Insurers are facing a rising tide of calls to account for climate change in the industry's business model, but industry officials said there are reasons to be reluctant to do so.
When the National Association of Insurance Commissioners passed its climate risk disclosure survey rules, the initial requirement was that all insurers with at least $500 million in premiums must file, but NAIC made the requirement voluntary in 2011 and left it up to states to require climate risk filings. The five states that passed laws requiring insurers to file have adjusted the initial threshold downward.
Connecticut and Minnesota in recent weeks have made Climate Risk Reporting Surveys mandatory in their states, bringing the number of states requiring this to five. Meanwhile Reinsurance Association of America President Franklin Nutter has called on the industry to integrate climate change into the insurance system.
Nutter, testifying to the Senate Committee on Environment and Public Works, said insurers must be proactive and forward-looking in a changing climate/weather environment. "The industry is at great financial peril if it does not understand global and regional climate impacts, variability and developing scientific assessment of a changing climate," he testified. "Integrating this information into the insurance system is an essential function." Nutter cited data from Munich Re indicating that natural catastrophes occurred at a rate of 400 per year on average in the 1980s, but have increased to 1,000 per year, with North American events increasing five-fold.
But insurance industry groups argue that difficulties abound in integrating climate change into a business that covers specific events that may or may not fall under the climate change umbrella. Insurers write policies that cover one year at a time, while they are being asked to integrate risk for climate change, a long-term event that looks many years forward.
While insurers relate risk to specific weather events, insurers do not know the risk of climate change. "It's hard for an insurer, really hard, to distinguish any risk caused by natural variability in weather patterns to the risk caused by climate change," said Bob Detlefsen, vice president, public policy at the National Association of Mutual Insurance Companies.
Trying to address climate change puts actuaries into a difficult position when writing policies, said David Kodama, senior director of research and policy analysis at the Property Casualty Insurers Association of America. Insurers who start tracking weather-related events have been challenged in trying to use catastrophe models that currently create projections for risk, he said. A climate change model would be an expanded version of those catastrophic models. "We haven't connected a climate model with an insurance model. You can say activity is increasing, but does that translate into an insurance loss?"
Risks are insurable because losses are definite, but climate change is not viewed as a concrete risk, Kodama said. "What is climate change? What loss does it create that's definable? That's a challenge," he said. Detlefsen said the issue of climate change integration raises a question for which there is no concrete answer. "How do you figure out which risks are climate change-related or climate change-influenced and to what degree is that risk influenced by climate change?'" he said.
Andrew Logan, insurance program director at the nonprofit group Ceres, an advocate for sustainable leadership, told Best's News Service that insurers have become more diverse on their thinking about climate change risk management in recent years.
Reinsurers, catastrophe modelers and larger insurers seem to be the most concerned about the issue, he said. The reinsurance industry faces a different type of risk and therefore is more willing to tackle the issue than insurers, who face systemic challenges in managing climate change risk. "It's a risk that hits at the core of the way insurers operate. By and large, they measure and manage risk based on historical data," he said. Climate change is a blind spot in insurers' risk management, Logan said. While insurers are gradually getting a better understanding of climate change risk, it remains difficult for actuaries to apply the concept in their daily work, he said.
The Climate Risk Reporting Survey initially was adopted by the NAIC in 2009 as a mandatory requirement, but later the NAIC allowed reports to be filed voluntarily. In recent years, California, Connecticut, Minnesota, New York and Washington have passed laws requiring insurers to file them. The survey asks about insurer investment practices that pertain to climate change, as well as their participation in the public policy process regarding climate change.
Questions about investment practices are troubling for insurers. Logan said the intent is not to dictate a shift of an insurer's portfolio into certain sectors, but to see how and whether companies are taking climate change into account.
Detlefsen said Ceres and others involved in creating the surveys need to acknowledge the difficulties insurers have in managing catastrophic risk regardless of whether it is related to climate change or is just the natural variability of weather. Some states, he said, have offered legislation that would make it harder for insurers to justify underwriting practices in catastrophe-prone areas based on catastrophe modeling. "They don't seem to understand that insurers are often restricted in their ability to use these models by legislation and regulation," Detlefsen said.
"I'm not suggesting that we can resolve this in a year," Logan said. "This is a longer term process. The survey helps us keep track of where things are at."
Ceres issued a report last March in which it said the 2012 filings by insurers in California, New York and Washington show the insurance industry is ill-prepared to deal with climate change risk, a weakness the authors said represents a risk to the global economy. The report called for insurers to treat climate change as a corporate-wide strategic issue and to formalize it in a policy statement. Also, the report said insurers should evaluate the need for future risk exposure due to climate change and make the findings public.
Detlefsen and Kodama said there are obstacles to managing weather-related events and that lawmakers could address them by considering tighter building codes and create policies that limit economic development and population growth in vulnerable coastal areas.
But Logan said insurers could incentivize product innovation to encourage a climate of innovative green-building insurance programs and provide more mileage-based automobile insurance. "These sorts of products are a real business opportunity for an insurer who's quick to move," he said.
Regulators could help insurers by clarifying what they seek in terms of responses to the climate survey, especially the level of detail and how substantive responses should be, Logan said. "We need a conversation between regulators and insurers on how to manage that process to make sure that rates reflect risk, and consumers are protected along the way," Logan said.
Kodama said PCI is ready for conversations with regulators about climate change. "We're hopeful regulators and insurance companies can have these conversations," he said.
Logan said the move toward regulators and insurers addressing climate change is likely permanent. Insurers could perform better internally as reinsurers are doing and that insurers do not have to believe climate change is certain before improving risk management. "It will require insurers to make a fundamental change in how they approach risk management," he said.
The insurance industry may be lukewarm to recognizing climate change as a risk, but remains focused on responding to disasters, Kodama said. "I see no evidence today that shows we are at jeopardy of being unable to respond effectively," he said.