Chilling prospects

The Copenhagen summit seemingly revealed no tangible plan to deal with the growing issue of climate change. What it did at least produce is insight into the realistic potential for progress. David Adams explores the relative risks and opportunities

Insurance is a hard-headed business. You wouldn't expect any decent underwriter's views on climate change to be swayed by public pronouncements like the Daily Express front page in January that shrieked 'SNOW CHAOS - And they still claim it's global warming' - or by media speculation that the 2003 heatwave or 2007 floods were conclusive evidence of climate change. Insurance is based on assessment of facts and risks, not speculation. But this is unfamiliar territory for underwriters, because risks associated with climate change cannot be calculated or priced on the basis of past events. What we do know is that a warmer world and rising sea levels would endanger people and businesses in thousands of places across the planet. The economic and social consequences of those events would affect every country in the world. The politics of energy, food and water security would all become more dangerous. And there would be huge implications for the insurance industry, with the potential for a seemingly infinite variety of claims, from extreme weather-related property damage to liability claims against companies using the most carbon.

It's particularly important that businesses in the developed world that have relocated or outsourced production or services to poorer countries appreciate these risks. As James New, an industrial development officer at the United Nations Industrial Development Organisation (UNIDO), based in China, notes: "The developing world is going to be hit so much harder by the negative impacts of climate change, partly because many developing countries do not have the necessary infrastructure to deal with it. Production [for companies] in the developed world is increasingly switching to such countries as China and Vietnam where the financial capacity of local companies can be limited in terms of their ability to react to climate change related impacts and to ensure the health of their work force as disease vectors such as malaria and dengue fever potentially increase in prevalence."

So, regardless of the veracity of climate change theories, the potential dangers are forcing insurers and reinsurers to address the issue actively: supporting the gathering and analysis of scientific data, applying pressure to policyholders to adapt behaviour, and lobbying policymakers. The latter now seems even more urgent since the failure of the 2009 United Nations Conference on Climate Change in Copenhagen to construct a binding agreement.

The most important initiative undertaken by the insurance industry to understand and act on these risks is ClimateWise, a collaboration set up in 2007 between insurers in Europe, North America and Southern Africa, including Allianz, Aon Benfield, Aviva, Catlin, Hiscox, Lloyd's, QBE, Swiss Re and Zurich. They have committed themselves to the six ClimateWise Principles: to lead risk analysis, help lead public policy making, support climate awareness among their customers, incorporate climate change into investment strategies, reduce their own environmental impact and report on their activities in an accountable way.

One ClimateWise member-sponsored project which demonstrates the support insurers can offer to the battle against climate change is the Catlin Arctic Survey, a major research project sponsored by the insurer and undertaken by a team from the University of Cambridge. It aimed to discover the rate at which Arctic sea ice was disappearing and ran for 73 days between March and May 2009, during which more than 6,000 observations and measurements were taken.

"We decided to do this because there is a lack of hard scientific data on which policyholders and insurers can plan for the future," says James Burcke, head of communications at Catlin Group. "We are trying to ensure that scientists and researchers get the data they need."

"It's also a very good branding opportunity," he admits, "but we're hoping that [our business partners and clients] have learned a lot about climate change and thought a lot about it because we've helped bring it to their attention. The more [insurers] talk about it, the more people take it seriously."

Although some of these activities might be coordinated by CSR (corporate and social responsibility) functions within insurance companies, these are not really altruistic actions. The urgent need for insurers to incentivise clients to adapt behaviour in response to these emerging risks was outlined by Celine Herweijer, director of climate change at Risk Management Solutions, in the Geneva Papers on Risk and Insurance, published in July 2009.

"Successful adaptation will be fundamental to maintaining and extending insurability both in existing and emerging private insurance markets," she wrote. "Insurer and reinsurer activities that incentivise and enable adaptation not only generate opportunities but are increasingly necessary for the sustainability of the industry."

Herweijer recommended measures including incentivisation through product development and pricing, direct financing of risk reduction and adaptation methods and more public-private partnerships such as that between the ABI and the UK government to tackle flood defence.

Examples of incentivisation within insurance policies started to appear a few years ago, such as 'upgrade to green' clauses that offer an option - or stipulate - that in the event of equipment loss replacements will be as environmentally sustainable as possible. Catlin is just one of several insurers that now use policyholders' environmental activities as criteria in writing fleet motor policies.

But Greg Lowe, sustainability coordinator at Aon UK, is cautious about the speed of progress in this area. He suggests that the underwriter/broker/client business model has also made it harder to engage policyholders directly, while risk pricing remains particularly uncertain in this area.

And as in businesses of all kinds, the bottom line remains a dominant factor. "[Green clauses] are often optional and the uptake is relatively low," says Trevor Maynard, manager of the emerging risks team at Lloyds. "The trouble is, it's all about pricing, particularly for personal lines. Where you have online aggregators in some of these markets it's difficult to overcome that."

The problem is, of course, an insurer behaving in a more sustainable way when settling claims may make itself less competitive. Maynard concludes that the ClimateWise Principle of engaging with public policymakers must incorporate a call for greater regulation. "If we were regulated and had to do this then it would be priced in from the start and there would be no competitive disadvantage for an insurer taking that approach voluntarily," he explains.

Insurers can also tackle climate change risks through facilitating infrastructural improvements. CCRIF, the Caribbean Catastrophe Risk Insurance Facility, launched in 2007, is the world's first regional insurance fund, partnership between insurers, governments, donor funds and other stakeholders. It insures government risk to limit the financial impact of catastrophic hurricanes and earthquakes on Caribbean governments, providing swift access to liquidity and saving each of the member governments about 40 per cent on the costs of insurance negotiated individually with commercial insurers. A number of other countries in Latin America and the Pacific region are considering forming similar partnerships.

Insurers could also have an important impact at a different level of society, by developing micro-insurance in developing markets to help stabilise the economies of countries vulnerable to climate change-related risks. Look up the Lloyd's 360 Risk Insight report on opportunities in microinsurance within developing countries to find out more.

It may also be necessary for insurers to work more closely with energy services providers, to help businesses and consumers gain a greater understanding and control over energy consumption. The energy sector faces climate change risks including the possibility of increased regulation and possible alteration of carbon trading markets. Carbon reduction, already a goal for many businesses, will become a mandated business objective for any business which spends more than a few hundred thousand pounds per year on energy under the Carbon Reduction Commitment Energy Efficiency Scheme (CRC), which comes into effect in 2011. Looking further ahead, national governments and regional structures like the EU may impose carbon taxes.

"Eventually it's possible that trade barriers will come up in the form of environmental taxes," says UNIDO's James New.

"The CRC will have an impact; there will be a value placed on carbon that will continue to drive energy prices higher and higher," says Dave Lewis, head of business energy services at nPower. "The investment that needs to happen in renewable energy will have an impact on energy prices too and there will be price volatility risks connected to resource security. All those things push you to the same conclusion: businesses really need to understand how much energy they're using and what they're doing to reduce energy consumption. That will give them a detailed understanding of what exposures they have."

Finally, the industry will need to play an important role in engaging with policymakers. David Bresch, head of sustainability and emerging risk management at Swiss Re attended the Copenhagen summit as part of the Swiss delegation.

At the end of the event he explained why, despite disappointment at its outcome, Copenhagen was still a step forward: "It is easy to forget that this is the first time the global community, including 193 countries, have sat down and discussed a common solution. The majority confirmed that the discussion is no longer about whether climate change is occurring and more about what can be done about it. This gives me confidence we are on the right path. The question just remains how quickly we can travel along it."

The answer will have profound implications for insurers and their customers and if the scientists are right and the climate change deniers are wrong, for everyone.

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