Should climate change’s impact on liabilities warrant life insurers to adapt their investment strategies?

Insurance, at its core, is a financial tool that provides individuals and businesses with protection against unforeseen risks. By pooling resources, insurers compensate policyholders when covered events, such as accidents, health emergencies, or natural disasters, occur. But as the world witnesses the intensifying effects of climate change, the scale and scope of these risks is changing.

Insurers are facing increasingly heightened liabilities as well as uncertainty and shifts in business dynamics driven by extreme weather, rising temperatures, and evolving regulatory frameworks. Not only must life insurers adjust their underwriting practices to account for emerging climate risks, they must also reevaluate their investment strategies to navigate these unprecedented challenges to ensure business continuity. This leads to the question – should they dynamically adjust to the changing risk profile of their liabilities, take proactive steps that pre-empts shifts in risk exposure, or wait and reactively respond?

Shifting climate risks within the liability context

Climate change is reshaping the world faster than many policymakers and organizations anticipate, with insurance being one of the most affected sectors. Natural disasters such as hurricanes, floods, and wildfires are occurring with greater frequency and intensity, resulting in skyrocketing damages and loss of life. However, it is the lingering long-term health effects that will be impacting health and life insurers more.

Heatwaves leads to heat-related illnesses and fatalities but also exacerbates chronic conditions such as respiratory diseases and heart conditions. Additionally, warmer temperatures are contributing to the spread of vector-borne diseases like malaria and dengue fever, putting more strain on health insurance systems.^1,2

How does this shift implicate investments (i.e. assets)?

From a life insurance liability’s perspective, a warmer climate amplifies the risk exposure within the pool of policy holders. In response, life insurers may need to raise premiums to meet the higher payouts and/or impose exclusions or higher deductibles to manage their risk exposure and maintain their business profitability. These changes in affordability and coverage could influence consumers' purchasing decisions and significantly impact a life insurer’s ability to write business, ultimately altering available capital on the asset side of the balance sheet.

Investment strategies: Dynamically adjust, proactively mitigate, or reactively respond?

By recognizing these shifting liability risks and their underlying interdependency with assets, how should life insurers adjust their investment strategies to optimize business performance and ensure portfolio resilience?

Dynamically adjust to climate impacts

One option is to dynamically adjust to evolving liabilities by gradually adapting investments as climate-related transition and physical risks materialize, or as these risks are priced in by the market. For example, insurers might gradually reduce their exposure to fossil fuel companies and increase their investments in renewable energy as markets or policies change. While this strategy ensures timely alignment with emerging risks and projected impacts, it exposes insurers to sudden and/or irreversible changes in new business dynamics driven from societal shifts and consumer behavior.

One example could be the shift towards vegetarian diets in Western countries, which may reduce the prevalence of chronic health conditions like heart disease and diabetes. This would, in turn, have a lasting impact on a life insurer’s liabilities by lengthening life expectancy and extending the exposure period for certain clients. Conversely, on the asset side, this trend could reduce returns related to livestock investments, affect its valuations, and create opportunities for investments in grains and meat substitutes.

Proactively mitigate against emerging climate risks

Alternatively, insurers can proactively mitigate anticipated liability risks, particularly those with a profound impact on future capital requirements, before they fully materialize. By taking early action, insurers can potentially capture higher returns in new or growing markets, reduce risks associated with changing consumer behaviors, gain positive reputational benefits, and secure additional business in emerging markets as industry leaders.

While US tropical cyclones causes an average of 24 immediate deaths at landfall, the disasters contribute to between roughly 7,170 and 11,430 additional deaths over the following 20 years.³ This is comparable to developing countries, such as the 2017 Hurricane Maria in Puerto Rico where the official death toll was 64 but caused more than 70 times the number of excess deaths in the following decade⁴ .Life insurers could opt to reduce their future liabilities associated with these subsequent deaths via significant long-term investments in climate-resilient infrastructure and real estate in these vulnerable areas. This would reduce negative health outcomes and enable the benefits to be incorporated into future premium pricing and policy design to maintain competitiveness.

However, this approach requires substantial upfront investments without tangible immediate returns and carries uncertainty—predicting the timing and impact of climate regulations, shifts in consumer behavior and when impacts will manifest in markets can be challenging.

Reactively adjust to climate risks and pricing in

The final option is to reactively adjust portfolios in response to climate change’s physical and transition impacts. A reactive response allows insurers to learn from the actions of others and avoid the initial costs associated with learning new and changing market dynamics.

For example, a reactive life insurer may look at withdrawing coverage from certain locations or products after a disaster as they were unprepared for the implications of climate change for their business. Hurricane Harvey, which struck Texas in 2017, caused 89 direct deaths, displaced over 30,000 people, damaged or destroyed more than 200,000 homes or businesses, and prompted more than 17,000 rescues⁵  whereas the death toll for the 2024 hurricane season has already reached over 300.⁶

This reactive strategy, which brings short term benefits in comparison to the others, exposes life insurers to significant long term risks arising from higher losses in current business and policy payouts. This in turn, may leave life insurers inadequately prepared for long term business continuity and profitability.

Which investment strategy should life insurers adopt?

The choice among these three options will have long-term implications for where a life insurer’s investments and product offerings sit in the competitive peloton, as well for their overall reputation and brand value. There is evidence that several prominent life insurers, including Allianz, Swiss Re, and ASR, are proactively mitigating their liability risks. For example, Allianz is shifting its investments away from fossil fuels and into renewable energy projects; Swiss Re is investing in climate-resilient infrastructure, such as flood defenses and sustainable urban development projects; and ASR is incentivizing sustainable farming by offering lower rents, leveraging its position as the largest farmland owner in the Netherlands. By aligning its investments with climate resilience, life insurers can not only reduce their own exposure to climate risks but also helping communities adapt to the changing environment.

One approach for insurance companies to overcome the challenges associated with proactive mitigation is to inform the investment process with a comprehensive climate scenario analysis. By utilizing a climate scenario analysis that realistically assess the impacts across different asset classes and sectors under plausible outcomes, this can help insurers to better identify sound investments that can contribute to mitigating their longer-term liability risks. Climate scenarios that outline the underlying views and assumptions can also help insurers considering a dynamic adjustment approach. Awareness of the drivers behind potential outcomes can act as 'warning signals,' providing early indications when a scenario may be materializing in reality and enabling a quicker response.

Looking ahead: Harnessing investments to effectively adapt to evolving climate risks across the balance sheet

Going forward, the insurance industry must continuously adapt to the increasing liabilities driven by climate change and recognize its interdependency with assets. Life insurers that proactively manage liability risks by adopting innovative investment strategies and robust risk assessment methods that consider the wide ranging financial and economic impacts of climate change will be best positioned to safeguard their financial stability and optimize its business performance.

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¹ Geneva Association (2024) CLIMATE CHANGE: What does the future hold for health and life insurance?.
² Swiss Re Institute (2023) The risk of a lifetime: mapping the impact of climate change on life and health risks.
³ Young & Hsiang (2024) Mortality caused by tropical cyclones in the United States, Nature.
⁴ Kishore et al. (2018) Mortality in Puerto Rico after Hurricane Maria, The New England Journal of Medicine.
⁵ NOAA (2024) Hurricane Harvey: A Look Back Seven Years Later.
⁶ Deaths in hurricane Helene, Milton push toll over 300 this season.