Survey results underscore rising concerns about global warming
- May 1, 2008
by Joan Tupponce
A recent international study identified climate change as the biggest strategic risk facing the property/casualty insurance industry. But the companies protected by that industry find it difficult to focus on the threat posed by a half-degree increase in temperature or a less-than-an-inch rise in sea level every decade.
“It’s virtually impossible,” says Walker Sydnor, president of Scott Insurance, a Lynchburg-based insurance broker. “Executives of publicly traded companies have to react to more short-term things like the subprime mortgage fiasco. Every quarter there seems to be something new.”
Nonetheless, experts in risk management and environmental science say those minuscule changes in the climate could lead to major damage in Virginia because of increased flooding, droughts and weather-related catastrophes, such as hurricanes. “This is a new risk that we need to pay attention to,” says Dr. Etti Baranoff, associate professor of insurance and finance at Virginia Commonwealth University. “Instead of projecting losses, we are projecting the cause of losses.”
Ernst & Young and Oxford Analytica were looking for those causes in a survey on the top 10 risks for the insurance industry. Researchers interviewed 70 industry analysts from around the world plus representatives from other fields, such as law, finance and economics. Respondents ranked climate change as the No. 1 risk. “[C]hanging weather patterns as a consequence of global warming will bring about a fundamental shift in the underlying probability of insured loss.”
In addition to storms, floods and heat waves, climate change over time can lead to broader consequences, the report says. Those include health problems, environmental litigation, political conflicts over resources and possible damage to capital markets.
Effects still unclear
Virginia’s Commission on Climate Change has echoed the concerns raised by the survey. During a March meeting at the University of Virginia, commission members warned that warming temperatures could result in forest fires and cause storms that could damage the Hampton Roads area. The commission also pointed out that some state enterprises, such as the oyster industry, could suffer from climate change.
Global warming will affect Virginia, but just how much remains to be seen, says Jerry Stenger, research coordinator with the climatology office at U.Va.
Higher temperatures, for example, tend to trigger more thunderstorms with heavy rainfall that could cause flash flooding. Warm air also can affect tropical systems because it raises ocean surface temperatures. The frequency of hurricanes has been linked to changes in sea surface temperature. “Since tropical systems derive energy from warm ocean waters, there is likelihood that the North Atlantic Ocean could produce an increased number of these storms,” says Stenger.
Because tropical storms strengthen in warmer waters, there is also the likelihood that these systems “will retain their strength as they progress farther northward more than we have seen in the past.”
Business risks posed by climate change are varied. In addition to property damage brought on by catastrophic events, they include legal and regulatory risks as well as harm to a company’s reputation. “Reputational risks would be incurred by businesses that are not taking into account their environmental responsibility,” says Stephen Myers, the New York-based vice president and environmental risk management practice leader for Rutherfoord, a major insurance broker based in Roanoke. “Negative reputations can be damning.”
Companies such as Rutherfoord and Zurich-based Swiss Re have had climate change on their radar for some time. “We have had people at Swiss Re working on these kind of issues for many years.” says Mark Way, director of Swiss Re’s Sustainable Development-Americas unit at the company’s U.S. headquarters in New York. “We could see the possibility of weather-related losses increasing,”
Way says Swiss Re continues to work to raise awareness about climate change but the focus has shifted to look for solutions by, for example, designing products and services to help mitigate its risks. One of the company’s current insurance products is a weather derivative that allows companies to purchase insurance that protects them in the event of unexpected short term weather fluctuations. For example, an amusement park that had purchased the product could offset a loss of revenue from an increased number of rainy days.
Myers points out two other climate change products: AIG offers carbon credit delivery insurance while Zurich insurance provides energy-efficiency insurance that guarantees the savings promised by companies that institute energy-efficiency plans for other businesses and entities.
To guard against any future weather-related problems, Way believes that “society, has to become more resilient.”
“We don’t want to build, for example, in a known flood zone,” he says. “We have to look at the design of our buildings, building standards and also natural barriers. We need to look at both sides — the risks and how we can reduce the impact of climate change which, in turn, could lead to new business opportunities.”
The growing concern about climate change and related insurance risks seems to be moving from east to west, from Europe and Asia to the United States. Much of the attention to climate change in other parts of the world stems from the Kyoto Protocol, an international agreement negotiated in 1997 in Kyoto, Japan. The agreement, ratified by 175 countries and government organizations, addresses greenhouse gas emissions. “There is general agreement that at least part, if not most, of the increase in temperature is the result of the release of greenhouse gases due to human activity,” says Stenger.
The Kyoto agreement, which took effect in 2005, requires 36 industrialized countries and the European Union to reduce their emissions by an average of 5 percent below 1990 levels over the five-year period 2008-2012.
The United States did not ratify the agreement. “We argued that it would harm our economy and also that other countries such as China and India were exempt from [greenhouse gas reductions],” says James Wetzel, an economics professor at VCU. “One issue that may occur between the U.S. and Western Europe is that they would like for us to become more serious about how we control climate change. There is pressure on the U.S. to alter the price of fossil fuels, to become more in line with [more expensive] world markets.”
Legislation to reduce greenhouse emissions in the U.S. is in the works. America’s Climate Security Act, sponsored by Sens. John Warner of Virginia and Joseph Lieberman of Connecticut, is expected to be debated in June. It aims to reduce total U.S. greenhouse gas emissions 63 percent below their 2005 levels by the year 2050. Companies would have to cap their emissions and then trade emissions rights.
That proposed legislation is drawing criticism. A study jointly commissioned by the National Association of Manufacturers and the American Council for Capital Formation concludes that the bill would have a profound effect on the U.S. economy. The study says, for example, that Virginia would lose 35,000 to 54,000 jobs by 2020 because of lower industrial output caused by higher energy prices.
No matter the outcome of the legislative battle“ what we definitely need to do is to take much more notice of climate risk and build this knowledge into planning on the business, political and private individual levels,” says Way of Swiss Re.
Rutherfoord and Swiss Re are leading by example by taking steps to become carbon neutral. “We’re beginning to see the undeniable effects that climate change has on our industry as well as the world in which we live,” Rutherfoord’s Myers says. “With climate change there is going to be an impact on business whether we like it or not. The question is: What are we going to do about it?”
Top 10 risks for the insurance industry
1. Climate change: “This threat is typically viewed as a long-term issue with broad-reaching implications that will significantly impact the industry.”
2. Demographic shifts in core markets: “As the post-WWII baby booomer market reaches retirement age, its financial needs will change.”
3. Catastrophic events: “Changing weather patterns, terrorist attacks and pandemics…”
4. Emerging markets: “Penetration of the emerging markets represents both a risk and an opportunity for insurers.”
5. Regulatory intervention: “New regulatory developments and increased scrutiny could lead to changes in operations and underwriting practices within organizations.”
6. Channel distribution: “Technology has changed the way insurance services are sold…”
7. Integration of technology with operations and strategy: “A further technology-related risk is the lack of integration at the strategic business level.”
8. Securities markets: “Increasing pressures from securities markets could have serious consequences if not monitored closely.”
9. Legal risk: “Our ninth strategic business risk involves legal uncertainties over liability, tort reform and other similar issues that could threaten a company’s standing or result in financial loss.”
10. Geopolitical or macroeconomic shocks: “While many disagree on their likely cause, there is general concern about the threat of a financial meltdown resulting form derivatives and hedge funds.”