Climate Change & Insurance – ‘Hope’ Is Not A strategy
The causes of anthropogenic climate change and its physical effects on the planet have been well reported and are truly global in nature. Less has been said about the economic impact that will result as those physical effects become more apparent. Most think the physical and economic effects of climate change are only to be realized in the distant future, if at all. But in fact, trends in the insurance industry reveal that climate change is already making a considerable economic impact to our world today, validating scientific forecasts of physical changes to the planet.
The Insurance industry is a good lens to view the effects of climate change: first, because it is the largest industry on earth and thus, is truly global, and second, because central to the industry’s profitability is recognizing loss trends within the marketplace and adjusting rates, deductibles or coverage accordingly. The art and science of understanding loss trends is known as “attribution”. In typical cases covered by healthcare or auto insurance, attribution of the loss is often crystal clear. For example, if you are overweight, smoke, and live a sedentary life, your physician (or your health insurance underwriter) would have no problem attributing your heart attack to those factors.
In the case of climate change however, attribution of a storm event, a drought, or the proliferation of a new invasive species is less clear. Attribution of individual events to a global phenomenon like climate change is inherently onerous and fraught with opportunities for obfuscation. Put another way, the scale and complexity of climate change is such that it’s current effects like the worldwide disappearance (melting) of glaciers or the Pine Beetle superinfestation decimating Canadian forests is easily obscured by opponents of action, or by current economic woes.
The difficult attribution of singular events to the broad specter of climate change is perhaps the biggest barrier the insurance industry faces in making adjustments. For better or for worse, we live in a world where empirical proof is usually required before we act. Given the stakes presented in the majority of climate model’s “most likely” outcomes, it seems ridiculous to operate in the business as usual mentality. Stop and consider the age old margarine versus butter health debate, by comparison, an inconsequential challenge for science. Yet, we still haven’t been able to determine empirically which is better for you. Given that, how can some filibuster and demand empirical proof on a question as large as the entire earth itself? By the time they get their “proof” it will be too late. The situation calls for us to go with our best interpretation of credible data, and the conclusion is compelling.
In the property and casualty (P&C) industry, loss trends have been tracked for decades, and a look back in time gives some helpful perspective from the business sector. As far back as 1950, global P&C losses reveal a gradual upward trend, corresponding with growing population and insurance density. In the early 1980s, the global loss curve begins to bend upwards at a sharper angle, and each year that passes, the angle gets sharper. Again, much of the increase in losses can be attributed to things such as increased population and insurance density, as well as the extreme development of coastlines and higher standards of living. But the curve is also largely indicative of the increasing frequency of catastrophic (CAT) losses.
The CAT losses which push the curve the most are made up largely of weather events such as devastating floods, storms and hurricanes, all of which are the most likely outcomes predicted in the majority of climate models. In 2008, global P&C losses were the highest in history and US P&C losses totaled $40 billion, exceeding 2007 losses by a factor of three, and 2006 losses by a factor of five. These losses affect the profitability of the world’s largest industry, whose coverage fosters the broad array of activities that drive the global economy. An unhealthy insurance industry will inhibit global economic growth, especially in world where government reserves have been depleted and no other backstop exists when disaster strikes. One key measure of health is known in the industry as the “combined ratio” (losses and expenses combined). In 2009, the US insurance industry’s combined ratio was essentially 1.0, meaning for every dollar they earned it cost them a dollar. Thus, we can expect rates to rise.
The causes of increasing CAT losses raise many questions about the insurance industry’s preparedness for climate change and also about things like the moral hazard of over developing vulnerable coastlines. Smoothing of rates across the P&C sector does not reflect the true cost of living in close proximity to areas that may experience more severe storms and/or rising seas. Furthermore, large companies who emit greenhouse gases or who are vulnerable to the effects of climate change (physically and economically), are increasingly being scrutinized for their contribution or exposure to climate change. Director’s and officer’s liability are already in the crosshairs of several class action lawsuits, targeting public companies for their greenhouse gas emissions or for their lack of preparation for the impacts of climate change.
Similarly, the US insurance industry has hardly begun its nascent efforts at preparing for a new reality and insurance products which respond to climate change are slow in coming. The failure to prepare leaves the US insurance industry vulnerable, and some who study the problem predict mounting losses, the failure of weaker carriers, and a shrinking of the US insurance industry. Contraction in the US insurance industry will spell opportunity for European markets who have been preparing for decades. An old boss of mine used to say: “hope is not a strategy”. However, continuing the wait for empirical proof is just that. It is time for the US insurance industry to make a reasonable attribution of climate change data and prepare, before it pays an even bigger price than it already has.
Ken Wolslegel is senior underwriter for Chartis.
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