Extreme weather events fueled by climate change are reshaping the commercial property insurance market, forcing CFOs to rethink risk management strategies.

According to the Insurance Information Institute, the cost of commercial property insurance in the U.S. surged by 15% last year—the largest annual increase in over three decades. Swiss Re Institute data further shows that commercial property claims ballooned by 30% during the first six months of 2023.

Brandon Thompson, senior vice president for risk management at Transwestern, a Houston-based commercial real estate company, described the situation as "certainly the most challenging property market we’ve seen probably since 9/11." He added, "We’re in for a rough ride for the next couple of years."

In an interview, Thompson noted that CFOs now face a seller’s market, with carriers raising premiums and retreating from high-risk areas. "You can’t just walk down the street any more and pick up an insurer," he said.

Risk management experts say the turbulence from global warming pressures CFOs and chief risk officers to precisely gauge company vulnerabilities and minimize insurance costs. Solutions range from closer partnerships with insurers and hardening buildings against damage to adopting new insurance structures and advanced data analytics.

Zaheer Hooda, head of North America for Cytora, a London-based InsurTech firm, warned: "If you hold on to your old ways, you’re not going to be able to move forward."

The frequency of climate-induced calamities shows no sign of abating. Through early November this year, the U.S. experienced 25 weather-related disasters, each causing at least $1 billion in damage, according to the National Oceanic and Atmospheric Administration (NOAA). From 1980 to 2022, the country averaged only eight such catastrophes annually, adjusted for inflation.

NOAA’s U.S. National Climate Assessment, released this month, notes that a $1-billion catastrophe now strikes the U.S. on average every three weeks, compared with every four months during the 1980s (inflation-adjusted).

The geographic footprint of destruction is expanding. Convective storms—heavy rain, lightning, hail, and violent wind—spread further north this year into Great Lakes states, widening the vulnerability range for insurers and businesses.

Swiss Re reports that convective storms caused $34 billion in insured damage in the U.S. during the first half of 2023—a record for a six-month period and 68% of insured natural catastrophe losses worldwide.

Insurers have traditionally balanced risks from policies in damage-prone coastal states like Florida and California with those in less vulnerable heartland areas. Thompson noted, "That’s no longer as effective with convective storm losses growing so much in the middle of the country."

Over the past decade, extreme weather costs to insurers have outpaced inflation in labor and construction materials, even accounting for high price pressures since late 2021. David Hemry, director of commercial strategy at LexisNexis Risk Solutions, said claim severity—the average cost of an insurance claim—has soared 150% in the past decade, about six times faster than inflation.

Several insurers are pulling back. State Farm announced in May it will stop accepting new applications for commercial and personal property insurance in California. Nationwide announced in June unspecified risk reduction in its small- and middle-market commercial property insurance in unidentified states.

Hemry noted that hail has hammered regions along the Interstate 35 corridor in Texas, Denver, and parts of Colorado, making claims harder to predict. Bill Clark, CEO of Demex Group, said in an email, "Insurers in Arkansas, Illinois, Kentucky and Indiana are in a particularly unstable situation."

Reinsurers are also retreating. According to an order signed by California Governor Gavin Newsom in September, reinsurers have hiked premiums from 30% to 50% across the U.S. for insurers with catastrophic losses, straining the retail market.

Thompson explained, "The impact of climate change and these billion-dollar losses has really put a strain on reinsurance, which ultimately dictates the terms of what you can buy in the retail insurance market." He added that CFOs and financial executives will likely gain greater C-suite clout: "Risk management is going to need a bigger seat at the table than they probably have had in the past few years."

Experts recommend five steps for CFOs to limit costs:

1. Run a clean-sheet review of risk tolerance

A CFO who thoroughly assesses the company’s ability to cope with extreme weather damage will adapt sooner to rising premiums and the prospect that inflation will exceed the Federal Reserve’s 2% target for a few more years. Insurance should no longer be treated as a routine expense item rolled over annually.

Financial executives will likely need to change insurance packages more frequently and gauge needs precisely, using data that models weather, labor, construction, and other costs. They should budget more for insurance for the foreseeable future. Shopping around for higher-value insurance can help hold down costs, Hooda said.

Hooda emphasized a basic principle: "Number One, accept the reality that premiums are increasing and adjust your bottom line implications for it."

2. Tighten partnerships with insurers

CFOs should increase the frequency and depth of contacts with carriers as the market adjusts. Experts suggest reaching out to insurers as many as 180 days before an application is due, rather than the usual 90 days, and detailing with supporting data how they are reducing risk and limiting losses.

Thompson advised, "Make sure you’re putting together a top-notch submission with a loss-control narrative."

3. Redouble efforts to avert loss

Installing improvements such as storm shutters, flood barriers, and fire-suppression systems remains a surefire way to reduce insurance costs. According to the National Institute of Building Sciences, each dollar invested in limiting property damage—through retrofitting or adopting updated building codes—can avert as much as $13 in damage.

Hemry noted, "It’s not just the property risk. It’s also the liability risks of people getting hurt on the property, breaking into the property—those sorts of things."

Many commercial property owners neglected maintenance after the pandemic reduced occupancy, and CFOs are focused on high refinancing costs with the Fed’s benchmark rate at a 22-year high. Thompson warned, "We’re in a bit of a vicious cycle that as occupancy drops and loans are coming due, there can be retreat from investing back in the properties. That’s only going to lead to increased severity of claims."

4. Consider insurance innovations

Alternatives to traditional policies can fill gaps left by scaled-back coverage. Parametric insurance, which pays a set amount based on event traits rather than repair costs, is often used as a supplement or substitute. Hooda said it "gives a bit of stability from a CFO perspective," though the loss-to-payout ratio is usually less favorable than with traditional policies.

5. Dive into data analytics

Gary Sullivan, senior director for emerging risks at the American Property Casualty Insurance Association, said, "Big data has been around for as long as insurance companies have been around." Yet today, advanced analytics can measure wind, wildfire, and other risks more precisely, identifying vulnerabilities and opportunities.

Hemry noted, "Historically, the insurance industry has been fairly glacial to move. It’s conservative in nature." Start-ups are using new data methods, such as analyzing rooftop photos from aircraft to gauge risk across vast areas, reducing claims and premiums. InsurTechs "integrate with carriers to help them do things that, quite frankly, they haven’t been able to do for the past 100 years because it’s not their nature," Hemry said.

CFOs should ask carriers how they use artificial intelligence and data analytics to measure risk. Thompson suggested using customized risk management systems "to tell a narrative that prevents getting baked into the general market trend."

Eventually, higher premiums will likely attract fresh capital, stabilizing the market. Hooda predicted, "Folks are going to see this as an entrepreneurial opportunity, and they’ll jump in. You’ll see an improvement over time."