Does Climate Change Matter to the Insurance Industry?

February 04, 2016

“Men argue,” wrote Voltaire, “nature acts.” Today people are certainly arguing about the scope, impacts, causes, and even (albeit increasingly rarely) the very existence of climate change. Meanwhile, nature certainly seems to be acting. But what does it all mean to the insurance industry?

Greater concerns

Many in the insurance world are paying increased attention to climate change in light of annually growing losses from atmospheric perils such as windstorms and flood. (Here it should be said that research has shown that most of the increase in losses is the result of exposure growth in at-risk regions.) Yet it remains a challenge to take concrete measures to address climate change. One possible explanation is that because the term of most insurance policies is one year, there is generally more concern about what will happen in the next twelve months than about the climate change that will likely occur over the coming decades.

However, insurers are increasingly being asked by regulators and rating agencies to explain what they are doing to manage the risk of climate change. As a result, clients are looking to AIR to keep them apprised of the current state of the science and to educate the regulators and rating agencies on what the catastrophe models currently capture.

Models Already Reflect Change

AIR’s catastrophe models reflect the current climate. That also means, for example, that the U.S. hurricane model estimates storm surge losses based on today’s sea levels, not those of 50 or 100 years ago. As the models are updated, they capture the most recent seasons of higher—or lower—activity. So whatever impact a warming climate has had to date is already reflected in the models.

AIR also offers tropical cyclone models conditioned on warmer-than-average sea surface temperatures. While clients welcome more of these ‘climate conditioned’ models and investigations into extreme disaster scenarios, there is considerable uncertainty in establishing robust relationships between various climate signals and the frequency of occurrence of natural disasters. Our goal, however, is to unravel as many of the complex relationships as we possibly can.

This is an active area of research being conducted by AIR scientists, the results of which will help clients have a better understanding of the sensitivity of risk to climate change, make better business decisions, and better meet regulatory requirements.

Considerable Uncertainty

Beyond AIR there is a global community of scientists researching the potential impacts of climate change on the frequency and intensity of natural disasters. The latest thinking from the scientific community as summarized in the Intergovernmental Panel on Climate Change (IPCC) report Climate Change 2014 is that the frequency of hurricane activity in the Atlantic basin may stay constant, or even decrease, but that storm intensity may increase. Climate model results for extratropical cyclones, or winter storms, show a similar pattern. Floods, on the other hand, may increase both in number and intensity.

But these are just current views, and scientists uniformly recognize that considerable uncertainty surrounds these findings, especially when it comes to regional-scale predictions. There does, however, seem to be wider consensus that climate variability may increase, but the current climate is already highly variable—witness the 10-year absence of Florida hurricane landfalls. Because the natural climate variability is so large, detecting a clear signal due to climate change will remain a challenge for many years to come. For decision makers, a prudent approach is to use scenario testing to evaluate financial impacts. Catastrophe models are a great tool for conducting such tests.

One thing is crystal clear: we cannot identify climate change as the cause of any single event, whether it is the record snowfall and cold temperatures in Boston during February, 2015, or Hurricane Sandy’s onslaught of the New Jersey coast in 2012.

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