Surging Insurance Costs due to Climate Change and their Impact on Banks: A Global Perspective

Abstract

Climate change is reshaping homeowners insurance markets—and, in turn, affecting banks—in the United States, Europe, Asia, and Australia. As natural disasters become more frequent and severe, insurers must raise premiums, cap coverage, or withdraw entirely from high-risk regions. These trends strain homeowners and pose significant risks to banks that rely on insured property values as collateral. We compare traditional reactive strategies with emerging predictive, data-driven approaches and discuss proactive risk management tools such as Riskthinking.AI’s Climate Digital Twin (CDT™). The paper argues that a coordinated, forward-looking, stochastic approach is necessary to maintain financial stability in these diverse markets.

1. Introduction

Global climate change is fundamentally altering risk profiles and forcing a reassessment of traditional insurance and banking practices. Insured losses from climate-related disasters have soared in the United States and elsewhere, prompting insurers to adopt reactive measures that have often resulted in steep premium hikes. Similarly, European, Asian, and Australian markets are witnessing dramatic shifts in how insurance is priced and delivered. This paper reviews current trends across these regions and discusses how banks are increasingly exposed to insurance-related risks—from depreciating property values to increased credit defaults. Advanced predictive tools, such as the Climate Digital Twin (CDT™), offer promising solutions to anticipate and mitigate these emerging risks.

2. The Rising Cost of Homeowners Insurance

2.1 Climate-Driven Losses and Market Responses

Across the globe, homeowners insurance rates are surging. In the United States, premiums have risen significantly over the past few years, particularly in regions exposed to hurricanes and wildfires[1]. In Europe, severe storms and flooding have led to increased losses and aggressive price adjustments by insurers[2]. In Asia, markets such as Hong Kong and Japan face heightened risks from typhoons and monsoonal flooding, leading to rapidly rising premiums[3]. Similarly, Australia has seen insurers recalibrate pricing amid a surge in extreme weather events, with reports from APRA noting a significant upward trend in premium costs[4].

2.2 Defensive Versus Offensive Strategies

Traditionally, insurers have taken a “defensive” stance by:

• Market Withdrawal: Exiting high-risk regions, leaving homeowners with fewer coverage options.

• Reactive Premium Increases: Raising rates after significant losses occur.

• Reliance on Historical Data: Using past claims data that no longer predict future risk accurately.

In contrast, an emerging “offensive” strategy uses forward-looking, data-driven, stochastic models to forecast climate risks. Insurers now deploy multi-scenario stress tests using advanced tools like Riskthinking.AI’s CDT™, enabling them to price risk more precisely and sustain market presence even in high-risk areas[5].

3. Implications for Homeowners and Banks

3.1 Impact on Homeowners

In markets across the United States, Europe, Asia, and Australia, rising insurance costs significantly burden homeowners. Higher premiums decrease disposable income and compel many to choose reduced coverage. In certain regions, insufficient insurance coverage—due to market withdrawal or prohibitive costs—has resulted in declining property values. For example, properties in high-risk areas of Europe and Asia are being sold at a noticeable discount compared to similar properties in lower-risk zones.

3.2 Consequences for Banks

Banks are exposed to several intertwined risks due to rising insurance costs:

• Market Risk: Property values in high-risk areas depreciate, undermining the collateral value securing mortgage loans. Evidence from the U.S. and European markets indicates that properties in disaster-prone zones sell for significantly less than those in safer areas[6].

• Credit Risk: Higher insurance costs can increase mortgage delinquency. Studies from the United States show that borrowers with high debt-to-income ratios are particularly vulnerable when insurance expenses rise[7].

• Macroeconomic Risk: As households spend more on insurance, disposable income and consumer spending decline. This effect is observed across European, Asian, and Australian markets, where increased insurance costs have contributed to broader economic slowdowns.

Furthermore, data gaps in insurance coverage information exacerbate these risks. A U.S. Federal Reserve study has highlighted challenges in integrating detailed insurance data into credit risk models—a concern shared by banks in European and Asian markets[8] (Federal Reserve System, 2024).

4. Proactive Risk Management: An Offensive Strategy

4.1 Advanced Climate Modeling and Predictive Analytics

Forward-looking insurers are adopting proactive risk management strategies that leverage advanced climate modelling:

• Predictive Risk Modeling & Scenario Analysis: Utilizing tools like the CDT™, insurers forecast multiple future climate scenarios, allowing dynamic underwriting and pricing adjustments and capturing forward tail risks.

• Granular Risk Pricing: By assessing local or even property-level risk, insurers in diverse markets can more accurately price premiums.

• Multifactor stress testing: This is necessary because the damage to homes and buildings may come from multiple hazards related to climatology. This is seldom done and is unique in Riskthinking.ai’s CDT.

• Sustainable Underwriting: Detailed asset-level data enables insurers to incentivize homeowners to invest in resilience measures—such as improved flood defences and storm-resistant building techniques—which reduce overall risk.

4.2 Implications for Banks

Banks must incorporate these predictive insights into their risk management frameworks:

• Enhanced Risk Assessment: Integrating forward-looking insurance data into loan underwriting processes can provide a more accurate view of collateral risk.

• Portfolio Stress Testing: Banks can evaluate the potential impacts of rising insurance costs on loan portfolios by conducting multi-scenario stress tests that reflect conditions across the US, Europe, Asia, and Australia.

• Collaborative Partnerships: Closer collaboration between banks and insurers, as seen in several European and Asian markets, can help bridge data gaps and refine risk assessments.

4.3 Consequences for Insurance Companies

Insurance companies are at the forefront of climate change impacts, facing significant operational and financial pressures as traditional risk models are disrupted by increasingly frequent and severe natural disasters. The following key consequences have emerged: insurers are experiencing a surge in claims resulting from extreme weather events—hurricanes, wildfires, floods, and severe storms—which drive up payout amounts. In markets like the U.S. and Australia, claim volumes have reached unprecedented levels, leading to higher loss ratios and straining insurers’ balance sheets.

• Increased Reinsurance Costs[10]: Reinsurance providers are raising rates to compensate for their own escalating losses from climate disasters. These higher costs are passed on to primary insurers, further squeezing profit margins and consumer premiums.

• Market Withdrawal and Coverage Gaps: In response to unsustainable risk exposure, some insurers have opted to exit high-risk markets completely. This withdrawal reduces competition and leaves homeowners and businesses with fewer coverage options, intensifying financial instability for policyholders and the broader financial system[11].

• Operational and Regulatory Challenges: Traditional actuarial models rely on historical data and become less effective as climate risks evolve. Insurers now face the challenge of integrating forward-looking predictive analytics into their underwriting processes. Furthermore, regulators in Europe, Asia, and Australia increasingly require that insurers maintain robust risk models and sufficient capital reserves to address these emerging risks[12].

• Pressure to Innovate: The cumulative effect of these factors is compelling insurers to reassess their business models. To stay competitive, they must invest in advanced risk modelling tools like the Climate Digital Twin (CDT™) and create innovative products such as parametric insurance and catastrophe bonds. These proactive measures are vital for stabilizing their operations and supporting the broader ecosystem by ensuring continuous, affordable coverage for high-risk properties.

The overall impact of these consequences is a rapidly evolving insurance landscape. Companies that do not adapt may experience financial instability, decreased market share, or complete exit from vulnerable markets. In contrast, insurers that adopt proactive, data-driven strategies are more likely to achieve sustainable growth and contribute to a more resilient financial system.

5. Conclusion

The challenges posed by climate change are compelling a fundamental reassessment of worldwide traditional insurance and banking practices. As insurers transition from reactive (“defensive”) approaches to proactive (“offensive”) strategies—utilizing tools such as the CDT™—homeowners and banks throughout Canada, the United States, Europe, Asia, and Australia must adapt. Advanced predictive analytics enhance underwriting accuracy and support robust risk management in an era of escalating climate hazards. By adopting these forward-looking methods, insurers can provide more resilient coverage, and banks can better safeguard their loan portfolios against climate-induced devaluation and credit risk. The shift to proactive risk management is crucial for maintaining financial stability and ensuring that communities remain insurable and investable in a rapidly changing climate.

References

1. Acharya, V. V., Berner, R., Engle, R., Jung, H., Stroebel, J., & Zhao, Y. (2023). Climate Stress Testing. Annual Review of Financial Economics.

2. APRA. (2023). Insurance and Climate Risk: Trends and Implications for Australia. Australian Prudential Regulation Authority.

3. European Central Bank. (2023). Climate Risk Stress Test: European Banks. European Central Bank.

4. European Insurance and Occupational Pensions Authority. (2023). Climate Change and the Insurance Sector: Impact and Adaptation. EIOPA.

5. Federal Reserve System. (2024). Pilot Climate Scenario Analysis Exercise. Retrieved from https://www.federalreserve.gov/publications/files/csa-exercise-summary-20240509.pdf

6. Insurance Council of Hong Kong. (2023). Climate Change Impact on Property Insurance in Asia. Retrieved from the Insurance Council of Hong Kong website.

7. Keys, B. J., & Mulder, P. (2024, June). Property Insurance and Disaster Risk: New Evidence from Mortgage Escrow Data. National Bureau of Economic Research, Working Paper 32579.

8. U.S. Department of the Treasury. (2025, January 16). Analyses of U.S. Homeowners Insurance Markets, 2018-2022: Climate-Related Risks and Other Factors. Retrieved from https://home.treasury.gov/news/press-releases/jy2791

9. How Rising Insurance Prices Affect Banks and Their Customers: A Primer on the Cost of Climate Change. (2025). Global Risk Institute in Financial Services.

10. Evolving Landscape of Homeowners Insurance. (2025, February 19). Dana Krechowicz, Global Risk Institute in Financial Services.

11. Offense vs Defense in Insurance, Ron Dembo, Riskthinking Working Paper, HTTPS://riskthinking.ai, February 19, 2025.