Extreme Weather Threaten Insurers’ Risk Models
New Report Shows
Posted: 09/22/2012 8:32 pm EDT Updated: 09/24/2012 8:28 am EDT
Following a damaging episode of extreme weather, communities turn to insurance companies to help them rebuild, but with costly extreme weather and climate events on the rise as the climate continues to warm, insurers may stop coming to the rescue, a new report warns.
The report from Ceres, a nonprofit group that advocates for sustainable business practices, calls attention to the threat that extreme weather events pose to the sustainability of the insurance industry, which has been hit hard by record-breaking extreme weather in recent years, on top of lower profits due to other reasons.
In 2011 alone, 14 individual extreme weather events struck the U.S., each costing upwards of $1 billion, and the 2012 drought is expected to cost insurers about $20 billion, although most of that may be in the form of federally-backed crop insurance.
Climate research has shown that manmade global warming boosts the likelihood of extreme weather events such as heat waves and heavy rainfalls. By making extreme events more common and severe, global warming is rendering obsolete the risk models that insurance companies use.
The companies have not yet taken this into account, the report states, and haven’t done the research needed to shift toward more accurate risk models. Many small insurers may not even have the capacity to conduct such research.
Both federal flood insurance and private plans have long been based on so-called “100-year storms,” or storms of a certain magnitude that it has a one percent chance of occurring in any given year. But climate change is making such events more frequent, so that a storm that used to occur about once every 100 years, on average, now occurs far more frequently. This changes the baseline of what companies should be insuring against.
“Insurance is the first line of defense against extreme weather losses, but climate change is a game-changer for the models that insurers have long relied on,” said Washington State Insurance Commissioner Mike Kreidler, who endorsed the Ceres study’s findings. Kreidler has joined with colleagues from California and New York in requiring that major insurers disclose their exposure to climate change risks, as well as their strategies to mitigate such exposure.
The number of Billion dollar weather disasters and total damage costs between 1980- November 2011. Click on the image for a larger version. Credit: NOAA.
In an interview, Kreidler said that while some insurance companies are being proactive in factoring climate change into their operations, many companies are pursuing a strategy of charging higher premiums in areas that are more likely to see extreme weather events, or pulling out of those regions entirely, or some combination of the two.
For example, after a string of devastating hurricanes battered Florida in 2004, the state has had to step in to become the largest insurer, after numerous private insurers fled the state rather than face such severe economic losses again.
Kreidler said excluding some areas from coverage is not a sustainable long-term business plan, and that the insurance industry needs to do much more to remain profitable.
Sharlene Leurig, a senior manager in Ceres’ insurance program and a coauthor of the report, said that recent extreme weather events have “Really thrown into question how [insurers] maintain profitability.”
Leurig said the risk management approach that many insurers have been taking, which has consisted of excluding as much coverage as possible and raising premiums, won’t work if the future is stormier. “If that’s the business model of this industry, then it’s a business model that’s fundamentally broken,” she said.
The report recommends that insurance companies play a more active role in conducting weather and climate research, so they can more accurately incorporate the latest science into their risk pricing. The report also says insurance companies should become involved in influencing decisions on infrastructure development, to minimize its vulnerability extreme weather events, as well as take on a more active role advocating for reductions in greenhouse gas emissions to mitigate global warming.
The report is based on a recent financial analysis of the property/casualty insurance industry from A.M. Best Company.
CORRECTION: A previous version of this article stated that a “100-year storm” is likely to happen only once a century. A 100-year storm is of a certain magnitude that it has a one percent chance of occurring in any given year.