Disasters triggered by climate change, such as tornadoes, floods, and hurricanes, are upending the foundations of risk management for Chief Financial Officers (CFOs). Commercial property insurance costs in the United States continue to rise; according to the Insurance Information Institute, these costs increased by 15% last year, marking the largest annual increase in over three decades. Data from the Swiss Re Institute shows that claims costs for commercial property insurance surged by 30% in the first half of 2023.

Brandon Thompson, Vice President of the Senior Risk Management division at Transwestern, a Houston-based commercial real estate company, stated that severe weather has created "the most challenging property insurance market we have likely faced since 9/11." "We will experience a difficult period in the coming years." Thompson noted in an interview that CFOs are facing a seller's market for commercial property insurance, with insurers raising premiums and withdrawing from high-risk areas. "You can no longer just find an insurance company on the street."

Risk management experts believe that the turbulence brought by global warming is forcing CFOs and Chief Risk Officers to precisely assess corporate vulnerabilities and minimize insurance costs as much as possible. Solutions include establishing closer partnerships with insurance companies, reinforcing buildings to withstand damage, adopting new insurance structures, and utilizing advanced data analytics. Zaheer Hooda, Head of North America at the London-based insurtech company Cytora, said: "If you stick to old methods, you will not be able to move forward."

The frequency of disasters caused by climate change shows no signs of declining. As of early November this year, the United States has experienced 25 weather-related disasters, each causing at least $1 billion in losses, according to data from the National Oceanic and Atmospheric Administration (NOAA). From 1980 to 2022, the U.S. averaged only about 8 such disasters per year, adjusted for inflation. NOAA stated in its National Climate Assessment released this month that billion-dollar disasters now strike the U.S. on average every three weeks, compared to every four months in the 1980s, with data adjusted for inflation.

The scope of destruction is expanding. This year, convective storms with heavy rain, lightning, hail, and strong winds have moved further north into the Great Lakes states, expanding the risk exposure for insurers and businesses. Swiss Re data shows that in the first half of 2023, convective storms caused $34 billion in insured losses in the U.S., a six-month record, accounting for 68% of global natural disaster insurance losses.

When assessing potential loss risks, insurers have long had to balance policy risks between disaster-prone coastal states like Florida and California and lower-risk inland areas. Thompson said: "With the significant growth in convective storm losses in the central region, this balancing strategy is no longer effective."

Over the past decade, the soaring costs that extreme weather has brought to insurance companies have exceeded the rise in labor and building material costs due to inflation—even considering the high inflationary pressures that began at the end of 2021. David Hemry, Director of Commercial Strategy at LexisNexis Risk Solutions, pointed out that so-called claims severity (i.e., the average cost per claim) has surged by 150% over the past decade, roughly six times the rate of inflation.

Facing losses from severe weather, several insurance companies are seeking to reduce risk. State Farm is one of several insurers withdrawing from California; in May, it announced it would stop accepting new applications for commercial and personal property insurance in the state. Nationwide announced in June that it would take "unspecified risk reduction measures" for its small and medium-sized commercial property insurance in unspecified states. Hemry said in an interview that in recent years, hail has severely impacted multiple regions, especially the Interstate 35 corridor in Texas and Denver and other parts of Colorado. Insurers that could accurately predict claims in many areas for years can no longer do so.

Bill Clark, CEO of Demex Group, said in an email response: "Insurers in Arkansas, Illinois, Kentucky, and Indiana are in a particularly unstable position." Meanwhile, reinsurers—the providers of insurers' financial lifeline—are contracting. According to an executive order signed by California Governor Gavin Newsom in September aimed at strengthening the state's private insurance market, reinsurers have this year increased premiums by 30% to 50% for insurers with catastrophic losses within the United States.

Thompson said: "The impacts of climate change and these billion-dollar losses are indeed putting pressure on reinsurance, and reinsurance ultimately determines what terms you can get in the retail insurance market." As insurance costs rise, CFOs and financial executives responsible for risk assessment and insurance matters may gain greater influence in the C-suite. He said: "Risk management will need a bigger seat at the table than it has had in recent years."

Risk management experts say that with a larger role, CFOs can limit the costs brought by climate change through the following five measures:

1. Comprehensively review risk tolerance

Risk management experts say that CFOs who can comprehensively assess their company's ability to withstand extreme weather damage will adapt more quickly to rising commercial property insurance premiums and the prospect that inflation may exceed the Federal Reserve's 2% target in the coming years. CFOs should no longer view insurance as an ordinary expense item carried over each year. Financial 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 need to allocate more budget for insurance at least for the foreseeable future. Hooda said in an interview that, as always, shopping around for higher-value insurance may help control costs. But Hooda reminded CFOs to keep the basic principle in mind: "First, accept the reality of higher premiums and adjust your profit expectations accordingly."

2. Strengthen cooperation with insurance companies

Experts say that as the commercial property insurance market adapts to extreme weather shocks, CFOs should increase the frequency and depth of their contact with insurance companies. Financial executives should engage with insurers 180 days before submitting an application (rather than the usual 90 days), accompanied by supporting data detailing their measures to reduce risk and limit losses. Thompson said: "Make sure you submit a high-quality application that includes a loss control statement."

3. Increase investment in disaster prevention

Risk management experts point out that CFOs should not overlook the reliable strategy of reducing insurance costs through improvements such as installing wind-resistant shutters, flood barriers, and fire suppression systems. According to data from the National Institute of Building Sciences, every $1 invested in limiting property damage through retrofits or adopting updated building codes can avoid up to $13 in losses. Hemry said: "It's not just property risk, but also liability risks such as personal injury and property break-ins." After occupancy rates fell due to the pandemic, many commercial property owners neglected maintenance. Instead, with the Federal Reserve having raised benchmark interest rates to a 22-year high, CFOs are more focused on the high cost of refinancing debt. Thompson said: "We are in a vicious cycle: as occupancy rates decline and loans mature, reinvestment in properties may decrease, which only leads to higher claims severity."

4. Consider innovative insurance products

Risk management experts say that alternatives to traditional commercial property insurance can fill the gap left by policies that have shrunk or withdrawn due to frequent severe weather. CFOs responsible for properties in disaster-prone areas may consider so-called parametric insurance, which pays a fixed amount based on the characteristics of a destructive event (rather than the cost of repair). CFOs typically use parametric insurance as a supplement to or replacement for traditional policies. Hooda said: "From a CFO perspective, this provides a certain degree of stability." But he also noted that the loss payout ratio of parametric insurance is usually less favorable than that of traditional policies.

5. Deepen data analysis

Gary Sullivan, Senior Director of Emerging Risks at the American Property Casualty Insurance Association, said in an interview: "Big data has existed since insurance companies have existed." But today, insurers can use advanced analytics to measure risks such as wind and wildfires more precisely, identify vulnerabilities, and discover new opportunities. Hemry said: "Historically, the insurance industry has been quite slow and conservative by nature." Insurance startups are disrupting established companies by using new methods of data collection and analysis. For example, computer analysis of roof photos taken from aircraft can precisely assess risk over large areas, thereby reducing claims and premiums. Hemry said: "Insurtech companies are integrating with insurers to help them do things they couldn't do in the past 100 years because it's not in their nature." Risk management experts advise CFOs to ask insurers how they use artificial intelligence, data analytics, and other advanced technologies to measure risk. Additionally, when preparing insurance applications, CFOs should consider using customized risk management systems "to tell a story that avoids being lumped into overall market trends," Thompson said.

Ultimately, higher premiums caused by destructive weather may attract new capital into the insurance industry. The commercial property insurance market will stabilize, and CFOs may find risk management costs more affordable. Hooda predicted: "People will see it as an entrepreneurial opportunity and flood in, and you will see conditions improve over time."