The benefits of climate risk insurance and artificial intelligence

The benefits of climate risk insurance and artificial intelligence

In July 2021, nature once again unleashed its devastating power. All over the world, many areas and their populations were plagued by hot, dry phases, devastating forest fires, severe storms, and flood disasters. Even Central Europe, especially Germany, was among the list of affected regions. Many German citizens first heard of the destruction on the news. Unfortunately, the reality was far worse for those affected: entire villages were flooded, and countless people lost their homes and were left with nothing. The media spoke of a once-in-a-century flood, with over 180 people dead as a result. Yet another horrific proof that climate change is real. During the damage assessment, the scope of ruin quickly became clear. In Germany, the storms destroyed – besides many homes – railway lines, roads, bridges, cell phone masts, and gas, electricity, and water supplies in many places. The Federal Agency for Civic Education calculated the economic cost of the damage to be approximately €5.5 Billion. The ramifications are enormous and raise the question of how we can better protect ourselves in the future. One major consideration for prevention options is artificial intelligence (AI) in association with climate risk insurance, which is being extensively researched. This option is discussed in more detail below.

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Artificial intelligence as a preventive measure

Climate change is not only present in a social context; it’s also a hot topic in business across all industries. The reason for this is simple: adverse weather events affect all businesses, regardless of the type. Accordingly, both citizens and companies recognise the risks of climate-related disruptions and the vital need to counteract them. However, just observing or evaluating weather patterns is not a reliable approach. Instead, data volumes and patterns of unimaginable sizes must be assessed to anticipate extreme weather events and prepare accordingly. The key to this is (AI) and its systems. Only AI can process phenomenal amounts of data via complex algorithms, helping to answer relevant specific questions and produce reliable results. Accordingly, it harbours the potential for a more positive environmental balance in the energy supply and many other industrial sectors. Furthermore, it presents opportunities for new insurance models to deal better with climate disasters and their consequences.

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Climate risk insurance - an overview

Most people understand what traditional insurance does: policyholders pay a certain amount or a premium in return for the insurance company’s promise to cover a specific loss if it occurs. However, the insurance amount is only paid out after the damage event has been determined, examined, and – in most cases - confirmed by an expert. As a result, insured persons often wait for months for the pay-out while at the same time struggling financially to stay afloat.

Innovative climate protection insurance follows a different approach. As a rule, these are so-called parametric or index-based insurance solutions: the insurance company makes a payment as soon as a specific event occurs. Accordingly, a parametric solution comprises a triggering event and a pay-out. The event is based on predetermined parameters measured against an objective index. If, for example, an earthquake, flood, wind speed or precipitation exceeds the index, the corresponding payment mechanism is triggered. Of course, countless other events can also be included as triggers, such as crop yields, power outages or the like. The pay-out, in turn, is generally based on a predetermined threshold value.

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Benefits of climate risk insurance

Climate risk insurance can help protect individuals, businesses, and even entire countries from permanent economic damage resulting from extreme weather events. Moreover, it’s also a political instrument that enables countries affected by climate change to become more independent. Instead of waiting months or longer for international aid, aid measures can be implemented immediately.

In addition, insurance offers can be tailored to suit local circumstances and conditions that factor in different types of climate risks and the needs of various economic interest groups. The tailored assessment and planning also enable a detailed solution development so that insurance offers for specific population groups can be affordable and sensible.

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Conclusion

On closer inspection, parametric climate risk insurance can be used in ways that are bespoke and factor in a complex range of detail and groups. In the event of damage, it can also offer significantly higher protection than conventional insurance products that compensate on an actual damage basis. However, climate risk insurance is not an isolated solution. It must always be closely linked to preventive risk management strategies to help minimise economic and environmental damage from natural disasters.

Moreover, the financing of risk-based premiums remains a significant challenge for vulnerable population groups, while measures to increase the affordability of products are of paramount importance to the success of insurance companies. To make this type of insurance affordable to all groups, governments or other bodies must partially or fully subsidise such products. Doing so would enable us to support regional risk pools and the poorest and most vulnerable in the event of a disaster. Therefore, payment plans must be tailored to factor in the personal and economic circumstances of the individuals and parties affected.

Of course, raising society’s awareness of climate change and its consequences also plays a vital role in this issue. Finally, we must be aware that almost every activity we humans do unfortunately adds to climate change. We build, move, generate and supply electricity, breed animals to eat, and produce things to an unimaginable extent. Clearly, we have reached a point where, more than ever, we must economically protect ourselves from devastating climate events. Still, that alone is not enough: we must become humbler. Cushioning the economic consequences is a positive step. However, we must pull together, make the best possible technological progress, and create climate neutrality. After all, we can never forget: our dependence on our planet and nature is total, and we have no other viable options.