Can insurers cope with climate change?

In October, 2014, the sustainability advocacy group Ceres reported findings from a climate risk disclosure survey conducted by insurance regulators in California, Connecticut, Minnesota, New York and Washington.

The survey covered 330 insurers operating in the US Property & Casualty (P&C), Life & Annuity, and Health sectors, representing around 87 percent of the nation’s insurance market in terms of premium volume. 193 of those responding were in the P&C sector, which is the sector I focus on in this post. Ceres released a similar report in 2012, involving 184 insurers in total.

In his foreword to the 2014 report, Washington’s Insurance Commissioner, Mike Kreidler, said that much of the insurance industry was still lagging on this issue, although the P&C sector was ahead of the others. He stated:

• “As key regulators of this sector, we strongly encourage insurance industry leaders and investors who own these companies to take this challenge far more seriously. There is no doubt that an early effort to adjust policies, premiums and insurance investments will result in less dramatic impacts later on, thus avoiding and reducing losses that we can already anticipate.”

One of the factors considered in the 2014 survey was the insurers’ approach to enterprise-wide climate risk management, including: (a) examination of the geographic spread of property exposures in relation to expected climate change impacts; (b) consideration of climate risks with regard to liquidity and capital needs, terms and costs of catastrophe reinsurance; and (c) frequency of reassessing climate risk.

Amongst the P&C insurers, 72 percent were rated “minimal” or “beginning”, with 20 percent “developing”, and the remaining 8 percent “leading”.The “leading” insurers were: Allianz; CSAA; First National; Grinnell Mutual; Hartford Fire & Casualty; Munich Re; Nationwide; PEMCO Mutual; Sompo Japan; Swiss Re; Hannover; Tokio Marine; WR Berkley; XL Group; and Zurich US.

Ceres found more positive results in relation to the respondents’ approach toward climate change modelling and analytics. It reported that 26 percent of insurers were in the “leading” category, and 21 percent in the second tier (of four) “developing” group. Ceres stated:

• “There are substantial benefits for insurers that effectively quantify risk exposure through the use of cat modelling. Ceres’ review of the survey results indicates that insurers that fully integrate catastrophe modelling into their risk management programs, through their underwriting and investment functions, are best positioned to both protect their businesses and capitalize on opportunities in a changing climate.”

The increasing use of modelling may contribute to more conservative premium rating and coverage offerings by insurers in future, as they seek to “protect their businesses” in an increasingly objective manner.

Ceres’ reporting framework had changed since its 2012 report, but there seems to have been little overall improvement since then. At that time (from its overall results): (a) almost all of the companies showed significant weakness in their preparedness to address the effects climate change may have on their business; (b) only 13 percent demonstrated a comprehensive climate change strategy; and (c) 48 percent viewed climate change as a potential future loss driver, even though scientific assessments from the UN’s Intergovernmental Panel on Climate Change (IPCC) and others emphasised that climate change was already amplifying extreme events that lead to insured losses.

However, as in 2014, the P&C sector in 2012 was ahead of the others:

• “Property and Casualty (P&C) insurers . . . demonstrate far more advanced understanding of the theoretical risks that climate change poses to their business. P&C insurers also tend to be at a further stage of development in implementing the tools needed to manage climate change risks . . .”

A stark example of a senior insurance industry participant experiencing critical problems with climate change involved Belinda Hutchinson, former chair of Australia’s largest international insurer, QBE. In April 2011, following another summer of extreme events, she said:

• “The catastrophe events that have taken place this year, the floods in Queensland, the fires, have nothing to do with climate change. They are part of Australia’s really long history of floods, fires, droughts.” 

She may have subsequently changed her views on the subject. In December, 2013, The Age newspaper reported (with my underline):

• “QBE shareholders have taken a $4 billion hit this morning after the company announced a major profit downgrade and Belinda Hutchinson signalled her retirement from the insurance behemoth. . . QBE’s US division has been pummelled by problems in its crop, lenders placed property insurance and program businesses. The crop arm has been hit by the worst drought in over 50 years . . .”

Despite climate change’s serious potential impacts on the insurance industry, capacity is abundant for P&C and other business.

The situation has come about largely through pension funds and other institutional investors finding that post-GFC returns from the insurance industry compare favourably with those from other sectors of the economy. Hence, they are directing capital to the industry, adding to capacity and competition.

However, will the insurance mechanism be able to cope with a risk of this magnitude in the future? To the extent that the industry manages to do so, I can only envisage far more conservative premium terms and scope of coverage.

The presentation embedded in my December 2013 blog post “Risk Management, Insurance and the Climate Crisis” (also embedded below) included the following summarised comments from Dr Liam Phelan, currently of the University of Newcastle (Australia) (my underline):

• “Insurance system responses are consistent with earlier international political economy perspective that reflects a linear understanding of the Earth system, whereas a non-linear understanding is required.” 
• “Climate change undermines the basis of the insurance system, i.e. the capacity to pool and spread financial risk on the basis of known probabilities.  
• “Strong and ecologically effective mitigation is the only viable basis for the insurance system to manage its medium and long-term climate risk.” 
• “Anthropogenic climate change is by definition of our own making, and an accelerating catastrophe that will continue to impact humans and our societies. Unmitigated, anthropogenic climate change promises impacts that will be felt comprehensively, if unevenly, across all populations. The system that provides insurance, along with the rest of human activities, is vulnerable.” 
• “. . . climate change can mean insurance for weather risks – including extreme events – shifts from affordable to barely affordable, and eventually the risks become uninsurable . . . insurance for weather risks operates as though past events are a reliable guide to future experience. This remains true as long as the Earth (including its climate) stays in its currently stable state, one that is familiar to humans through the course of human history. Human-caused climate change means shifting the state of Earth, perhaps comparatively suddenly, from its familiar state into an alternative – and perhaps radically different – state.”

A key problem is that insurers and others are relying on projections from the UN’s Intergovernmental Panel on Climate Change (IPCC) that are dangerously conservative, as they ignore critical feedback mechanisms in the climate system that accelerate the impacts.

However, even those projections indicate frightening global average temperature increases from pre-industrial times by 2100, ranging from +1.5°C to +4.9°C. Temperature increases at the poles are multiples of the global average, which is a factor contributing massively to the acceleration in warming and the non-linear nature of the impacts. It is likely that critical tipping points, leading to abrupt changes and potential runaway climate change, will be triggered (and many may have been already) by the time we reach +1.5°C.

Very credible sources are predicting much quicker developments than the IPCC. Here are some recent examples:

• Distinguished Professor of Meteorology at Pennsylvania State University, Michael Mann, recently predicted in a Scientific American article that we will reach +2°C by around 2036.
• A recent paper by Steven J Smith et al. in Nature Climate Change indicated a temperature increase of around +1°C over the coming forty years (and accelerating), in excess of the +0.85°C increase that has already occurred

Importantly, how do such increases translate in terms of extreme events?

A key aspect of higher temperatures is that they increase the amount of water vapour in the atmosphere. According to Dr. Kevin Trenberth, former head of the Climate Analysis Section of the National Center for Atmospheric Research, commenting on the increase over the past thirty years:

• “It’s about a 4% extra amount, it invigorates the storms, it provides plenty of moisture for these storms and it’s unfortunate that the public is not associating these with the fact that this is one manifestation of climate change. And the prospects are that these kinds of things will only get bigger and worse in the future.”

Another example is the fact that the warmer temperatures at the poles are having an enormous impact on the icecaps on Greenland and Antarctica, accelerating sea level rise, as is thermal expansion of the oceans.

Sea level rise is not uniform across the globe. The former Australian Climate Commission (disbanded by the current government) reported that a 50 centimetre (19 inch) rise in sea level would increase the likelihood of major inundation events by a factor of between several hundred and a thousand.That means that an event that had been classed as “1 in 100 years” could be expected to occur almost monthly. Cities like Norfolk, Virginia and Miami, Florida, are extremely vulnerable.

Critically, according to Dr James Hansen, former head of climate science at NASA and regarded by many as the world’s leading climate scientist, at +2°C, most of the world’s coastal cities are likely to be uninhabitable.

To the extent that organisations consider investing or developing supply chains internationally, they need to be aware that the climate change risks vary considerably from one country to another. Global risk analytics firm, Verisk Maplecroft, has identified 32 “extreme risk” countries in its Climate Change Vulnerability Index, which evaluates the sensitivity of populations, the physical exposure of countries, and governmental capacity to adapt to climate change over the next 30 years. Those countries include the growth economies of Cambodia (12), India (13), Myanmar (19), Pakistan (24) and Mozambique (27).

Without emergency mitigation measures, the insurance industry and its clients will almost certainly witness catastrophic impacts of climate change, which may occur much sooner than many had assumed.

Author: Paul Mahony (also on Twitter, Scribd, Slideshare and Viva la Vegan)

References

Ceres, “Insurer Climate Risk Disclosure Survey Report & Scorecard: 2014 Findings & Recommendations”, https://www.ceres.org/resources/reports/insurer-climate-risk-disclosure-survey-report-scorecard-2014-findings-recommendations/view (accessed 18th April, 2015)

Ceres, “Insurer Climate Risk Disclosure Survey 2012”, http://www.ceres.org/resources/reports/naic-report/view (accessed 18th April, 2015)

Phelan, L., Macquarie University, “The relationship between anthropogenic climate change and the insurance system: Imperatives, options and reflections on theory”, 4 Aug 2010 (PhD Thesis);

Phelan, L., “Cuts in emissions are at a premium”, The Age, 25 Jan 2011, http://www.theage.com.au/it-pro/cuts-in-emissions-are-at-a-premium-20110124-1a2ul.html

Hutchens, G., “QBE blames La Nina for disasters”, Sydney Morning Herald, 20/04/11, http://www.smh.com.au/business/qbe-blames-la-nina-for-disasters-20110419-1dng1.html

Liew, R., “QBE takes $4b hit on profit downgrade, chair’s exit“, The Age, 9th December, 2013, http://www.theage.com.au/business/banking-and-finance/qbe-takes-4b-hit-on-profit-downgrade-chairs-exit-20131209-2yzyi.html

Mahony, P., “Risk Management, Insurance and the Climate Crisis“, 2nd December, 2013, Terrastendo.net, https://terrastendo.net/2013/12/02/risk-management-insurance-and-the-climate-crisis/

Mann, M.E. “Earth Will Cross the Climate Danger Threshold by 2036“, Scientific American, 18th March, 2014, http://www.scientificamerican.com/article/earth-will-cross-the-climate-danger-threshold-by-2036/

Smith, S., Edmonds, J., Hartin, C.A., Mundra, A., Calvin, K., “Near-term acceleration in the rate of temperature change”, Nature Climate Change, 9th March, 2015, http://www.nature.com/nclimate/journal/vaop/ncurrent/full/nclimate2552.html

Science2.0, “James Hansen: To mitigate climate change, nuclear energy should be included”, 18th April, 2015, http://www.science20.com/news_articles/james_hansen_to_mitigate_climate_change_nuclear_energy_should_be_included-154923

Verisk Maplecroft, “Climate change and lack of food security multiply risks of conflict and civil unrest in 32 countries – Maplecroft:, https://maplecroft.com/portfolio/new-analysis/2014/10/29/climate-change-and-lack-food-security-multiply-risks-conflict-and-civil-unrest-32-countries-maplecroft/ (accessed 19th April, 2015)

Update 19th April, 2015: Comment on Dr James Hansen relating to a 2°C temperature increase added, and my December, 2013 presentation embedded (refer below).

Image: Lightning, night storm © Petr Mašek | Dreamstime.com

Presentation from 2013:

PDF (Downloadable)