I.I.I. chief actuary Jim Lynch offers his perspective on how insurers are responding to climate change:

The insurance industry got a report card this week on a test I’m not sure they knew they were taking. And the grading curve was, in my opinion, harsh.

Ceres, a nonprofit group that promotes sustainable business practices, rated 330 insurers – life, health and property/casualty – on how well they are responding to climate change.

Before I wade further into the topic, it is important to acknowledge that insurance companies and their managers have a range of opinions on global warming that is as wide as the opinions of Americans overall on the topic. There is no insurance industry position, though there are individuals and companies with strong opinions – just as with all Americans.

On a four-point scale, nine companies got the highest mark (“leading”): Ace, Munich Re, Swiss Re, Allianz, Prudential, XL Group, The Hartford Financial Services Group, Sompo Japan and Zurich. Matthew Sturdevant of the Hartford Courant does a nice job rounding up how these firms earned their grade.

Ceres gave “minimal” or “beginning” rankings to 276 insurers, 84 percent on my calculator. The New York Times played up that aspect. But the analysis may be skewed because of the source of the rankings and how Ceres adapted that source.

Ceres took a National Association of Insurance Commissioners (NAIC) survey that six states require on climate change. The survey consists of eight yes-or-no questions, each of which follows up with why the insurer answered as it did. The follow-up questions are open-ended – companies can respond with as little or as much information as they like.

The questions help regulators when they assess a company’s enterprise risk management, specifically how hard a company looks for potential problems that might not hit them until years from now. Climate change certainly has that potential.

Ceres took those answers and graded them on its own criteria, resulting in six scores from 1 to 4, which it then re-summarized into a single grade.

Boiling a complex set of open-ended answers is tricky enough, but Ceres has, in my opinion, misused the NAIC survey, which is supposed to help regulators understand how well insurers are considering climate change in their risk management, not whether insurers are acting as stewards of the environment.

So it doesn’t seem like Ceres is giving a fair test. Insurers are answering questions on how climate change might affect their business then being rated on how their actions will reduce carbon emissions. It’s like being told to write an essay, then being graded on penmanship.

How could this skew results? Some insurers are minimally exposed to climate change, so it would not be prudent risk management for them to devote valuable resources to the issue. Medical malpractice writers are an obvious example. Climate change might be important to the world at large, but how relevant is it to the operation of a medical malpractice writer?

Property insurers are in a different boat, pardon the irresistible pun. Rising sea levels and growing weather extremes are important developments, and it would seem a prudent coastal writer would consider whether those trends will continue, abate or accelerate. A company that writes worldwide has still more to think about, as climate trends would affect other countries more than our own.

Seen that way, it makes perfect sense that some large, multinational insurers are concerned about climate change while small writers not exposed to property insurance are less so.

On the life/health side, there is a signal-to-noise problem. Climate change appears to have an impact on mortality, but it’s really small. A 2011 Brookings study suggested that climate change will increase U.S. age adjusted mortality rates by about 3 percent over the next 85 years or so. That rate has declined by 1 percent per year over the past 35 years. So the impact of climate change on mortality is likely to be overwhelmed by other forces at work.

That’s not to say that life expectancies outside the U.S. won’t be affected more. But a life insurer that only writes U.S. risks might not want to incorporate climate change-induced mortality changes from, say, Australia, into its business model.

Regardless, life insurers have a built-in mortality hedge in pairing annuity sales with life insurance. People who die sooner drive life insurance profits lower. But they push annuity profits higher, and vice versa. Combine that with the small impact of climate change on U.S. mortality and it makes perfect sense that a great many U.S. life insurers have decided that climate change doesn’t form a central part of their risk management strategy.

Health insurers are in a similar situation. Gradual changes in health have small effects on their business, and those changes can be easily adjusted to year by year. Pandemics are a bigger risk, so risk management efforts focus there.

That helps explain why health and life insurers didn’t score as high as property/casualty insurers. They have less at stake.

California’s insurance department doesn’t sound too concerned. Ceres relied on CA DOI information to compile its report, so there’s a good chance the Ceres researchers saw a 2013 press release that said this:

The results of this year’s survey are a positive sign for the insurance industry and the environment,” said Commissioner Jones. “It is encouraging to see that insurers are aware of the risks that a changing climate brings, and moreover they are taking steps to ensure their responses to these risks are sufficient to protect their business.”

More than 1,000 companies [Duplicates and multi-company insurance groups account for the difference between Ceres’ total and California’s.] were required to respond to the survey. The survey revealed that roughly 75 percent of insurers have a plan for identifying climate change-related risks that could affect their business, and are taking actions to mitigate these risks. Responses to the eight survey questions reveal that nearly every insurer is aware of the risks posed by a changing climate, and an overwhelming majority of insurers have incorporated mitigating practices into their business model.”

That sounds like an industry that is handling the issue prudently, even if it is not the way an environmental group would prefer.

As the number of companies suffering a data breach continues to grow – with U.S. retailer Staples now reported to be investigating a breach – so do the legal developments arising out of these incidents.

While companies that have suffered a data breach look to their insurance policies for coverage to help mitigate some of the enormous costs, recent legal developments underscore the fact that reliance on traditional insurance policies is not enough, notes the I.I.I. white paper Cyber Risks: The Growing Threat.

A post in today’s Wall Street Journal Morning Risk Report, echoes this point, noting that a lawsuit between restaurant chain P.F. Chang’s and its insurance company Travelers Indemnity Co. of Connecticut could further define how much, if any, cyber liability coverage is included in a company’s CGL policy.

Collin Hite, partner and leader of the insurance recovery group at law firm Hirschler Fleischer tells the WSJ that whatever the outcome of this case, companies that want to be sure they are protected against cyber-related losses may have to purchase separate cyber liability policies—and make sure those policies are broad enough to encompass the myriad ways an attack could cost the firm money.

P.F. Chang’s confirmed in June that it had suffered a data breach in which data from credit and debit cards used at its restaurants was stolen.

An earlier post in the Hartford Courant Insurance Capital blog by Matthew Sturdevant has the details on the legal action between Travelers and P.F. Chang’s.

To-date the application of standard form commercial general liability (CGL) policies to data breach incidents has led to various legal actions and differing opinions, according to the I.I.I. paper on cyber risks.

One recent high profile – and oft-cited case – followed the April 2011 data breach at Sony Corp. in which hackers stole personal information from tens of millions of Sony PlayStation Network users.

A New York trial court ruled that Zurich American Insurance Co. owed no defense coverage to Sony Corp. or Sony Computer Entertainment America LLC.

In his ruling, New York Supreme Court Justice Jeffrey K. Oing said acts by third-party hackers do not constitute “oral or written publication in any manner of the material that violates a person’s right of privacy” in the Coverage B (personal and advertising injury coverage) under the CGL policy issued by Zurich.

Further expertise and analysis on cyber risks and insurance is available from the I.I.I.

Winter storms caused $1.9 billion in insured losses in 2013, five times higher than the $38 million in damages seen in 2012, so it’s good to read via NOAA’s U.S. Winter Outlook that a repeat of last year’s winter of record cold and snow is unlikely.

In a release, NOAA’s Climate Prediction Center says:

Last year’s winter was exceptionally cold and snowy across most of the United States, east of the Rockies. A repeat of this extreme pattern is unlikely this year, although the Outlook does favor below-average temperatures in the south-central and southeastern states.”

While the South may experience a colder winter, the Outlook favors warmer-than-average temperatures in the western U.S., Alaska, Hawaii and New England, according to NOAA.

It’s important to note that for insurers, winter storms are historically very expensive and the third-largest cause of catastrophe losses, behind only hurricanes and tornadoes, according to the Insurance Information Institute (I.I.I.).

From 1994 to 2013, winter storms resulted in about $26.6 billion in insured losses, or $1.4 billion a year, on average, according to the Property Claim Services unit of ISO.

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Meanwhile, NOAA’s Winter Outlook also suggests that California’s record-setting drought will persist or intensify in large parts of the state this winter.

Mike Halpert, acting director of NOAA’s Climate Prediction Center, says:

Complete drought recovery in California this winter is highly unlikely. While we’re predicting at least a 2 in 3 chance that winter precipitation will be near or above normal throughout the state, with such widespread, extreme deficits, recovery will be slow.”

Some 25 years after the Loma Prieta earthquake, the San Francisco Bay area faces increased risk of a major quake, two separate studies suggest.

A study published online in the Bulletin of the Seismological Society of America says that sections of the San Andreas fault system—the Hayward, Rodgers Creek and Green Valley faults—are nearing or past their average earthquake recurrence intervals.

It says the faults ‘are locked and loaded’ and estimates a 70 percent chance that one of them will rupture within the next 30 years. This would trigger an earthquake of magnitude 6.7 or larger, the study’s authors say.

A second study by catastrophe modeler RMS says the next major quake could be financially devastating to the Bay Area economy in part because of low earthquake insurance penetration.

RMS warns that a worst-case 7.9 magnitude earthquake on the San Andreas fault could cause over $200 billion in commercial and residential property losses, yet only 10 percent of households currently have earthquake insurance.

Dr. Patricia Grossi, earthquake expert at RMS says:

The Bay Area has made significant progress in terms of infrastructure preparedness and retrofitting, but without significant earthquake insurance penetration to facilitate rebuilding, the recovery from a major earthquake will be considerably harder.”

Without insurance, homeowners may walk away after a quake if the residual value of their property is less than the outstanding value of their mortgage, RMS notes. Even those with insurance are likely to struggle to meet high deductibles, potentially leading to significant blight and disrepair in badly damaged neighborhoods.

Despite low earthquake insurance penetration, a magnitude 7.0 earthquake rupturing on the Hayward fault could produce $25 billion in insured loss across residential and commercial lines of business, RMS concludes.

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A glance at the economic context shows that since the 1989 Loma Prieta earthquake, population in the Bay Area has increased 25 percent, while the value of residential property has jumped by 50 percent, reaching $1.2 trillion.

The Bay Area is also the most productive economy in the U.S. with a gross domestic product of $535 billion, ranking 19th in the world compared to national economies, RMS says.

Check out I.I.I. facts and stats on earthquakes.

Unmanned aerial vehicles (UAV), otherwise known as drones, appear to be moving closer to commercial application, and property/casualty insurers are getting involved.

On the one hand, insurers are looking at ways to use this emerging technology to improve the services they provide to personal policyholders, at the same time they are assessing the potential risks of commercial drone use for the businesses they insure.

The Chicago Tribune this week reported that several home and auto insurers are considering the use of UAVs, and at least one has sought permission from the Federal Aviation Administration (FAA) to research the use of drones in processing disaster claims.

According to Sam Friedman, research team leader at Deloitte, drone aircraft could be the next mobile tech tool in claims management.

In a post on PC360.com, Friedman says that sending a drone into a disaster area would enable insurers to deliver more timely settlements to policyholders and spare adjusters from being exposed to the hazards of inspecting catastrophe claims in disaster areas.

Commercial insurers also have a huge stake in the drone business. In a recent post on WillisWire, Steve Doyle of Willis Aerospace, says businesses need to consider UAV risk issues such as liability and privacy:

Risk managers for organizations that could potentially gain considerable competitive advantage from eyes in the sky should consider the risk issues now so they are ready to advise their organizations as UAV options broaden.”

Insurance is not the only industry eyeing commercial applications. Agriculture, real estate, oil and gas, electric utilities, freight delivery, motion pictures, to name a few are seen as major potential markets for UAVs.

A recent report by IGI Consulting predicts that U.S. sales of UAVs could triple to $15 billion in 2020 from $5 billion in 2013.

However, the broader commercial use of drones in the U.S. will depend on federal regulators developing appropriate rules. In September the Federal Aviation Administration (FAA) gave the go-ahead for six TV and movie production companies to use drones for filming.

In his WillisWire post, Doyle notes that regulation is a key element to the successful widespread development of the drone industry in the U.S. given the complexities of the liability environment, the crowded skies over metropolitan areas, and the variety of UAVs and their uses.

One thing’s for sure, when UAV use takes off in the U.S., insurers are ready to support this emerging technology both as risk takers and risk protectors.

While low interest rates are likely to continue to present a challenge well into 2015, a stronger economy presents the property/casualty insurance industry’s best opportunity for growth, according to I.I.I. president Dr. Robert Hartwig.

Dr. Hartwig shared his thoughts on the industry’s growth outlook in his Commentary on 2014 First Half Results.

There are two principal drivers of premium growth in the P/C insurance industry he noted: exposure growth and rate activity.

Exposure growth—basically an increase in the number and/or value of insurable interests (such as property and liability risks)—is being fueled primarily by economic growth and development.

Although the nation’s real (inflation-adjusted) GDP in the first quarter of 2014 actually declined at an annual rate of -2.1 percent, economic growth snapped back in the second quarter, as real GDP surged by 4.6 percent.

Dr. Hartwig says:

Growth in key areas of the economy such as new vehicle sales, multi-unit residential construction, and consistent employment and payroll growth are clearly benefitting the P/C insurance industry. For the remainder of 2014 and into 2015, the consensus forecasts call for real GDP growth to hold steady at about 3 percent.”

The other important determinant in industry growth is rate activity. Rates tend to be driven by trends in claims costs, conditions in the reinsurance market, marketing and distribution costs, and investments in technology, among other factors.

Although it’s challenging to foresee the interplay of all of these and macroeconomic factors, Dr. Hartwig says it is certainly possible that overall industry growth in net written premiums could keep pace with overall economic growth in 2014.

In the first half of 2014 the industry’s net written premium growth actually decelerated slightly to 4.0 percent in the first half of 2014, compared to 4.3 percent in the first half of 2013.

But, as Dr. Hartwig concludes:

Premium growth, while still modest, is now experiencing its longest sustained period of gains in a decade.”

Workers compensation is likely to remain the fastest growing major P/C line of insurance in 2014 if economic growth and hiring behave as projected.

A second annual survey from Experian and the Ponemon Institute appears to show that more companies are prepared for a data breach, and that cyber insurance policies are becoming a more important part of those preparedness plans.

The study, which surveyed 567 executives in the United States, found that 73 percent of companies now have data breach response plans in place, up from 61 percent in 2013. Similarly, 72 percent of companies now have a data breach response team, up from 67 percent last year.

In the last year the purchase of cyber insurance by those companies has more than doubled, with 26 percent now saying they have a data breach or cyber policy, up from just 10 percent in 2013.

However, this means that two-thirds of respondents – 68 percent – are still not buying cyber policies. (Six percent of respondents are also unsure whether their company has cyber insurance.)

Interestingly, the fact that more companies have data breach response plans in place does not appear to instill greater confidence that they are effective.

Despite the existence of plans, only 30 percent of respondents say their companies are effective or very effective in developing and executing a data breach plan, the survey found.

Why are the plans not effective?

The survey indicates that in many cases a breach response plan is largely ignored after being prepared.

Some 41 percent of respondents say there is no set time for reviewing and updating the plan, while 37 percent say they have not reviewed or updated the plan since it was put in place.

All of this comes as the frequency of data breaches is accelerating. Some 60 percent of respondents say their company experienced more than one data breach in the past two years, up from 52 percent in 2013. And 43 percent say their company had a data breach in the last year, up from 33 percent in 2013.

Check out the latest I.I.I. white paper on this topic Cyber Risks: The Growing Threat.

More on this story from the Wall Street Journal’s Risk & Compliance Report.

Growth in U.S. liability claims could accelerate to 5-6 percent in the near future, according to a just-released report by Swiss Re sigma.

The slowdown in U.S. liability claims paid after 2008, primarily due to economic drivers such as the recession and weak recovery, is expected to reverse.

Why the change?

Cyber risk and the liability from emerging technologies including hydrofracking and autonomous cars, combined with stronger economic growth will drive liability claims costs higher, sigma says.

Interestingly the report suggests that the effects of tort reform, which contributed to a slowdown in claims growth in the mid-2000s in the U.S., were a one-off benefit and will no longer suppress claims growth to the same degree.

It notes:

Often these types of reform have only a temporary effect on claims growth, which fades as the rules eventually soften again or the legal profession learns how to optimize the pursuit of claims in the new framework.”

Tort reform in the U.S. has focused on medical malpractice and class action claims, the report says.

Many early studies concluded that medical malpractice reforms such as limits on lawyers’ fees and non-economic compensation were effective in reducing medical malpractice liability. However, some of these caps were later overturned by state supreme courts.

Despite passage of the Class Action Fairness Act in 2005, empirical evidence on the effects of federal class action reform in the U.S. remains inconclusive, sigma adds.

The report also warns that litigation funding, in which a third-party funding company pays the costs of litigation and is paid only if the litigation is successful, is still in its infancy in the U.S. but developing.

There are fears it will grow, driving up litigation and future claims costs for insurers.”

Check out this I.I.I. backgrounder on the U.S. liability system here.

Drought continues to make the headlines, with the latest U.S. Drought Monitor showing moderate to exceptional drought covers 30.6 percent of the contiguous United States.

Its weekly update also shows that 82 percent of the state of California is in a state of extreme or exceptional drought. Reservoir levels in the state continued to decline, and groundwater wells continued to go dry, the U.S. Drought Monitor says.

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The LA Times reports that California’s historic drought has 14 communities on the brink of waterlessness. It quotes Tim Quinn, executive director of the Association of California Water Agencies, saying that communities that have made the list are often small and isolated and have relied on a single source of water without backup sources.

However, Quinn also tells the LA Times that if the drought continues, larger communities could face their own significant problems.

A recent article at CFO.com by Lauren Kelley Koopman, a director in PwC’s Sustainable Business Solutions practice, makes the point that when water-related disruptions affect operations, companies can suffer significant profit and losses and pay higher prices for goods in the supply chain.

Water management issues pose significant operational, regulatory and reputational risks to companies, the article noted.

And a recent report from the University of California found that farmers had spent an extra $500m in pumping extra water to cope with the state’s drought, while the total economic cost to the state’s agricultural industry reached $2.2bn.

For insurers, droughts can be costly. Drought, wildfires and heat waves caused 29 deaths and $385 million in insured losses in the U.S. in 2013, according to Munich Re.

In 2012, drought in various parts of the U.S. caused $15 billion to $17 billion in insured losses, making it the second costliest disaster after Hurricane Sandy.

As world leaders gather to discuss climate change at the United Nations this week, a new report from the Global Reinsurance Forum (GRF) says risk prevention and mitigation measures as well as risk transfer are the key to managing this threat.

According to the report, up to 65 percent of climate risks can be averted by adaptation measures including infrastructure development, technology advancements, shifts in systems and behaviors such as improved building codes and land use management, and financial measures.

The global re/insurance industry plays a vital role in planning and implementation of such measures. As the GRF says:

Future insurability will depend on well-planned adaptation: without it, property insurance will become less affordable and less accessible.

The world cannot simply insure its way out of the effects of climate change, but adaptation allows the global burden of potential loss to be reduced and shared, helping to keep the most vulnerable from being overwhelmed.”

The report points out that the reinsurance industry is particularly exposed to the impact of climate change given its role as an ultimate destination of risk:

The industry identified climate change as an emerging risk more than twenty years ago; it has since become a key component of every company’s long-term risk management strategy.”

Citing a 2012 IPCC report, the GRF notes that extreme weather events, such as storms, floods, droughts, heat waves as well as rising sea levels, crop failures and water shortages have become more numerous and severe.

Reinsurers can make an important contribution by developing protection and mitigation-finance solutions to address the specific challenges that climate change presents.

At the same time, the GRF says reinsurers are advancing understanding of climate change-related risk through the development of natural catastrophe models and via collaboration with universities and scientific institutions. They are also monitoring relevant phenomena such as urbanization, population concentration, property and commercial activity in high-risk areas along the coasts and flood plains.

Check out a great I.I.I. backgrounder on climate change and insurance issues here.

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