From the February 2013 issue of Property Casualty 360 — National Underwriter • Subscribe!

Climate Change & Insurance: Existential Threat—or Extraordinary Opportunity?

While the predicted increase in the frequency and severity of catastrophes will pose huge coverage challenges, many see a big business upside as the world responds to extreme weather

By Bryant Rousseau

With additional reporting by Phil Gusman, Chad Hemenway, Melissa Hillebrand, Anya Khalamayzer, Shawn Moynihan, Arthur D. Postal, Mark Ruquet and Laura Toops 

Few—if any—industries would seem to face a greater existential threat from the effects of climate change than insurance. As flood waters rise, as hurricanes and tornadoes grow more intense and as droughts last longer, trillions of dollars of insured assets are at risk. In the ugliest scenario imaginable, even the most solvent, best-managed carriers are overwhelmed by catastrophe claims and driven into bankruptcy. The insurance industry, as we know it, ceases operations.

While voices at the extreme doom-and-gloom end of the spectrum see such a future as a distinct possibility, the consensus view of the impact climate change will have on the industry is far more complex—and significantly less dire. Indeed, many observers actually see enormous opportunities for the industry as the world responds to a warming planet.  

In terms of possible business benefits, climate change is driving the creation of massive new industry sectors—think alternative energy, for one—that need multi-billion-dollar insurance solutions and advice. Those carriers and brokers that establish their mastery of these new risk classes will be positioned to experience significant growth for decades to come.

On a grander scale, the insurance industry is uniquely equipped to help the world prepare for—and recover from—the perils posed by climate change. As governments grapple with one of the most daunting challenges of modern times, the industry can play a critical part in devising cost-effective and practical adaptive strategies that will make society more resilient. 

REALITY OF THE RISK

But first things first. What is the industry’s stance on a question that remains highly contentious in some circles: Is climate change happening?

Of the more than 30 insurance executives interviewed for this report—insurers, agents and brokers, reinsurers, risk managers, association executives and others—there was near-universal agreement that the climate is changing; that severe weather events already are increasing in frequency and severity and that this trend is going to worsen; and that this raw reality requires any organization involved with insurance in any capacity to start taking decisive action now. 

“Push politics aside. To us it is very clear: The risk of climate change is very real, and it has a real potential to be disruptive to our business,” says Chris Lewis, the senior vice president of insurance risk management at The Hartford. 

“We are seeing and feeling the effect of what we know is climate change. We know more intense storms and weather will continue; it’s just a matter of how often they occur,” says Mario Vitale, CEO of Aspen Insurance.

“We’re not sticking our heads in the sand. Clearly there is a change in temperature. We need to mitigate and adapt,” says David Zona, chief underwriting officer at Fireman’s Fund, a unit of Allianz. 

“Climate change is real, and you don’t risk the solvency of your company by saying, ‘I don’t believe it,’” says Maurice “Hank” Greenberg, CEO of the Starr Cos.  

“In our SEC filings, we have stated that we believe climate change is occurring and is contributing to an increased probability of more severe weather events,” says Stephen Weinstein, senior vice president and general counsel at RenaissanceRe. 

“The climate is changing, and it is increasingly more reliable to associate certain kinds of events—such as wildfires and drought—with climate change,” says Lindene Patton, Zurich’s chief climate product officer and co-author of “Climate Change and Insurance,” published by the American Bar Association in November.

“Statistically, it’s clear something is happening. An increase in the frequency and severity of natural catastrophes can be plotted—and they’re getting worse,” says Rod Taylor, managing director of Aon’s Environmental Services group. “We have to rethink damage amounts, rethink risk management, rethink the planning and design of buildings. The assumptions we have made based on the past are no longer valid. We have to plan for a much different future with more frequent droughts and forest fires in areas where they never had them before.”

“We recognize climate change is having an impact on the globe, with weather-related risk as just one of the potentially increasing exposures companies face,” says Dale Lindstrom, director of insurance & risk management at Vestas Wind Systems.

“Given all the attention around climate change, clients, naturally, are asking us when it’s going to happen,” says Cliff Warman, who heads Marsh’s Environmental practice in Europe, the Middle East and Africa. “Given the loss experiences of the last two to three years, our answer is: ‘It’s starting to happen now.’”

PICK YOUR PERIL

If “nearly unanimous” is the right way to characterize the industry’s view that climate change is occurring, then “broad consensus” is the best phrase to describe the industry’s assessment of what this means for the frequency and severity of various types of natural disasters going forward.

Tornadoes, Thunderstorms and Hail

The EF-5 tornado that struck Joplin, Mo. in 2011 and caused upward of $2 billion in damages underscored the destructive power of convective storms. And in the industry’s view, the science is compelling that the world not only will see more of these ultra-violent events—but that this “new normal” is already here.

“We’re looking at a warmer planet, which means more energy for more intense thunderstorms,” says Richard Dixon, the group head of catastrophe research at Hiscox and a scientist with a Ph.D in meteorology from Reading University in the U.K.. 

“The increase in the intensity of thunderstorm-related events—hail and tornadoes—is already happening,” adds Peter HÖppe, head of Munich Re’s Geo Risks Research/Corporate Climate Centre. “The increase of normalized losses over the last 40 years cannot be explained by higher property values and greater exposures alone. Warming oceans means more evaporation, which means more water in the atmosphere—which creates more favorable conditions for causing bigger thunderstorms. This is clearly backed by climate-science research and meteorological data. The chain of evidence is there that we can say we have the first footprint of global warming in more severe convective storms.”

Hurricanes

On the hurricane front, one bit of good news is that the general expectation is for fewer named storms to form, with most climate models predicting higher wind shear and velocity in the upper stratosphere that will make it more difficult for tropical depressions to organize.

But the bad news is: The models call for the storms that do form to be larger and more powerful. “There’s still much we don’t know, but the science is improving all the time—and the possibility that the frequency of Category 4 and 5 hurricanes may increase a lot is a major issue for us as an industry,” says Mark Way, a senior vice president at SwissRe who directs the reinsurer’s sustainability efforts in the Americas.

The science also indicates the direction these larger storms take will shift away from the Gulf of Mexico and toward the mostdensely populated area of the country: the Northeast.

“The science is not definitive yet, but the research suggests increased severity and a change in the path of tropical storms further north,” says Zurich’s Patton.

Drawing a clear line of causation between climate change and Superstorm Sandy—for which insured loss estimates are around $25 billion—is difficult, but the immense size of this storm and its landfall in the Northeast are indicative of the types of hurricanes that may become much more common in the near future. 

Wind, Water & Winter

While Europe is immune to hurricanes, it is subject to catastrophic wind events, and “a recent study suggested increase in losses of 25 percent from European windstorms” in the years ahead, says Hiscox’s Dixon. Conversations about wind losses are often accompanied by conversations around flooding claims, and the picture there is rather grim.

“We know sea levels are rising,” notes SwissRe’s Way. And this sea-level change, adds Dixon, means a “hugely greater area is at risk” from coastal flooding. As just one example among many of the impact of rising oceans, “a study predicted a half-meter change in sea level in the North Atlantic would mean a 70-percent increase in the total property value on Long Island that will be affected by storm surge over and beyond existing 100-year boundaries,” Dixon says.

The increase in flood risk will not be confined to the coasts, either. “We’re looking at the same problem with rivers,” says Aon’s Taylor, who points to two 500-year floods hitting the Midwest in the last four years. 

More intense winter storms are another climate-change-related peril causing a lot of grave concern among many insurance executives. 

Droughts

Extended heat waves and droughts of epic duration are a further widespread worry. “There is clear indication global warming will increase the length and frequency of drought,” says Munich Re’s HÖppe, echoing the comments of Zurich’s Patton and Aon’s Taylor. “What was a 20-year event in our old climate will be a two- to three-year event in the middle of the century.”

The Crop insurance implications of drought are obvious—and made plenty of headlines this year. The U.S. Department of Agriculture announced in January that corn farmers alone have so far received $12.3 billion in insurance payouts due to last year’s severe drought. Total indemnities could top $20 billion—doubling the old record. 

And the coverage implications of drought extend far beyond Crop insurance. Water rationing, for example,  could lead to large Business Interruption and Contingent Business Interruption losses for a whole host of industries that depend on an ample and reliable supply of H2O.  

In developing nations, which will be much less able to mitigate the impact of droughts on food production and pricing, the chances for major civil disturbances will increase precipitously—which means losses arising from Political Risk policies could become an important factor for insurers and insureds with large-scale global operations.                           

HOW TO RESPOND: PRICING IS PRIMAL ISSUE

With such a litany of potential losses staring them in the face, one reasonable response of insurers might be to drastically reduce capacity in regions and risk classes highly susceptible to the negative consequences of climate change.

But this isn’t expected to happen—as long as insurers can respond to the additional risks presented by climate change with that most basic but essential tool at their disposal: rate.

And already today, price increases for Property insurance overall—and Cat-Exposed Property especially—are far outpacing the rate gains being realized in most any other coverage class.  

The issue of capacity “all comes back to risk-adequate pricing,” says HÖppe. Capacity, he adds, will be available in markets where “a fair return” can be achieved by insurers that have exposed their capital.

But the availability of private-sector insurance could become a sizable problem in those jurisdictions that limit insurers’ ability to charge risk-based rates. Indeed, homeowners in certain coastal states are already well aware that their only insurance option is with a state-run insurer of last resort—whose rates are typically far from actuarially sound and whose ability to pay claims may ultimately depend on taxpayer bailouts.

“In Florida, we’ve long struggled with the availability and affordability of home insurance, something our friends to the north [may] soon experience [as a result of] Superstorm Sandy,” says Sue Ray, the director of communications for the Florida Association of Insurance Agents.

“Regulators need to understand that there is a linkage between insurers appropriately managing climate-change risk and the insurers’ ability to make use of appropriate tools, such as pricing and underwriting and contract terms,” notes Robert Detlefsen, vice president of public policy for the National Association of Mutual Insurance Companies.

One of the more fascinating scenarios circling around the pricing question is the “strange bedfellows” situation to which it could quite conceivably give rise: Joining forces to collectively push for greater rate freedom could be free-market conservatives—those against pricing regulation and any sort of government-subsidized insurance program (i.e. the National Flood Insurance Program, or NFIP)—with left-leaning environmentalists who would welcome the strong signal sent by higher rates about land use in particular (i.e., don’t overbuild on the shoreline) and, more broadly, about the true cost to consumers and businesses of not doing more to address climate change. Many skeptics, in other words, might be converted to the carbon-cutting cause if their insurance bill tripled.  

Even for risks written on non-admitted paper, however, where rate restrictions largely do not apply, insurers do face a real and potentially disastrous dilemma. Underwriting decisions have always been based on historical data. If the replied-upon models no longer accurately capture the frequency and ferocity of risk—and there is growing concern on this front as the past becomes an increasingly unreliable predictor of events on a changed planet—then insurers could underprice policies to a survival-threatening degree.

But a basic fact of the insurance business could help insurers avoid this fate: Most policies are renewed annually, and the worst-case predictions for climate change still have it happening incrementally. So insurers may have time to adjust their underwriting to account for a world where old assumptions no longer hold true.

“The best insurance for the insurance industry against the effects of climate change are one-year contracts,” says Rowan Douglas, CEO of global analytics for Willis and chairman of the Willis Research Network. 

HOW TO RESPOND: RISK MANAGEMENT

While rate is perhaps the most powerful weapon insurers can deploy in confronting climate change, the proper approach to loss-prevention—and post-event resiliency—is a crucial ally as well. 

At Zurich, one of Patton’s primary responsibilities is supporting existing products by making sure that the underwriting and engineering criteria for them take into account the implications of climate change.

As an example of her responsibility for helping Zurich and its clients better adapt to a changing world, Patton points to commercial properties in the U.S. West, where wildfires are likely to become an increasing threat. “We’re working tremendously hard through risk engineering to assure that we can continue to underwrite these exposures even as the climate changes,” she says. 

By limiting the amount of on-site fuel accumulation, changing roofing materials, clearing brush around the buildings and even by not using a lot of oil-based plants in the landscaping, “we can manage the liability so we can still put our capacity out there even in high-risk zones.”  

Zurich also has a longstanding history as a provider of Agricultural insurance in the U.S., and with drought as an increasing worry, Zurich is working to develop Yield Guarantee coverage that would incentivize water management. “We’re trying to make sure farmers on the ground [practice sound] resource management to maintain reliable water access.” 

And overwhelming industry consensus exists around one risk-management point: Constructing or retrofitting buildings so that they are better able to withstand natural catastrophes—and locating them outside of obvious hazard zones—is the most practical and cost-effective loss-control strategy of them all. 

As a result, insurers are pushing for jurisdictions to adopt stricter building codes and more sensible land-use policies. And independent of government action, they are promoting stronger buildings, on safer sites, as much as they can with that highly persuasive instrument: price. 

ALTERNATIVE OPPORTUNITIES

While the threat of a world battered by more frequent and severe catastrophes presents challenges of epic proportions to insurers—and humanity—a riskier world also offers up a very real chance for producers and carriers to increase revenue by placing and providing coverage to all the emerging businesses trying to solve the problem. 

Foremost among this class of insureds: alternative-energy providers.

“I’ve seen figures that predict $38 trillion will be spent on the energy sector over the next 25 years. We don’t know yet how that will be split between fossil fuels and alternative energy, but we believe anywhere between 30 to 90 percent of the world’s power supply by mid-century will come from renewable sources,” says SwissRe’s Way. “As these technologies are less mature than those used to produce fossil fuel, it is reasonable to assume the greater risks involved will mean a greater demand to transfer those risks via insurance. From our point of view, this is a market with real growth potential.”

Inquiries around renewable-energy insurance solutions “have certainly gone up by an order of magnitude,” adds Marsh’s Warman. “Five years ago, we had a person-and-a-half in London working on these products. Now we have five people in a number of different geographic hotspots, including Germany where government incentives are driving the solar industry.”

The risks around solar, wind, bio and other alternative fuel sources are not just operational in nature. Opportunities also exist to craft coverage around insuring production shortfalls—if enough wind doesn’t blow or enough sun doesn’t shine, for example.  

“Those types of products are already available for alternative-energy owners and investors and more will have to be developed,” notes Taylor.

And as regulations look to minimize the impact of fossil fuels, insurers and producers also see lots of latent coverage opportunities in carbon-capture and sequestration technologies, where insurance solutions are still in their infancy.  

ENVIRONMENTAL EXPANSION

The effects of climate could also drive insureds to purchase more Environmental cover—or to buy it for the first time. Today, observers note, the vast majority of Environmental cover is secured because either a government body or a lender mandates it. 

But severe flooding and wind storms can lead to both first- and third-party Environmental claims for many businesses that may not think they need protection against pollution-related risks. Big storms, for example, can dislodge tanks of petroleum or cause waste to flow from an insured’s property to another—or vice versa. Insureds “need to make sure they’re considering those kinds of risks when deciding whether or not to purchase pollution coverage,” says Taylor.

Chris Smy, global practice leader of Marsh’s Environmental group, agrees. “We have definitely seen more clients purchasing Pollution insurance the last few years,” he says. Part of what’s driving this trend is the low Environmental premiums currently being charged. But he says another factor, echoing Taylor, is increasing awareness of the Pollution risks that follow severe storms. “[A company] may not be making or storing hazardous materials, but their business can feel the impact from the operation of others. Consider the disruption created if a storm causes sewage overflow onto your property.” 

“Widespread reports of the spread of toxic materials that can follow floods have increased the desire among commercial insureds to purchase Environmental policies, especially those located along waterways downstream from Superfund sites,” says John Glomb, executive vice president and chief underwriting officer at Philadelphia Insurance Cos. 

GREEN ROOFS, RESILIENT REAL ESTATE

During the height of the global economic slowdown, interest in green-building endorsements waned considerably as budget-minded buyers viewed the higher-premium costs as outweighing the benefits. “Two years ago, those discussions were not happening at all,” says Marsh’s Warman. Now, he says, “interest is much greater” in embedding green-building clauses that, should a loss occur, allow for the property to be rebuilt in a more energy-efficient way. 

The positive effect of these policy endorsements is twofold: more premium, of course, but they also help “future-proof” the building stock, Warman points out, as the properties are rebuilt to more demanding—and resilient—standards.  

Fireman’s Fund, with its “Green-Gard” coverage launched in 2006, was the first insurer to offer a product that would cover the extra costs of rebuilding a commercial property to green standards. Buildings already certified green at the time a property policy is written enjoy a 5-percent premium discount because the insurer has found such buildings present fewer risks when it comes to some of the biggest causes of loss, such as issues with electrical fires and plumbing leaks, says Stephen Bushnell, the product director at Fireman’s Fund who developed the coverage.   

TAKE IT TO THE LIMIT

Another area where climate change could translate into more business for producers and carriers: Insureds increasing their coverage limits as worry grows over the frequency and severity of events.

“Clients are clearly concerned about inadequate limits,” says Aon’s Taylor, especially around BI and CBI. Superstorm Sandy has helped make it powerfully, painfully clear just how long it can take to restore normal operations following a catastrophe and how grueling the restoration process can be. The storm has led to clients “recalculating the way they are looking at their maximum potential loss,” says Taylor. 

Higher BI and CBI limits are available from carriers, Taylor says, but adds that insureds “may have to demonstrate in better detail their attention to non-insurance risk management issues, such as having a plan that will enable them to get back to normal operation in days not months.” 

FLOOD OF INQUIRIES

As bad as the current funding problems are at the NFIP—a law passed in January raised its borrowing authority by an extra $10 billion, partly in response to Sandy claims—observers only expect them to be exacerbated by the effects of climate change.  

Climate change could be the push that “gets government actors out of the moral-hazard game that is the NFIP” and state-run insurers of last resort, says a senior executive at a global reinsurer, who agreed to speak freely in exchange for anonymity. “Thanks to the NFIP, we’re subsidizing construction on barrier islands.  And in high-risk places like Florida, officials freely admit that state-insurance programs are actuarially unsound.  We’d be thrown in jail for operating a private company like this.” Just scaling back the NFIP program—such as excluding second homes and investment properties—would represent “an enormous opportunity” for the industry, this executive notes. 

But even barring a single change in the federal program, which caps commercial coverage at $500,000, insurers anticipate more flood business in light of climate change. “It’s not a product that gets a lot of air time right now, but Excess Flood policies will become increasingly in vogue,” says Philadelphia’s Glomb. 

Click to See Standardized Precipitation Map

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