Climate science: Too hot for comfort

Perhaps it was inevitable that Andrew Voysey would be disappointed in December 2009. The secretary of ClimateWise - the insurance industry initiative designed to address the issue of climate change - admits that its recommendations for the COP 15 climate change conference in Cophenhagen were aggressive.

ClimateWise had asked for a 40% reduction in carbon emissions by developed nations by 2020 from levels recorded in 1990, progressing to an 85% reduction by 2050. The organisation wanted a plan for the flow of money from developed to developing countries to help them mitigate climate change and it wanted mandatory plans for reducing climate risk.

"Not enough was done at Copenhagen at the headline level to reduce the threat of climate change," Voysey laments.

Present danger
The existence of the three-year-old organisation signifies just how concerned the insurance industry is with climate change. The risks associated with it are increasing around the globe and most leaders in the insurance business are long past scepticism. As Voysey points out, the insurance sector has a long and respected history of examining issues dispassionately - and a dispassionate eye understands the importance of assessing risks no matter how contentious they might be.

Trevor Maynard, manager of emerging risks at Lloyds, says: "We are under no doubt that climate change is happening because the IPCC tells us so; it's in large part due to man-made activities."

The InterGovernmental Panel on Climate Change is the UN group that most organisations concerned with climate change look to for answers. Its last assessment report, version four (published in 2007), was pessimistic about the effects of climate change, which it said is an unequivocal fact.

The atmosphere is becoming warmer, according to the report, with a 90% chance or more that human activity is contributing towards it. The inertia associated with climate change means that we are already "dangerously close" to hitting a 2°C increase in average temperature in the next few decades - compared to pre-industrial levels - according to executives from the non-profit Climate Group, which brings businesses together to discuss climate change. The momentum of global warming is like that of the tankers carrying the oil that helps to cause it: once it is moving, it takes a a long time to slow down and change direction.

Quite how much global temperatures will increase beyond the 2°C figure is not yet known, although much will depend on action taken now. As the global average temperature increase moves beyond 3.5°C, the IPCC's models predict the extinction of between 40-70% of global species.

Other predictions include a gradual shift in extra-tropical storm tracks towards the poles, placing large cities at higher latitudes directly in the path of changing wind, rain, and temperature patterns. Those higher latitudes (such as Europe and some parts of North America) will see higher annual river runoffs, while areas such as the western US will continue to experience more severe droughts.

"If we do nothing about climate change and just allow greenhouse gas emissions to grow then models suggest we could see a 5°C or higher rise in climate by the end of the century," says Bob Ward, policy and communications director at the Ransom Research Institute on Climate Change and the Environment at the London School of Economics. "The difference between our current average temperature today and the last ice age is 5°C."

Cyclic effect
Warmer temperatures mean greater moisture and kinetic energy, Ward says, which leads to stronger winds and more rain - something that will dramatically impact insurance companies' risks. Perhaps the most worrying aspect of the IPCC AR4 report is that new studies are already suggesting that it might have been too modest in its predictions.

The report suggested that, in the most pessimistic of its nine tested scenarios, Arctic sea ice might disappear after 2050. Yet a 2009 study of the Arctic ice, sponsored by the Catlin Group, in which researchers traversed the floating ice cap taking samples, arrived at a different conclusion. "The upshot of the Catlin 2009 survey? A team predicted that the Arctic sea ice would disappear in the summer in 20 years' time and that most of it would disappear in a decade," says James Burcke, spokesperson for the Catlin Group.

He continues: "Once you lose the Arctic sea ice, the Arctic ocean and the rest of the oceans will warm precipitously because you are absorbing a lot more sunlight.

"You could see large coastal cities 50-60 years from now having significant problems. Large cities such as New York, London, Shanghai, Mumbai, are at sea level."

Madeleine Cobb, policy manager at the Climate Group, says: "With the data we're seeing now, the IPCC is now being seen as optimistic because there are so many scientists involved that the lowest common denominator comes into it." However, a recent report published by the National Academy of Sciences suggests an even-more dire scenario. The IPCC says that sea levels could rise 1.8mm per year, which is 9cm in 50 years. Cobb continues: "This recent study suggested that global sea levels could rise 75-190 cm."

Unknown variables
Why do such estimates vary? Much has to do with a lack of knowledge about exactly what will happen to the physical environment as a result of climate change. Scientists still do not really understand the extent and characteristics of glacial melt in the Antarctic and Greenland, for example. Pamela Matson, dean of the School of Earth Sciences at Stanford, who helped to compile the report, explains that the US must unify research efforts into climate change.

Gaps in research knowledge have allowed sceptics to contest the IPCC's report, though a review by the Netherlands Environmental Assessment Agency published in early June found "no errors that would undermine the main conclusions".

Climategate
Others recall the University of East Anglia's climategate issue in which hackers unearthed scathing e-mails exchanged between researchers at the university that appeared to discuss ways of misleading critics. A third report on the incident - conducted by former civil servant Muir Russell - confirmed the findings of the first two reports into the incident: while the scientists could have been more open with their data, they were nevertheless honest in their dealings.

With the insurance sector largely accepting the reality of climate change, it is bound to consider the potential financial impact of the phenomenon long term.

For many insurers, property damage will stand out as the major risk and, in certain parts of the world - including the UK - these companies are right to identify it as such. According to the Association of British Insurers, average annual insured flood losses in the UK could rise by 14% to £633m should the global temperature rise by an average of 4°C. Furthermore, if the storm track in the UK shifts 1.45° south, average annual insured wind losses in the UK could rise 25% to £827m, it predicts.

Emily Farnworth, senior adviser for the finance sector at the Climate Group, comments: "We haven't built our sewer systems to drain the rainfall that we're seeing and flooding from these systems is causing as much of a problem as flooding from the riverbank."

Hurricanes on the other side of the Atlantic are also an increasingly important risk factor. A report from the Chartered Insurance Institute (Coping With Climate Change) shows that losses from extreme weather activity have accelerated in the last 30 years. "Factors can hide slow trends but then stars can align," warns Maynard, who points out that this year is set to be a particularly active one for hurricanes.

Further risks
Other potential damage includes increased wildfire risk in areas such as north America from average temperature rises of below 2°C; with an increase of 3°C, the globe could lose around 30% of its coastal wetlands. Millions will experience coastal flooding each year even if the temperature rises by only 2°C, the IPCC AR4 document predicts.

The broader economic impact of such property damage will be exacerbated by the small and medium-sized enterprises being unprepared to cope with the problem: the CCI report found that SMEs are particularly unready to cope with the chronic effects of climate change.

The developing world will be particularly badly hit. A report from the Economics of Climate Adaptation Working Group, Shaping Climate Resilient Development, found that locations it studied would lose up to 12% of their gross domestic product as a result of existing climate patterns. The economic loss for lower-income populations in the developing world, such as small-scale farmers in India and Mali, would be particularly severe.

Farnworth remarks: "On the issue of drought, not only is it about property risk, it is about agricultural risk also. There needs to be an understanding of risk issues in the agricultural sector as well."

The IPCC report says that high temperatures and drought will worsen in southern Europe, which is already vulnerable to climate change. Water availability, hydropower potential, summer tourism and crop productivity could all be affected, the fourth assessment review says.

"Scientific evidence is quite strong on the health impact," warns David Gardiner, president at David Gardiner & Associates, a consulting firm that helps companies cope with the threats presented by climate change. "All insurance in life and health needs to be looked at."

The IPCC report agrees: health impacts start with very low temperature increases, it says. Everything from a change in insect-borne diseases to the health effects associated with air quality and an increase in heat-related deaths are all risk factors for insurance companies. Notably, spokespeople for Prudential refused to acknowledge any such risks, calling it "a bit of a stretch".

Maynard highlights: "We must also consider issues such as terrorism, political risk and contract frustration." He explains that Lloyd's has written reports on climate change as it pertains to energy and water-related risks. The IPCC document predicts that hundreds of millions of people will be exposed to "extreme water stress" over the next few decades.

Changing world
The geopolitical implications of this will affect not only travel as people find it riskier to venture abroad, but also energy as organisations moving into increasingly hostile environments to source fuels find themselves contending with exacerbated risks from climate-driven unrest.

There are other, perhaps less obvious risks associated with climate change. Maynard says: "There are a number of lawsuits going on in the US in which people are attempting to take action against a variety of parties over carbon emissions."

Organisations might feel that a large-scale polluter indirectly contributed to the loss of their business by helping the climate to warm up; a ski resort in Colorado facing losing the mountain snow pack, for example, might hold a coal-burning utility responsible. Maynard point out that insurance companies would argue that pollution exclusions don't cover these types of claim but, in the past, unexpected judgments in these types of cases have caused sudden re-evaluations.

Significantly, only half of the insurance and reinsurance companies evaluated by the Climate Group were considered to have mature programmes to handle climate change; one-third were still testing approaches while 17% were in the process of implementing programmes.

The principles for insurers outlined by ClimateWise are similar to those identified by other organisations such as the Climate Group, which identifies the need to develop knowledge to better assess risks.

Both Munich Re and Swiss Re have been leaders in this area, according to the Climate Group. Munich Re has established the Globe of Natural Hazards, a tool designed to help identify areas in which natural disasters are more likely to occur; it is also working with the London School of Economics' Centre for Climate Change Economics and Policy. In June, Munich Re and the LSE undertook their first joint symposium, entitled "Interpreting Models in a Climate Change context", which explored modelling techniques for climate change.

Fresh approach
The need to evaluate climate change models more effectively is key in the battle to manage risk. The industry is used to short-term thinking and relying on empirical evidence to inform future risk management decisions.

Ward says that now is the time for a reassessment of this approach. He highlights: "The thing about climate change is that you cannot predict the types of losses that you can expect simply by extrapolating data from the past; it will be very difficult to quantify the risk."

This does not necessarily mean rethinking contracts to form longer-term legal agreements; it could mean a smarter approach to business relationships. In the CCI's report, Dr Andrew Dlugolecki not only advises insurers to calculate flood exposures with a climate change allowance increasing by 2-4% each year, he also advises them to incorporate an aggregate clause to cope with the expected increase in the frequency of extreme weather events.

"The extremes change very rapidly indeed. The best evidence we have is temperatures in the UK because we have wonderful data there going back hundreds of years," Dlugolecki says, adding that previously once-in-a-century temperatures now happen every 12.5 years.

He highlights: "When you insure things, you're insuring them against extreme damage, so extremes changing rapidly matters a lot. We will get many more surprises and things that you thought were impossible are likely to happen a lot more often."

This forward-looking view will aid insurance companies in both their technical approach to risk management and the associated business practices. Dlugolecki argues that a change to actuarial practices is needed and recommends focusing on catastrophe modelling. A version of this is also being undertaken by the broader community: www.climatechange.net is using tens of thousands of consumer PCs to help model a variety of potential climate scenarios. Insurance catastrophe modelling is different from the modelling that the IPCC has already done because insurers will often use models designed to focus on smaller areas in fine detail.

Reaching out
Trust and cooperation will be an increasingly important part of the insurance landscape as organisations struggle to cope with greater risks. In a world of increasing uncertainty, one word is particularly important: partnership.

"The Association of British Insurers' principles are a good example of how industry is partnering with government," explains Ward. "It stands in stark contrast to the stand-off between US regulators and insurers."

A restatement of principles published by the ABI on flooding effectively ruled out the mandatory insurance of property against flooding from 2013 onwards. Increased flood risk in the UK has made it difficult for insurers to take on the burden by default without some assurance that policymakers will assist. Although flood insurance for domestic properties and small businesses will continue if the flood risk is not significant (no worse than a 1.3% probability), it will take a different stance on significant risk from July 2013. The Environment Agency must have announced the intention to reduce the risk for customers in significant danger of flooding within five years.

Such clauses are likely to become more common, along with others designed to help different parties share the increasing burden of risk to avoid insurance market collapses. This works better in some cases than in others. For example, in Florida, insurance companies and policymakers ended up at loggerheads: the former group, deeming property insurance in the hurricane-battered region too risky, signalled plans to pull out of the market.

Partnership approach
Dlugolecki says that, just as insurance firms and governments should avoid ending up in court, so they should also adopt a conciliatory approach with customers in an attempt to share risks. "For example, a policy could have a clause in it that, should an insurer loses large amounts of money, the insured party pays a 10% surcharge," he suggests, pointing out that such contracts should work in the other direction also so that, if customers fail to make a claim, they could be eligible for a partial return on their premiums.

Brokers are of particular importance in these discussions, Voysey asserts. Their role is to smooth agreements between customers and insurers as they work together to share greater risks.

What else can insurance companies do to help alleviate some of the risk? Rewarding activities designed to cope with climate change is crucial, which can be done through appropriately structured policies. For example, Ward points out that some companies are rewarding adaptation in the agricultural sector by providing more favourable prices for crops that have been engineered to be more resistant to climate change problems. In the meantime, Allianz subsidiary Fireman's Fund has taken a lead in insuring green buildings. "Fireman's Fund was the first property and casualty insurance company to offer green insurance to the US commercial market," says Stephen Bushnell, senior director of emerging industries at Fireman's Fund.

Bigger picture
Another option involves looking at the other side of the balance sheet, Maynard points out. Insurance companies often have significant investment arms and can direct that capital in different ways. It would seem foolish to invest in a large-scale polluter with a poor corporate social responsibility stance if that company could be seen as indirectly contributing to the climate change-induced threats that are increasing insurance risks. Surely it would make more sense to invest in companies pursuing renewable energy initiatives?

Clearly, then, insurance companies face complicated decisions in numerous areas as they attempt to tackle what is becoming one of the biggest single issues in the sector's history. Like the climate itself, the insurance business is a complex ecosystem.

Climate change in the US
The US, already battered by increasing hurricane activity and flooding in certain areas, is likely to experience more adverse effects from climate change in the next few decades, according to a report from the National Science and Technology Council released in late 2008. The report, entitled Scientific Assessment of the Effects of Global Change on the United States, predicted changes in a variety of areas ranging from agriculture through to public health and property damage.

One of the most stark aspects of climate change identified by the report is that the US will experience drought. "Across the western United States, there is a trend toward reduced mountain snowpack and earlier spring snowmelt runoff peaks, which is very likely due to long-term warming with potential influence from decadal-scale variability," the report said.

Crops will be more likely to fail, with horticultural goods such as tomatoes, onions and fruits expected to be particularly sensitive to changes in climate.

Other issues include a shift in precipation patterns so that rain will fall less frequently in the US overall, though more intensely when it does occur. "This increase in storminess is likely to be accompanied by greater extreme wave heights along the coasts," the report warned.

Source: PB Green issue - August 2010