Report Points to Insurance Industry’s Vulnerability to Climate Change

A report out late last month urges the insurance industry to act to protect itself and the community against the increasing frequency of extreme weather due to climate change.

In short, the report, its authors and those endorsing it want more efforts made to calculate climate change into risk management.

Washington Insurance Commissioner Mike Kreidler was among those who endorsed the report’s recommendations, and Kreidler spoke during a conference call with the press on behalf of the report, urging a change by the industry and his fellow regulators.

The report, “Stormy Future for U.S. Property/Casualty Insurers: The Growing Costs and Risks of Extreme Weather Events,” provides tools for insurance regulators and investors to engage industry and protect consumers, its authors say.

Ceres, the nonprofit that advocates for environmental leadership, authored the report, which builds on this summer’s devastating drought and record high temperatures. It notes that extreme weather events pose a great risk to U.S. property/casualty insurers, which were hard hit by last year’s $32 billion in insured losses.

The analysis is based on a review of U.S. property/casualty insurance industry financial results as reported by A.M. Best Company earlier this year, and it highlights how local governments and taxpayers face growing financial risks as insurers withdraw from high-risk regions.

“As an insurance commissioner, I care deeply about making sure that insurance companies are able to fulfill their promises,” said Kreidler, who’s running for his fourth term in office, which would make him the U.S.’ longest serving commissioner. “Climate change represents some significant challenges for the insurance industry.”

Kreidler noted that “improving the forecasting and modeling by the insurance industry will improve value for the companies.”

He lauded the report for urging the insurance industry to look at improving land use practices and creating stricter building codes because of the changing climate and the threat that it represents to the industry.

Kreidler, a Democrat, equated this push for new standards with the push to require seatbelts and seatbelt usage in automobiles.

“We need to make sure that this is consistent in the American insurance industry,” he said.

One of his concerns was what happens when insurers begin to withdraw from areas considered too high risk, leaving states to create insurers of last resort, a situation that ultimately could lead to undercapitalization and force taxpayers to pay for losses.

“It can have a very dramatic impact,” Kreidler said.

Considerations

California Insurance Commissioner Dave Jones said the Department of Insurance would consider the report’s findings.

“Ceres should be commended for its hard work in this area and a thoughtful report which highlights some of the potential risks climate change and extreme weather events present to the insurance industry,” Jones said in a statement. “We will evaluate this report and consider its findings and recommendations in conjunction with our Climate Risk Survey results. Data of this nature can be very useful in ongoing risk analysis to help insurers and regulators identify areas of concern posed by climate change.”

Like Jones, there are those in the industry who are reviewing the report.

The American Insurance Association was eager to note the industry is well-capitalized and ready to respond to natural catastrophes.

“AIA is currently reviewing the Ceres report and its recommendations,” said AIA spokesman Willem Rijksen. “Whether it’s reducing their own carbon footprints or meeting consumer demand by offering ‘green’ products, insurers have a strong public record on this issue. The insurance sector remains well-capitalized, financially stable and ready to respond to policyholders’ natural catastrophe claims.”

Also endorsing the study was Jack Ehnes, CEO of the California State Teachers’ Retirement System and former Colorado insurance commissioner.

Ehnes, who is on Ceres’ board, noted that he looks to insurance investments for the pension fund for CalSTRS, which is at about $153 billion, and he noted that as an investor CalSTRS analyzes the portfolio of companies it invests in by looking at exposure to climate change.

“The insurance sector has broader importance because of the role it plays in the broader economy,” Ehnes said. “Insurance is the oxygen that keeps our economy alive. Despite the significant risk that climate change represents, the insurance industry’s response is still well short of what we need.”

He urged greater efforts to calculate climate change into risk management, such as impacts from a rise in sea levels, intensified storms, drought and wildfires.

The report shows that there are more frequent extreme weather events, and those, along with increasing populations in coastal areas and other exposed regions, are having profound impacts on the P/C insurance sector.

The value of insured losses due to weather perils has been trending upward over the past 30 years, with 2011 exacting an especially heavy toll, the report states, citing a report released earlier this year by Munich Re, 2011 “Natural Catastrophe Year in Review.”

The estimated $44 billion of insured catastrophe and extreme weather losses in 2011 was second only to 2005, which is when hurricanes Katrina, Rita and Wilma hit the Gulf Coast, the report states. That year was also marked by a record 99 disaster declarations by the government.

“It is notable that while the property/casualty industry remains strongly capitalized, shock events can push more vulnerable companies into the red and even insolvency,” the report states.

2012

While 2012 has been relatively tame compared with 2011 in terms of insured losses, extreme weather losses have still had an impact, including extreme drought conditions that have devastated crops, according to the report.

A string of record heat days was experienced this summer, as well as a severe and intensified drought, which made many states vulnerable to raging wildfires that are expected to cost $25 billion, with most of that being paid by federal crop insurance, according to Mindy Lubber, president of Ceres.

“Losses due to weather perils have been moving upward over a 30-year period,” she said.

And the report paints a bleak picture of the future out to 2030, where global average land and ocean temperatures have increased and extremely hot summers becoming more the norm.

“Within the United States, average temperatures have risen over the past half-century, while extreme weather events, including heat waves, droughts and floods, have become more frequent and intense,” the report states, citing climate data from the National Oceanic and Atmospheric Administration. “More than 25,000 new record highs have been set in 2012 alone across the U.S.”

The report cautions insurers to work to better understand such data and adapt pricing accordingly, as well as promote effective risk management strategies.

“However, recent loss data suggests that many property/casualty insurers may not currently be well equipped to address the uncertainty of increasingly unpredictable and severe extreme weather events,” the report notes. “Connecting the linkages and impacts between rising temperatures and extreme events remains a highly technical exercise fraught with uncertainty. As a result, many insurers now and increasingly in the future will be underwriting business without fully comprehending the probability and severity of the losses they may sustain.”

There are other exposures as well from the current economic doldrums the global market continues to try and work its way through. According to the report those risks include low interest rates and weak capital market performance that have narrowed insurer investment returns, and the overall economic growth is dragging on new premium production.

ROE

The report backs its claims up with a report earlier this year from Insurance Information Institute President Robert Hartwig, who reported that the P/C sector return on equity has substantially lagged behind all Fortune 500 companies every year since 1994.

Those earnings added to other factors, such as the increase in extreme weather, are impacting the affordability and availability of property insurance, the report states.

The report draws on Risk Management Solutions’ recognition that its 100-year database of historical Atlantic hurricane activity is no longer a good predictor of future risk, and RMS’s new catastrophe model’s projections for the next five years that include a 20 percent higher likelihood of a category 3 storm making landfall on the U.S. coast than previously modeled. That report also shows modeled losses increasing by 40 percent on average for the Gulf Coast, Florida and Southeast and model losses increasing by 25 to 30 percent on average for mid-Atlantic and Northeast coastal regions.

“Changes introduced by the new RMS model, combined with last year’s record losses, are already creating cost ripples for commercial insurance buyers,” the report states. “The Willis Group and Marsh & McLennan have both seen property insurance rates for catastrophe-exposed risks increase in the range of 10 to 20 percent during first-quarter 2012.”

Insurer Role

Thus the role for insurers, according to the report, is clear.

“There is evidence from all around the world that society is increasingly vulnerable to the impacts of weather related natural catastrophes,” the report states. “In even the best-case scenarios, this will increase due to climate change. Building resiliency, while reducing future greenhouse gas emissions, are necessary and complementary strategies for dealing with climate change. Insurers have historically been influential in motivating society to reduce risks, whether by advocating for smoke detectors in buildings or safety restraints in vehicles. Insurers have much to offer, and much at stake, in helping governments and private markets to further understand and develop solutions to better predict and prevent losses from extreme weather events. For instance, stronger resiliency to extreme weather is of great importance to the insurance sector as it reduces property risks, and promotes future insurability.”

Among the recommendations in the report for insurers and reinsurers are:

• Evaluate and price risk exposure on new patterns – insurers need to look at their risk exposure and evaluate losses to insured property based on new and emerging weather patterns, not on past experience.
• Research on national and regional forecasting of future weather and cat patterns – there is a particular need to advance the understanding of the likely impacts of warming temperatures on the frequency and severity of thunderstorms, hailstorms and tornadoes, of which little is known.
• Develop cat models that anticipate the probable effects of climate change on extreme weather events — insurers with deep scientific resources should partner directly with climate scientists to develop new modeling capabilities.
• Update insurance pricing and underwriting to reflect changes in extreme weather impacts — insurers need to ensure that rates and loss reserves adequately cover damages from higher frequency and severity of catastrophic events. Insurers will also need to increase their ability to offer preferential pricing to property owners who have increased the resiliency of their structures.
• Inform planning, infrastructure design and building codes in exposed — the potential for damages from extreme weather events is a threat to society, including critical infrastructure. Insurers can lend their expertise directly to planners and work collaboratively with nongovernmental organizations with on-the-ground capacity in critical population centers.
• Promote reduction of carbon emissions — reducing greenhouse gas emissions can limit the severity of climate change impacts. Insurers must also help enable transition to a low-carbon economy by offering new products and services that promote scaling clean and efficient uses of energy.

The report states that heat, drought and wildfires took a heavy toll on the industry in 2011, New Mexico, Texas, Arizona and Minnesota all seeing record-breaking wildfires.

And the first half of 2012 saw more of the same, with record wildfires in Colorado.

Droughts are also wreaking havoc on crops. The report cites a 2012 report by crop risk insurance experts at the University of Illinois that shows publicly owned crop insurers are expected to pay losses of about $18 billion due to droughts that plagued crops.

Bottom Line

This has bitten into the industry’s bottom line. The U.S. property/casualty insurance industry’s reported combined ratio in 2011 was 107.5 percent, of which 10.1 percent was due to cat losses, the report states.

In 2011 the number of P/C insurer impairments rose 33 percent to 28 from the prior year, the report notes. It refers to a 2012 Industry Outlook report from A.M. Best that states the industry’s reserve cushion was approaching exhaustion “primarily as a result of significant reserve releases and the extent to which rate levels have been inadequate as a result of predominating soft-market conditions in recent years.”

The report also draws on reports and assessments made available by insurers themselves.

One from Allianz states:

“With 40 percent of industrial insurance claims that Allianz now pays out being due to natural catastrophes, climate change represents a threat to our business. … Insurance companies need to adapt their products and services to take climate change risks into account. Already, insurance payments relating to climatic events are increasing rapidly, with a 15-fold increase in weather-related claims over the past 30 years.”

That report agrees that as scientific understanding advances it will offer a greater understanding of the relationships between global warming and extreme weather events, but “in the meantime, insurers and reinsurers alike must make capital allocation and business decisions in light of changing extreme event trends.”

The report continues: “The problem is that while scientific assessments are punctuated by years, insurers must constantly assess pricing and exposure controls. And for insurers, inaccurate projections of changing risk may spell the difference between a profitable year and insolvency.”