February 6, 2012 • The year 2011 was painful for the reinsurance industry—the companies that insure other insurance companies against especially big losses—thanks to the tsunami in Japan, earthquakes in New Zealand, floods in Australia and the U.S. Midwest, and tornadoes, drought, and wildfires in the United States. Insured losses for the first half of 2011 were already five times higher than average since 2001, with economic losses totaling $265 billion, according to reinsurance giant Munich Re.
As political debates over climate change linger, the reinsurance industry, whose financial interests are connected to climate and weather, has forged ahead in planning for a warmer world.
Frank Nutter, president of the Reinsurance Association of America (RAA), talked to AtmosNews about how the industry is increasingly incorporating climate models and data into its business model.
The industry generally relies on what we refer to as catastrophe models, which assimilate scientific information with the industry's traditional actuarial approach to assessing and pricing risk. The typical business model is to look retrospectively at events that have happened, and then set prices going forward, taking things like inflation and cost of living into account. But in terms of extreme weather events, it’s become very clear that historical patterns have changed.
The industry is seeking to overlay climate science onto its database of information about homes and commercial property, and then run stochastic models [a prediction technique that takes into account a certain degree of randomness] to come up with probabilistic assessments of what losses could be in the event of extreme events. This assists in determining insurance rates and exposure analysis. The modeling that UCAR/NCAR does is very applicable to insurance because it has a forward-looking approach to hurricanes, hailstorms, drought, and other such events.
The wake-up call was Hurricane Andrew in 1992. A southeast hurricane had been previously estimated to cause no more than $8 billion in damage, but Andrew caused nearly $21 billion in damage. The industry had relied on prior damage experiences, and no major storm had struck Florida in 20 years. The industry had failed to assess the dramatic increase in the concentration of property in coastal areas and become complacent about potential storm severity. At that point, it didn’t use any forward-looking modeling or rely at all on climate and long-term weather assessments. The idea of catastrophe models had been recently proposed but didn't take off until after Andrew. It was about that time that the models became more sophisticated.
The 2004 and 2005 hurricane seasons put enormous emphasis on the value of forward-looking climate information and, in particular, extreme weather information. Climate models became relevant to the industry. Now, there is probably not an insurance company in the United States—and there are thousands—that doesn’t rely on catastrophe modeling, which incorporates the kind of information that comes from scientific assessment of extreme weather and climate events.
Some companies are. When I look across the industry at which companies are looking to promote alternative energy technologies or sources, Swiss Re, Munich Re, Allianz, and Zurich Insurance stand out. All of these are European companies with major interests in the U.S. insurance market. These companies have a corporate culture of addressing emerging risks, such as climate change, and seeking business opportunities in emerging risk areas. In addition, they have corporate goals of reducing risk where possible through adaptation measures, including new non–carbon-based technologies and the reduction of carbon concentrations that affect potential loss severity or frequency.
The U.S. insurance industry, painted large, is still very much a traditional market focusing on things such as automobiles, homeowners, and workers' compensation, and is not a business that has embraced emerging green technologies as a business opportunity, whereas the European companies generally have.
Municipalities and certain government entities with local or regional responsibility are becoming much more sensitive toward climate and climate risk. At the RAA, we work with the Association of State Floodplain Managers, whose members are state and local government officials. They are clearly very focused on looking at climate risk and the potential for increasing flood risk. And I see more local governments on the cutting edge of looking at climate risk with regard to public infrastructure.
Although most U.S. insurers remain on the sidelines regarding political approaches to reducing carbon emissions, all insurers now seek to assess extreme weather event risk on a forward-looking basis. This is a clear recognition that recent extreme-event years suggest that the recent past is not prologue.