How Should CFOs Respond as Climate Risk Drives Up US Commercial Property Insurance Costs?

Tornadoes, floods, hurricanes, and other disasters triggered by climate change are upending the bedrock of CFO risk management. The cost of U.S. commercial property insurance has risen sharply, increasing 15% last year, the largest gain in more than three decades, according to the Insurance Information Institute. Data from the Swiss Re Institute shows that in the first half of 2023, commercial propertyclaim costs surged 30%。

Brandon Thompson, vice president of the senior risk management department at Transwestern, a Houston-based commercial real estate company, said severe weather has created "the most challenging property market we have probably seen since 9/11." "We are going to go through a difficult period over the next few years."

Thompson said in an interview that as insurers raise premiums and withdraw from high-risk areas, CFOs face a seller's market for commercial property insurance. "You can no longer just find an insurance company on the street."

Risk management experts point out that the turmoil brought by global warming is forcing CFOs and chief risk officers to precisely assess corporate vulnerabilities and minimize insurance costs. Solutions include building closer partnerships with insurers, reinforcing buildings to withstand damage, adopting new insurance structures, and leveraging advanced data analytics.

"If you stick to old methods, you will not be able to move forward," said Zaheer Hooda, head of North America at Cytora, a London-based insurance technology company.

The frequency of disasters triggered by climate change shows no signs of declining. As of early November this year, the United States had suffered 25 weather-related disasters, eachcausing at least $1 billion in losses, according to data from the National Oceanic and Atmospheric Administration (NOAA). From 1980 to 2022, the country experienced an average of only 8 such disasters per year, adjusted for inflation.

NOAA said this month in the U.S. National Climate Assessment, citing inflation-adjusted data, that a $1 billion disaster nowstrikes the United States on average every three weeks, compared to once every four months in the 1980s.

The scope of damage is expanding. This year, so-called convective storms—heavy rain, lightning, hail, and strong winds—have pushed further north into states around the Great Lakes, broadening the exposure for insurers and businesses.

According to Swiss Re data, convective storms in the United States in the first half of 2023caused $34 billion in insured losses, a record for a six-month period, accounting for 68% of global insured natural catastrophe losses.

When assessing potential loss risks, insurers have long sought a balance between risks underwritten in disaster-prone coastal states like Florida and California and lower-risk policies in central regions. "That balance is no longer working as convective storm losses have grown significantly in the central region," Thompson said.

Over the past 10 years, the surge in costs from extreme weather for insurers has outpaced inflation-driven increases in labor and building material costs—even accounting for the high price pressures that began in late 2021. According to David Hemry, director of commercial strategy at LexisNexis Risk Solutions, so-called claim severity—the average cost of an insurance claim—has soared 150% over the past decade, roughly six times the rate of inflation.

Facing losses from severe weather, several insurers are seeking to reduce risk. State Farm is one of several insurers withdrawing from California; the company announced in May it wouldstop accepting new applications for commercial and personal property insurance in the state. Nationwide announced in June that it would takeunspecified risk-reduction measures。

in commercial property insurance for small and medium-sized markets in unspecified states.

Bill Clark, CEO of Demex Group, said in an email responding to questions: "Insurers in Arkansas, Illinois, Kentucky, and Indiana are in a particularly unstable position."

Meanwhile, reinsurers—the institutions that provide a financial lifeline to insurers—are retreating. This year, they haveraised premiums by 30% to 50%。

for insurers suffering catastrophic losses within the United States, according to an order signed by California Governor Gavin Newsom in September aimed at strengthening the state's private insurance market.

Thompson said: "The effects of climate change and these billion-dollar losses are really putting pressure on reinsurance, and reinsurance ultimately determines what terms you can get in the retail insurance market." As insurance costs rise, CFOs and finance executives responsible for assessing risk and securing coverage may gain a greater voice in the executive suite, he said: "Risk management is going to need a bigger seat at the table than it has had in the past few years."

Risk management experts say CFOs given a larger role can limit the costs of climate change through the following five steps:

1. Conduct a thorough review of risk tolerance

Risk management experts say CFOs who can comprehensively assess their company's ability to withstand extreme weather damage will adapt more quickly to rising commercial property insurance rates and the prospect that inflation could exceed the Federal Reserve's 2% target in the coming years. They note that CFOs should no longer view insurance as an ordinary expense item carried over year to year. Finance executives may need to adjust insurance programs more frequently and use data simulating weather as well as labor, construction, and other costs to assess company needs more precisely. CFOs will likely find that, at least for the foreseeable future, they need to set aside more budget for insurance. As always, shopping around for higher-value insurance may help control costs, Hooda said in an interview. However, Hooda said CFOs need to keep a fundamental principle in mind: "First, accept the reality of rising premiums and adjust your profit expectations accordingly."

2. Strengthen collaboration with insurers

Experts say that as the commercial property insurance market adapts to the shock of extreme weather, CFOs should increase the frequency and depth of their engagement with insurers. Finance executives should contact insurers up to 180 days in advance, rather than the usual 90 days. They should also use supporting data to detail how they reduce risk and limit losses. "Make sure you submit a first-class submission with loss control narratives," Thompson said.

3. Double down on loss preventionRisk management experts say CFOs should not overlook proven strategies to lower insurance costs through improvements such as installing wind-resistant shutters, flood barriers, and fire suppression systems. According to the National Institute of Building Sciences, every $1 invested inlimiting property damage

through retrofits or adopting updated building codes can avoid up to $13 in losses. "It's not just property risk; it's also liability risk like bodily injury, people breaking into the property," Hemry said. Risk management experts note that after the pandemic depressed occupancy rates, many commercial property owners have neglected maintenance. Instead, CFOs are focused on the high cost of refinancing debt, as the Federal Reserve has raised its benchmark interest rate to a 22-year high. "We are in a vicious cycle where, as occupancy declines and loans mature, there could be a pullback in reinvesting in properties, which only drives claim severity up," Thompson said.

4. Consider insurance innovation

Risk management experts say alternatives to traditional commercial property insurance can fill the gap left by policies that have been reduced or withdrawn due to frequent severe weather. CFOs overseeing properties in disaster-prone areas may consider so-called parametric insurance, which pays a fixed amount based on the characteristics of a damaging event rather than the cost of repairs. CFOs typically buy parametric insurance as a supplement to or replacement for traditional policies. "From a CFO's perspective, this provides a certain level of stability," Hooda said, while noting that its loss payout ratios are typically less favorable than traditional policies.

"Big data has existed since insurers have existed," said Gary Sullivan, senior director of emerging risks at the American Property Casualty Insurance Association, in an interview. Today, however, insurers can use advanced analytics to measure risks like wind and wildfire more precisely, identify vulnerabilities, and uncover new opportunities. "Historically, the insurance industry has been fairly slow and conservative by nature," Hemry said. Insurance startups are disrupting established companies by using new forms of data collection and analysis. For example, computer analysis of roof photos taken from aircraft can assess risk precisely across large areas, reducing claims and premiums. Insurtech companies "integrate with insurers to help them do things that frankly they haven't been able to do in the past 100 years because it's not in their DNA," Hemry said. Risk management experts say CFOs should ask insurers how they use artificial intelligence, data analytics, and other advanced technologies to measure risk. Additionally, Thompson said, when preparing insurance applications, CFOs should consider using customized risk management systems "to tell a story that avoids being swept into the overall market trend." Ultimately, higher premiums driven by destructive weather may attract new capital into the insurance industry. The commercial property insurance market will stabilize, and CFOs may find the cost of risk management more manageable. "People will see this as an entrepreneurial opportunity, they will come in, and over time you will see improvement," Hooda predicted.