The economic damage wrought by climate change is worse than previously thought. Record-shattering heat waves and floods are smacking us in the face. While these more intense and frequent disasters impact all industries, insurance companies face significant challenges to weather the storms ahead.

Climate-related catastrophes across the region are increasing, mounting financial losses are rising, and bringing higher-than-usual mortality rates are occurring.

According to the World Economic Forum, the global cost of climate change damage is estimated to be between $1.7 trillion and $3.1 trillion annually by 2050. This includes the cost of damage to infrastructure, property, agriculture, and human health. The project cost is expected to increase over time as the impacts of climate change become more severe.

“2024 is an exceptional year. It has opened up many questions about how products have been designed, reinsurance treaties have been arranged, risk occurrence absorbed, and a lot of change recorded this year,” said an insurance industry expert, who did not want to be named.

Oman, for instance, with its history of natural calamities, led to a more proactive government approach that focused on creating awareness that residents should have home insurance.

In the Middle East, motor insurance is mandatory; however, with the increased occurrence of natural disasters, regulators are examining ways to embed natural perils into the coverage.

Overall, climate change’s impact is far-reaching in the Middle East, and insurers are understanding this and coping by building back-to-back reinsurance arrangements.

Furthermore, experts say because the region is small, insurance companies cannot afford to take these losses that reach millions, so it has to distribute and reinsure itself across global entities—which step in only if there is enough volume to take these setbacks every few years. These changes are directing the industry’s course, especially over the next two years.

Regarding changes, experts agree that people will have to pay increased reinsurance costs, with more global reinsurers poised to enter the market.

There has already been a surge in home insurance. Following the flooding in the UAE, people are now seeking more robust car insurance.

“The growing threat of climate change, with its increased frequency and intensity of heatwaves, sandstorms, and potential flooding, necessitates adaptations in property damage models employed by insurers,” said Neeraj Gupta, CEO at Policybazaar.

HOW CAN INSURERS ADAPT

As a result of the increase in the number and intensity of natural disasters, insurance companies are having to pay out more in claims.

They could use historical data and probabilistic models to set their premiums. “Essentially, they must continually adjust their plans to account for the costs of climate change,” Dr Stephen Wilkinson, Associate Professor, Director Research, Engineering and Information Sciences at University of Wollongong, Dubai, said.

Natural disasters are becoming more expensive because climate change is intensifying them and because of human factors. More and more people have been coming to work and live in the Middle East, which has higher risks of climate impacts.

In addition, as developers continue to build in areas at risk of flooding, climate change is expanding the areas at risk for various disasters. For example, the risk of flooding is rising even in areas not on the coast.

According to Swiss Re, the world’s largest reinsurer, property losses from natural disasters due to climate change could increase by more than 60% by 2040.

The region’s insurance landscape faces challenges when it comes to predicting future property and car insurance risks when historical weather data no longer reflects climate change’s “new normal”, said Gupta. “Limited data on extreme events like intense heat waves or sandstorms makes traditional risk assessment methods less reliable.”

He suggests ways insurers can adapt, such as relying on crowdsourced weather data to supplement historical and real-time weather information. “Smartphone weather apps and sensor networks can provide valuable insights into localized weather patterns and microclimates. This data can then be integrated with traditional datasets to create a more dynamic risk picture,” Gupta added.

Another way to adapt is by conducting stress tests by simulating various climate scenarios, such as unprecedented heatwaves or flash floods. Gupta said that by analyzing potential damage caused by these simulated events, insurers can gain insights into vulnerabilities and strengthen risk models.

“Insurers should shift the focus from solely predicting damage to actively promoting resilience.”

Another plausible option is to partner with construction companies and policymakers to encourage using climate-resistant building materials and infrastructure development. This proactive approach reduces overall risk and allows insurers to set premiums based on a more stable risk profile.

Lastly, flexibility is key. “There’s a need for flexible insurance products that adapt to changing risk profiles. Parametric insurance solutions offer one option. Additionally, consider offering tiered coverage options—basic protection for standard events and add-on modules for specific climate threats. This allows policyholders to customize their coverage based on their perceived risk.”

HIKE IN PREMIUMS AND CLIMATE CHANGE: THE CORRELATION 

Another concern is whether insurers can cope with the rising financial burden without substantially raising premiums. “Managing the burden doesn’t necessitate substantial premium hikes across the board,” said Gupta.

According to him, a different approach would involve leveraging data for granular risk assessments. By analyzing climate data alongside property details, insurers can create a more precise risk profile for each location, allowing for differentiated premiums – high-risk areas might see moderate increases. In contrast, lower-risk areas could potentially maintain stable or even reduced premiums.

Additionally, insurers can incentivize risk mitigation. One approach is offering discounts for properties with heat-resistant roofing or flood barriers, encouraging homeowners to adopt climate-resilient practices to reduce the overall risk pool, and mitigating the financial burden on insurers.

Furthermore, exploring parametric insurance for specific climate events offers a unique solution. These policies trigger payouts based on predefined parameters, like exceeding a temperature threshold, rather than traditional damage assessments. In turn, this streamlines claims processing and potentially reduces the financial burden compared to traditional methods.

Finally, in the longer term, collaboration with the government and reinsurance companies plays a key role. Partnering with the government to promote climate-resilient infrastructure development reduces future risks. At the same time, collaboration with reinsurance companies allows insurers to spread the financial burden of large-scale disasters. “By implementing nuanced strategies, insurers can navigate the financial challenges of climate change without resorting solely to substantial premium hikes, promoting a more sustainable insurance market that benefits both policyholders and insurers,” Gupta said.

Several changes are sure to trickle down to the level of insurance offerings.

The recent flooding in the UAE is a stark reminder of the millions in losses people are still grappling with, catching the attention of key industry players.

“Insurers had an opportunity to examine their tipping points—whether they could absorb a loss of ten million dollars, for example, which during the recent rains was easily exhausted. This has made reinsurers more aware of the limits of local insurers, how much loss they can bear, at what point they would need support, and just how much they can handle,” said the industry expert.

Climate change has exposed the gaps in the insurance industry’s product design and highlighted the region’s unique needs. “The future isn’t just about insurance products; it will be about lifestyle,” the expert added.

Consider the example of a taxi ride: for those 15 minutes, one may need insurance for the journey. Today, car, home, and travel insurance are sold separately, each as a product. The future, however, will be more nuanced. A person will recognize they have 365 days a year, with varying circumstances that might require different coverage for different periods—necessitating tailored insurance. Essentially, lifestyle needs will dictate insurance coverage. This means more subscription models and more need-based insurance will emerge.

“Disruptive products are on the horizon,” the source added. “Customization to individual needs, rather than forcing customers into a one-size-fits-all approach, is the way forward.”

The insurance industry faces the harsh realities of climate change, driving significant and often unwelcome changes that fundamentally reshape the coverage and risk management landscape. As climate-related events become more frequent and severe, traditional insurance models are being challenged, forcing insurers to rethink their strategies and adapt to a new and more uncertain environment.