Insurance Companies and Climate Change

By Jessica

In our case on Travelers Insurance, we learned about the immense effect climate change can have on insurance companies: claim volume has been climbing year over year and catastrophes like Hurricane Sandy can cause drops in profits of over 50%. As climate change increases the amount of catastrophic natural disasters, insurance companies have to find a way to improve their bottom line. While some have already or are looking to increase premiums, there have been some very early attempts to solve the problem where it starts, to mitigate the effects climate change can have on their claim volume before it happens. Unfortunately, these cases often focus on where the insurance company chooses to play (e.g. not insuring homes in coastal areas, insuring clean energy projects that are likely to be important over the long term) rather than trying to actually slow climate change.

Given how much insurance companies stand to lose from climate change and their large customer bases, these companies may have an ability to make a real impact on how large portions of the population (at least in countries where insurance is widely adopted) contribute to climate change.

Health insurance provides an excellent corollary to what this might look like: in recent years, as claim volume and size has risen dramatically for health insurers, they have looked for ways to prevent diseases, identifying key factors such as obesity and smoking as those that can lead to higher instances of disease, and trying to decrease the number of policyholders that are obese and/or smokers. There are a number of documented ways this has been done (and I actually experienced some of these at my old job):

– Coverage of all preventative check-ups to encourage policyholders to identify issues before they require more expensive procedures

– Discounts provided to those that do not smoke (in my case, the premium rate rose by $100/year for everyone and then you could get a discount of $100/year if you did not smoke…so you can also call this an additional charge for those who do smoke)

– Discounts provided for individuals who get their cholesterol checked annually

– Working with towns to create safer routes for children to walk or bike ride to school to prevent obesity

– Pilot program where a Fitbit is provided to policyholders that are overweight or have some form of cardiovascular risk to encourage them to lose weight and be more active

Just as health insurance companies are beginning to experiment with rewarding good behavior related to health, I believe insurance companies like Travelers could consider some ways to reward behaviors in customers that could mitigate climate change. Because these companies often insure cars, homes, and businesses, they have a wide variety of measures available to them. Consider the following examples:

– Decreasing the cost of car insurance for those driving hybrid or electric vehicles

– Partnering with utility companies to provide discounts to customers that use under a certain amount of energy per square foot

– Discounts to homes that have been weatherproofed

– Discounts to homes that use alternative forms of energy, such as installed solar panels or purchasing electricity from green providers

– Discounts to businesses that have green rooftops, which involves putting plant cover on the roof to manage storm water and provide insulation

I believe these types of discounts (combined with some form of rate increases if policyholders don’t do any of these things, similar to my smoking example above) could have a major impact on climate change given the number of policyholders each of these companies touch and could help improve insurance companies’ bottom line over the long term. The question is whether or not the companies would be willing to implement such changes given the perceived risk for companies to declare climate change real and support efforts to change it given the politicization of the issue.

Sources:

William Davidson Institute. Travelers Insurance: Focusing on Climate Change and Natural Disaster Risk, 2013.

America’s Health Insurance Plans (AHIB). Reducing and Preventing Childhood Obesity: Health Insurance Plans Partnering in Communities, Summer 2012.

America’s Health Insurance Plans (AHIB). Health Insurance Plans’ Innovative Initiative to Combat Cardiovascular Disease, Fall 2012.

Website: http://ahip.org/Innovations-in-Wellness/

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About macomberjohnd

HBS Finance faculty interested in sustainability in the built environment including devices, structures, townships, and cities.

One Response to “Insurance Companies and Climate Change”

  1. Thanks for a very interesting post here. I like the specific examples you’ve laid out, and think health insurers’ push to preventative care is a great case example. I also agree that insurance companies have a great deal to lose in a real climate-change scenario, and there is significant economic incentive for them to coordinate some sort of action.

    My concern here, however, comes from the specific incentives at play.

    One fundamental issue is the mismatch between the length of many insurance contracts today, and the timeline most scientists expect before climate change takes hold in a major way. For example, it is clear that over a 100 year time period, homes on the beach in potential flood zones should pay more for insurance. However, home insurance is typically written over a much shorter time period. As a result, any insurance company charging a “climate-adjusted rate” would risk loss of share in the near- and medium-term; its competitors could continue to charge today’s rates, without sacrificing margin (because the impact of climate change will occur only after the current policy has expired).

    One might therefore respond that the savvy insurer should instead offer a 100-year package at an appropriate rate; it may be more expensive than policies on the market for the next 5-10 years, but would offer savings over what the same consumer might find available once other insurance companies must offer their own “climate-adjusted” rate. But this assumes a level of consumer foresight, and ability to innovate in insurance products, that may be difficult to believe.

    For this reason, insurance companies may find it difficult to change consumer behavior by charging *more* for policies. Of course, a smart insurer may just choose to lose share in the business and re-enter the market once competitors have been beaten down by their poor pricing decisions today; but that is a separate conversation.

    You also raise the interesting point of whether insurance companies might accomplish the same goal by offering discounts for preferred behaviors. Certainly, if all insurers coordinated to do so, they might help stave off the worst impacts of climate change and realize cost savings in the long run.

    But if we assume that insurance companies are rational profit-maximizers and already operate at the optimal point on the demand curve (i.e., cutting price does not result in sufficient increases in volume to grow profits as a whole), we must believe that reducing prices today would also reduce profit dollars today. The CEO of the bold insurance company risks lower compensation or being fired due to underperformance relative to peers; and peers have several incentives to both avoid lower CEO compensation of their own, and also free-ride on the good environmental work of their competitors, and are therefore unlikely to follow. And so there is a problem of policy sustainability (i.e., price reductions require willingness to absorb lower margins in the short term), and perhaps even industry coordination. First-mover companies would need to understand this issue, and adjust governance/compensation/long-term-goalsetting structures in response.

    Of course, this is where the health insurance analogy you mention comes into play. Health insurers incentivizing preventative care today may actually increase Year One costs, in order to achieve benefits in the out years (which – if the customer switches providers – might even accrue to a competitor!). I might argue that a difference between the industries is health insurer expectation of retaining specific customers for longer periods of time, despite the short-term nature of each individual service contract; but I don’t know if that’s true. As a result, I’d be fascinated to learn more about the way in which players in that industry think about the economics and coordination issues. I can imagine these problems are quite compelx.

    Industry coordination offers a potential solution to both of the problems above; an agreed “price” for certain types of risk would allow insurers to take the actions you recommend, without fear of sacrificing share or margins. This might, of course, fall afoul of government regulation on price-fixing; but perhaps there is a way around that.

    Another solution would be a shift toward longer-term insurance contracts, where the benefits of the price actions you mention today accrue over the same contract term as the costs would be realized (e.g., the 100 year home insurance policy I mention above). This would require some significant investment in consumer education (perhaps the govt could help on this) to make consumers less myopic and help them change behavior more quickly, but also may be a longer-term, but less-illegal process than the price agreements mentioned above.

    Anyway, this comment has gotten kind of long, so sorry about that. I think the issue you raise is extremely interesting, and the push to preventative care in health insurance offers a compelling case example of another industry overcoming similar structural issues. But I would push towards one more level of game-type analysis to ensure that a company’s pricing decisions are not only attractive on paper, but also effective and sustainable in the long run.

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