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Lloyd’s: Insurers Must Adapt to Climate Change or Go Bust

12 June 2006

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Lloyd’s of London has released a new report urging insurers to face up to the growing threat of climate change. The “360 Risk Project” report says that new weather patterns are changing insurers’s exposures, and they need to act now.

Sidestepping the issue of causality, Lloyd’s states that scientific evidence shows that global temperature, sea levels and rain fall are rising faster than previously thought. If the insurance industry wants to survive, it must adapt its responses to these trends sooner rather than later, says Lloyd’s.

That means investing both time and money in business-focused academic research which will help the industry come up with workable risk models—a key instrument for assessing risk exposure and therefore setting the right price, terms and conditions.

Lloyd’s says that the industry needs to stay ahead of the game by taking a new approach to underwriting, with pricing and capital allocation models regularly being updated to reflect the latest scientific evidence.

For example, current sea levels are higher in the Gulf of Mexico than in the past and, with sea temperatures rising, the industry must prepare for increased windstorm activity. It also means that US hurricane exposure will remain high and insurers need to plan for that. Risk modelling and pricing are key factors the sight of which the industry cannot afford to lose.

The models the industry has been using up until now may not adequately anticipate the pace of change. Thanks to scientific advances, underwriters can now take into account the increasingly reliable predictions which exist for the storm season immediately ahead, and factor these into their planning and pricing.

Although it’s almost two decades since the UN recognized that climate change was a catastrophic threat to earth, it’s clear that the insurance industry has not taken catastrophe trends seriously enough. As an industry we must work together to understand and manage these new risks, and to change our behaviour.

Today’s risk environment is changing and evolving—more rapidly than ever before. So at Lloyd’s, understanding and anticipating major risk trends is at the heart of all we do. Climate change is today’s problem, not tomorrow’s. If we don’t take action now to understand the changing nature of our planet and its impact, our industry will face extinction.

—Rolf Tolle, Lloyd’s Director, Franchise Performance

The report also says that the industry needs to figure out how to work in partnership with governments and businesses to look for practical solutions to help society adapt to climate change. Such partnerships would help to mitigate risks such as the number of people living on coastlines, and kickstart work to reduce CO2 emissions.

And although most natural perils are insurable “as long as the market is free to price risk adequately,” Lloyd’s warns that long-term insurability of weather-related risk is by no means guaranteed because climate change is developing much faster than initially thought.

Lloyd’s is the world’s leading insurance market providing specialist insurance services to businesses in more than 200 countries and territories.

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June 12, 2006 in Climate Change | Permalink | Comments (4) | TrackBack (0)

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With hundreds of billions on the line, insurers have both the resources and the motivation to understand any risk as accurately and unbiasedly as possible. When they talk, I listen. This is eye opening.

This is also the kind of wake-up call that no sophisticated business or government can rationally discount. I expect that most blue-chip firms will begin to make efforts to cope with these new risks. Without coordinated mass action, however, the rational business response is not necessarily stricter environmental standards to reduce the magnitude of the environmental threat overall, but more prosaic responses such as shifting essential facilities inland, pricing out their products to account for greater risk, etc.

There is a fundmanental "commons" or "public good" problem here. For every dollar a firm spends on pollution reduction or cuts in CO2 emissions, a certain measure of reduction is achieved, from which the firm might only reap a couple of cents of direct reward. Yet, to the community in aggregate, that measure of reduction is worth well over a dollar. Without finding some way to ensure that the firm will value that measure of reduction highly enough -- or without simply dictating in excruciating detail how to conduct their business affairs -- the community will not convince the firm to spend on enough pollution control. Ways of convincing a firm to value pollution control include taxes on excessive emissions, bounties for cleaning up operations beyond certain minimums, outright bans on certain emissions or certain levels of emissions (which essentially operate like a very high tax), and incentives placed on consumer behavior, which affects demand, which in turn affect the suppliers.

A coordinated response on a global scale is likely needed. Kyoto was deeply flawed because it did not include China and India, which have since emerged as massive and quickly growing polluters. However, the American failure to get on board has both lead to a measure of higher environmental CO2 loading, as we have consumed more than we otherwise would have over the past few years, and more importantly, has lead to a complete loss of U.S. credibility on the international scene.

Without coordinated national and international action to promote adequate risk reduction by targeting the source, private risk reduction will in many cases be limited to the sorts of environmentally neutral protective actions noted before. One unplanned-for large-scale effect, however, might be to effectively reduce the income of world consumers, as product prices escalate to accomodate the increasing cost of environmental risks. This may in turn force consumers into more parsimonious behavior, which would reduce consumption of resources and thus cut the emission of pollution.

If everything suddenly became a lot more expensive, motorists would trade in their Tahoes for Focuses, fly abroad on fewer expensive vacations, eat out less, drink less liquor, buy less clothing, move into smaller, denser and more cheaply heated (and air-conditioned) homes, consider using public transit, consume less on expensive hobbies or distractions, and live more frugally in general. In economic terms, the average standard of living would go down, though some commentators might conclude that a moderate number of such lifestyle changes would actually increase subjective health and happiness for many people. On the developing-country end of the spectrum, however, many consumers will be forced to do without even the most essential goods and services, as costs go up beyond their means.

Of course, it would be far less damaging to the earth and to our economy to stop the problem at its source by pricing out the common value of prevention in advance, and by using a judicious measure of national and international regulation to convince members of society at large to expend effort to take the most effective steps now to contain the problem.

It's fairly simple really: businesses and consumers will generate less CO2 if it is more expensive for them to do so. The way to raise the price is to shift the burden of taxation away from revenue/income and toward the consumption of energy. Charge for carbon emission, reward for carbon capture. And be careful not to substitute one form of dangerous emissions (CO2) with another (radioactive waste) in the process, so tax nuclear appropriately as well. Renewables are no panacea, but they are better.

As for indirect risks: homeowners will not build on oceanfront property in at-risk areas if neither private insurers nor the government are willing to insure new construction there. Same thing for flood-prone zones inland (e.g. San Joaquin delta in N. California). Of course, landowners in the affected areas will scream blue murder but why should everyone else shoulder a risk that they are creating?

Perhaps if Lloyd's of London talks, NOW everyone will listen? This report is very well written, backs up its statements with data, and makes no grandiose claims or predictions for dire situations. It presents the data clearly in a way that most people should be able to understand easily.
If widely circulated, this report can really help get our government to take the climate change more seriously. Hopefully, the U.S. will be able to take action quickly enough so that it will actually help reverse the trends.

Insurers now face the risk of people torching their unwanted SUVs.

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