“How about this weather we're having?” While this statement has saved many stalled in uncomfortable dinner party conversations from a premature end, it has taken on new life in recent years. People can tune into a television station dedicated solely to weather newscasts, brokers trade newly released weather futures on the US Chicago Mercantile Exchange, and farmers can access US government websites for long-range forecast information on El Niño events in the Pacific to help them determine when and how deep to plant seed in the ground. For companies with stakes in the weather, this interest relates directly to the bottom line.
The magnitude of economic losses due to natural weather disasters has increased dramatically over the last 50 years. According to a report published by Munich Re, natural disasters caused 50,000 deaths worldwide and damages of $30 billion in 1998, the second highest figure ever. Compared with the 1960s, three times as many severe natural disasters occurred over the past ten years and cost the global insurance industry 15 times as much as in claims, after adjusting for inflation, as they did in the past.
It's no wonder that the US industry is more concerned than ever about putting a price on the weather. At the Chicago Mercantile Exchange, investors can purchase weather futures for four US cities based on the likely average temperature in each city. Businesses with a stake in the weather, such as utilities and insurance companies, can use these futures to hedge their risk.
The introduction of weather futures grew out of the recognition that risks for some businesses have become less insurable because of high costs and more concern about the scientific community's belief that humans are in part responsible for recent climatic changes. The insurance industry has perhaps the largest stake in this area since people depend on insurance to protect them from hazardous conditions.
In 1995, the Intergovernmental Panel on Climate Change (IPCC), convened by the United Nations Environment Programme and World Meteorological Organization, gathered a number of the world's leading scientists and climatologists to update their previous findings on the science and possible impacts of global climate change. The IPCC concluded that the balance of evidence suggests that there is a discernible human influence on the climate.
Subsequently, at the international climate treaty negotiations in November 1999, Robert T. Watson, chairman of the IPCC, told the audience: “It is undisputed that the last decade has been the warmest this century, indeed the warmest for hundreds of years, and many parts of the world have suffered major heatwaves, floods, droughts, and extreme weather events leading to significant economic losses and loss of life.” Mr Watson cautioned: “While individual events cannot be directly linked to human-induced climate change, the frequency and magnitude of these types of events are expected to increase in a warmer world.”
Human activities, such as the burning of fossil fuels to power our homes, factories and vehicles, produce emissions of carbon dioxide, nitrous oxide and other gases that build up in the atmosphere. These gases are called “greenhouse gases” because they trap heat from solar radiation. The greenhouse effect is a natural and necessary phenomenon that makes the planet habitable. The concern today, however, is that a buildup of greenhouse gases caused by human activities is causing an accelerated greenhouse effect.
Warming temperatures can contribute to sea level rise, degradation of natural habitats, more frequent storm events and extension of the habitat of the organisms that carry infectious diseases such as malaria and dengue fever. Of most direct concern to the insurance industry is the possibility that climate change may lead to an increase in the frequency and severity of weather events.
Global warming and the insurance industry
Although a potential rise in extreme weather events may increase the demand for insurance to protect policyholders against damages from extreme weather, it also could be a threat to the industry's financial viability.
Scientists do not have sufficient data to attribute current changes in weather directly to climate change, but the increase in insurance claims related to extreme weather events is sufficiently conspicuous for the industry to consider the risks of global warming.
In recent years, occurrences of El Niño Southern Oscillation (ENSO), a naturally occurring warm ocean current that can change weather patterns around the world, have become more frequent. From March 1997 to June 1998, El Niño caused total losses of nearly $14 billion and insured losses of approximately $2 billion. Recent studies at the National Center for Atmospheric Research in the US suggest that global warming may accentuate ENSO's impacts by intensifying the strength and duration of the ENSO cycle.
The United Nations Environment Programme (UNEP) officially recognized the link between the environment and the insurance industry when UNEP established an Insurance Industry Initiative in 1995. The initiative is a voluntary program aimed at helping the industry integrate environmental considerations into its internal and external business operations. Since the initiative's inception, it has steadily expanded to 83 member companies (and five associates) in 27 countries.
In 1996, UNEP's Insurance Industry Initiative issued a position paper on climate change that called for an immediate reduction in emissions of greenhouse gases, particularly carbon dioxide. Currently, the initiative's members are discussing a corporate carbon dioxide standard that would enable companies to calculate their contribution to global warming.
An uncertain outlook
The uncertainty of the effects of climate change poses a challenge to the traditional risk management practices of US insurance companies. Although future weather conditions will inevitably have an impact on the financial condition of US insurers, the vast majority of insurance products are based on a retrospective look at data. For example, when insurance companies are evaluating their rates for coverage of residential and commercial buildings, traditionally they look at the historic numbers and then project future values using economic factors, such as the cost of living.
In addition, state regulators of the industry require that US insurance companies submit proposed rates for review and approval. Insurance regulators are wary of considering future factors that many consider to be subjective and conjectural.
Over the past 15 years, however, US insurance companies and insurance regulators have begun to use computer models that consider projected costs based on a presumption of certain kinds of weather activity as well as the affect that weather would have on the existing base of homes and buildings.
When staff scientists with insurance companies have used computer models based on future factors, dissenting scientists have sparked debate in state legislatures. One Florida insurance company was faced with political opposition when it proposed a premium increase that was based on a forward-looking model. The state insurance commissioner criticized the accuracy of the model's predictions and doubted the need to increase rates.
Insurance companies and climate research
One organization of insurance companies is supporting research on climate change. The Research Prediction Initiative (RPI), a nonprofit research and educational program established by the Bermuda Biological Station for Research, was created to facilitate a working relationship between climate scientists and businesses that can benefit from climate-related information.
Additional involvement by insurance companies
According to Frank Nutter, president of the Reinsurance Association of America, the insurance industry's efforts have largely concentrated on adaptation measures that reduce the impact of severe storms on homes or buildings.
For example, companies focus on encouraging people to put shutters on their homes. Insurers also work to upgrade building codes requiring owners to improve the ability of their buildings to withstand intense storms and conduct research on building techniques that would help improve resistance to extreme weather.
In addition to these measures, Mr Nutter believes that companies should promote a scientific understanding of the issue. “I feel that the financial interest of the insurance industry is so intertwined with weather and climate that it is incumbent upon the industry to better understand climate and make it part of its business strategy,” he says, adding that the insurance industry can serve as an effective messenger to the public.
Initiatives by the US Environmental Protection Agency
In recognition of the difficulties that climate change poses to the insurance industry, the US Environmental Protection Agency (EPA) began initiatives to inform insurance executives about the issue and address their concerns. EPA has hosted roundtable discussions of climate change in an effort to provide a forum for members of the insurance industry to ask questions and exchange ideas.
The most recent roundtable, held in March 2000, was co-sponsored by EPA, the Risk and Insurance Management Society, the US Federal Emergency Management Administration, the US Department of Energy's National Renewable Energy Laboratory, and the National Oceanic and Atmospheric Administration's National Climatic Data Center. Guest speakers from insurance companies, universities and US government agencies discussed the latest scientific research, economic and technological strategies for addressing climate change, and international opportunities. The agenda focused on risk management, risk communication and mitigation strategies.
“No-regrets” strategies were also discussed because they have the dual benefit of slowing global warming while reducing or preventing deaths and property loss - beneficial measures under any scenario. John Thornton of the National Renewable Energy Laboratory spoke of the benefits of energy efficiency and renewable energy technologies as no-regrets strategies. When a natural disaster occurs, solar-powered generators can be more reliable - and safer - than gas-powered models, cutting losses due to business interruption and reducing the risks associated with combustible fuel.
EPA continues to work with individual companies to increase awareness of climate change. Looking forward, EPA is working to strengthen existing partnerships with insurance trade associations and use these partnerships to encourage individual insurance companies to consider climate change in their corporate strategies. Collaboration by the industry will help to inform the public about the issue.
The agency encourages industry to lead by example by joining voluntary programs that encourage environmentally conscious practices. For more information, please see the insurance industry page on EPA's global warming web site at http://www.epa.gov/globalwarming/actions/industry/insurance.html. EPA also urges US insurance companies to consider supporting climate monitoring and research. The benefits of this support not only serve the insurance industry, but also help promote better understanding among consumers and government officials.
John Foster is a program analyst in the Office of Atmospheric Programs at the US Environmental Protection Agency in Washington, DC.