Insurance and Climate Change: A Matter of Policy
If government policies won't lead to aggressive action on climate change, maybe the insurance industry will.
It seems to have gone largely unreported in the U.S., but in the past week, two developments have shaken the largely staid world of insurance. On Tuesday, preliminary estimates released by the Munich Re Foundation at the international climate conference in Montreal found that world has suffered more than $200 billion in weather-related economic losses over the past year, making 2005 the costliest year on record.
Just days before, 20 leading U.S. investors urged 30 of the largest publicly-held insurance companies in North America to disclose their financial exposure from climate change and steps they are taking to reduce those financial impacts. The group cited the enormous risks that insurance companies face from escalating losses caused by extreme weather events and the financial risks and opportunities associated with climate change.
According to a recent study by the Ceres investor coalition, U.S. insurers have seen a 15-fold increase in insured losses from catastrophic weather events in the past three decades -- increases that have far outstripped growth in premiums, population, and inflation over the same time period. The study, Availability and Affordability of Insurance Under Climate Change: A Growing Challenge for the U.S., warns of larger financial losses in the years ahead if climate change trends continue and no actions are taken to face the challenge.
The investor demand comes on the heels of devastating back-to-back hurricane seasons in the U.S. that caused a record $30 billion in insured losses in 2004 and as much as $60 billion in insured losses from Hurricane Katrina alone in 2005. Worldwide, the $200 billion in damages cited by Munich Re significantly exceeded the previous record of $145 billion set in 2004. More than $70 billion in 2005 losses were covered by insurance companies, compared to some $45 billion in damages last year, according to the Foundation.
The insurance industry has reason to be worried about such trends. A study in June by the Association of British Insurers found that climate change could increase the annual costs of flooding in the UK almost 15-fold by the 2080s under high emissions scenarios. If climate change increased European flood losses by a similar magnitude, annual costs could increase by up to $150 billion.
In the ABI study, using high emissions scenarios (where carbon dioxide levels double), insurers' capital requirements could increase by over 90 percent for U.S. hurricanes, and by around 80 percent for Japanese typhoons. In total, an additional $76 billion could be needed to cover the gap between extreme and average losses resulting from tropical cyclones in the U.S. and Japan alone.
What can the industry do? Answers can be found in a nearly 10-year-old study by the Lawrence Berkeley National Laboratory (and funded by the U.S. Energy Department):
The insurance industry can take a reactive approach to mitigating climate-change risk by raising deductibles or withdrawing coverage. Alternatively, the industry can take a proactive approach by, for example, encouraging actions to reduce greenhouse-gas emissions.
Energy consumption is the largest contributor to global climate change, so promoting energy efficiency is a particularly promising strategy. Many energy-efficient technologies also have the potential to reduce ordinary insured losses involving property, health, or liability. This report illustrates 60 specific ways in which targeted energy-efficiency improvements can translate into reduced risk of insured losses. The measures can reduce losses from: fire, ice, wind, and water damage; temperature extremes; occupational injuries; poor indoor air quality; equipment performance problems; and uninsured drivers. These loss-reductions translate into benefits for a variety of insurance providers, including property-casualty, professional liability, health, life, workers' compensation, business interruption, and automobile.
Promoting energy efficiency aside, there are even tougher measures coming from the big insurers.
Swiss Re, Munich Re's competitor and one of the world's largest re-insurers, recognizes climate change risk to be a potentially serious exposure for directors and officers. It now requires companies to disclose their climate strategy as part of their D&O insurance application.
The message is implicit, if not explicit: "If you don't care enough about the risks to your company resulting from severe climate change, we just might not insure you."