Climate Change Raises Commercial Property Insurance Costs: Five Strategies for CFOs

Disasters triggered by climate change, such as tornadoes, floods, and hurricanes, are upending the foundations of CFO risk management. The cost of commercial property insurance in the United States has risen sharply, increasing 15% last year, the largest jump in over three decades, according to the Insurance Information Institute. Data from the Swiss Re Institute shows that commercial property insurance claim costs soared 30% in the first half of 2023.

Brandon Thompson, senior vice president of risk at Houston-based commercial real estate firm Transwestern, said severe weather has created "the most challenging property insurance market since 9/11." "We're going to be in a tough spot for the next few years."

Thompson noted in an interview that as insurers raise premiums and withdraw from high-risk areas, the commercial property insurance market has become a seller's market. "You can't just walk down the street and find an insurance company anymore."

Risk management experts believe 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 won't be able to move forward," said Zaheer Hooda, head of North America at London-based insurtech company Cytora.

The frequency of disasters triggered by climate change shows no signs of declining. As of early November this year, the United States experienced 25 weather-related disasters, each causing at least $1 billion in losses, according to the National Oceanic and Atmospheric Administration. From 1980 to 2022, the U.S. averaged only about 8 such disasters per year (inflation-adjusted).

The National Oceanic and Atmospheric Administration said this month in the U.S. National Climate Assessment that billion-dollar disasters now strike the U.S. on average every three weeks, compared to once every four months in the 1980s (data inflation-adjusted).

The scope of destruction is expanding. This year, convective storms with heavy rain, lightning, hail, and strong winds have pushed further north, affecting states in the Great Lakes region and expanding risk exposure for insurers and businesses.

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

For a long time, insurers balanced the risk of policies in disaster-prone coastal states like Florida and California against those in lower-risk central regions when assessing potential loss exposure. 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 surge in costs from extreme weather for insurers has outpaced increases in labor and building material costs due to inflation—even accounting for the high inflationary pressures that began in late 2021.

David Hemry, director of commercial strategy at LexisNexis Risk Solutions, noted that so-called "claim severity" (i.e., average claim cost) has soared 150% over the past decade, about six times the rate of inflation.

Facing severe weather losses, several insurers are seeking to reduce risk. State Farm announced in May it would stop accepting new applications for commercial and personal property insurance in California, becoming one of the insurers exiting the state. Nationwide announced in June it was taking "unspecified risk reduction measures" in small business commercial property insurance in unspecified states.

Hemry said in an interview that in recent years, hail has severely impacted many regions, especially along Interstate 35 in Texas, Denver, and parts of Colorado. Insurers that for years could accurately predict claims in many areas are now struggling.

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

Meanwhile, reinsurers—the financial backers of insurance companies—are pulling back. According to an executive order signed by California Governor Gavin Newsom in September aimed at strengthening the state's private insurance market, reinsurers this year raised premiums by 30% to 50% for insurers covering catastrophic losses.

Thompson said, "The impact of climate change and billion-dollar losses is really putting pressure on reinsurance, and reinsurance ultimately determines the terms of the retail insurance market."

As insurance costs rise, CFOs and finance executives responsible for risk assessment and insurance matters may gain greater influence in the C-suite. "Risk management needs a bigger seat at the table than it has had in past years," he said.

Risk management experts say CFOs can limit costs from climate change through the following five steps:

1. Comprehensively assess risk tolerance

Risk management experts say CFOs who 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 could exceed the Federal Reserve's 2% target for several more years.

Experts point out that CFOs should no longer view insurance as a routine expense item that renews annually. Finance executives may need to adjust insurance programs more frequently and use data simulating weather as well as labor and construction costs to more accurately assess company needs. CFOs will likely need to allocate more budget for insurance in the foreseeable future.

Hooda said in an interview that, as always, shopping around for cost-effective insurance may help control costs. But he reminded CFOs to keep the basics in mind: "First, accept the reality of premium increases and adjust for the impact on profits."

2. Strengthen partnerships with insurers

Experts say that as the commercial property insurance market adapts to extreme weather shocks, CFOs should increase the frequency and depth of their engagement with insurers. Finance executives should contact insurers 180 days in advance (rather than the usual 90 days) and detail their measures to reduce risk and limit losses, supported by data.

Thompson advised, "Make sure you submit a top-notch submission with loss control explanations."

3. Increase investment in disaster prevention

Risk management experts say CFOs should not overlook reliable methods to reduce 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 in disaster mitigation measures such as retrofitting or adopting the latest building codes can avoid up to $13 in losses.

Hemry noted, "It's not just property risk, but also liability risks such as personal injury and property break-ins."

Experts say that after the pandemic led to lower occupancy rates, many commercial property owners neglected maintenance. Instead, with the Federal Reserve raising benchmark interest rates to a 22-year high, CFOs are more focused on the high cost of refinancing debt.

Thompson said, "We're in a vicious cycle: lower occupancy, maturing loans, potentially reducing reinvestment in properties, which only leads to higher claim severity."

4. Consider insurance innovation

Risk management experts say alternatives to traditional commercial property insurance can fill gaps left by policies that have shrunk or been withdrawn due to frequent severe weather. CFOs in disaster-prone regions may consider "parametric insurance," which pays a fixed amount based on the characteristics of a damaging event, rather than the cost of repairs. CFOs often use parametric insurance as a supplement to or replacement for traditional policies.

Hooda said, "From a CFO perspective, this provides stability." But he also noted that parametric insurance payout rates are typically less favorable than traditional policies.

5. Deepen data analytics

"Big data is as old as the insurance industry," said Gary Sullivan, senior director of emerging risks at the American Property Casualty Insurance Association, in an interview. But now, insurers can use advanced analytics to more precisely measure risks such as wind and wildfire, identify vulnerabilities, and uncover new opportunities.

Hemry said, "Historically, the insurance industry has been quite slow-moving and conservative by nature." Insurance startups are disrupting established companies with new data collection and analysis methods. For example, taking aerial photos of roofs and analyzing them with computers can precisely assess risk across large areas, thereby reducing claims and premiums.

Hemry said, "Insurtech companies are working with insurers to help them do things they haven't been able to 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 advanced technology to measure risk.

Additionally, Thompson suggested that when preparing insurance applications, CFOs should consider using customized risk management systems "to tell a story that avoids being lumped into the overall market trend."

Ultimately, premium increases driven by destructive weather may attract new capital into the insurance industry. The commercial property insurance market will stabilize, and CFOs may find it easier to bear risk management costs.

Hooda predicted, "People will see it as an entrepreneurial opportunity and flood in, and you'll see conditions improve over time."