Climate Change Risk Gives Industry An Opportunity to Be Part of the Solution

By Huhnsik Chung | April 21, 2008

Global warming, the consequence of which is referred to as climate change, is the heating of the earth’s surface temperature caused by man-made activity linked to release of greenhouse gases (GHGs). The burning of fossil fuels account for more than 75 percent of GHG emissions.

According to the Intergovernmental Panel on Climate Change Fourth Assessment Report, Climate Change 2007: Synthesis Report, there is now a consensus among the scientific community that global warming has been the cause of the increased prevalence and severity of natural disasters in recent years which have lead to exponentially larger losses in the world’s coastal geographic locations. As the largest industry in the world with $3.4 trillion in yearly premiums and $1 trillion in investment income, the insurance industry is in the center of it all as a risk bearer and investor with direct exposure to climate change.

Climate related losses will likely expose the insurance industry to: (1) property losses resulting from storms, rising sea levels, droughts, fires, heat waves and pollution; (2) commercial general liability losses arising from claims of negligence, personal injury, business interruption, supply chain disruptions and data loss from power surges or outages; (3) products liability claims associated with cause of climate change; (4) environmental claims against emitters of GHGs; (5) professional liability claims for corporate directors and officers for failure to preserve shareholder value; (6) political risk related losses from change in laws related to carbon emissions; (7) personal and commercial auto liability claims; (8) mono-line losses from financial guarantees backing collateralized debt obligations (CDO) tied to real estate and carbon credits being exchanged under various “Cap and Trade” schemes originally developed under the Kyoto Protocol; and (9) personal injury and death claims from natural disasters as well as additional life and health losses.

The insurers are also directly exposed to climate related losses regardless of policies sold. For example, direct and indirect investments in real estate represent a substantial percentage of all assets held by insurers. Insurers also hold direct investments in the form of properties occupied by the company in addition to properties held for production of income or sale.

Insurers also hold reserves funded by investments in assets that are secured by real estate such as mortgage-backed securities and pass-through securities, which are also put at risk because of climate change. For these reasons, insurers and regulators have focused on preserving and strengthening policyholder surplus needed to pay large losses, by reexamining an insurer’s financial stability which is heavily dependent on its investment portfolio.

Insurers are now focused on limiting their overall exposures to climate related losses through various creative and still evolving solutions because traditional responses are simply not enough. The insurance industry strives to understand and quantify the risk that it is assuming through adequate pricing based upon anticipated future potential losses. While the industry continually modifies its natural catastrophe risk models to appropriately price risks, uncertainty lies in the question of whether present climate data and adjusted climate models provide sufficient basis to forecast and price future anticipated losses with reasonable accuracy.

There is tremendous incentive, therefore, to promote, implement and enforce risk management practices or preventive measures that may help reduce future insured losses as a way of maximizing profits. Due to the insurance industry’s vested interest, many of the world’s largest insurers have, to a varying degree, committed to support green efforts that focus on reducing the carbon footprint. Such insurers have shown their commitment through its innovative products, investments, sponsoring and marketing activities. They have committed to supporting lower energy consumption and alternative, lower emission and renewable sources of green energy.

While climate change is a potential catastrophe facing the world, it nonetheless must be assessed and prepared for, which in turn presents the insurance industry with the opportunity to be a part of the solution.

Topics Carriers Claims Profit Loss Market Climate Change

About Huhnsik Chung

Huhnsik Chung is a partner in the Insurance and Reinsurance Department of Edwards Angell Palmer & Dodge in New York, N.Y.

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Insurance Journal West April 21, 2008
April 21, 2008
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