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Insurance Industry Grapples With Impact Of Climate Change

By Janet Whitman (CNBC) - August 2, 2011

As a surge in catastrophic weather events leads to billions of dollars in claims, climate change may pose the insurance industry’s biggest problem — and profit potential.

An unusual onslaught of floods in Mississippi, tornadoes in the Midwest, drought and wildfires in Texas and earthquakes abroad has wiped out hope of much profit for many insurance and reinsurance companies this year.

Natural disasters, including Japan’s earthquake and tsunami, have left the industry on the hook for $60 billion in the first six months of this year alone, according to data from reinsurance giant Munich Re.

That’s nearly five times the first-half average since 2001, and the oftentimes costly hurricane season is just getting underway.

Although the damage has been worse than expected, the industry has plenty of capital set aside to weather the losses — barring the occurrence of more off-the-charts disasters, which insurers and reinsurers say may or may not be linked to global warming.

“Many companies that write large catastrophe risks, primarily reinsurance companies, are getting paid money in many years when nothing happens,” says Matthew Rohrmann, an insurance industry analyst with Keefe, Bruyette & Woods. “There really haven’t been that many devastating hurricanes over the past few years, for example, and reinsurers and insurers are still getting paid premiums. They may lose a lot of money in one year, but their pricing is based on many years.”

Indeed, a year after hurricanes Katrina and Rita wiped out a whopping 25 years worth of insurance premiums back in 2005, the industry bounced back with record profits.

The big question now is to what degree might this year’s wave of extreme weather — including record-breaking floods, devastating wildfires, tornado outbreaks and scorching heat waves across the country — might increasingly become the norm as the planet warms.

“If you have one bad year in 20, that’s okay, but if you start having 10 bad years in 20, that’s something that a risk scientist should be figuring out how to quantify,” says Andrew Castaldi, head of the catastrophe risk unit for the Swiss Re America Corp. “Last year in Texas it was all floods and this year it’s drought. Is that climate change or just natural variability? We’re investigating whether these phenomena are simply normal variability or normal variability with some climate change influence.”

Climate change has been on the radar screens of the insurance industry since the early 1970s.

More erratic weather — like an unprecedented hurricane that hit Brazil in 2004 — could be on the way as the Earth’s temperature rises.

But at this stage, most insurance and reinsurance experts say it’s impossible to measure to what degree a catastrophic event might be caused by climate change. That means global warming isn’t being directly priced into insurance premiums and more capital reserves aren’t being set aside.

“If you apply climate models and let them run into the future as has been done in Germany, the models show strong evidence that losses will go up in that country in the next 30 to 60 years and the only cause is greenhouse gas emissions,” says Peter Hoppe, head of Munich Re’s corporate climate center. “This makes it plausible that the increase in catastrophes we’ve seen in the last decade could be partly attributable to global warming. But it’s hard to have 100% certainty.”

Munich Re has a team of nearly three dozen scientists and meteorologists figuring out how to manage the risk of natural catastrophes, including the possible effects of climate change.

“If we know the risk, then climate change is no problem for our business model,” says Hoppe. “We don’t see it as a danger in the next 30 years, but if we don’t do something to contain greenhouse gas emissions now, this is definitely a challenge for the insurance business model in the second half of this century. In 30 or 40 years, climate change could become critical, and we are convinced that it is cheaper to act now than to pay the rising losses later.”

In the wake of Hurricane Katrina — a devastating storm that caught many insurers unprepared — the industry is in some ways better equipped to handle catastrophes.

“But every time there’s a loss, there’s a lesson learned,” says Swiss Re’s Castaldi. “With the earthquakes in Chile and Japan, the impact of business interruptions was greatly underestimated because of advances in technology. No one realized how much of a bottleneck would be created because of damage to high-tech machinery.”

The insurance industry — credited with helping create the original fire departments — isn’t only looking at assessing the risks they face when it comes to climate change.

Among insurers’ other efforts are the introduction of new products to encourage a drop in emissions, such as mileage-based car insurance, and a push for better building codes and materials in catastrophe-prone zones.

But critics say the industry could be doing more.

“Many insurers seem to be letting the messy politics of the issue trump their core competencies in risk assessment and risk management,” says Evan Mills, a scientist at Lawrence Berkeley National Laboratory and an authority in the role global warming plays in the rapid growth of weather-related insurance claims. “Putting their heads in the sand will result in a substantial downside for this industry.”