In a July 2013 hearing in front of the Senate Environment and Public Works committee, the insurance industry made a bold move. Telling legislators that weather-related catastrophes have resulted in billions of dollars in claims, the Reinsurance Association of America went on to urge lawmakers to address climate change going forward and to help taxpayers by offering incentives that help them prepare for severe weather events. Yet the political hot potato is being lobbed about with no concrete decision in sight, at least at the legislative level. While political parties debate and hash out whether climate change is a reality or a myth, insurers have responded in typical fashion—by relying on the science.

Who knew the insurance industry, renowned for its conservative approach, would be one of the first industries to fully embrace the effects of climate change? However, for insurers, it’s not a change in business practices, per se, but more of a continuation of standard underwriting practice. Yet the insurance industry is indeed on the forefront of climate change. As far back as 2005, comprehensive studies were being conducted on the global impact of natural disasters on insurance.

That same year, Munich Re established its Munich Climate Insurance Initiative, which is tasked with developing insurance-related solutions, supporting their implementation, promoting insurance solutions to organizations such as the United Nations, and identifying and promoting loss-reduction strategies. The industry is, indeed, taking climate change seriously.

Add to that the known changes in the global climate and the hazards multiply quickly. “What we do know about the changing climate is sea levels are rising,” says Dr. Lou Gritzo, vice president of research for FM Global. “There’s some confdence the severity of thunderstorms is increasing.”

Still, there is reason to believe the numbers themselves could be misleading. Gritzo says: “There’s no doubt global average temperatures have increased. That’s a clear trend. Temperature is one of the easiest things to measure, so we have fairly good data over a long period of time.” Where it becomes more complex is knowing how that global temperature rising is manifesting into different hazards that could affect property loss, he adds. To date, there is no definitive data to link temperature fluctuation with an increased severity of storms.

Gritzo says that while there is evidence that the climate is changing, claims could be on the rise due to other factors. “There’s no doubt that claims due to natural hazards continue to rise,” he says. “That’s a trend that has become more pronounced in recent years.”

Gritzo says there are three factors at play that are contributing to the increase, none of which is directly linked to climate change: increased exposure due to more value in harm’s way and economic growth in emerging countries along with hazards that are not as well known. The third factor is the globalization of business and increased interconnectivity. “We’ve built a global infrastructure that’s very brittle,” says Gritzo. “Companies are lean or counting on lowest cost. They’re not coming up with backup suppliers. When something goes wrong it tends to propagate through the supply chain and cause losses a long way away from where the hazard occurred.”

How insurers respond

Dr. Robert Hartwig, president and economist with the Insurance Information Institute, believes that the insurance industry has been positioned to deal with climate change since its inception. “In reality, it’s not new,” he says. “There have always been and always will be changes and cycles in the climate.”

Hartwig says that the insurance and reinsurance industry are well equipped to handle whatever changes the climate may bring. In his estimation the industry is in a financially sound position globally, and that the many options for diversifying the risks have made it easier for insurers to remain well capitalized. “Not only is primary insurance capacity at a record all-time high and not only is traditional reinsurance capacity at an all-time high, so is the capacity being provided by the capital markets and other forms of alternative capital,” he says.

Despite the ability of the market to respond, David Kodama, senior director of research and policy, PCI, says the industry’s best approach is to understand the entirety of the climate and how each specific region is affected by its own set of risks. Where he sees the disconnect is in where the burden has been placed. “I’ve been told that the insurance industry should be at the forefront of combatting climate change as though we would stop it,” he says. “We write insurance policies— how do policies stop climate change?”

What he says the industry does well is manage risk. One way to do so, he says, is to advise customers on the risks they face daily in their particular region. “If people live in Tornado Alley, they have to understand they have a greater risk of windstorm damage. People have a choice,” he says, in where they live and what risks they will take on.

To date, climate change has not been met with any regulatory scheme. Hartwig says the NAIC has suggested disclosures be made in a few states that require it, but he believes the disclosures have no meaningful impact on how insurers set rates or reserves. Plus he says there won’t be any regulations tied to climate change that attempt to control how insurers set rates, establish reserves or impact their underwriting practices. “It would be very presumptuous of regulators to put into writing some methodology that would somehow fundamentally alter pricing, underwriting, and reserving due to climate change,” he says. “The reality is that while there is evidence that there is human impact on the climate, it doesn’t exist at a sufficient level of granularity to bring down to the level of an individual insurer and the risks it holds on its portfolio.”

With one possible area of exception, climate change, for insurers, is mostly business as usual. That one area? Says Gritzo: “If you’re going to focus on something that’s changing in the climate, the best place to focus is food.”

Flood and Biggert-Waters

This could be news the feds don’t want to hear as they debate what to do with a National Flood Insurance Program that is, ironically, under water financially. Post-Hurricane Sandy, all eyes were on the National Flood Insurance Program (NFIP) to see what changes would come to coverage of properties in high-impact areas. Perhaps the bigger question is what will happen to a program with a $24 billion debt should the climate changes impact further the severity of flooding?

Says Kodama, “That’s the big uncertainty—capitalized, underscored.” He says that uncertainty is keeping insurers from acting. “We don’t know what the regulatory and political environment is going to be in the short term, therefore you don’t know what it’s going to be in the long term,” he adds.

Kodama also believes the situation has been further complicated by what he calls the “unintended consequences of the Biggert-Waters Flood Insurance Reform Act of 2013. Kodama says the passage of the Act brought about an impact on pricing that was unexpected—“continuing this pattern of underpriced, suppressed insurance premiums,” he says. The problem is in the pricing, he adds. “Are we overpricing? Is that determined by one’s ability to afford insurance, or should it be based upon the risk?”

For that reason, Kodama says insurers won’t gamble on the food market. “In the long term what is needed is us starting to take those steps that the Biggert Waters Act was intending to implement—getting more risk-based pricing into the market place.”

Still, exposures along coastlines are growing, property values are increasing and more people are moving into food zones. Hartwig points out that since 1968 when the NFIP was established, millions more people now live in vulnerable areas. “If you went back 50 years, far fewer people lived in Florida,” he says. Today, there are over two million policies in Florida alone, says Hartwig. Also, he estimates tens of thousands of structures along the coast of New Jersey are sitting just a few feet above sea level. “To a very real extent, the increase in losses that the NFIP has seen has far more to do with demographics than it does with climate change,” he says.

What agents should do

According to Gritzo, there is a huge opportunity for agents to help clients protect their properties and the business value associated with it. The best way, he says, to make a business more resilient is to make physical improvements to protect against the hazards they know in that area. “If it’s wind, it’s strengthening the roof, protecting the windows and protecting equipment,” he says. “If it’s food, it’s keeping the water out. Physical improvements are the best thing.”

The next-best thing, Gritzo adds, is to make physical modifications to reduce damage, such as keeping the valuable equipment above the food level. Also, Gritzo suggests agents should recommend their customers have a good food emergency plan.

One other opportunity for agents, Gritzo says, is changing the way natural hazards are talked about. “When we talk about a hundred-year food, the message that is commonly communicated is that’s something that occurs regularly about every hundred years,” he says. “The reality is that the hundred- year food event has a 1% chance of happening every year. There are lots of ways to communicate the risk in a way that represents the actual hazard potential. One-hundred- and five-hundred- year don’t tend to do that.”

Hartwig says agents should make sure they understand the food risk associated with a particular property. Then, using what he calls “very explicit and no uncertain terms” agents need to explain the risks to policyholders. “Then go one step further,” Hartwig says. “Warn that policyholder that in the event that they decline the coverage and a major flooding event occurs, they should have no expectation of any means of recovery.”

A lot of the problem, as Gritzo points out, is in the language used to describe natural hazards. Agents should be the first ones to adopt a more sensible approach to describing risks, and pointing out that the hazard continues beyond any perceived expiration date. “The food is not going to stop magically at the hundred-year level if you’re in a hundred-year food zone. You’re going to get whatever water level comes and whatever you do (to protect against it), the better.”

The author

Lori Widmer is a Philadelphia-area writer and editor who specializes in insurance and risk management writing.