Mills, Evan. Reprinted with permission from Risk Management magazine, May 1998 issue, pages 20-27.

There is little question that global climate conditions have been getting worse. Statistics from Munich Re show that, in comparison with the 1960s, five times as many natural catastrophes such as major hurricanes and tornadoes occur in a "typical" year nowadays, costing the world's economies eight times and the insurance industry 15 times as much as 40 years ago (all corrected for inflation). A record 600 catastrophes occurred in 1996, causing 12,000 deaths and $9 billion in insurance losses. And if climatic trends continue, these numbers could pale in comparison to what we can expect in the not-so-distant future.

Many experts ascribe these trends to global warming, and global warming in turn to a human-induced increase in greenhouse gas emissions. The potential consequences of this warming-whatever its causes-include more potent or frequent windstorms, increased rainfall and ensuing floods, mud slides, hailstorms, subsidence, drought, crop damage and wildfire.

Insurers and the risk management community are likely to experience early and profound effects if these predictions are accurate.

Hot Today, Hotter Tomorrow

It is undisputed that the naturally occurring level of greenhouse gases (especially carbon dioxide) provides a heat-trapping blanket in the atmosphere that makes the earth habitable. It is also agreed that human activities—primarily the burning of fossil fuels and deforestation—have contributed to a dramatic increase in the concentrations of these gases. Pre-industrial era levels have increased by a third and are expected to double within about 50 years if humans don't change their behavior.

This increase is likely to trap more heat than our current climate can tolerate. The National Oceanic and Atmospheric Administration (NOAA) recently announced that 1997 was the warmest year of the twentieth century, as were nine of the past 11 years. They note—with a 90 percent degree of statistical certainty that this is part of a trend linked to human activities.

These temperature increases—however seemingly modest—can lead to startling consequences. The NOAA reports that a three-degree average temperature increase would result in a five-fold rise in the likelihood of killer urban heat waves. Similar studies have shown that a small increase would also result in a sharp rise in catastrophic grassland wildfires.

Using future scenarios of high and low energy demand, the intergovernmental Panel on Climate Change (IPCC) projects that by 2050 average air temperatures will increase by about two degrees to six degrees Fahrenheit, accompanied by sea-level increases of six inches yo 37 inches.

These predictions are estimates, at best; the precise effects and timing of increased global temperatures, and their geographical distribution are not fully known. Complicating matters further, a host of complex feedbacks exist, some of which amplify the greenhouse process, while others dampen it. Again, the net effect of these feedbacks is poorly understood. Another ominous possibility is what the IPCC refers to as "surprises," very rapid and hard-to-predict changes resulting from hair-trigger climate processes. (See Risk Reporter, page 8.)

These kinds of changes are not unusual when viewed on geological timescales. What is of concern, however, is the relatively fast rate of change, which would likely defy the ability of populations and ecosystems to adjust.

The Catastrophe Connection

As noted, average annual catastrophe losses have increased considerably in recent years. (See Exhibit 1.) The 19 natural disaster insurance losses exceeding $1 billion have all taken place since 1983. According to the Reinsurance Association of America (RAA), nearly 50 percent of the insured losses from natural catastrophes during the past 40 years have been incurred since 1990. The most damaging storm in the history of the insurance industry, Hurricane Andrew, led to $20 billion in insured losses, followed by rapidly increasing premiums, insurer insolvency's and the withdrawal of some insurers from the region.

Gerhard Berz, Munich Re's leading climate scientist, says, "It is to be feared that climate change will produce in nearly all regions of the world new extreme values of many insurance relevant parameters that will lead to natural disasters of unprecedented severity and frequency."

Since the full costs from extreme weather events are much higher than the insured losses, the specter or climate change is even more worrisome to risk managers and self-insured companies than to underwriters. Global catastrophe losses are typically 10 percent to 20 percent of the total cost of natural disasters. According to Munich Re, of the $60 billion total cost of natural catastrophes in 1996, only $9 billion was insured. Even in a highly insured country like the United States, total catastrophe losses are typically twice the insured losses. Of added concern, the increasing tendency of natural disasters to fail to meet the standards of insurability means that the future may see higher premiums increased deductibles and even the withdrawal of certain coverages altogether.

While there is a clear trend toward increased losses, the relative contributions of climatic and nonclimatic factors have not been clearly identified. Nonclimatic factors include the continuing movement of populations toward the relatively risky coastal areas; the increasing penetration of insurance coverage; and policy-holders possessing more and more insured goods. Factors working to reduce insured losses include the dramatic rise in self-insurance; advanced risk management technologies; stringent construction standards; and dramatic strides in flood control, firefighting and fire suppression efforts.

It is hard to believe, however, that the net effect of these trends fully explains a 15-fold increase in catastrophe-related insurance losses. More work must be done to isolate and understand the exact effects of climatic changes.

While there are scientists who disagree with forecasts of substantial warming and its attribution to human activity, many insurers take the position that any chance of climate change is an imperative for some level of action. Eugene Lecomte, president emeritus of the Institute for Business and Home Safely (IBHS), states that "the scientific uncertainty surrounding climate change ... does not relieve [insurers] of their responsibility to continue to protect people and their possessions." Franklin Nutter, president of RAA, notes that "people have become a geological force."

Insurers Speak Out

With a report issued in 1990, Munich Re was perhaps the first insurer to publicly show its concern about the climate change issue. They later concluded, "the insurance industry must demand that political decisions are taken on climate protection immediately." In 1994, Swiss Re stated that "human intervention in the natural climatic system could accelerate global climatic change to such an extent that society might no longer be able to adapt quickly enough."

Arkwright Mutual may have been the first U.S. primary insurer to put their views in print. Their research indicated a discernible trend toward greater flooding, and they warned, with respect to flood coverage, that "insurers must carefully evaluate their use of large limits as well as other terms and conditions." They also pointed out that other human activities such as river diversions, deforestation and land use exacerbate the growing risk of flooding.

By the mid-1990s, insurers started to appear at the international climate negotiations. In 1995, an ad hoc group of seven major U.S. insurance industry groups met with Vice President Gore to discuss the issues. In a follow-up letter emphasizing the importance of climate research and disaster preparedness, they wrote: "We share your concerns about our changing climate. . . . We do recognize that the historical paradigm we have used in the past to assess the catastrophe risk we insure must be re-examined.... We commit to explore with you and the business community the synergies between initiatives associated with alternative and sustainable energy." However, despite these initial constructive steps, few individual U.S. or Canadian insurers have made an effort to become fully engaged in the issue.

There is no single explanation for this relative lack of involvement among North American insurers. The business philosophy of European and Asian insurers appears to be more proactive and more attentive to fundamental causes and to asserting their interests-and those of their clients- in the public policy process. North American companies are far more focused on mitigating damages than on working to address the roots of problems. There is also a greater tradition of scientific inquiry among European insurers. Differences in regulation and taxation may also be a factor.

In one of the most prominent expressions of commitment to a precautionary policy dealing with environmental and climate change risks, the Statement of Environmental Commitment by the insurance industry was launched at the United Nations in Geneva in November 1995, calling for signatories to integrate environmental considerations into their underwriting, investment, property management and research activities. By early 1998, the statement had been signed by 71 insurance companies from 26 countries. It remains open to new signatories.

In 1996, the United Nations Environment Programme Insurance Industry Initiative presented a position paper calling for substantial reductions in emissions and stressing that action shouldn't be delayed in the name of attaining full scientific understanding of all mechanisms involved in climate change. This group convened again in late 1997 at the climate negotiations in Kyoto.

Mirroring this movement, interest in doing something about climate change is spreading from environmentalists to the business community. Utilities and car companies are offering more energy-efficient and renewable energy products. Even major oil companies such as British Petroleum, Royal Dutch Shell and Texaco have come forth with new initiatives. BP recently stated that it has "moved beyond denial" on the climate change question.

What Can You Do?

Leading by Example

Natural disaster losses have been increasing at an alarming rate, and it is prudent to consider what practical steps can be taken today. The following are some suggestions:

Educate: Risk managers and insurers alike should educate themselves and their customers on the climate change issue and options to help minimize potential exposures. They may choose to participate in the public policy process with other industry groups.

Articulate a policy: Many firms have published policy statements concerning environmental issues. For example, General Accident's Statement of Environmental Principles asserts: "As a successful commercial business, we consider minimizing resource use, energy use and waste production to be integral to good business practice."

Lead by example: Many companies have initiated efforts to manage energy in their own buildings. Swiss Re (see side-bar), Storebrand and other insurers have adopted environmental criteria for purchasing office products and equipment. The voluntary ENERGY STAR and Rebuild America programs offered by the U.S. Environmental Protection Agency and Department of Energy are open to risk managers seeking technical assistance in this realm.

Mobile disaster preparedness technology and planning: Many of the losses sustained during natural disasters stem from inadequate building codes or poor compliance. The IBHS has advanced a major initiative that includes special training for code officials and working with ISO to implement a community-level code rating system. In another example of fostering disaster preparedness, Arkwright has recently provided weather-warning radios to its large customers. Also, the tendency to locate buildings and populations in high-risk areas muse be addressed.

Support climate monitoring and research: While on the one hand climate research is arguably not the domain of insurers and risk managers, Mr. Nutter has noted that "it is incumbent upon us to assimilate our knowledge of the natural sciences with the actuarial sciences." To this end, 13 insurers formed the Risk Prediction Initiative in Bermuda in 1993. The members collectively fund a $1.3 million annual research program aimed at understanding the risks posed by hurricanes. Some insurers are also hiring staff climatologists.

Make green investments: It helps to invest in environmentally sound ventures. Storebrand, of Norway, has launched the Scudder Environmental Value Fund, a mutual fund that invests in companies passing an environmental screening test that includes nine indicators for pollution, resource use and sound environmental management.

Capitalize on energy-efficiency and renewable energy: Energy consumption is the largest contributor to human-induced greenhouse gas emissions. Fortunately, there is a class of energy-efficient and renewable energy technologies that also helps mitigate insurance risks. For example, efficient refrigeration equipment minimizes the likelihood of food or pharmaceutical spoilage following power outages and solar energy systems can help keep lights on following natural disasters. Risk managers should encourage their insurance providers to assist them: in implementing such technologies. (For more information on technologies that offer both financial and environmental benefits, see "Energy Effciency: Proactive Stratefiies for Risk Managers," in the March 1998 issue of Risk Management).

In a statement following the recent climate negotiations in Kyoto, Stuart Eizenstat, the U.S. Undersecretary of State for Economic, Business and Agricultural Affairs, commented that "some have argued that we can wait to act on the climate issue until all the details of the climate system have been fully understood. Science tells us that this is a recipe for disaster. We will only fully confirm predictions when we [too late] experience them." Rather than waiting for that confirmation, risk managers can join together to try and understand and prepare for what may be a warm, but not so cozy, future.


Evan Mills, Ph.D., leads the Center for Building Science at the U.S. Department of Energy's Lawrence Berkeley National Laboratory in Berkeley, CA.

Support for this work was provided by the Assistant Secretary for Energy Efficiency and Renewable Energy of the U.S. DOE, office of Building Technologies and State and Community Programs, and by the U.S. EPA, Atmospheric and Pollution Prevention Division. This article draws on a report prepared by the author and Ivo Knoepfel, climate change advisor, Swiss Re. For more information, consult Climate Insurance and Intergovernmental Panel on Climate Change.