United States: Climate Change Issues For Management

Last Updated: August 23 2013
Article by Jones Day

Insurance Industry Think Tank Turns Attention to Climate Change

The United States has experienced numerous extreme weather events in the past year. From Superstorm Sandy along the East Coast, to extreme drought in the Midwest, to deadly wildfires in Colorado, these weather events have caused enormous loss of both life and property. Some in the scientific community attribute an increase in both the number and severity of natural disasters to the effects of climate change.

The brunt of the financial loss from these natural disasters is likely to fall on the insurance and reinsurance industries. According to the Property Casualty Insurers Association of America, natural disasters in 2012 generated $35 billion in direct insured property losses (before reinsurance recoveries) for all insurers, an increase of $1.3 billion from 2011. Beyond property losses, changing weather patterns may also render prior risk models obsolete, requiring new modeling and adjustments to premiums.

Despite the potential impact of climate change on its business model, the insurance industry has been slow to lend its support to political action to counteract climate change, or to otherwise respond to insuring in a changed environment. A recent industry publication may signal a shift in this trend. In June, the Geneva Association, an international insurance "think tank," issued a report, "Warming of the Oceans and Implications for the (Re)insurance Industry."

The report explores the evidence for ocean warming since the mid-20th century, the impact of ocean warming on extreme events, and the consequent impact on the global insurance industry. In this final category, the report notes a "significant upward trend in the insured losses caused by ... extreme weather events" for both primary insurance and reinsurance providers. With increased losses and newly ambiguous return periods due to extreme weather, the report questions the continuing commercial viability of the catastrophe risk business in some areas. The report then focuses on potential industry responses to predicted impacts of extreme weather through internal risk reduction and external risk mitigation.

Regarding internal risk strategies, the report predicts that use of "simple stationary climatological approaches to quantify probabilities of extreme events" will increasingly fail. A company that does not adequately adapt to this issue could face penalties from ratings agencies. The report therefore calls for updated internal risk modeling that takes into account a reasonably wide range of "hypothetical but scientifically justifiable scenarios."

As to external risk reduction, the report expresses concern that the public reaction to recent climate events could be increased self-insurance coupled with decreased self-protection, creating "a risk environment that is uninsurable in some regions." Consequently, the report calls on the insurance industry to play an active role in raising awareness of the impacts of climate change through risk education and dissemination of risk information. The report also notes new market opportunities in the transition to a low-carbon economy and calls on the insurance industry to support this transition by using its "unique knowledge base to inform the debate on climate change and actively lobby[ing] government to take action to reduce risks and curb emissions of greenhouse gases." Such actions, the report predicts, "will help the insurance industry to avoid market failures and increase societal resilience."

The Geneva Association's recommendations rest on market analyses of the potential impacts of climate change to the insurance industry's business model. Responses from the industry may also be fueled by regulatory factors. California, New York, and Washington now mandate that major insurers disclose how they are managing climate change risks. At the federal level, changes are occurring to the National Flood Insurance Program, which has long provided federally subsidized flood insurance to property owners in designated areas. In 2012, the Biggert-Waters Flood Insurance Reform and Modernization Act required changes to the program, including a scaling back of subsidized rates and a redrawing of rate maps to reflect actual risk.

Mounting evidence of the impacts of climate change on current risk models and business practices is likely to lead the insurance industry increasingly into the climate change policy debate.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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