Rising cost of insuring against climate crisis will have wider knock-on effects for UK economy

Climate Risk and Insurance Challenges

The CityUK report highlights the challenges of pricing climate risk, which is becoming increasingly difficult due to the intensifying climate hazards. Traditional actuarial methods, which assume a stable probability of loss, are no longer reliable. This is leading to protection gaps, where individuals and businesses are left without adequate insurance coverage.

The report argues that the difficulties of pricing climate risk will have knock-on effects across the financial system, affecting bankability, investability, and orderly economic activity. This is because insurance plays a crucial role in oiling the wheels of investment, and the unpredictability of weather events is likely to be increasingly felt more widely.

Vicious Cycles and Public Backstops

The report suggests that there may be a vicious cycle, in which too little is spent on adapting to climate risks, which increases the cost of climate damage and, in turn, raises the cost of investment. To break this cycle, the report argues that there may need to be more public or partly public backstops.

Economist Swati Dhingra's speech points to another related vicious cycle, where the increasing impact of adverse weather events on UK inflation leads to higher interest rates, which in turn increase the cost of borrowing for much-needed investments in the transition to net zero and climate adaptation.

Policy Responses and Breaking the Cycle

Dhingra argues that monetary policy and government tax and spend policies may need to work more closely to break the cycle. This could involve using fiscal policy to support investments in climate adaptation and resilience, rather than relying solely on monetary policy to offset the inflationary impacts of the climate crisis.

The CityUK report and Dhingra's speech highlight the need for a more active role for government in moderating the effects of the climate crisis. This could involve developing ways to account for climate resilience in insurance, as well as providing public or partly public backstops to support investment and economic activity.