When a hurricane or a wildfire strikes, the economic damage is usually very visible — roofs are ripped off or charred homes line roads. Heat waves cause financial damage, too, but it’s more diffuse: Farm crops might wither, construction workers pause or data centers sputter out, forcing customers offline.
Climate risk models, which are widely used in the insurance industry, can estimate the likelihood that fires or floods will affect a specific place in the US, even down to the address level, and how much damage that would wreak. So far, the models don’t typically make detailed projections for extreme heat. For one thing, heat is less of a threat to real estate than it is to health, energy infrastructure and the food supply.
But cities, businesses and insurers need the financial risks to be outlined more clearly, and some believe a new market for heat insurance — driven in part by artificial intelligence and the need to cool data centers — is around the corner.
Hedging against heat
The property information firm Cotality, previously known as CoreLogic, recently started offering heat-hazard modeling on its widely used risk-analysis platform. And Mercer, a unit of Marsh & McLennan Cos Inc., in May launched a climate health cost forecaster tool evaluating how extreme heat and other risks could impact companies’ health insurance costs. It draws on historical incidence data, medical claim codes associated with climate events and published research.
“The health cost is but one of many,” said Tracy Watts, Mercer’s US leader for healthcare policy. “You’ve got increased workers’ compensation cost, disability issues, life insurance, absentee issues.”
These newer tools follow the emergence of hedging instruments like weather derivatives, forward contracts and parametric insurance. Using a forward contract, for example, a utility might agree to buy extra electricity from a producer at a certain price for the summer. If temperatures stay low, they lose; if they soar, they win. Parametric insurance pays out only if predetermined physical criteria are reached — say, temperatures above 95F for five days running.
“I think when we look more closely at extreme heat,” said Garrett Bradford, a principal at Milliman Inc., an actuarial and management consulting firm, “we will find the risk often isn’t taken sufficiently into account” in insurance, “and the downside of a major heat event is potentially significant.”
