Insurance sector faces claims of climate risk underpricing

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Claims of climate risk underpricing

Highlights

Whistleblowers allege underwriters and brokers pressure catastrophe risk modellers to reduce risk estimates, leading to underpriced insurance premiums despite high disaster exposure.
A legal opinion shared with the UK Financial Conduct Authority warns these practices could represent significant breaches of financial and prudential regulation if verified.
Anonymously signed open letter by over two dozen senior executives highlights that short-term financial incentives drive systemic underpricing of climate risk, potentially exposing clients to sudden coverage cuts.

Whistleblower claims and regulatory scrutiny

As first reported by the Financial Times, five insurance industry professionals say underwriters, brokers and senior staff commonly press catastrophe risk modellers to alter analysis in ways that reduce quoted premiums. The allegations suggest some policies are being priced below the level implied by the underlying disaster exposure, according to the accounts shared with the newspaper.

One junior catastrophe risk modeller at an insurance and reinsurance provider says policies are "being underpriced" and that staff are asked to change figures for accounts even when the risks of a disaster are high. The person says analysts can be asked to mark flood-prone properties as having defences in place when they do not, adding that attempts to draw a line have at times been overridden by more senior colleagues.

A legal opinion shared with the UK Financial Conduct Authority, and seen by the Financial Times, describes the claims as exceptionally serious and says they would likely imply significant breaches of financial and prudential regulation if true. The FCA says it will consider carefully the information provided to it, including the legal advice based on hypothetical scenarios, and encourages anyone with information on potential wrongdoing to report it.

Industry incentives and market impact

Catastrophe models are used across insurance and reinsurance markets to estimate the risk of natural disasters for portfolios that can include hundreds of properties or large commercial and infrastructure projects. While four of the people interviewed say modelling involves legitimate interpretation and that reruns can at times be justified, they also warn that inputs or outputs can be tweaked to bring premiums down to levels customers are willing to pay.

An open letter compiled earlier this month by non-profit Inside Track, signed anonymously by more than two dozen senior insurance executives, warns that short-term financial incentives are driving the sector to underplay and underprice physical climate risk. Professionals interviewed say that dynamic is creating systemic risks for the industry and could leave clients facing abrupt coverage cuts or withdrawals when long-building risks are eventually reassessed as too high.

Oliver Wing, chief scientific and product officer at risk modeller Fathom, who is not involved in the whistleblowing effort, says there is industry-wide incentive and pressure to produce optimistic models, though not necessarily in bad faith. He says the uncertainty and flexibility within climate risk models can allow users to reach widely varying outcomes, while another senior professional at one of the world's top five brokers says some market participants dismiss low-probability disasters in order to meet short-term targets even as underlying risk continues to change.

Our earlier article on rising sovereign borrowing risks in a higher-rate environment explained how prolonged geopolitical shocks and elevated fiscal spending can erode countries’ fiscal headroom and worsen refinancing pressure. It highlighted that emerging and frontier markets are especially exposed because interest-service burdens are high relative to narrower revenue bases, while energy and food price spikes add to inflation and strain credit outlooks.

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