according to the climate consulting group of Tyche Investments, a consultancy.
This was recognised early by the world’s largest reinsurance companies – Munich Re, Swiss Re and Gallagher Re, which are last in the chain of insurance, providing insurance to other insurance companies. Reinsurance companies are conservative in offering reinsurance for natural or climate-induced disasters because of the risk uncertainty. Munich Re, India’s largest foreign reinsurer, has said in media interviews that there is no room for a reinsurer to pass on the risks.
Major floods and landslides killed over 700 people and caused damages worth $11 billion in 2018-19 in India, Munich Re said in a 2021 article. “Storms, flooding and drought are the key weather perils for the Indian region and will likely become more severe in the future,” it said. “Since they are unpredictable and extreme, these weather events are driving ever greater loss volatility, which makes structuring reinsurance solutions all the more challenging.”
As is the case in most developing economies, the lack of awareness of insurance capabilities and benefits presents formidable challenges to insurers in India. “It is certainly necessary to educate our market about the real need for extreme weather cover and for people to understand the changing risk landscape due to climate change, especially in this region,” said Ajeet Phatak, Munich Re’s Asia regional head for agriculture, in the article.
Low awareness, low penetration
Low awareness has led to low penetration of insurance that covers natural disasters. For instance, the Swiss Re Institute found that 70% of economic losses caused by natural catastrophes over the past decade were uninsured, with 90% of these losses in Asia alone.
In May 2020, Cyclone Amphan in the Bay of Bengal caused economic losses of more than Rs. 950 billion, the reinsurer said in a report. “This was the most destructive tropical cyclone India has ever experienced, and insured losses are expected to be just a fraction of the economic losses due to the region’s low insurance penetration,” Swiss Re had said.
Countries such as India do not have sufficient protection against the financial impact of natural and climate-induced disasters. A failure to close this protection gap can drain state and national budgets and divert funds away from other critical areas of need. One way to build protection is to transfer the financial risk of natural catastrophes to insurance companies.
In India, the total insurance penetration (combining both life and non-life insurance) was 4.2% in 2021, as opposed to the worldwide insurance penetration rate of 7% during the same period.
Closing the protection gap is crucial, according to the Insurance Regulatory and Development Authority of India (IRDAI). The sector regulator has identified steps to support the growth of the domestic insurance industry to increase penetration so that by 2047, most citizens and enterprises in the country can have appropriate insurance solutions and coverage.
Cover costs could be key
The aim to increase insurance coverage against natural disasters, while laudable, cannot be achieved unless the industry makes insurance more accessible, affordable and available, said an executive at a reinsurance firm, requesting anonymity. “At present, this is at a very nascent stage and most companies are recalibrating how to cope with the fresh challenges it poses,” he added.
A case in point is the glacial lake outburst flood that swept away a hydropower project in Sikkim in October. The state-owned Sikkim Urja has made an insurance claim of Rs. 114 billion for the destroyed 1.2 GW Teesta III hydropower project.
This could become a landmark in climate risk management in India. Although there is no decision yet on the claim, insurers are reluctant to settle it. They point to reinsurers capping liability on glacial lake outburst floods at Rs. five billion as assessment frameworks are inadequate to account for these extreme weather events.
“We are in the thick of a climate crisis. Its manifestations cannot be dismissed as acts of God or natural catastrophe. The return periods of various climate events are shortening. Hence, the risk management, underwriting and pricing ought to be robust. Asset buildup and its aggregates, particularly in fragile geographies, needs to be watched and managed closely,” said Praveen Gupta, former chief executive of Raheja QBE General Insurance Company.
Climate risks are evolving rapidly and getting increasingly complex, Gupta said. “Traditional pricing models will not work, and risk modelling needs to quickly catch up,” he added.
It is in this context that new risk assessment frameworks have a crucial role to play, said an official at another reinsurance company. The sector has to be quicker in making payouts so that people can bounce back faster from extreme and untimely weather events, he said. The framework will explain how companies are going to factor in climate-related disasters.
As climate disasters multiply and become more frequent, insurance premiums to cover them are bound to rise, but not to the extent that it deters both individual and corporate clients, he said. Insurance premiums can be a useful signal to prevent the infrastructure buildup in locations that are exposed to climate hazards, he added.
“Pricing models to cover for climate risks is an evolving area that must take into account multiple aspects that would encourage policy purchase but at the same time is not such that insurers have to operate at a loss,” he said.
Identifying evolving risk landscapes
Studies have shown that more than 80% of Indians live in districts vulnerable to climate risk. It is, therefore, important to better identify and understand the evolving risk landscape for insurance firms.
“Integrating granular risk assessment is imperative since it will lead to risk-based pricing of assets and innovation in risk financing products,” said Abinash Mohanty, global sector head of climate change and sustainability at IPE Global, a consulting firm. “It will also ensure an effective risk transfer mechanism without high-priced premiums and underwriting.”
This is where the reinsurance companies can provide frameworks that work on the ground. By using predictive analytics and automated assessment systems, insurance companies can stay ahead of the curve and better prepare for future risks, officials said.
Climate concerns are already impacting pricing in the property insurance and reinsurance markets in the richer countries in the West. The rate rises reflect some important structural changes in the market, according to an official at Swiss Re. But in markets such as India, where budgets are often thin, these Western models might not work, he added.
“With the onset of new risks, new risk assessment models will also need to be thought through,” said Saon Ray, visiting professor at the Indian Council for Research on International Economic Relations. “An area of concern that arises here is the ability of insurers to efficiently price these risks.”
Technological fixes such as predictive analytics could become an increasingly valuable tool for minimising the financial risks posed by climate change, insurance executives said. These tools can help assess risk exposure, allowing businesses to make informed decisions about their future strategies.
There are now initiatives in this regard. Lloyd’s, the world’s top marketplace for insurance and reinsurance, in October, launched a new data tool that generates a systemic risk scenario that models the global economic impact of extreme weather events leading to food and water shocks, estimating the loss to be $5 trillion over a five-year period.
Sector experts agree that India’s insurance sector has the potential to grow further by pricing in climate risks due to the underpenetrated nature of the market and low density. But how that translates into specific products is still a work in progress.
Banner image: Indian Navy personnel clearing a tree from a road in the aftermath of Cyclone Hudhud in 2014. Increasing natural or climate-induced disasters highlight the importance of insurance coverage to minimise loss. Photo by Indian Navy/Wikimedia Commons.