The Warming of the Globe

Global warming has the potential to not only increase the severity of hurricanes, flooding, and wildfires, but also claims for business interruption and heat-related workers' compensation. Here's a look at the risks associated with climate changes.

The scientific community continues to improve its understanding of the scope and magnitude of the risks associated with global warming. At the same time, many companies have begun to explore ways to better analyze climate change impacts on claims and promote adaptation and mitigation measures that reduce climate risks.

Costs from weather events captured most people's attention in 1992 when insurance companies paid out $22.9 billion, the record for total catastrophe losses in a single year. Most of the 1992 losses were from a single event, Hurricane Andrew. More recently, many severe weather events caused a combined total of $18.2 billion in claims in 1998 and 1999.

Future losses may dwarf even the record losses of the 1990s. Data from A.M. Best Co. in Oldwick, N.J., an insurance rating company, indicate that global warming, if linked to extreme weather events, could cause catastrophes that would cost insurers $100 billion, reportedly equal to the total value of the capital and surpluses of the world's top 25 global reinsurers.

If losses increase significantly, insurers and risk managers will be forced to deal with costlier claims, a more demanding public, and more reactionary regulatory bodies. Officials with the Risk and Insurance Management Society in New York stated in March 2000 that "the sharp increase in claims (for losses from natural disasters) shows there is a need for the insurance industry to address and find manageable answers to the problems ranging from local environmental pollution to global climate change."

The Science

Despite many uncertainties of understanding the earth's complex atmospheric system, there is a general scientific consensus that climate change is happening and human activity is likely playing a role. The 10 warmest years since records were kept have all occurred since 1983, with seven of them since 1990. Recent evidence shows the 20th century was the warmest in the last 1,000 years. The 1990s were the warmest decade; 1998 was the warmest year, and 1997 was the second warmest year of the past millennium.

How does global warming happen? A natural phenomenon called the "greenhouse effect" occurs when heat from the sun is trapped near the earth's surface by atmospheric gases. The natural presence of these "greenhouse gases"--carbon dioxide, methane, chlorofluorocarbons, and others--are responsible for keeping the earth warm enough to be habitable. But if abnormally large quantities of greenhouse gases are released, they throw the natural greenhouse effect out of balance, increasing the rate of warming.

Human activities such as burning fossil fuels to power our cars, factories, and utilities are known to release large quantities of carbon dioxide. Atmospheric carbon dioxide levels have increased more than 30 percent since the beginning of the industrial revolution. Most researchers see a link between the increased output and observed warming and climatic changes.

Higher temperatures from the warming lead to a more active hydrological cycle, increasing both evaporation and precipitation. Because a warmer climate makes moisture evaporate more quickly, more damaging and costly droughts could occur in some areas. In other areas, increases in precipitation will likely come in more short-duration extreme deluges. Data from the National Climatic Data Center already shows increases in such extreme precipitation events.

The Intergovernmental Panel on Climate Change--an international scientific organization created by the Washington-based United Nations Environmental Program and the World Meteorological Organization in Geneva--projects that sea level will rise between 0.5 feet and 3 feet over the next century, which would intensify the storm surges that threaten low-lying coastal areas.

The Risks

What does climate change mean for risk management professionals? Climate change can lead to a number of losses, both directly and indirectly. Direct costs are associated with property and casualty claims from hurricanes, flooding, and wildfires or crop failures associated with drought.

Less obvious effects of climate change include increases in the number of heat-related workers' compensation claims. Heat waves and severe weather can cause work stoppages for construction companies and other outdoor occupations, which translates into insurance claims.

At least one insurance company is trying to meet this need. The Chubb Group of Insurance Cos. in Warren, N.J., offers Hurricane Evacuation Coverage, a policy that is designed to limit the income lost by a company due to a mandatory evacuation of its premises during a hurricane.

Severe weather can affect sporting events and outdoor recreation. The winter of 1999-2000 saw the first-ever "snow insurance" from MDM Group Associates Inc. in Steamboat Springs, Cob., which is backed by Lloyd's of London. The insurance was purchased by ski resorts from California to Maine in the face of dwindling numbers of available ski days and therefore fewer skiers.

Increased flooding in some regions potentially means more washed-out highways. Just-in-time inventory systems that depend on trucks to move goods could face manufacturing disruptions for which businesses may file claims. The same applies to rail systems if a train is blocked by flooded tracks or derailed by buckled tracks, due to a prolonged and intense heat wave such as what happened in Texas last year. About 20 percent of the losses from Hurricane Andrew were for business interruption.

Insurers' Role

Insurance companies can play a pivotal role in helping businesses and communities develop proactive policies for minimizing potential losses from severe weather events. Risk managers can prepare for increased variability in extreme weather events and begin to develop planning and capital investment strategies for reducing climate-related risks and lessening the long-term consequences. Insurers can take a number of steps to help reduce the costs from claims and serve as national leaders in reducing risks by supporting voluntary mitigation activities.

The first step that a risk manager can take, as with any other risk, is to learn about climate change. With a better understanding of all sides of the issue, and at least a basic understanding of the science, risk managers and insurers can more aptly recognize potential risks, and learn what can be done to mitigate them.

Frank Nutter, president of the Reinsurance Association of America in Washington, has long been concerned with the risks of climate change. "The financial interest of the insurance industry is so intertwined with weather and climate that it is incumbent upon the industry to understand them better and consider them in their business strategy," he explains.

Insurance companies are in a good position to educate the public about climate change risks. Just as an insurance company might offer a course in bicycle or fire safety to reduce its customers' risks, the company could point out to its customers that there are measures, such as replacing an old furnace or water heater, that reduce energy use and therefore greenhouse gas emissions. Upgrading an old furnace or water heater will cut down on the homeowner's energy bill and may even reduce risks of fire or a water leak that can result in claims costs.

Similar energy efficiency opportunities exist for commercial buildings. Thousands of businesses have seen huge savings on energy bills by participating in federal voluntary programs such as the Washington-based U.S. Environmental Protection Agency's Energy Star Buildings program or the U.S. Department of Energy's Rebuild America program. These programs offer technical assistance to help building managers upgrade the efficiency of their structures.

Insurers also can encourage businesses and private citizens to take steps to help prevent or reduce the damage from storms and sea level rise. Insurers can explore ways to introduce financial incentives (lower premiums or lower deductibles) to customers who take appropriate measures to protect themselves and their property. Some of these measures include installing permanent window shutters on coastal buildings and ensuring that properties adhere to local building codes to better withstand high winds.

Insurers are an important safety net to a stable economic and social system. States and federal agencies like the EPA can serve to build partnerships that promote a healthy insurance sector by reducing risks associated with climate change. The EPA has already initiated partnerships with key industry associations to explore risk reduction opportunities. Much more can be done to open new channels of communication among these groups, including roundtable discussions, and conference panels.

Insurers can help reduce the risks by supporting climate research that advances our understanding of the potential climate change impacts. A great example is the Risk Prediction Initiative (RPI) at the Bermuda Biological Station for Research in St. George's, Bermuda. In addition to researching climate science, the RPI educates insurers and re-insurers on climate change through a Web site (www.bbsr.edu/rpi) and informative publications. Partners in this initiative include the American Re-Insurance Co. in Princeton, N.J., USAA Property and Casualty Insurance in San Antonio, Texas, and State Farm Fire and Casualty Co. in Bloomington, Ill.

Refining computer climate models can help us gauge the risks better. Fred Marcon, the chairman, president, and CEO of Insurance Services Office Inc. in New York, says "the winners in our industry will be those companies that properly use information--and leverage technology--to gain a strategic competitive edge." He adds, "Those that are slow to adapt run the risk of being driven from the field."

John Foster is a program analyst at the U.S. Environmental Protection Agency in Washington.

COPYRIGHT 2000 Axon Group
COPYRIGHT 2001 Gale Group