Climate change and mitigation measures by Insurance Industry

Introduction:

The Earth’s average temperature warmed by about 0.76°C over the past 100 years with most of this warming occurring in the past 20 years. This temperature rise may appear small, but small rises in temperature translate into big changes for the world’s climate and the amount of extra energy needed to increase the world’s temperature, even by a little, is vast. This rise in Earth’s average temperature by about 0.76°C means:

 1. More hot days.

2. More severe storms, floods, droughts and fire.

3. Higher sea levels.

 

This small temperature rise could threaten human health, lives, industries and jobs. Global warming threatens agricultural production and the survival of native species and ecosystems too.

 

This small temperature rise also means:

1.More hurricanes and cyclones in the Caribbean, the United States and Burma

2.More extensive droughts in eastern Africa, Australia, southern Europe and parts of China and India

3.More devastating floods like those in Pakistan (in 2010), Brazil and Australia (in 2011), and other parts of the world.

 

The impacts of a warming upon the world are concerning enough and Global warming has emerged as the single greatest threat to the biodiversity. Scientists predict that a 1.5°C global temperature rise may see 25% of the Earth’s animals and Plants disappear while a 3%C rise may see 30% disappear.

 

In 2007, the U.S. Supreme Court recognized that there is a relationship between global warming and severe weather events and always has been a driver of property and casualty claims and the insurance industry has been considering the impact of climate change for years after years.

 

For example, Munich Re had done studies estimating that domestic weather-related losses had increased fourfold since 1980 and extreme weather events led to more than $500 billion losses between 1980 and 2011.

 

Scientists predict that the incidence of hurricanes, super-storms, and mega-tornados will increase due to average temperature rise of the Earth. As a result, flooding incidents will become more frequent as sea levels rise due to climate change. Scientists predict for 50% more lightning strikes based on increases in precipitation and temperature. Additional risks include habitat loss, famine and an increase in diseases such as malaria because of wetter weather conditions spawning mosquitoes.

 

Measures adopted by Insurers towards Climate change

Growing evidences suggest that the worsening effects of climate change are causing droughts and severe weather such as heavy rain, hurricanes, tornadoes and floods.

 

Natural disasters can destroy homes, cars, businesses and crops leading to an increase in the number and severity of insurance claims. As a result, insurers in some parts of the country have stopped offering certain types of insurance coverage and many insurers have limited the types of coverage they offer. This has also led to higher insurance premiums that are often unaffordable for consumers and some consumers buy policies that don’t provide as much coverage as they need, while others go without insurance.

 

Climate change is not just a property and casualty issue which can also affect Consumers’ health. Poor air quality can lead to an increase in the number of people with asthma and lead to an increase in health insurance claims. Climate change is making differences in weather patterns and causing an increase in the intensity and frequency of adverse weather conditions. Weather conditions such as flooding, hail and drought can affect a policy holder’s insurable assets and, therefore, creates risks to both movable and immovable property and issue remains important for the insurers on how to underwrite the additional risks that climate change brings. Climate change leads to an increase in claims which needs to be addressed by the Insurance Industry.

 

Climate change can also impact on the sustainability of the Insurance Industry, apart from its effects on policy holders, Climate change can, therefore, pose a financial threat to the Insurance Industry and understanding and management of climate change and its effect on insurable assets are crucial in ensuring the future sustainability of the insurance industry.

 

Neither, the Long-term Insurance Act No. 52 of 1998, nor the Short-term Insurance Act, No. 53 of 1998, makes any provision for addressing the risks arising out from the effects of climate change. Despite the lack of guidance, there are various measures that insurers can adopt to mitigate or avoid the risks posed by climate change:

 

Risk assessment needs to include climate change as a component in its management of future risk. While assessing risk, weather patterns and their potential effects on an insurable asset must be a component in an underwriter’s estimation of future risks.

Pricing needs to reflect the underlying weather-related risks as a result of climate change. In this way, insurance companies can influence their customers to reduce their exposure to climatic risks through the differentiation in the pricing of insurance premiums. As for example, a policy holder can receive a reduction in their premium if they take steps to protect their insured property against climatic risks such as flooding and hail. By the same methodology, a policy holder may face a higher premium if they choose to develop a project in an area that is prone to climatic risks such as floods and droughts.

Insurers can draft their policies to limit their loss in the face of weather-related risks. The scope for claims can be limited providing various measures aimed at protecting property against weather-related risks.

 

Climate change can create uncertainty in the pricing process but insurers can develop models to assess their possible loss based on statistics of past loss and probabilities for any climate change related risk. It will be necessary also to collect data on climate change related risks as well to develop the resources needed to anticipate and analyse climate risks and their impact.

 

Insurers’ contribution towards Climate change :

(i) Lowering Greenhouse Gases: Like companies in other industries, Insurers, are also promoting strategies to lower greenhouse gas emissions. Some insurers have been warning public policy leaders and the general public about the threat of climate change for years and to enact legislation to reduce greenhouse gases. Some reinsurers are sponsoring research and working with others interested in the same kind of problems and finding ways for individuals and society to adapt to extreme weather, particularly in developing countries.

 

Many insurance companies are committed to reducing their own total greenhouse gas emissions and offsetting the remainder through contributions to reforestation and renewable energy projects. They also encourage their employees to adopt “green” policies in their private lives. Some were involved in projects to reduce greenhouse gases even before such efforts gained widespread public attention, and many are now reinforcing their policyholders’ desire to reduce their carbon footprints by offering them paperless billing and documentation. Some have upgraded the quality of their Websites to encourage policyholders to transact business electronically.

 

(ii) Property Losses: Much remains unknown about the potential impact of climate change on property losses. Most scientists agree that precipitation is becoming more intense and more erratic, leading to hotter and drier environments that raise the risk of wildfires in some regions and damaging rainstorms that increase the risk of flooding in others. According to Karen Clark, president of the Boston-based Karen Clark & Co. hurricane modeling consulting firm, Global warming could lead to a 2-5 percent increase in hurricane peak wind speeds over the next 20 years, which in turn, could result in a 30-40 percent increase in property insurance losses.

 

Property losses may include not only claims for structural damage such as broken windows, a hole in the roof and the resulting water damage to the inside of the structure and contents, but also ,for the extra expense of living elsewhere while the home is being repaired or rebuilt. On the commercial side of the business, in addition to direct property damage, losses may include the policyholder’s loss of income and extra expenses during the rebuilding or relocation process.

 

(iii) Catastrophes and Managing Catastrophes Risks: Catastrophes appear to be growing more destructive and insured losses are also rising. In 2005, the year of hurricanes Katrina, Wilma and Rita, catastrophe losses totaled $64.3 billion. Out of $64.3 billion, Hurricane Katrina caused losses of $41.1 billion, the highest on record, about twice as much as Hurricane Andrew would have cost had it occurred in 2005. If hurricane-related loss grow by as much 40 percent over the next 20 years, a Katrina-like storm could cause $60 billion losses, or significantly more if it struck a densely populated metropolitan area like Miami or New York City.

 

If climate change results in more frequent and damaging windstorms, floods and droughts, developing countries that are poor and vulnerable to extreme weather events will be disproportionately affected. They generally have fewer resources to devote to mitigation in advance of a catastrophe, fewer resources to promote economic recovery after a catastrophe and lower insurance penetration rates-the proportion of individuals and businesses with insurance-than in the developed world.

 

Traditionally, they have relied on emergency donations from wealthier countries and aid from international relief organizations. Now, the need is to adapt with the development of new insurance products such as microinsurance policies, disaster recovery bonds and multination government insurance pools which is leading to new kinds of public/private initiatives to better manage risk.

 

One such proposal is the Munich Climate Insurance Initiative (MCII), which was launched in 2005 by insurers, climate research organizations, the World Bank and agencies associated with the United Nations, among others, in response to the growing realization that insurance related-solutions can play a role in adaptation to climate change. The basic idea behind the project is to create a balance between the emitters of greenhouse gases and the developing countries that are confronted with the consequences of climate change.

 

(iv) Liability Losses: Most businesses purchase commercial liability policies to cover negligence that results in bodily injury, property damage and personal and advertising injury. Companies may also purchase coverage to protect their directors and officers against charges that they failed to properly manage the company’s global warming liability exposures. Professionals who design the products or projects carried out by a company may be sued for the harm caused by these projects.

 

Lawsuits may be filed by shareholders or consumers against a business for actions or inactions that could harm the environment. In addition, shareholder’s lawsuits may target a company for failure to disclose important information that could materially affect its financial health and thus influence shareholder’s investment decisions.

 

The potential increase in property losses may be relatively small in comparison to what could happen on the liability side. Liability suits could be filed based on legal concepts yet untested as well as existing ones tailored to “sustainability” cases. Sustainability is broadly defined by the U.S. Green Building Council as “meeting the needs of the present generation without compromising the ability of future generations to meet their own needs.”

 

Awards could be substantial because, by their very nature, activities that result in harm to the environment and future generations can impact large numbers of people. Even where lawsuits are not successful, and there is no court award against the defendants, insurers can incur substantial legal costs.

 

To minimize the likelihood of lawsuits, insurers analyze their policyholders’ liability risks and provide guidance as to the best approach based on their extensive experience. Among the activities reviewed to reduce the risk of global warming lawsuits, would be the company’s efforts to adapt to global warming to help ensure that they did not cause harm along with their emissions reduction program and their energy conservation projects.

 

Opportunities vs. Risks

(i) There are new risks while insuring new industries such as wind farms and other alternative fuel facilities, and emerging financial risks such as those involved in carbon trading.

(ii) Insurance policies related to carbon trading protect those who invest in clean technology projects and deliver the agreed-upon emission rights.

(iii) A number of companies are also offering their clients carbon project risk management consulting services. A carbon credit permits the holder to emit one ton of carbon. Investors in clean technology projects such as reforestation and renewable energy buy the rights to credits and sell them in the international carbon trading market.

 

Risks: Among the risks associated with purchasing carbon trading rights is that the technology/project designed to reduce carbon emissions will not meet expectations or that the company will become insolvent before it is able to fulfil its contract, leaving the investor without the necessary carbon offsets. The need to curb global warming has spurred the creation of insurance policies that provide incentives to policyholders to contribute to these efforts. These include discounts on (i) auto insurance policies for driving fewer miles and (ii) policies for green building construction.

 

(i) Auto Insurance: Pay-As-You-Drive (PAYD), also known as usage-based insurance, among other things, gives drivers the option of driving less in return for a lower premium. Driving less is expected to reduce pollution. Since motor vehicles are responsible for about 25 percent of all U.S. greenhouse gas emissions, anything that reduces driving reduces the amount of carbon released into the atmosphere. The number of auto insurers offering PAYD options is growing as are the number of states and cities investigating whether and how to promote their development.

 

Drivers that participate in PAYD programs are required to either get their odometer checked at the end of the policy period to verify the number of miles driven or to install a special device that transmits mileage to the insurance company. This device may be linked to the odometer or be a wireless sensor that can monitor mileage. Some insurers offer usage-based programs with sensors that also provide information on driving behaviour such as speeding and sudden braking.

 

(ii) Property Insurance: “Green” Building Insurance Coverage: Homeowners at the leading edge of the environmental sustainability movement are generating their own geothermal, solar or wind power and selling any surplus energy back to the local power grid. Several insurers are supporting this trend by offering a homeowners policy that covers both the income lost when there is a power

 

outage from a covered peril and the extra expense to the homeowner of buying electricity from another source. Policies generally cover the cost of getting back online, such as utility charges for inspection and reconnection.

 

Some insurers offer homeowners insurance policies that, in the event of a fire or other disaster, allow policyholders to rebuild to environmentally responsible “green” standards, even if they had not purchased such a policy originally. Green standards, part of the sustainability movement, include energy conservation benchmarks and the use of renewable construction materials. The Green Building Council introduced its Leadership in Energy and Environmental Design (LEED) certification program in 2001. According to Ceres, a climate change research organization, buildings account for more than one-third of greenhouse gas emissions and green building practices can reduce energy use and emissions by more than 50 percent.

 

With green commercial building construction expected to rise significantly over the next few years, a growing number of insurers are offering green commercial property insurance policies and endorsements, some of which are directed at specific segments of the business community such as manufacturers. The first green commercial policy was introduced in 2006.

 

In general, the policies allow building owners to replace damaged buildings, whether or not they are already certified green, with green alternatives including energy efficient electrical equipment and interior lighting, water conserving plumbing, and nontoxic and low odour paints and carpeting. They may also pay for engineering inspections of heating, ventilation, air conditioning systems, building recertification fees, the replacement of vegetative or plant covered roofs and debris recycling. Some cover the income lost and costs incurred when alternative energy generating equipment is damaged.

 

Conclusion:

Now, there is a consensus among the scientific community that climate is changing, with potential risk to the global economy, ecology, and human health and well-beings. But how much of this is due to natural phenomena and how much to the effects of human activity is a matter of debate. Any increase in damage and litigation is likely to raise insurance company’s losses. What, then, are insurance companies doing to lessen the impact of global warming?

 

As assumers of risk, both in property and liability risk, insurers seek to mitigate potential losses every day through a process known as risk management. Since climate change could lead to losses on a scale never before experienced, insurers are not waiting for researchers to produce all the answers.

 

On the property side, they are redoubling their efforts to raise awareness of climate change and pointing out how potential damage can be limited through more prudent use of land, stronger building codes and better planning. Some large companies have launched innovative projects to help developing countries adapt to climate change or have invested in renewable energy. On the liability side, insurers are helping clients to focus on risk management related to climate change avoiding harm to the environment.

 

Failure to protect against or disclose such harm may lead to lawsuits. Insurance industry groups are studying the effects of climate change on the industry. The Geneva Association, whose members represent the world’s largest insurers and reinsurers, agreed in May 2009 to continue its CC+I research project on climate change and its economic impact on insurance. In a comprehensive report, “The Insurance Industry and Climate Change-Contribution to the Global Debate,” the association sets out the issues and the role insurance can play in the process of adapting to the negative effects of change, particularly in developing countries.

 

References:

1. Climate change and its impact on the insurance industry by John G.Nevius and Robert M.Horkovich
2. The effect of climate change on the Insurance Industry by Byron O’Connor
3. Climate change and Insurance issues
4. Responding to climate change by Dr.Evan Mills, Staff Scientist, Lawrence Berkely National Laboratory