Insurers Can Rise To Climate Challenge

The challenges associated with climate change are fast becoming a major industry concern, and it is a topic that is certainly on the minds of many who think about the issues impacting the insurance industry.

According to a global survey of more than 100 insurance equity analysts recently conducted by Accenture, "climate change and environmental issues" was the most widely cited industry challenge among property-casualty insurers--ahead of aging systems and information technology modernization as well as new regulations and reforms.

One major concern is increased hurricane activity caused by warmer-than-average ocean temperatures, partly the result of global warming.

There is statistical evidence that hurricanes from the Atlantic Ocean and Gulf of Mexico have increased in frequency and power since the mid-1990s, creating a dangerous and costly storm era of historical proportions. These changes within our environment will create less predictability in underwriting and increase the financial pressure on insurers.

In a world where change is constant, insurers need to understand this new force and respond strategically.

The key questions facing carriers is how to diversify geographically, develop new climate change-based products, and enhance underwriting and claims functions--all while avoiding adding complexity and costs to their operations.

While climate change will affect many aspects of an insurer's operations (including product design and development, marketing and sales, claims, risk management and regulatory compliance), underwriting will be the most profoundly impacted.

Pricing will need to be strategically evaluated to reflect the impact of climate change at both the portfolio and individual risk level.

o First, insurers should consider how they can protect their surplus in the aggregate against a major catastrophic weather or climate-related event. The magnitude and severity of a climate change event affects wide swaths of geography, dwarfing a fire in a building, so portfolio pricing is critical.

o The pricing strategy needs to be executed on a risk-by-risk basis through the underwriting, quote and renewal process, in order to achieve that aggregate portfolio pricing outcome.

o When reinsurers are confident in a carrier's underwriting on the portfolio level, as well as risk-by-risk, the reinsurer will likely provide more favorable pricing and terms for their catastrophe treaties.

This is why it is important for carriers to have the technological tools and analytical ability to accurately evaluate and price for catastrophic events due to climate change. Expanding to a more sophisticated scenario-based modeling platform is another way to improve pricing relative to climate change.

Hurricane Katrina introduced the need for multiperil modeling and the assumption of different levels of magnitude and severity. But as climate change produces bigger and more severe weather patterns, those event-based models are no longer sufficient to address the increasingly complex array of catastrophe scenarios.

Insurers must begin to model for a serial wave of hurricanes, tornadoes and other weather-related events in a given calendar year--not unlike what the United States experienced in 2008. The Atlantic hurricane season produced a record number of consecutive storms last year, ranking as one of the more active seasons in the 64 years of recorded history, according to the National Oceanic and Atmospheric Administration.

At the same time, insurers should model for climate-related events concurrent with other conditions, such as an economic recession or terrorism. For instance, are carriers considering what the likelihood is in the current economic downturn that homeowners will neglect to repair roofs to minimize windstorm damage, or even fail to buy flood insurance due to affordability?

Insurers must also do a better job of integrating enterprise risk management with underwriting. Historically, management of catastrophic exposures has been a back-office function. Instead, it should be more holistic and integrated into the risk decisions made on the front lines.

That, in turn, requires metrics and traceability to ensure a very defined risk appetite and approach to the portfolio and execution against that appetite every day.

Insurers should also continue taking a leading role in encouraging and contributing to sustainability and low carbon initiatives. Some insurers, for example, are offering lower premiums to owners of hybrid or other low carbon-emission cars.

Insurers can also invest in "pay as you drive" insurance to help encourage reductions in auto emissions by limiting unnecessary driving.

Revised pricing approaches can have a positive effect--such as new debit and credit policies aimed at getting customers to adopt greater energy efficiency, carbon emissions management and other carbon footprint reduction initiatives.

Insurers offer "green coverage" for rebuilding damaged commercial building structures using environmentally friendly practices, and recently extended this "green insurance" to homeowners. Others provide carbon emission credit guarantees. Insurers could also offer services related to risk assessment/audit and recommendations related to sustainability.

The increasing popularity of green behavior offers insurers an opportunity to grow by launching innovative products and services targeting customers eager to use clean energy and live in green houses as well as sustainable energy businesses such as wind power producers.

In addition to the environmental benefits of such actions, insurance promotion of sustainability can become a unique selling point in an increasingly competitive market.

For those carriers that approach sustainability in a strategic manner, the payoff can be improved customer retention, increased revenues from new services and improved branding as a responsible "corporate citizen." Another benefit will be better alignment with governmental global warming policies. Indeed, what may be considered proactive today may become mandatory tomorrow.

An interesting question for insurers to ponder is how climate change will reshape the insurance industry in the future. For now, better exposure management, stronger underwriting and more sophisticated modeling are clearly needed.

Beyond that, there may be regulatory or litigation ramifications from the green movement the industry has not even imagined yet.