Why Insurer Climate Risk Responses May Vary

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.

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