Weathering the storm – climate risks, premiums, and what it means for investors

Freddie Fuller 00:02
Welcome, everyone. My name is Freddie Fuller, and I'm the Senior Institutional Portfolio Manager for the RBC European and International Equity teams. Today, I'm delighted to be joined again by David Howells, a Senior Analyst on the desk. Welcome, David.

David Howells 00:21
Morning, Fred, and a pleasure to join you today.

Freddie Fuller 00:24
David, in the year that we are seeing a record El Niño, and here in the UK, but also across Europe and other areas, citizens are being told to stockpile essentials and food to prepare for its impacts, we thought this would be a good moment to look in-depth at an area of the stock market which is deeply exposed not just to individual events such as this year's El Niño, but also to the broader long-term impacts of climate change, namely the insurance industry.

Now, the industry itself is sizable; it's varied, with very different exposures across different areas. Perhaps you could give us a quick overview of the industry itself and, in your view, where the main exposures lie.

David Howells 01:16
Yes, of course. I think when we first started to discuss this topic on the desk, our initial question was: does climate change make insurance more valuable, or does it have the potential to make insurance obsolete? As a background, so primary insurance is the insurance companies that we, as consumers, deal with, whether it's motor or life. Essentially, when these companies have too much isolated risk, whether it be insuring a lot of Teslas in the Midlands or the health of Welsh farmers, they want to diversify and sell some of this risk, and that is where reinsurers come into play.

Going back to natural catastrophes, or NatCats as they're more commonly known, these are central to this conversation. The first thing you really notice about the insurance of NatCats is how little the losses are actually insured. If you look between 1980 and 2024, only 25% of the European NatCat losses were actually insured.

The first question really is, why does this protection gap exist? There are four major points. The first is apathy, whether that's the low perceived probability or the low perceived understanding. The second is the policy exclusions, and this pretty much covers the illusion of being protected. I think I've got flood insurance on my house insurance, but I don't really know. The third is affordability, and the fourth is public infrastructure. Roads, bridges, these aren't insured, but are self-insured because they're on the government's large balance sheet.

There is some further nuance on this protection gap point. It isn't all just increased NatCats. It's also the fact we're building more stuff, we're building more valuable stuff, and we're building it in exposed locations, and the price of this rebuild is only increasing. How much is climate versus how much is inflation versus economic growth? This is a very important aspect and one that we will not cover today.

Freddie Fuller 03:37
I suppose picking up on your point of the scale of the issue facing both consumers but also businesses themselves, you mentioned a European figure there. Looking worldwide, figures seem to suggest that total economic losses from natural disasters globally last year, in 2025, were around 224 billion US dollars, of which insurers covered 108 billion. Now, this was the sixth consecutive year that NatCat losses exceeded USD100 billion. Interestingly, despite there being no US hurricane landfalls that year for the first time in a decade, and clearly US hurricane landfalls are extraordinarily damaging in economic terms.

Coming back to your other point, NatCat loss growth is between 5-7% per annum, and growing at a fair clip. Swiss Re, which is a major European reinsurer, has modelled that a peak loss scenario for this year could reach USD320 billion. Then coming back to that US hurricane point, a single one of those, a major one hitting Florida, for example, could generate insured losses exceeding 300 billion alone.

Now, if we bring it back to Europe, I suppose some might say this all matters a lot less because we are not as exposed to severe weather events such as hurricanes or typhoons, but I suppose what the last few years has shown us is that we are increasingly exposed in different ways. The most obvious example being the growing prevalence of wildfires. Wildfire land loss in Europe has risen by 57% in just four years, which really is a reflection of the startling change in climate conditions that we have experienced.

Given all of this backdrop globally and in Europe, what, in your view, are the immediate impacts on the insurance sector, and then what are you seeing in terms of management reacting to that?

David Howells 05:50
I think in this steady world of increased NatCat premiums, whether that's through climate or economic growth, and this is a world that we subscribe to, the immediate impact will be within pricing and an increased emphasis on reducing that protection gap. Now, we can have a spirited debate of whether this will fall really into primaries or reinsurers, and it depends a lot on things like attachment points etc. The net impact of consumers, in any case, will be increased pricing. Now, this is largely wearable from today's starting point for consumers and business, but for us investors, the key differentiation point will be how good is the underwriting quality of the insurers within such a fast-moving industry.

If you look at traditional insurance products, whether it be life or non-life, they typically have quite a slow-moving evolution. The amount and costs of car crashes or mortality rates, they don't change that much year on year, whilst climate-driven repricing can be expected to be much, much quicker, and therefore, you need a much more nimble underwriter. This is where I get intellectually excited. In a world of increasing NatCats, we are actually moving further away from uncorrelated risks.

For uncorrelated risks, if you think about it, what's the correlation between my car and my house insurance seeing claims in the same period or me and my neighbour's car both seeing claims? Unless we drive into each other, the correlation is quite low, whereas in a world of a flood, all of a sudden, that correlation is trending towards one. Therefore, the gap between good underwriters and bad underwriters is so much more important, and diversification between business lines and geographies becomes more important as domestic and indeed intercontinental correlations increase.

This could lead to consolidation within the sector as scale and diversification are key priorities for survival, never mind profitability. It also raises that wider point: what happens when pricing hits a tipping point? Will entire areas become uninsurable?

Freddie Fuller 08:20
That's an interesting point, and one that I suppose is beginning to feel a bit more pertinent than perhaps we would like to admit. I'm thinking, an example is the LA wildfires in California recently and what is now being viewed as a dereliction of duty by insurers by leaving the state. What happens when insurers decide they can no longer insure either certain events or perhaps even entire cities? The most obvious ones in Europe would be Venice or Amsterdam, which are far more exposed to climate change. What happens in that situation?

David Howells 09:01
I guess without stating the obvious too much, if insurance becomes too expensive, then the bottom line is people stop insuring themselves. You'll end up in this weird situation where some of the population will pay too-costly insurance, and then some will be uninsured and pay nothing. Now, in these regions that you have this weird situation, if you have a flood or a bad storm, because governments can't afford thousands of people becoming homeless overnight, they will be forced to step in as an insurer of last resort.

Of course, all of a sudden, those people who are paying expensive insurance realise that they're actually insured whether they pay the primary insurer or not. This is what we call charity hazard logic. The real impact of climate change, therefore, is moving to a structural fiscal burden where houses and the mortgageability of these homes come under serious question if the government doesn't step in.

Freddie Fuller 10:06
Interesting.

David Howells 10:07
The uncomfortable irony of all this is that governments who are better on social welfare are more likely to crowd out private insurance demand. Also, you can end up in a very, very dark spiral very quickly within the financial system where cat bonds, which are held by pension funds, held by European households, whose houses have been flooded and are both unmortgageable and uninsurable. These, I'll admit, do sound a little bit apocalyptic, but they aren't quite as out there as you may believe. The ECB has now proposed a public-private reinsurance mechanism which should pool cat risks across countries and perils which the individual markets find too large to do themselves.

Freddie Fuller 10:53
What you're saying is, yes, these are tail risks, but they are ones that are being taken increasingly seriously by policymakers.

David Howells 11:02
Yes, exactly. Yes, this isn't pure fiction.

Freddie Fuller 11:06
Coming back to the investment point, there's a lot here which could theoretically paint a rather damaging picture in the medium to long term for the sector, but you take a slightly more nuanced view of how to approach investing here, particularly in terms of the increased requirement for insurance versus the higher exposure to tail risks.

David Howells 11:30
Yes, I think that extreme case that I talked about before is fun to talk about, but I think the likelihood of the entire system falling over is very much a tail risk, like you said. However, what I think there is little debate on, be it through conventional routes or state-sponsored utility-style offering, there is a clear trend that insurance will take a higher share of our personal and commercial wallets and, indeed, importance.

Freddie Fuller 11:59
Sorry. On that point, is that just effectively a position where claims inflation leads to price inflation and, by proxy, is just yet another way that climate change itself is inherently inflationary?

David Howells 12:13
Exactly, yes. Yes. The relationship between claims to pricing is tried and tested, and you get a lag on it, but yes, essentially, if everyone's car price goes up, then so does your motor insurance. It's like for like. I think this is why you have to be quite positive in the near term for insurance, because that pricing power is very real and the sector is delivering good results, but this can allow it to continue to deliver strong results. The other side of the coin worth mentioning is the cost of equity.

Insurance becomes more important as a part of our lives, and you get higher growth rates that we have historically seen, but you also now have a higher emphasis to tail risks and, of course, large and frequent claims. Which is the dominant driver here? For us, and I mentioned this on the outset, but you have to look at businesses which have good scale, good diversification, and strong underwriting standards. Those monoliners, those mono-geography insurers, they've got a very challenged business model as it stands, almost regardless of how much the industry gets shaken up.

Freddie Fuller 13:33
Ultimately, then, the investment case isn't necessarily clear why these things are never black and white, but it does emphasize the need for stock picking and a focus on company fundamentals.

David Howells 13:46
Definitely, yes. Yes.

Freddie Fuller 13:48
Perhaps we could finish by thinking about how the industry itself is changing in the way that it does business or the way that it thinks about business. An example, I suppose, is in the same way that health insurance has moved to more of a preventative model, or I suppose you could say encouragement of adaptation in this case. How, then, do you think this feeds through into changes in the economics of the sector?

David Howells 14:20
The development of this preventative angle, I think, is one of the most interesting aspects. It's taken straight from the playbook you see in cyber insurance, where primaries give much more emphasis and time to prevention, whether that's in the form of software or in terms of teachings rather than on the traditional claims and payouts. Whether it's flood defences, building standards, tree management, garage usages, there are lots of ways that personally you can make a difference. There is a clear need from insurance, governments to promote this behaviour in order to keep both the fiscal burden but also the premiums under control.

Now, the caveat and the problem to this is that speed of change, because if it's slow, then you force governments into backstopping this before the prevention enticement comes in. Then all of a sudden you have this reverse phenomenon where you're discouraging personal resilience. Essentially, we've just gone through a period where energy and food have become considerably more scarce than ever of poor farming seasons, and obviously the wars in Ukraine and Iran, and yet no one has changed their consumer behaviour because there were no food shortages or blackouts.

Short-term, we can be quite positive on the economics and the importance of the insurance sector. Into the medium term, there are some very serious questions to be asked, and that includes obviously that absolute bogeyman: if nothing is done at all, is this the beginning of the end for primary insurers as we know it?

Freddie Fuller 16:12
On that very interesting note, we should probably conclude. I want to thank David for taking the time for joining us again, and also to our listeners for tuning in. Goodbye.

David Howells 16:24
Thanks for having us. Goodbye.

Note: Peak-loss modelling figure is from Swiss Re Institute, 2026.