« Disasters »

Lloyd's on Climate Adaptation

Lloyd's of London has an interesting new report out on the need for the insurance industry to improve their adaptive capacity in the face of climate change (here in PDF). The report is titled "Climate Change: Adapt or Bust." Here is the executive summary:

1. TOO LITTLE BUT NOT yet TOO LATE. The insurance industry must do more now to understand and actively manage climate change risk.

An increasing wealth of scientific evidence is available to predict the impact of changing weather patterns and future climate change on the insurance industry. So far, efforts to do so have been patchy and there is little evidence of industry behaviour changing as a result. Much of the latest science suggests that climate change will take place faster than we thought. Urgent and active management of climate change – starting with investment in research – is now imperative. It is not too late to change, but change is long overdue.

2. Recent events have shown capital and pricing models to be wanting. We must regularly update and recalibrate our models to keep pace with REALITY.

Catastrophe modellers have now reacted to criticisms following the recent record US hurricane seasons. However, much of this work could and should have been done prior to these events. Going forward, the industry must take a new approach to underwriting, looking ahead and not simply basing decisions on historical patterns. Insurer pricing and capital allocation models must be updated regularly – and not just in extremis – to reflect the latest scientific evidence. Our responsibilities in this regard will be increasingly widely drawn: regulators will require the industry to maintain a level of capital adequate for changing levels of climate change risk.

3. Windstorm trends will put particular pressure on businesses and their insurers.

Based on natural cycles alone, we can expect the current trend towards extreme windstorm events to continue and increase over the next decade. Climate change can only exacerbate this, and insurers must plan for a higher frequency of extreme events, over a longer storm season and over a wider geographical area. Insurers must also take advantage of scientific advances to factor forecasts for the season ahead into their planning, instead of relying only on long-term trends.

4. Climate change means Exposures are changing and new ones emerging.
insurers must regularly review and communicate conditions of coverage.

We foresee an increasing possibility of attributing weather losses to man made factors, with courts seeking to assign liability and compensation for claims of damage. Exposures can also be expected to increase in respect of property, business interruption and political risks, demanding the same response. That means the insurance industry will want to regularly review conditions of coverage against risk appetite, and do more to educate the public about changing exposures. The industry can help by creating incentives for policyholders to reduce risk. Opportunities for those insurance markets which are flexible and innovative will emerge too: as society adapts to the impact of climate change, new technologies will be required and insurance of these developments will be needed.

5. Insurers must prepare for the impact of climate change on asset values. Underwriting for profit will be key,

As major corporate investors, insurers rely on returns from assets to boost their own financial performance. We expect climate change not only to produce extreme capital damaging events, but also to increase uncertainty around corporate business plans and potentially reduce asset values. This makes it even more important for the industry to price risk according to exposure and to underwrite for profit. We also see industry players having increased opportunity to use their influence as investors, in order to encourage responsible and climate proof behaviour from the boards of corporations in which they invest, and with which they do business.

6. Effective partnership with business and government will be key to
managing risk. The insurance industry must engage now.

Based on long experience, Lloyd’s believes that insurance markets operate most efficiently when left to free market forces, and the vast majority of natural perils are insurable – as long as the market is free to price risk adequately. However, if this freedom is removed, or if the pace of climate change grows faster than expected, this could change our view. Industry strategists will want to consider the long-term insurability of weather-related risk. We believe that a meaningful partnership with government and business, supported by a series of practical actions, has the best chance of providing solutions. In particular, this should address the issue of increasing concentrations of population and economic wealth in high risk areas, for example on coasts. This report focuses on adaptation but we recognise that mitigation of the risk itself (ie the reduction of CO2 emissions) is crucial.