Lloyd’s U.S. Chief on Board with Climate Change

Despite risking offense to non-believers, Hank Watkins didn’t hesitate when he was asked if climate change was upon us.

Watkins, president of Lloyd’s America, talked about an extensive report Lloyd’s of London just released, “Catastrophe Modeling and Climate Change.”

“Everybody that produced this report on our behalf is in agreement that climate change is here,” he said. “I’d say the majority of them also suggested that man has certainly had a hand in that. We’re not suggesting that it’s happened over time, and there’s no cause and effect.”

The stance that the world’s oldest insurance firm is taking may not be too far out in the limb, because Lloyd’s headquarters is in the United Kingdom, a region of the world where the nation and its European neighbors seem have embraced the concept of climate change more so than other industrialized countries.

It’s one in a line of several reports and actions on climate change.

Standard & Poor’s Ratings Services published a report earlier this week examining how climate event risk can “damage profitability, impair asset value, and constrain cash flow.”

“In Standard & Poor’s Ratings Services’ opinion, corporate credit quality may suffer if companies do not implement adequate risk management measures regarding climate events,” the report states.

Earlier this month the White House’s National Climate Assessment report was released as part of President Barack Obama’s effort to prepare the nation for the impacts of a changing climate now and in the future.

That report, which was guided by a 60-member federal advisory committee and was reviewed by experts, federal agencies and the National Academy of Sciences, was attacked by some as a political move timed so that Obama could renew his call for a national energy tax.

Farmers Insurance in April filed nine class actions against nearly 200 communities in the Chicago area arguing that local governments should have known rising global temperatures would lead to heavier rains and did not do enough to fortify their sewers and stormwater drains.

And in late March the Intergovernmental Panel on Climate Change issued its latest report, which states that the effects of climate change are already occurring across all continents and the oceans and that the world isn’t prepared for risks from a changing climate.

The Lloyd’s report calls out observed changes in weather patterns, it paints a serious picture insurers face in the future and it calls on catastrophe modeling to reflect anticipated changes in Earth’s climate.

Many assertions in the report pull no punches:

• “It is virtually certain that since the 1970s there has been an increase in the frequency and intensity of the strongest tropical cyclones in the North Atlantic basin.”
• “The approximately 20 centimetres of sea-level rise at the southern tip of Manhattan Island increased Superstorm Sandy’s surge losses by 30 percent in New York alone.”
• “The Earth’s global climate system is warming. This conclusion is supported by a large body of evidence which is presented in the scientific literature and most comprehensively in the five Assessment Reports published by the Intergovernmental Panel on Climate Change (IPCC).”

The report states that increasing greenhouse gas concentrations in the atmosphere, “largely due to human activity such as combustion of fossil fuels and land use change,” have enhanced Earth’s natural greenhouse effect and has resulted in increased surface warming and additional energy captured in the oceans.

The report reviews findings in climate change science, and examines whether and how catastrophe models account for climate change. The report looks several case studies from modelers like AIR Worldwide, RMS and EQECAT.

It notes that global average air temperatures during the last three decades were the warmest since 1850, and that in the northern hemisphere the past 30 years were likely the warmest period for at least 1,400 years.

Consciousness

For those in the insurance industry, the point of the report is to drive home how important it is to be aware of aggregate exposures, Watkins said.

“It’s really a matter of raising people’s consciousness,” he said. “If we could somehow convince governments and individuals to perhaps build differently next time, or to take resiliency into account when they are thinking of building at all. That’s a win right there.”

The report supports earlier assessments that more regions have a statistically significant increase in the number of heavy precipitation events than a decrease in chances of such events. It’s these types of events that should serve as warning signs for insurers with risks in flood-prone areas, Watkins said.

“They’re suggesting that there are going to be fewer low severity storms, but more frequent high severity storms,” Watkins said. “The way the industry has to prepare for it is to, first of all be well aware of the aggregate exposure that they have in any given part of a country or a region. They’ve got to be prepared to not only provide insurance cover for that, but do it at an appropriate rate, so that there is money available to pay the claims.”

Using as an example Hurricane Andrew in 1992, when 11 insurance companies went bankrupt after more than 600,000 claims were filed, Watkins noted the event led to stricter building codes, as well as steps to ensure adequate insurance capacity.

“That walloped everybody,” Watkins said. “The point is after current natural catastrophes, we don’t see many insurance companies going out of business anymore. The industry has come a long way in determining what its absolute exposure could be, absolute worse exposure could be, in the event of a catastrophe.”

He added, “We have to continue to model that and be prepared for it.”

The best way for the industry to be prepared is to consider the future impacts of climate change when looking at risks, and Watkins feels a harder look at those potential impacts is a must.

“In these days … anybody really with a stake in potential damages of a natural or manmade event subscribe to models, some more than others,” Watkins said. “I’d suggest that even though they’re imperfect, we clearly have to use them. The most important takeaway from our report is that going forward all the modeling agencies have to take into account how climate change is going to impact the severity of future storms.”

Not only are storms expected to increase in volatility, but also an anticipated shift in the European storm track driven by climate change could almost double the number of properties at significant risk of flooding by 2035, the report states.

“In considering the consequences of these changes to insured loss, the overall impact on European exposure from these results implies a 3 to 5 percent decrease in the total number of potentially damaging storms but a 10 to 20 percent increase in the number of larger storms,” the report states, drawing off a paper by EQECAT. “Likewise, the progressive shift of storm tracks to the central latitudes in Europe could increase the severe storm losses seen in major European markets, disproportionately impacting France and Germany.”

Inherent Modeling

One notable point in the report is that much of the modeling, which has only come into prominence in the last 25 years as many of these most recent climate shifts have occurred – in other words, climate change to some degree may be already factored into some models, such as windstorm models.

“EQECAT does not incorporate future climate change scenarios into its standard catastrophe models,” the paper contained within the Lloyd’s report states. “It would be largely premature to do this given the enormous volatility in catastrophic event activity on annual and decadal timescales. However, given the use of historically recorded wind speed data over the last 50 years in constructing EQECAT’s European windstorm model, climate variability during this time could be considered to be implicitly built into the model.”

Shane Latchman, manager of research and client services groups for AIR, was one of the contributors to the report.

In AIR’s section of the Lloyd’s report it forecasts an increase in average annual loss across all the South Pacific Islands of roughly 4 percent using end-of-century projections, and an increase in the 250-year return period loss across all the South Pacific Islands of roughly 8 percent.

“If you look at the report, all the companies included in the report would definitely say any sort of trend will inherently be in the catastrophe model output,” Latchman said.

Latchman noted the difficulty of pinning any decrease or increase in catastrophe chances to climate change.

“It’s something that we definitely are looking into,” Latchman.

One of his colleagues at AIR, Milan Simic, managing director of international operations, suggested that there’s not a way to determine which catastrophes now occurring can be tied to climate change.

As an example Simic highlighted 2010, a year with high sea surface temperatures in the North Atlantic, yet there were no U.S. hurricane landfalls that year.

“There are so many different values, so many different parameters,” he said. “I think there is consensus that climate change is happening … that is the case in all the scientific studies that point to that. But the question is how this relates to specific activity in a specific region. Impact on weather is one thing, but the impact on catastrophes is completely different.”

He added, “In some cases the conclusion cannot be drawn.”

While that built-in evaluation is a step in the right direction, the report states climate change should be quantified in the emerging models.

“Studies have already stressed the need to quantify climate change in catastrophe modelling,” states a paper within the report by JBA Group. “It is anticipated that methods to do this will develop if, as expected, the effects of climate changes become more apparent over the coming decades.”

Despite the inherit addition of the impacts of climate change in modeling some groups are already actively accounting for climate change, such as in the U.K. where climate projections are gradually being incorporated into flood risk models for local flood risk management and investment plans, the report states.

Businesses should at least take a more serious assessment of their climate risks, according to the Standard and Poor’s report.

“The increasing frequency of extreme weather events such as flooding, intense storms, heat waves, and cold snaps is putting pressure on companies to identify, quantify, and disclose the material risks related to such events,” the report states.

According to that report, extreme weather events were responsible for 90 percent of documented natural catastrophe loss events in 2013, causing $124.5 billion of overall losses out of the $135 billion total natural catastrophe losses.

Adaptation

The report is heavy on suggesting better understanding and adaptation to climate change, and as he spoke about the report Watkins was emphatic about resilience.

“What you’ve seen after (Hurricane) Sandy … a lot of these homes now that are being rebuilt by the insurance companies or by the National Flood Insurance Program, whichever coverage they bought, are built on stilts, 6- or 8-feet, or 10-feet high,” Watkins said. “So that when the next one comes, which it will someday, that the water is going to flow under the house and not through it.”

Not all lessons are being learned though, Watkins pointed out.

The lengthy drought over the western region of the U.S. is another perceived result of climate change. Drought has not only resulted in a water crisis, but drought is being blamed on an early and severe fire season that’s just starting to take hold across the region, endangering lives and homes, especially those being built in the wildland urban interface.

“I grew up in Southern California,” Watkins said. “It was a rite of passage every spring and every fall, more so in the fall after a hot summer, to stay inside during recess. The wildfires burning 100 miles away were dropping ashes and dirty air on our schoolyard.”

Yet people didn’t learn their lesson, and many still haven’t seemed to learn, he said.

“Next year you go out to that burned‑out area, and homes are being rebuilt,” Watkins said. “I don’t understand it. People want to live, where they want to live. As long as insurance companies will sell them coverage that lets them rebuild, then they’re going to do it.”

Catastrophe Modelling and Climate Change