Adaptation and the insurance industry
Mike Kreidler, Commissioner, Washington State Insurance
15 November 2012 | Finance & The Green Economy, North America
Much of the world’s economy relies heavily on insurance to manage risk, and climate change poses formidable challenges to the risk modelling and prediction that underlie the insurance industry. At the same time, however, insurers are uniquely positioned to help address these issues.
The worldwide insurance industry, for whom forecasting, modelling and managing risk are critical, faces an unprecedented challenge from climate change. Changes in the climate will affect the risks that insurers take on, the premiums they charge, where they offer coverage, and how they manage the investments that help pay claims.
But climate change alsobrings new opportunities for insurers to offer innovative products that support mitigation of the effects of climate change. Moreover, insurers are also well-positioned to encourage broader solutions, much as they helped push successfully for auto safety improvements. For example, I believe the industry needs to be a strong advocate for land-use practices, improved building codes and other property risk mitigation related to climate change.
As the insurance regulator in the State of Washington, USA, I focus on the solvency of insurance companies, access to the coverage people need, and doing as much as I can to make insurance affordable. The insurance industry must step up and adapt to the challenges of climate change. I and like-minded regulators in other states are taking steps to encourage insurers to move in that direction.
Accuracy in forecasting and modelling
Insurers rely on forecasting and modelling to rate risks, set prices, and decide what they are willing to insure. For many if not most types of insurance, climate change throws a new and powerful variable into those models.
Failure to prepare and adapt now could make it difficult – if not impossible – for some individuals and businesses to find the coverage that our economy relies on to mitigate economic damage. As can be seen in some areas of the United States prone to hurricanes and floods, such situations often lead to government becoming the insurer of last resort. For insurers, failure to carefully prepare could leave them at risk of financial instability. Never have accurate modelling and a long-range view been more important.
Risks to the insurer’s financial stability
The financial stability of an insurer is also heavily dependent on its investment portfolio. Insurers invest in real estate either directly or through the purchase of mortgage-backed securities. A changing climate could increase the risk to those investments from weather-related perils such as hurricanes, flooding and fire.
Insurers also face risk from investments in sectors of the economy that have heavy exposure to the effects of climate change. Insurer investments in bonds, preferred stocks and equities of businesses with substantial exposure to the impacts of climate change can take on an unexpected element of risk. These businesses face direct weather-related losses to property, as well as business interruption. In addition, product liability and environmental liability exposures might arise. Municipal bonds, a significant investment holding for many insurers, are a potential source of risk as municipalities face increasing pressure, and perhaps costs, to adapt to the impacts of climate change.
On the other hand, the movement to mitigate the effects of climate change will also provide new investment opportunities for insurers. As new economic sectors emerge to provide goods and services that reduce greenhouse gas emissions or that are carbon-neutral, there will probably be public pressure for insurers to invest in them. New energy sources will result from developing technologies. As these ventures will need capital and infrastructure, they may be an attractive investment opportunity for insurers in certain circumstances. Carbon trading could also offer new possibilities for investment.
Charting a new direction
As an industry, insurers are well positioned to capitalise on new marketing opportunities by offering insurance products with a carbon-friendly component. In Washington and other states, for example, we’ve seen recent interest in insurance offerings for car-sharing programmes and pay-by-the-mile insurance. Both programmes are intended to ease congestion and reduce greenhouse gas emissions.
Homeowners’ and business policies can include a provision to rebuild to environmentally responsible standards after a loss. Similarly, provision of risk management services presents a further opportunity for property and casualty insurers.
More broadly, insurers can lend their expertise and influence to efforts to curb the underlying causes of climate change. They have long performed a valuable public service by advocating for safer buildings and automobiles, with spectacular results. The fact that these measures often also reduced insurers’ losses does not detract from their value to all of us. I believe that insurers can play a similar role in climate change.
The role of insurance regulators
USinsurance regulators all belong to the National Association of Insurance Commissioners (NAIC) and use their association to accomplish things collectively in everyone’s best interest. Collectively, the 56 US state- and territory-based insurance markets represent roughly one-third of worldwide insurance premiums. I lead the NAIC’s work group on climate change. Rest assured, climate change is on our radar. It has been for years.
The NAIC involvement in climate change began in February 2005, when, at the annual commissioners’ conference, climate scientists and reinsurance representatives presented information about climate change and global warming to the commissioners.
Later that year, the NAIC Property and Casualty Insurance Committee hosted a public hearing. This was intended to serve as a fact-finding and education tool regarding the implications of climate change on insurers and insurance consumers. Insurance regulators became aware that climate change might have significant implications for insurers and that the viability of certain insurance markets or products might be questionable. Regulators wanted to know more about the risks and rewards associated with the changing environment.
Recognising that climate change might have implications beyond the property and casualty world, the NAIC created the Climate Change and Global Warming Task Force. I helped initiate and co-chaired the committee, which met for the first time in 2006.
The Task Force was charged with, among other duties, the responsibility of drafting a white paper documenting the potential insurance related impacts of climate change on insurance consumers, insurers and insurance regulators. In 2008, the Task Force issued its white paper – The Potential Impact of Climate Change on Insurance Regulation. The white paper documented challenges and opportunities for insurers and their customers. It concluded that more information was needed about the impact of climate change on insurers and the insurers’ responses to the change.
Climate risk disclosure by insurers
In March 2009, the NAIC adopted a voluntary climate risk disclosure survey for states to use if they wished. The Task Force hoped that all states would implement the disclosure survey and share the results. As it turned out, some states used the survey, while others opted not to. But the responses we did receive strongly suggested that insurers in the United States were not uniformly addressing climate change.
Earlier in 2012, I and my counterparts in two other key states – California and New York – decided to issue another disclosure survey to major insurers in our states. This time, the survey would be mandatory. We’re now in the process of analysing the data that insurers provided.
Based on what we’ve seen and heard from insurers over the past couple of years, there seems to be a growing awareness among insurers that climate change is an issue that will directly affect them. That said, there remains much work to be done.
I’m also encouraged that the United States Securities and Exchange Commission now requires climate risk management disclosures for publicly traded insurers. That helps keep climate change in the forefront of insurers’ minds.
I believe that an alliance of the insurance industry, the public sector, the scientific community and other corporate citizens can help develop policies to protect our people and economy from the harm posed when devastating forces of nature are unleashed. We are truly all in this together; we should share information, applying investment and business strategies to address the outcomes of a changing climate.
Mike Kreidler, a former state legislator and member of Congress, is serving his third term as elected insurance commissioner for the State of Washington, USA. He chairs the National Association of Insurance Commissioners’ Climate Change and Global Warming Working Group.
The Office of the Insurance Commissioner
The Office of the Insurance Commissioner oversees Washington’s insurance industry to make sure that companies, agents and brokers follow the rules and protect consumers. The Office investigates problems from more than 100,000 consumers each year, conducts licensing, auditing and monitoring of Washington-based insurers and collects about US$900 million a biennium for the state’s general operating budget.