We expect rated insurers can mitigate the risk arising from the increase in natural catastrophe-related claims through underwriting actions. Over the medium term, we do not rule out credit impacts on insurers that are more exposed to physical climate risk and less diversified.

Why it matters:  2023 was the fourth consecutive year that insured losses from natural disasters exceeded $100 billion globally. The insurance sector's profitability suffered from unusually frequent and severe natural catastrophes, including thunderstorms in the U.S., France, and Italy in 2022 and 2023.

What we think and why:  Insured losses will continue to increase over the long term. Economic and population growth, as well as claims inflation, are the main drivers of this trend, while climate change contributes to the volatility of both event frequency and severity. To quantify the effects of climate change, we highlighted the potential risk to our credit ratings if primary insurers did not consider the effects of climate change in their underwriting approach over the medium term.

Chart 1

Risk Diversification And Reinsurance Provide Some Mitigation Against Climate Change

Climate change-induced underwriting losses will remain relevant, mainly for the property/casualty (P/C) sector.  Of the three main insurance sectors--P/C, life, and health--only the P/C sector will experience a climate change-related rise in underwriting claims over the medium term, in our view. The risk of an increase in costs from natural disasters will have important effects on P/C insurers' pricing and insurance considerations, with the cost of physical damages or business disruptions mainly covered by insurers' residential or commercial property offerings.

Rated primary insurers generally exhibit diversified loss profiles because of their broad product offerings.  Depending on the size of the property portfolio, climate risk could represent a medium-term business challenge. We note, however, that most rated primary insurers' risk portfolio is relatively well diversified, with the property book representing, on average, less than one-quarter of total premiums (see chart 2). The motor book could be prone to weather-related damages that are caused by, for example, hailstorms or floods and could be a source of risk accumulation. On a global basis, however, we think motor books' exposure to weather-related damages is significantly lower than that of property books.

Chart 2

One-third of premiums in the global P/C sector relate to property risk (see chart 3).  In contrast, we estimate premiums for natural catastrophes only account for, on average, 20%-25% of policyholders' property premiums in 2023. Homeowners in areas that are more prone to natural disasters must pay higher premiums than those in low-risk areas. Overall, less than 10% of global P/C insurers' collected premiums are earmarked for covering the cost of natural catastrophes.

Primary Insurers Rely Heavily On Reinsurers

Reinsurers shoulder a significant proportion of natural catastrophe risk.  We estimate that about $50 billion in natural catastrophe-related premiums were ceded to the reinsurance industry, including insurance-linked securities in 2023. This represents about one-third of primary insurers' natural catastrophe premiums (see chart 3).

Chart 3

Natural disaster claims that are not covered by reinsurers represent on average about 7% of claims paid by primary P/C insurers.  This highlights that natural disasters are not the main source of insurance claims for most primary insurers (see chart 4). We think an orderly increase in the average contribution from natural disaster claims is unlikely to have a significant effect on the primary P/C sector's financial performance. This reflects rated insurers' generally well-diversified loss profiles and our expectations that insurers and reinsurers will continue to have access to reinsurance and retrocession markets, respectively, to spread the risk.

Chart 4

The split of natural catastrophe losses between primary insurers and reinsurers can vary, depending on retention levels and reinsurance structures.  In years with significant tail events--including 2017, when several hurricanes in the U.S. caused global insured losses of more than $180 billion--reinsurers usually cover a significant portion of insured losses. By contrast, the top 19 global reinsurers, a benchmark group of global reinsurers defined by S&P Global Ratings, covered only about 10% of insured natural catastrophe losses globally in 2023, compared with the 20% average (see chart 4).

Due to its concentration on property risk, the reinsurance sector is more exposed to tail risks, such as physical risk, than any other insurance sector (see chart 5).  We generally reflect this in our credit ratings on reinsurers through our 'moderately high' or 'high' risk exposure assessments. Risk exposure assessments can lower the credit rating by at least one notch.

Chart 5

The Effects Of Climate Risk On P/C Markets Vary

Not all primary insurers are equally exposed to climate risk.  Most P/C markets are resilient, and we are unlikely to revise our view on these markets over the medium term. Our Insurance Industry And Country Risk Assessments (IICRAs) address typical risks for insurers that operate in specific industries and countries. Climate risk could affect our view of insurers' profitability or product risk. Since we typically apply the same IICRA to all insurers operating in the same country and industry, the re-assessment of an IICRA could have a widespread effect on our credit ratings within an industry. For example, a significant deterioration in the profitability of insurers that operate in the same country could lead us to review the IICRA of that country. We note, however, that we have taken rating actions related to physical risk for certain insurers without revising our IICRA of the country they operate in.

To assess the potential effects of climate change, we analyzed the 10-year average effect of insured natural catastrophe claims on insurers' expected underwriting profitability at a country level.  In most countries, P/C insurers' profitability would only come under pressure if the average cost of natural catastrophe-related claims doubled and if insurers did not take any mitigating underwriting actions (see chart 6). The potential rise in claims is therefore unlikely to significantly affect our view of P/C insurers' profitability in these markets.

Chart 6

For countries where underwriting profitability is most sensitive to an increase in natural disaster-related costs, we will continue to monitor insurers' underwriting actions and their management of physical risk as part of our credit rating analysis.  U.S. and Japanese P/C markets' underwriting profitability is among the most sensitive to an increase in natural catastrophe claims. This is because these insurers' claims profiles are more weighted toward natural catastrophe claims, compared with other markets, while their underwriting margins are not as strong as they are in other countries. Our IICRAs of the U.S. and Japan already consider that these countries' natural catastrophe insurance markets, which are the two largest globally, exceed the average (see chart 7). We assess U.S and Japanese P/C insurers' profitability as satisfactory as part of the IICRA.

Chart 7

P/C insurers in some markets will likely have to take underwriting actions to offset the effects of climate change on insured costs.  In our sustainability research "Lost GDP: Potential Impacts Of Physical Climate Risks," published on Nov. 27, 2023, we estimated that, under a slow climate transition scenario, global GDP exposure to physical climate risk could increase by at least one-third by 2050 (in real terms and without adaptation). Under this scenario and all else being equal, we think most primary insurance markets' profitability will not deteriorate significantly over the medium term. Even if insurers do not take any mitigating underwriting actions, the resulting 33% increase in the cost of natural catastrophe claims in most countries remains well below the increase that we estimate would make most P/C insurers unprofitable (see chart 8). Considering that the increase will happen over a long period, we think insurers can absorb the deterioration by organically increasing their revenue base. We note that claims inflation and demographic changes will likely increase insured claims additionally and affect underwriting profitability over the medium term. We have not considered these factors in this analysis, which solely focuses on the potential medium-term exposure to physical climate risk (see "Scenarios Show Potential Ways Climate Change Affects Creditworthiness,") published July 25, 2024).

Chart 8

Primary insurance markets that are most exposed to the effects of climate change could face a decline in profitability if they do not take any underwriting actions.  We generally expect insurers will use various de-risking strategies to respond to the increasing cost of natural disasters. As part of their underwriting strategies, insurers could adjust pricing, reduce exposure through higher deductibles or higher insured retained limits, and share more risks with reinsurers. Insurers could also diversify away from areas in which they cannot offer an adequate insurance coverage. We expect these actions will benefit rated insurers' business positions because we consider that they will have a limited effect on insurers' revenue expectations. Since most P/C insurance contracts are renewed annually, we also consider insurers are reasonably flexible in their decision-making.

Climate Change Increases Uncertainty In The Insurance Industry

We think insurers could face challenges to capture the potential rise in claim volatility and the increase in average costs in their risk pricing.  This is because of their reliability on historical data to predict the future and model uncertainty. Insurers' inability to price the evolving risks adequately could increase earnings volatility over the short term and add an element of uncertainty to underwriting these risks. We believe this could differentiate more sophisticated insurers over time.

Primary insurers, which rely on reinsurers to manage claim volatility, face the risks of having to pay more for ceding the risk and of having to retain a higher proportion of the risk.  This could impair the profitability and volatility of earnings. Over the past few years, reinsurers negotiated improved terms and conditions, with prices related to natural catastrophe reinsurance rising significantly (see chart 9). While this demonstrates that the pricing and structure of reinsurance coverage are potential sources of uncertainty, we expect the medium-term risk of a reduced reinsurance coverage for rated primary insurers is limited. This is because natural catastrophe risk coverage serves as a source of diversification and earnings generation for reinsurers and will remain an important and significant element of most reinsurers' business models over the medium term.

Chart 9

We could re-assess product risk in a specific country if insurers' exposure to risk in a specific market changes unexpectedly.  Since we expect most P/C insurers will retain a meaningful level of diversification across different business lines, we are unlikely to change our view of product risk as we would need to see high unexpected losses in P/C insurers' property book.

Public Sector Involvement Will Support Insurability

We do not expect that insurers or reinsurers will materially withdraw from covering natural catastrophe risk, but they may likely do so in areas that become riskier.  This is because natural catastrophe risk coverage is key to property insurance policyholders. Nonetheless, insurers could increase property insurance premiums and deductibles significantly in an increasing number of places globally if claims become more frequent. This could ultimately make natural catastrophe risk coverage less affordable or even inaccessible for homeowners or businesses.

The reduced affordability of natural catastrophe risk coverage raises public awareness of the insurance protection gap.  Policymakers' increasing focus on the lack of mandatory property insurance against natural catastrophes in countries such as the U.S. and Germany could reinforce the role and relevance of insurers in mitigating risks. Closing the insurance protection gap, however, requires more than public intervention to make natural catastrophe risk insurance mandatory. It also necessitates government support to guarantee affordable premiums. In France, for example, where property insurance against natural catastrophes is mandatory, property and motor insurers cover natural catastrophe claims via a central fund that is managed by public reinsurer Caisse Centrale de Réassurance (CCR). To replenish the central fund, the French government decided to raise contributions from property and motor premiums to 20% and 12%, respectively, from 2025, which will inevitably make customers' insurance policies more expensive. Other countries are also implementing, or revising, property insurance that is supported by government-backed reinsurance programs.

Related Research

• Record Weather-Related Losses Hit U.S. Homeowners Insurers And Pose Challenges In Estimating Catastrophe Risk Charges, Sept. 3, 2024
• Reinsurers Show Growing Appetite For Natural Catastrophe Risks, Aug. 30, 2024
• Reinsurers Dodge Severe Convective Storm Losses Amid Rising Threats, Aug. 7, 2024
• Scenarios Show Potential Ways Climate Change Affects Creditworthiness, July 25, 2024
• Insurance Industry And Country Risk Assessment Update: July 2024, July 11, 2024
• Lost GDP: Potential Impacts Of Physical Climate Risks, Nov. 27, 2023