Report Questions Insurer Readiness, Attitudes on Climate Change

By Don Jergler | March 7, 2013

A report out Thursday that details responses to a climate change survey from insurers doing business in California, Washington and New York shows many insurers are prepared to deal with today’s extreme weather events, but not longer-term “baseline changes” driven by climate change that may lead to more potent catastrophes like Superstorm Sandy.

The report draws on responses required on surveys issued to insurers with more than $300 million in direct written premiums doing business in the three states to disclose their climate risks. Those responses were submitted in May, 2012.

A large insurance association took exception with the findings in the report, saying the industry has made great efforts to deal with extreme weather events by calling for smater building, stronger zoning codes and pushing green programs.

Commissioned by Ceres, a nonprofit that advocates for environmental leadership, the report is designed to give a picture of how well prepared the industry is to deal with new risks associated to climate change.

Ceres has issued several reports in the past addressing the industry’s activity and stance on climate change. A report from Ceres in September last year urged the insurance industry to act to protect itself and the community against the increasing frequency of extreme weather due to climate change and called for more efforts made to calculate climate change into risk management.

The results of the report, “Insurer Climate Risk Disclosure Survey: 2012 Findings & Recommendations,” were discussed on Thursday on a conference call held by Ceres that included a representative for the California Insurance Department, Washington Insurance Commissioner Mike Kreidler and the head of California’s teacher’s retirement system.

“Climate really does have the potential to be a game changer for the insurance industry and we want to be sure it stays on their radar,” Kreidler said.

Kreidler, who said “the clock is clearly ticking” on the time to act on climate change, lauded the report as a good indicator of who is working to be prepared and take action on climate change and who is not.

“I think the report shows there are some strong standouts in the insurance industry, but there is room for improvement,” Kreidler said.

Jack Ehnes, CEO of California State Teachers’ Retirement System and a former insurance regulator in Colorado, noted that CalSTRS has $153 billion in investment holdings, including extensive insurance company holdings.

“The insurance industry response is well short of what we need,” Ehnes said. “As a matter of fact you can say it’s tepid.”

Geoff Margolis, deputy commissioner and special counsel in the California Department of Insurance, spoke on behalf of Jones, who he said “applauds Ceres” for undertaking the report.

Margolis, who noted CDI has the responses posted on its website, said “climate risk is something that insurers and regulators need to be thinking about.”

The survey on climate risk, which was developed by the National Association of Insurance Commissioners, generated 184 responses, and Ceres’ framework for assessing the responses is as follows: How the companies manage climate change issues, what drivers shape their strategies, what actions they take in their core functions or operations and how they interact with external stakeholders.

“The implications are profound, for the insurance industry is a key driver of the national and global economies,” the report’s authors state. “If climate change undermines the financial viability of the insurance industry, it will have a devastating impact on the economy, as well.”

The report notes that 2012 was the warmest year on record in the lower 48 states and the second most extreme weather year in U.S. history, calling such extreme weather, including stronger, more damaging storms and flooding in some areas, and drought and heat in others “the predictable consequences of rising global temperatures.”

Eleven extreme weather events each caused at least a billion dollars in losses last year in the United States, while Superstorm Sandy caused more than $50 billion in economic losses, according to the report.

The report covers life and annuity, health and property/casualty insurers, but zeros in on the latter.

“By far, the industry segment with the most climate risk management activities underway is property and casualty—unsurprising as weather events are a major driver of losses to these companies,” the report states. “In general, the current view of Life & Annuity companies is an absence of current risk exposure to climate change on their underwriting business, but nearly a quarter describe some active management of invested assets to manage climate change risks. Despite predictions of more pronounced heat waves, expansion of insect-borne disease and poorer air and water quality, few health companies describe climate change as a factor relevant to their risk assessment.”

The report draws a distinction between climate variability and the long-term impact of climate change.

“While most insurers in the P&C segment have policies in place to manage climate variability, the annual and decadal variance inherent to the global climate system, few have explicit policies to identify or manage the trends of global climate change,” the report states. “Some insurers do not seem to understand the difference between climate variability and climate change.”

Climate change is global, it’s related to a growing amount of carbon in atmosphere and the increased capacity for heat to be stored in the ocean, rising sea levels, stronger storms, and longer droughts that can leave more tender for massive wildfires, according to the report’s lead author, Sharlene Leurig, senior manager of the insurance program at Ceres.

“Those are baseline changes,” Leurig said.

Especially within the health and L&A segments, but even among some P/C insurers, many companies view climate change as an environmental issue immaterial to their business, with many of the remaining companies regarding climate change as a risk that will inherently be captured in their enterprise risk management strategies, the report shows.

According to the report, only 23 of the 184 companies have “comprehensive climate change strategies,” and of those 13 are foreign-owned, while eight are property/casualty companies.

“Yet even among those companies with comprehensive climate strategies, the view of climate science is remarkably diverse,” the report states.

The report also shows larger companies may be better prepared for the impacts of climate change. For the purpose of the report, companies were categorized by size: small (between $300 million and $1 billion annual premiums); medium ($1 and $5 billion); large ($5 billion-plus).

Insurer responses vary, with some companies seemingly more enthusiastic about dealing with the topic than others.

There are companies like The ACE Group that are funding climate change research, while companies like Swiss Re actively lend their brand to efforts at the Intergovernmental Panel on Climate Change, a global cooperative to synthesize the state of climate change science, the report shows.

“Some of the world’s largest insurers have concluded that climate change is already driving extreme events to diverge significantly from historic trends,” the report states. “Among them is Munich Re, which includes climate change among the set of factors amplifying decadal weather-related losses in North America, particularly for heat waves, droughts and thunderstorms. The increasing unpredictability of extreme events, and the potential for climate change to undermine the industry’s diversification models, threatens the industry’s long-term financial viability along with the very concept of insurability itself in some parts of the world.”

Leurig said that while the industry today may well be capable of dealing with extreme weather events, the findings in the report reflect a lack of forethought about the future impacts of climate change.

“Obviously the last couple of years, while they’ve been very challenging for the industry, profits have taken a hit, the industry is still very well capitalized to deal with that,” Leurig said, adding that the report’s goal is to try to get insurers to think about the longer term and “Where is the industry going?”

According to the report, most insurers regard climate change as a risk that will inherently be captured in their enterprise risk management strategies, and many of the responses imply that simply having an ERM framework is sufficient to identify and manage climate change risks.

But Leurig called the impacts of climate change “a fundamentally different challenge” that is being posed than a typical ERM strategy is geared to handle.

“What it takes to be resilient to extremes is different, the baseline is changing,” she said.

Common strategies for risk management include catastrophe modeling, reinsurance, higher deductibles or broader exclusions in risk-prone areas, particularly coastal zones, and a tight control of aggregate exposure, including rebalancing property with other lines of business, the report states.

“The most frequent challenge to risk management cited by insurers is regulatory pricing controls in which prices are not permitted to rise as quickly to higher risk levels in regulated markets,” the report states.

In fact, risk modeling was specified by 40 insurers in the report as an important technique in order to explore their capital adequacy, using realistic disaster scenarios and catastrophe models in the case of P/C insurers.

Twenty underwriters, mainly P/C insurers, mentioned accumulation control in which the insurer limits the amount of risk it will accept in high-hazard regions.

For example, Mercury Casualty stated in its response: “Because of the predicted increase in hurricane frequency, Mercury is taking numerous steps to monitor, control or even reduce exposure to catastrophic losses caused by hurricanes. Mercury is also exiting the homeowners insurance market in Florida.”

David Snyder, vice president of international policy for the Property Casualty Insurers Association of America, took exception with assertions in the report that insurers are relying on standard risk strategies.

“That’s not, by a long shot, all of what the industry is doing,” Snyder said.

He noted that insurers have rolled out usage-based auto insurance, which helps decrease carbon emissions, insurers are increasing the effectiveness of catastrophe modeling, they are pricing for changing weather patterns, and are pushing building codes and smarter development so that stronger buildings are constructed in safer areas and existing buildings are made more weather resistant.

“Across the board we think the industry is responding to the needs of its policyholders,” Snyder said, adding that “the industry responds to risks as proven though actuarial means that have to meet a very high test of credibility.”

David Kodama, PCI’s senior director of research, noted that after Superstorm Sandy “the vast majority of claims were handled in a quicker timeframe than ever before,” meaning information is being shared in a more efficient manner.

“We are working in an extremely dynamic environment in terms of the risk landscape that this industry operates in,” Kodama said. “The industry continues to show its meeting those challenges. We believe we have a very strong track record in meeting the needs of our main stakeholder, which is our policyholder. And we continue to follow the latest science and the modeling techniques and exercise our best underwriting strategies possible to maintain the risk to the best of our abilities.”

Snyder, who said he doesn’t think a “one size fits all” strategy should be adopted for all insurers, suggested better reporting is not the answer.

“Future actions shouldn’t be more reporting, but rather be focused on joint action to actually reduce risk,” he said.

Despite the proactive stance by some, there were several P/C insurers with relatively strong strategies for dealing with extreme natural disasters that were ambivalent about acknowledging the scientific reality of climate change, according to the report.

For example, Travelers qualified its reply to the survey by stating: “This survey, and its responses contained herein, do not endorse, reject or otherwise express an opinion on the existence or absence of, or causes of, climate change.” Allstate took a similar position, stating: “ Allstate is not endorsing, rejecting or expressing any opinion with respect to any particular scientific pronouncement about climate change/global warming.”

Both Travelers and Allstate had good disclosure about risks related to climate change, Leurig said, noting the responses from Travelers and Allstate “are heavily hedged comments.”

Representatives for Travelers were not immediately avaialable for comment.

Kyle Donash, a spokesman for Allstate, issued the following statement:

“It is clear to Allstate that weather events have driven a much higher amount of insured losses. The recent increase in severe weather all across the country and the continued increase in frequency and severity of storms are real. As a company in the business of helping people managing risk and protect their property, we have focused on helping our customers protect themselves from more extreme and unpredictable weather patterns. We are not ambivalent about climate change, as suggested or stated in the Ceres report, but instead are focused on helping our customers.”

Ambivalence about climate change science was not the norm among the responses, Leurig said.

“Generally, among the industry overall, there was a pretty strong agreement among companies that extremes are becoming more extreme, that something is changing,” she said.

One change the report highlights is the changing attitudes in other business sectors. Investment advisor Mercer treats climate change as a systemic risk, estimating it could introduce as much as 10 percent portfolio risk for institutional investors, including those with diversified holdings in sovereign fixed income, equity, credit and agricultural assets.

“A growing number of institutional investors outside the insurance industry are already taking affirmative steps to manage climate-related risks in their portfolios,” the report states.

The California Public Employees’ Retirement System (CalPERS) now requires such risks to be built into portfolio construction decisions across all asset classes, and the California State Teachers’ Retirement System (CalSTRS) is taking similar steps, the report notes.

“The ability of the industry to survive and remain viable in the future really depends on policymakers and businesses to be able to understand that climate change is real, it is happening,” Leurig said.

The report also dispels notions held by insurers about the industry’s ability to deal with the long-term impacts of climate change.

“Often insurers argue that they issue annual policies, and as a result are protected from climate risks because they view climate change as a trend that will evolve gradually, allowing them time to adapt,” the report states. “This is a problematic argument, for several reasons. First, it is the extreme weather events that matter most to the industry, and while data suggest that their probability is changing due to climate change, the infrequency of these events means that this phenomenon is largely unseen by insurers who only look out one year at a time. Secondly, there may not be freedom of underwriting action, due to regulatory restrictions. Thirdly, social factors that create insurance risk may move faster than the climate itself, so for example climate-related litigation may impose significant costs on insurers indemnifying historic carbon emitters.”

Beside revealing attitudes about climate change, the report highlights how insurers view the impacts of climate change affecting the industry.

Some insurers believe climate change could potentially affect the availability and cost of risk transfer options, reinsurance, catastrophe bonds, and catastrophe swaps, according to the report.

In its response, Progressive Insurance Group says: “Extreme global weather volatility could increase risk financing costs. Risk financing is the process by which a company secures the appropriate funds to cover unexpected financial losses arising from a risk that the company has deliberately retained. Both capacity in the reinsurance market and availability of capital from the catastrophe bond market could, theoretically, become constrained after the occurrence of extreme weather events.”

Reputation was another motivating factor for insurers embracing climate change policies and attitudes, according to the report.

One such company is The Hartford Insurance Group: “We believe that companies that themselves demonstrate a strong, comprehensive and sustained approach to environmental stewardship and offer appropriate products at the appropriate price can build a green insurance brand. Also, in the war for talent, companies that can demonstrate to their employees that they have a serious commitment to environmental stewardship will be better positioned to attract and engage talented employees.”

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