Will climate change shrink the insurance industry?
Posted on April 1st, 2008By John J. Fialka
Climatewire: The financial impacts of climate change will target a wide array of industries, but it is the insurance industry — believed to be the largest industry in the world — that is in the uncomfortable position of being nearest to the bull’s-eye.
One of the closest students of insurance’s problems is Evan Mills, a staff scientist at the Department of Energy’s Lawrence Berkeley National Laboratory. He has been watching the industry for 15 years. He predicts that the collision between the heightened risks posed by climate change and what he sees as the secretive, splintered and late-to-respond industry will result in a severe shakeup.
Lately he has been in big demand for talks before groups of insurance executives and actuaries. Mills presents them with a scenario that is both stark and bleak: “As the globe warms, climate change puts a chill on the insurance market. Insurance ceases to be the world’s largest industry.”
He says the coming crunch will probably mean that larger companies will shrink and some smaller insurance companies could fail or be swallowed up by larger ones. Although larger U.S. firms have begun scrambling to rearrange and limit their risk portfolios, European and Asian companies, he believes, are positioned to take market share from U.S. competitors because they are better prepared to deal with the storm damage, health and life insurance risks posed by climate change.
A shrinkage of the insurance industry — which Mills estimates holds $18 trillion worth of investments around the world — could also deliver a seismic economic shock to millions of homeowners and businesses. He calls it a “contraction dynamic.”
Mills is certainly not alone in his worries. A recent survey by Ernst & Young, the accounting and consulting firm, found that climate change is regarded by industry officials as the top insurance risk this year. A white paper being prepared by the National Association of Insurance Commissioners says, “the threat that weather-related risks pose to insurer solvency is of universal concern.”
A federal ‘climate change czar’?
State insurance commissioners, who are the insurance industry’s prime regulators, have traditionally resented federal intrusions into insurance-related issues. But one of the solutions the group is pondering is the creation of a federal “climate change czar” to help coordinate the nation’s response to weather and health disasters.
The Senate will get a taste of the insurance industry’s mounting case of climate angst later this year when the National Flood Insurance Program comes up for renewal. The federal program is verging near bankruptcy after being hit with $20 billion in losses from Katrina and other huge storms that have hit Louisiana, Mississippi, Florida and other Gulf Coast states.
The Senate is expected to continue the program and forgive the debt, but some forces in the industry and in Congress are trying to plant the federal government much more deeply into the insurance business, in ways that would shield the private insurance industry from risk.
One measure being pushed by the Florida delegation, representatives of other coastal states and some large insurers would make the U.S. Treasury the insurer of last resort for future catastrophic storms like Katrina. Another measure, promoted by some insurers and Rep. Gene Taylor (D-Miss.), would expand the federal flood insurance program to cover wind-related damage, increasing its risks fourfold or more.
The House has already passed both measures. This is a “historic achievement,” according to Edward Collins, national director for an alliance called ProtectingAmerica.org, which is mainly run by Allstate and State Farm, the nation’s two largest property insurers.
“This is not about insurance companies, this is about consumers,” Collins said, asserting that the moves will protect homeowners from rising insurance rates and from rising taxes. He pointed out that the federal government’s “after-the-fact” approach to the damage caused by Katrina cost taxpayers at least $110 billion.
‘Government has to get involved’
“This is an issue where the government has to get involved,” insisted Rep. Taylor, who started a crusade for federal wind insurance after he lost his Bay St. Louis, Miss., home to Katrina and then was told that his private insurer, State Farm, would not pay for wind damage.
There was an obscure clause in Taylor’s policy that said if wind and water damage coincide, the damage is assumed to be caused by flooding; thus the federal program pays. He has since converted House Speaker Nancy Pelosi (D-Calif.) to his cause and is busy lobbying senators to expand the federal program to include wind.
But many insurers are opposed. Eric Goldberg, associate general counsel of the American Insurance Association, a trade group that represents 350 insurance companies, said his group will fight both bills because they are designed to keep insurance rates artificially low, below the real costs of the risks involved.
Goldberg said that private insurers, backed up by international reinsurance companies, have adequate resources to insure the current risks from storms. Allowing subsidized federally backed insurance to spread, he said, will encourage state and local officials to grant more building permits. “What that does is it encourages people to build,” he argued, increasing the risks in sensitive coastal areas.
“It’s like if you build it, they will insure,” Goldberg said. “That was true for a long time, but it’s really not the case anymore.”
David Keating, a consultant with the National Taxpayers Union, is busy building a coalition of conservatives backed up by environmental groups to fight against the expansion of federal insurance programs.
“We’re free-market types,” Keating said. “People should be able to build where they want to, but if they do, but if they build there [on the storm-threatened coastline], they’re on their own.”
Working beside him is David R. Conrad, a specialist for the National Wildlife Federation, who said environmental groups will oppose the expansion of federal insurance “vigorously.” He said the two bills are “almost exclusively focused on reducing insurance rates and not on what’s a far more critical role for the government, which is to reduce the risk to people and their dwellings.”
Another ‘big one’ could shift the Senate’s agenda
John Echeverria, executive director of Georgetown University’s Environmental Law and Policy Institute, said that under ordinary circumstances the Senate would be reluctant to enlarge the federal role in insurance. “But that could change, depending upon what the weather is like this summer,” he said. “If a major hurricane hits Florida, the politics could turn around in a few days.”
Groups on both sides of the debate constantly refer to the need to protect against “the next big one,” but just when that might be is unpredictable. Two research scientists at Colorado State university have published a study that predicts that the probability of a major hurricane hitting the United States this year is about 15 percent above the long-term average.
Chris Landsea, an expert at the National Weather Service’s National Hurricane Center in Miami, said the season for big storms begins in June and becomes most intense in August, September and October.
Landsea said the public has come to understand that rising ocean temperatures from global warming are producing more powerful storms and slowly rising sea levels that increase damage risks. But the increase from these factors is still relatively small, he explained, compared with the rush of people building more and bigger homes along the nation’s coastlines.
“What is going on is the population [along the coastlines] is doubling every 10 to 15 years,” Landsea said, “and that’s not due to any climate changes.”
Just who can stop Americans from moving to scenic but risky coastal areas — where builders and local zoning authorities are often eager to accommodate them — is the multibillion-dollar question. Is this a job for the “federal insurance czar”? No one knows because the position hasn’t been created yet.
Mills, the insurance expert from Berkeley, thinks the real power to force meaningful action resides within the insurance industry itself. It has reacted to past calamities by forcing governments to create the first fire departments, the first building codes and the first auto safety testing protocols. But so far, he estimates, insurance has been a slumbering giant. Less than half of the companies in the industry appear to have thought much about steps insurers might take to deal with climate change.
“It’s hard to quantify,” Mills said. “But they’re clearly not doing all that they can.”