Global warming represents watershed event for insurance industry

At various points in history — the Great Dust Bowl of the 1930s, urban riots of the 1960s, and terrorism today — watershed events or trends ushered in structural changes within the U.S. insurance industry. While entirely different in their specifics, each of these had in common an element of acute surprise followed by subsequent realizations that the future would not be like the past. Global warming is the next watershed of this type. The growing destructive power of extreme weather events coupled with increasing insured exposures pose a material challenge to insurers. I believe that the industry is up to it — especially if assisted by its regulators.

It is sobering to note that the average annual insured losses from weather-related catastrophes exceed those of the Sept. 11, 2001, attacks, and yet weather extremes receive only a fraction of the attention. Loss ratios are higher in Nebraska due to hailstorms than those in New York following the attacks of 9/11. The U.S. Department of Homeland Security views as similar the risks of hurricanes and terrorism.

Rising weather-related losses are already having adverse impacts on insurance affordability and availability. The residual markets contain about 3 million customers today, and the National Flood Insurance Program is bankrupt. Left unchecked, even more of the burden will shift to consumers and government, and growth of the industry itself could be slowed.

Among the daunting implications of climate change:

• Market blind spots due to lack of fundamental data on exposures and historic losses and weaknesses in CAT models.
• Declining predictability coupled with a rising incidence of losses correlated across lines.
• A host of liability-related claims and associated defense costs.
• Non-gradual changes in losses due to abrupt climate change.
• A “perfect storm” involving simultaneous hits to the underwriting and asset management sides of the house through the impact of mega-catastrophes on financial markets.
• Reputational risks to insurers perceived as not acting on behalf of their customers.

The ultimate concern is the threat to insurability itself. A shift to publicly funded insurers of last resort may be appropriate in some cases, but only as a very last resort. It is highly preferable to craft market-based solutions rather than allowing markets to fail and plugging the proverbial dike with inferior government solutions.

Climate change has the potential to impact virtually all segments of the property/casualty business — including property, crops and livestock; business interruption, supply-chain disruptions or loss of utility service; equipment breakdown; data loss from power surges or outages; and a host of emergent liability-related exposures.

According to a major new study from the Harvard Medical School (sponsored by Swiss Re), the life/heath lines are not immune to anticipated increases in infectious diseases, heat stress, respiratory and coronary disease triggered by elevated pollens and molds, waterborne diseases, physical injury, toxic effects of materials released and distributed by weather extremes, food poisoning, and post-event mental health effects. The resulting cost of increased asthma-related claims in the United States alone could equate to a large hurricane each year.

Small events have significant impact
The current emphasis on impacts of climate change within the insurance community seems to track that of the popular media, which is myopically focused on large headline-catching events. The problem with the fixation on Atlantic hurricanes (which represent only 5 percent to 10 percent of the world’s total) is that aggregate losses from a litany of relatively small-scale events can have very significant cumulative impacts on insurers as well. It may come as a surprise that the $5.27 billion in U.S. catastrophe losses in the “uneventful” first half of 2006 exceeded by almost a factor of two those from 2005.

Some classes of small events are themselves evolving into catastrophes. Among the “Top 10” potential U.S. catastrophe scenarios from Risk Management Solutions are $5 billion in insured losses from a Western wildfire and almost $4 billion from a Northeast ice storm and blackout.

The risks are real, but so are the opportunities. A small but growing cohort of insurers and reinsurers has made major strides toward solutions such as green-building insurance products. Similarly, insurance regulators can make a contribution toward moving forward, as evidenced by the work of the National Association of Insurance Commissioner’s Climate Change and Global Warming Executive Task Force.

Insurance can support society’s adaptation to the impacts of climate change. Managing risks is central to insurance. While the primary focus in recent years has been on financial risk management (through tightened pricing and terms, alternative risk transfer, etc.), physical risk management is rightfully receiving renewed attention and could play a large role in helping to maintain the insurability of natural hazards and preserving insurers’ reputations.

Dr. Evan Mills is a staff scientist at the U.S. Department of Energy’s Lawrence Berkeley National Laboratory. For the past decade, he has studied the impacts of climate change on the insurance industry, both in the United States and abroad. He has published more than 50 reports and articles on the topic. http://eetd.lbl.gov/insurance.

Topics Catastrophe USA Profit Loss Climate Change Market Risk Management