Chapter 6: Insurance industry

6.1 Background 6.2 Importance of the insurance market in climate change adaptation 6.3 Scope of risk and other considerations in the New York City area 6.4 Research on climate change, underwriting, and adaptation planning 6.5 Reducing greenhouse gas emissions: new opportunities for the insurance industry 6.6 Conclusions and recommendations This chapter provides an overview of the private insurance industry's key role in developing flexible climate change adaptation pathways by transferring and mitigating risk. It also provides a discussion of climate change–related risk and adaptation from the standpoint of the property and casualty insurance industry, both in general and specific to New York City. This perspective, while not inclusive of all viewpoints, is pertinent to discussions of risk, particularly given the New York City Panel on Climate Change (NPCC)'s risk management approach to Flexible Adaptation Pathways. Insurance industry tools and risk experience, on the one hand, and the work of government adaptation planners and decision makers, on the other, can be mutually supportive. The insurance industry is often referred to as the “canary in the coal mine” in discussions of climate change. Current research indicates that as climate change impacts become evident, both hurricane and nor'easter frequency and intensity will change (see Climate Risk Information (CRI), Appendix A). Any increase in the frequency or intensity of weather-related catastrophic events will increase insurance risk and directly affect property and casualty premiums. Thus, the insurance industry follows closely the scientific research on the likelihood of changes in frequency and intensity of these storms as a result of climate change. Currently, a major driver of natural catastrophe losses globally is weather-related extreme events (Fig. 6.1), with large contributions from North Atlantic tropical cyclones and European winter storms. Together with sea level rise, these storms could result in significantly higher insured and economic losses in the future if, as is expected, climate change results in more intense storms that hit densely populated coastal areas. Insured global catastrophe losses, 1970–2007.Source: Swiss Re Sigma 1/08. Recently, climate-related events, such as extreme flooding in the United Kingdom, heat waves in France, and prolonged drought in the southwestern United States, have also caused concern among insurers. Projected future changes in the underlying climate system will also affect the life and health insurance industries, as changes in precipitation and temperature globally will shift the distribution of infectious diseases. Many insurance companies recognize the scientific consensus that climate change is already occurring and anthropogenic activities, such as combustion of fossil fuels and tropical deforestation, are having a discernible influence on global climate. While it is not possible to attribute individual weather-related catastrophes, such as Hurricane Katrina, to anthropogenically induced climate change, the Intergovernmental Panel on Climate Change (IPCC) and other scientific assessments have identified relationships between climate change and changes in the frequency or severity of extreme events (IPCC, 2007). For New York City, the primary near-term risk from weather-related disasters is coastal flooding from nor'easters, powerful coastal storms occurring during the autumn and winter months. Historical nor'easters have reached intensities comparable to category 1 or 2 hurricanes on the Saffir-Simpson scale. These extratropical cyclones bring hurricane-like conditions: strong winds, storm surge, and beach erosion. Significant damage to New York City and the surrounding metropolitan area has already occurred in the past. The nor'easter of December 1992 demonstrated the susceptibility of the New York City infrastructure to flooding and storm surge. Over $1 billion of damage occurred in New York City, the transit system of lower Manhattan was inundated, and the highest storm surge since modern record keeping was recorded at the Battery. In the future, storm surges from nor'easters and hurricanes will be exacerbated by already ongoing sea level rise. Insurance and reinsurance transfer risk from an individual policyholder or primary insurance provider to a larger risk-sharing community. The insurance company facilitates this transfer of risk among insured individuals in a way that attempts to be equitable and cost-effective for customers while maintaining solvency and shareholder value for the company. Premiums are set to represent an insured's contribution to the overall shared risk; therefore, to be equitable, those with greater risk should pay higher premiums than those who contribute less to the overall risk. The insurance industry studies risk in actuarial terms, meaning that the mathematical and statistical traits of each risk are carefully monitored. The risk absorbed by the insurance industry is reduced by basing the terms and conditions of insurance policies on actuarially derived premiums and deductibles or by limiting coverage based on risk. Furthermore, private insurance companies are not required by law to write in high-risk areas and will cease to offer coverage in an area deemed high risk. On the basis of actuarial principles, a property at higher risk from weather-related events will pay more for insurance than a property located in an area or built with recognizably reduced exposure to weather-related risk. For example, properties located in designated flood plains or hurricane zones generally pay higher premiums than those elsewhere. Thus, increased weather-related risks will lead to higher rates, higher deductibles, and limited coverage, providing incentives for adaptation or risk reducing measures. 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