Limited Coverage: Climate Change and the Insurance Industry

Forecasts for more unpredictable and more extreme weather patterns have some insurers increasingly factoring climate change evidence into their actuarial tables. 

The insurance industry is famously, intentionally, even proudly, backward-looking: Its assessments of risk traditionally draw from data on prior losses over long periods of time.

In a world of extreme weather and non-linear trends, however, the times, and with them the actuarial tables, are changing in some quarters. International insurance firms and big reinsurers like Swiss Re and Munich Re are incorporating projections for more unpredictable and extreme weather.

In addition, groups such as the U.K.-based Carbon Disclosure Project and ClimateWise are providing global leadership for the industry, encouraging responsible stewardship.

Some U.S.-based companies, such as Prudential Insurance Co. of America, now have formal climate policies for their operations and corporate citizenship, but American insurance corporations on the whole appear relatively slow on the science front. That reality leaves a number of questions looming large for the U.S. property and casualty sector in coming years.

“Very few companies in the U.S. model anything other than hurricanes,” according to Sharlene Leurig, senior manager of the insurance program at Ceres, an environmentally minded investor group.

Her firm, which has taken the lead in prodding the U.S. industry, issued a report in September 2011 on insurers’ climate policies, pointing to their “sluggish and uneven” response. Moreover, only 11 of 88 companies reported “having formal climate risk management policies in place.”

Leurig elaborated in a recent interview: “They’re not modeling tornadoes, thunderstorm activity, hail storms. And we saw just last year those can be multi-billion dollar events, and you can have multiple multi-billion dollar events, in geographies where they might not be pricing accordingly.”

In 2011, there were a record 14 weather-related events costing more than $1 billion each. (Incurred losses last year for the entire industry totaled $345 billion, with total revenue generated through premiums at $434 billion.) In 2010, U.S. insurance payouts resulting from abnormal weather totaled about $40 billion. Overall, natural catastrophes and their associated costs in the U.S. have been rising over the past two decades, according to the Insurance Information Institute.

Stressing the Industry Beyond Its Capacity?

Some in the U.S. industry, though, have clearly begun to grow worried. MIT atmospheric scientist Kerry Emanuel now sits on the boards of two insurers, Bunker Hill and Homesite.

“Both companies have seen rapidly escalating losses in recent years, and in the case of Homesite, which operates across the U.S., most of this is from hail and tornadoes,” he said in an e-mail interview. “They do not know what to make of it, and neither do I, but they are highly concerned about it.”

In the 2011 National Association of Insurance Commissioners (NAIC) survey that Ceres reviewed, some U.S. companies acknowledged striking new realities. PMA Group, for example, said, “We remain concerned that future events, if climate change, due to global warming, is not reduced, will become so extreme that they stress the insurance industry beyond its financial capacities.”

Likewise, ACE USA noted, “Higher losses or higher volatility means higher insurance prices and may impact availability. This balance between policyholder and shareholder will be tested by climate change-driven events, particularly for risks and coverages where it is difficult to ascertain a fair loss cost and risk premium based on historical experience or scientific methods.”

View larger image

An Allstate graphic showing the recent history of its ratio of losses to premiums from non-earthquake, non-hurricane catastrophic weather events — mostly tornadoes and hail. Credit: Kerry Emanuel, MIT.

Leurig said that, in general, many big insurers in the United States, such as Allstate, State Farm, and Travelers, lack substantial in-house scientific expertise: “So that makes them fundamentally different from the reinsurers and the really large global, multinational players in the industry who typically do employ some climatologists and meteorologists, and people who actually construct their own catastrophe models.”

The 2011 Ceres report also notes a potential knowledge-based divide between the larger and more sophisticated companies and smaller ones with fewer resources; it is eventually “possible that asymmetrical information can be used by individual companies to secure a competitive advantage against their peers.”

But on the whole, all of this makes for a strangely ironic situation in the U.S., where the credibility of companies is called into question on their purported core competency: risk assessment and management.

‘Underwriting’ and Media Coverage

Unlike many elements of the climate change issue, the insurance industry story has very concrete aspects to it: it has direct pocketbook implications for citizens and their property and livelihood; and real price signals can, in principle, be sent to the larger economy about a warming world.

In the U.S., the story involves 50 distinct government entities responsible for oversight — the state insurance commissioners’ offices responsible for setting pricing for policy, and for regulating business practices. The climate-insurance nexus is also the focal point where academic modeling might influence real dollars and cents.

The story in the media, however, gets infrequent coverage at best. A general review of news clips and blog posts over the years suggests that updates and overviews come out periodically, such as the excellent recent ones by journalists Marc Gunther and Ben Schiller. In addition, occasional pieces have surfaced in The New York Times or Reuters. Some interesting think pieces have also been done at the Daily Kos “Climate Hawks” blog and by Fast Company. But there has been little consistent investigation of the issue, and daily reporting on insurance industry news is typically confined to the financial press.

However, in trade press publications, such as Best’s Review, Business Insurance and National Underwriter’s magazines, including PropertyCasualty360, there has been regular coverage of climate change-related issues for the past several years. Indeed, these publications are a potential front of story ideas and trends for more general interest environmental reporters and bloggers.

Part of this lack of more mainstream coverage is the plodding nature of the U.S. industry; but the spotty coverage may also relate to the arcane, wonky, and often-confusing nature of the insurance business itself and, it must be said, the economic stresses and other challenges facing many news organizations.

Prices and the Dance of Many Interests

In the end, the ways the industry functions are not easily explicable and not the stuff of today’s daily newspapering — particularly in the United States. The mechanisms for pricing risk and passing it along to consumers involve a number of moving pieces and bets that are less-than-scientific. Setting a premium for, let’s say, the average house on the Gulf Coast, or on the plains of Kansas, involves a negotiation among a number of parties. These include:

  • The insurers themselves who are all competing with one another on pricing, and thus have incentive to keep risk on their balance sheets.
  • Three large modeling firms, AIR, RMS, and EQECAT, that create commercial catastrophe models that are used by the insurance companies.
  • State insurance commissioner’s offices, which tell companies how much rates can be adjusted.
  • The reinsurers with their large catastrophe-linked securities, called catastrophe bonds or “cat bonds,” floating on the global markets, allowing the insurance companies to protect themselves from unmanageable losses.

Further complicating matters, in places like Florida there is even a giant state-run insurance pool, Citizens Property Insurance Company, which has become a political football.

Observers explain that each year a delicate dance goes on among all the players, as reinsurers try to get insurers to see deeper risks — protecting their investments, while also attracting more capital — as the insurers try to keep more risk on their balance sheets and limit their reinsurance payments. Moreover, the large modeling firms, sometimes called “third-party vendors,” must update their models in ways that they not only think are correct, but will have market value and be accepted by both insurers and commissioners’ offices.

The modeling firms, which all along have been fairly conservative in their use of climate change science, have their own delicate balance in this regard. “The area of climate change and changing sea surface temperatures — that’s a part of this model and the science more broadly which continues to change,” said Claire Souch, RMS vice president of model solutions, as the company rolled out its latest product for insurance companies. “Again, it’s an area where we’ll continue bringing in the latest research into that.”

But this is all to say that even the best science must bend to multiple interests and in multiple ways.

MIT’s Emanuel said this dynamic is shaped primarily by state officials. “My conversations with the insurance executives are more qualitative; I generally apprise them of the state of climate science where it bears on extreme events,” he said. “In general, insurance companies tend to be more reactive than proactive; this is not so much their choice as the consequence of regulation: State regulators are not inclined to grant rate increases based on climate projections.”

Climate Costs for Americans?

It may come as a surprise to many, but some Americans may already be beginning to pay for climate change through insurance, as the top-level reinsurance costs filter down to premiums.

In an interview with The Yale Forum, John Seo, who founded a pioneering hedge fund, Fermat Capital Management specializing in this area, explained the chain of influence and costs:

Whether or not a state allows an insurer to acknowledge climate change in their insurance premiums, climate change can still impact insurance premiums indirectly via the cost of reinsurance. Insurers are allowed to integrate the cost of reinsurance in their rate filings. If reinsurers price-in climate change, that is reflected in the premiums they charge insurance companies. Such elevated reinsurance premiums, if they are persistent, are subsequently integrated into insurance premiums. This reinsurance effect does not cover the insurance companies for the entire cost of climate change, but it helps.

In its 2011 NAIC survey response, First American Financial Corporation acknowledged this unfolding reality: “The company purchases reinsurance for catastrophic losses that may be related to climate change. The potential impact of climate change would be assessed by these reinsurers as part of their computing modeling and reflected in their rates, retention requirement and/or their terms and conditions.”

Seo, who was profiled in writer Michael Lewis’s 2007 New York Times Magazine piece “In Nature’s Casino,” said that climate change is indeed affecting U.S. insurance policy. But it’s part of a larger array of factors:

The net effect of all of the above is that reinsurers are basically … moving away from insurers in general as far as climate sensitive risks like U.S. hurricanes are concerned, but particularly in states that prohibit climate change charges in insurers’ rate submissions.

Climate change is not, however, the main driving force underlying reinsurance and insurance availability and pricing in the U.S. hurricane market. The main driver is coastal concentrations of property values, which are soaring into the trillions of dollars. We, as a society, are simply putting more property in harm’s way with each passing decade. Climate change only exacerbates the effects of this trend. Climate change is the straw that breaks the camel’s back in states like Florida.

A recent overview of the issue by Reuters’ Matt Stroud, titled “As Weather Gets Biblical, Insurers Go Missing,” explores a number of angles relating to reduced coverage that can be localized by the media in many states.

Eye of the Political Storm

On the American political front, it is worth knowing the related history, too — and watching carefully where it may all lead in the future.

In March 2010, appointed state insurance commissioners, in what is seen as a politically motivated move, rolled-back an emerging effort to get more of the nation’s large insurance companies to disclose how they incorporate climate change risk, policy and science into their business practices

The incident culminated when the state commissioners voted to reverse their previous decision to participate in a uniform survey, organized by Ceres, with the results to be made public.

“We don’t do stockholder reports. That’s not our job,” South Carolina insurance commissioner Scott Richardson, who led the charge to shut-down the disclosure effort, said at the time. “That ain’t our job, either, to be environmental or not environmental.”

As of now, only the states of Pennsylvania, New York, New Jersey, California, Washington and Oregon participate in a transparent survey.

“The holdup remains politics,” Leurig said. “Let’s just look at the states where there is a very large concentration of carbon-intensive industries, and you have a commissioner appointed by their governor who is responsive to those industries. They were told under absolutely no circumstances are you going to implement that survey.”

Areas of Further Inquiry

For the wider media, the chief questions over U.S. insurance companies and related issues might be usefully organized into some loose categories, which can help frame coverage:

  • Whether insurers are using their massive investment clout in a socially responsible way (the U.S. industry alone has $5.9 trillion in investments, of some $23 trillion worldwide.) Academic research on the industry has identified dozens of ways companies are already doing this around the world.
  • How well insurance companies are being managed, and thus how much investors can feel confident in returns — and their general solvency.
  • How rational state insurance offices that dictate pricing are, and how much they allow climate change-related science to be factored into premiums. The federal government may get involved on this front.
  • How lawsuits relating to climate change — along the lines of the suits the tobacco industry faced — might over time affect certain kinds of companies.
  • In the event of major catastrophic losses for big companies, how much taxpayers could be on the hook for any systemic risk to the economy.
  • Because most flood damage is covered under the tax-funded National Flood Insurance Program, how state-level officials are managing climate risk on behalf of taxpayers.
  • How well consumers are being served, and whether the policies being offered will protect them.

On this last point, Leurig notes that the media might be well-served to keep their eye on the details of new policies that give less coverage to consumers as risk rises in the U.S. But it remains a difficult story to report.

“The more enlightened companies here in the U.S. have very serious concerns that there is more and more loss that is being shoved off to consumers,” she said. “Companies are trying to maintain their market share, and they are trying to retain more risk. And how do you do that? You write in a lot of exclusions and things that are not in your insurance contract. That is very hard to capture. It’s very hard to capture how much loss or risk is being transferred from the insurance sector to just consumers and the economy in general, but it’s a really important question.”

And it’s a question some enterprising business or science reporters might find well worth exploring.

John Wihbey

A regular contributor to The Yale Forum, John Wihbey is an editor and researcher at the John F. Kennedy School of Government at Harvard. (E-mail: johnwihbey@gmail.com, Twitter: @wihbey)
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5 Responses to Limited Coverage: Climate Change and the Insurance Industry

  1. Rudy says:

    everything’s changing!!
    nice post.

  2. Alejandro Grajal says:

    Nice post! It looks like insurance companies are experiencing and inflection point!

  3. James Newberry says:

    Interesting article, thanks.

    Given the recent (Texas) ruling about the atmosphere as a common trust, how about an article on liability indemnification as related to fuels? Of course, the classic one is Nuclear Insurance Indemnification for electric utilities. I wonder what might be found in a similar regard for burning fossil substances. Are we all indemnified?

  4. John Wihbey says:

    By the way, Ceres has issued a new report (Sept. 2012) that may be of further interest:
    http://www.ceres.org/press/press-releases/u.s.-insurance-companies-vulnerable-to-extreme-weather-changing-climate