Climate Change Heats Up Insurance Industry

Greenhouse gases (GHGs) have gotten a bad rap, according to Mark C. Bove, senior research meteorologist, catastrophic risk management for Munich Reinsurance America. Speaking on a panel about climate change at the Chartered Property Casualty Underwriters Society Golden Gate All Industry Day, Bove said that without GHGs, the planet could be up to 50 degrees cooler, essentially turning it into one big ball of ice.

Yet Bove admitted that there can be too much of a good thing, which is the point the earth is at now. The gases are starting to have an adverse effect on the planet and on those that inhabit it, he indicated. Consequently, global warming affects everyone — including the insurance industry.

According to the CPCU climate change panelists — Bove, Sanford Kingsley and Kevin Haroff, both attorneys at Sonnenschein, Nath & Rosenthal LLP, and Rodney Taylor of Aon Environmental Services Group — property, liability, and directors’ and officers’ coverage policies will be affected by global warming. The industry has been called on to react to this issue. But first the industry must understand climate change’s effects and take a look at what is happening to this planet that billions call home, the panelists advised.

Genesis of Gas

Of the greenhouse gases that are causing climate change, CO₂ (carbon dioxide) appears to be the main culprit. About 10 years ago, CO₂ was named a pollutant. Although CO₂ does not directly affect respiration, unlike other pollutants, Munich Re’s Bove said the atmospheric CO₂ concentration is at a height that has not been seen in at least half a million years.

CO₂ can increase naturally, but the question is what impact have humans had on this increase? Aon’s Taylor asked. “While there is evidence to support the theory that human activity has contributed to the global warming phenomenon, it is uncertain whether it is the primary cause,” he said.

Nevertheless, that hasn’t stopped such arguments from ski resorts blaming automobile manufacturers for the shorter ski seasons, or Katrina victims from blaming utility companies for causing wind damage to their properties. Until there is more conclusive evidence as to the actual degree of human impact on the climate, the issue of who or what to blame for the change is just one of the many challenges facing insurers today, particularly regarding legal insurance ramifications.

Bove said high levels of GHGs are having an effect on the planet, and that could increase insurance claims. “Arid regions are becoming drier [and] wet regions are becoming wetter,” leading to more common occurrences of extreme drought and flood countrywide, he said. With the increased drought, there is an inevitable increase in the occurrence and intensity of wildfires. It also could affect certain industries (i.e. hydroelectric facilities), and lead to business interruption, he added.

Some theories state that windstorms and winter storms will increase in frequency and intensity as a result of the climate change. A few years ago, scientists discovered that human activity may play a role in the warming of the oceans. That is important because hurricanes are fueled by water vapor emitted from warm ocean waters, Bove said.

“Much of the excess retained heat from the increased level of GHGs has gone into heating the world’s oceans,” Bove said. Therefore, global warming leads to warmer oceans, which in turn paves the way for more severe hurricanes, and could result in increased property and liability claims.

Directors’ and Officers’ Responsibilities

Directors’ and officers’ coverages have been the earliest areas of insurance to be affected by climate change, according to Aon’s Taylor. That is because their actions affect their corporations and stakeholders, he explained. As such, education and disclosure are key to protecting directors and officers.

“Directors and officers that fail to educate themselves and take appropriate actions with respect to global warming issues may subject themselves and their corporations to liability from a variety of stakeholders,” Taylor warned. If company leaders are not in line with what their industry is doing, they could, and very likely will, face claims from shareholders that will ultimately cost more than addressing the issues themselves.

“If information provided to the shareholders is inaccurate or incomplete,” Taylor continued, “the officers and directors may be liable for resulting damage (i.e. investors might not have purchased the stock if they knew what the company had done or was doing) … Coverage can also be voided by inaccurate and incomplete disclosure of relevant information, making the reporting of past and current activities even more important to the corporation.”

Property Claims

Although D&O coverage may have been the first area to be affected, it isn’t the only line of insurance that is being disturbed by climate change, the panelists said. They noted climate change issues will span personal and commercial lines. Windstorms, flood, storm surges and forest/brushfires are increasing in strength and regularity, which will affect both homes and commercial operations.

For instance, historically, forest fires have been common in the western United States. However, fires are now spreading to different areas of the country, such as the Southwest. As fires spread, they result in a greater degree of physical loss to both residential and commercial structures.

“Losses have also been impacted by the increased values of properties in high-risk areas, where people continue to build despite of the known risks,” Taylor said.

Flooding is another result of climate change that will affect insurance. As temperatures warm, sea-levels rise, storms have become more frequent and severe, and thus the incidence of flood is expected to increase. The National Flood Insurance Program provides insurance for residential properties. Yet it is questionable whether the NFIP will be able to cover homeowners’ losses if they increase.

Furthermore, the bigger issue for insurance companies lies with commercial property, as excess flood losses continue to be covered by commercial insurers. According to Taylor, property owners have had to incur a larger percentage of losses as both premiums and deductibles have increased.

“The full impact of higher premiums that would be necessary to pay losses has been softened by the state-affiliated insurers that are charging inadequate rates and spreading the costs of storm damage to state residents and insurers of other lines of coverage which have lower or no storm-related exposure,” Taylor said.

Liability Concerns

As climate change inflicts more damage on homeowners and commercial businesses, people will be seeking someone to blame, or someone from whom they can recover their losses. Looking at liability, a number of claims have been filed against CO₂ emitters, but most have been unsuccessful, Taylor indicated.

There is still a great deal of debate surrounding the issue of who or what is to blame for the climate change. Consequently, liability insurers are still considering what, if any, changes need to be made to their policies.

“In some cases, global warming and climate change exclusions have been inserted in liability policies for insureds that are exposed to these claims,” Taylor said. “The insurers are looking primarily at the defense cost of claims, which can run [in the] millions of dollars, even where cases are ultimately dismissed with no indemnity obligations.” Taylor said he expects that trend to continue.

More Climate Change Reactions

Increasing insurance rates and deductibles for high-risk areas are inevitable for those with great exposure to windstorm, flood and fire losses, as a result of climate change, the panelists indicated. With the ongoing research taking place, storm zones have been mapped on a much broader scale, and areas that are considered “high risk” have increased as a result. As more people and businesses are being deemed in high-risk areas, their insurance rates will increase as well.

Aon’s Taylor noted that not all states have approved adequate rate increases. That has led a number of insurers to withdraw from markets, particularly in Florida, Mississippi and Louisiana for windstorm coverage.

“Where this has happened, the states have reacted to provide markets in state-owned insurers such as Citizens Property Insurance Corp. in Florida, which is now the largest insurer of windstorm risks in the state,” Taylor said.

Meanwhile, research continues to be conducted on climate change. With this research, more sophisticated models have been created to predict weather-related phenomena that have helped “fine-tune rating for areas subject to more frequent losses from windstorms, flood and fire,” Taylor added. Yet even with that additional research, it is still difficult to pinpoint whether or not climate change is specifically linked to a claim or a loss.

In addition to the research, a number of products have been developed by insurers to control risk. One such program is the “Green Building Program,” which offers property and casualty rate credits to owners of “high-performing” buildings. As another incentive, drivers can save a little money with the “Pay-As-You-Drive” Program, where lower insurance premiums are offered to drivers that use their cars less. Credits are also being offered to those who drive hybrid vehicles.

States also are addressing climate change. For example, in 2006, California passed AB32, “California Global Warming Solutions Act of 2006. Sonnenschein, Nath and Rosenthal’s Haroff called AB32 the “first enforceable statewide program to put a cap on all GHG emissions from major industries.” The bill includes a mandated reporting system for emissions.

Managing Insurance

The insurance industry itself will be managing its business differently because of climate change, the panelists predicted. “For the property side of the industry, companies have the ability to adjust premiums and deductibles to manage losses. The challenge will be to allow rates to reflect actual losses and avoid being materially impacted by state rules that do not allow the full application of actuarial data to pricing of policies,” Haroff said.

Global warming has not yet had a great impact on casualty insurance — yet. “The question is whether there will be litigation that … involves current and past policies in claims seeking to address the costs of climate change and rectifying past damages,” Taylor said. “If this occurs, the industry could face losses that would make asbestos claims costs pale by comparison.”

To prevent such claims, the industry needs to take responsibility for climate change, the panelists advised.

“Insurance companies and risk managers can be agents for change in providing leadership in the area of insuring risks associated with global warming, and in leading industry and the general public to embrace the principles of sustainable development,” Taylor said.

We are still learning a lot about global warming, and the jury is out as to whether what has already been done can be rectified, he added. Nevertheless, Taylor added at this juncture all the industry can do is attempt to make positive changes that will affect the earth’s present and future state. After all, “If people are causing global warming, then they should be able to stop it,” he concluded.

The “Global Climate Change” panel was one of several sessions at the CPCU Golden Gate Chapter’s All Industry Day held on March 6 at the Grand Hyatt in San Francisco. For more information, visit www.goldengate.cpcusociety.org.