Brewer's Guidance:

For you industry, I suggest you first identify a range of key issues that climate change and/or energy changes pose for the industry. This will give your analysis breadth.

Issues are questions about what should be done about such and such - where the 'such-and-such' is a problem (threat)or opportunity. For balance, in general, it would be good to mention at least one threat and at least one opportunity.

Then select one - or perhaps two - of those issues for the focus of your analysis. This will give it depth. It will be the threat or opportunity that gets most of your attention/time/space.

Be sure to include at least one specific firm to illustrate the points you make. You can include more than one, if you would like.

Michael's Suggestion:

Hey Steve,

For researching the effect of climate change on the insurance industry, I was thinking that I would investigate the policies and reactive/proactive measures of individual insurance firms like AIG and State Farm and you could look at the insurance payouts, and general policy changes that resulted from hurricane Katrina.

Let me know if that sounds good to you, or if you would rather split it up another way.

Mike

Paper Outline

• Introduction
• Hurricane Katrina
• Magnitude of storm
• "It was the costliest and one of the five deadliest hurricanes to ever strike the United States. Katrina first caused fatalities and damage in southern Florida as a Category 1 hurricane on the Saffir-Simpson Hurricane Scale. After reaching Category 5 intensity over the central Gulf of Mexico, Katrina weakened to Category 3 before making landfall on the northern Gulf coast. Even so, the damage and loss of life inflicted by this massive hurricane in Louisiana and Mississippi were staggering, with significant effects extending into the Florida panhandle, Georgia, and Alabama. Considering the scope of its impacts, Katrina was one of the most devastating natural disasters in United States history" (Knabb et al p. 1)
  
• Destruction / death toll
• Death Toll
  
• "The total number of fatalities known, as of this writing, to be either directly or indirectly related to Katrina is 1833, based on reports to date from state and local officials in five states: 1577 fatalities in Louisiana, 238 in Mississippi, 14 in Florida, 2 in Georgia, and 2 in Alabama. The total number of fatalities directly related to the forces of Katrina is estimated to be about 1500 spread across four states, with about 1300 of these in Louisiana, about 200 in Mississippi, 6 in Florida, and one in Georgia. Presumably, most of the deaths in Louisiana were directly caused by the widespread storm surge-induced flooding and its miserable aftermath in the New Orleans area." (Knabb et al. p. 11)
• "If the assumption is correct that most of the Katrina-related fatalities were caused directly by the storm, then Katrina ranks as the third deadliest hurricane in the United States since 1900, and the deadliest in 77 years" (Knabb et al. p. 11)
• Damages Overview
  
• "Thousands of homes and businesses throughout entire neighborhoods in the New Orleans metropolitan area were destroyed by flood. Strong winds also caused damage in the New Orleans area, including downtown where windows in some high rise buildings were blown out and the roof of the Louisiana Superdome was partially peeled away. The storm surge of Katrina struck the Mississippi coastline with such ferocity that entire coastal communities were obliterated, some left with little more than the foundations upon which homes, businesses, government facilities, and other historical buildings once stood" (Knabb et al. p. 11-12)
• Insurance payouts
• "The final tally for Hurricane Katrina losses is $41.1 billion stemming from 1.75 million claims. By contrast, losses for 2007, a year of little hurricane activity in the U.S., were $6.5 billion." (III website)
  
• "The American Insurance Services Group (AISG) estimates that Katrina is responsible for $40.6 billion of insured losses in the United States. A preliminary estimate of the total damage cost of Katrina in the United States is assumed to be roughly twice the insured losses, or about $81 billion. This figure makes Katrina far and away the costliest hurricane in United States history. Even after adjusting for inflation, the estimated total damage cost of Katrina is roughly double that of Hurricane Andrew (1992). Normalizing for inflation and for increases in population and wealth, only the 1926 hurricane that struck southern Florida surpasses Katrina in terms of damage cost. The Insurance Information Institute reports that, mostly due to Katrina but combined with significant impacts from the other hurricanes striking the United States this year, 2005 was by a large margin the costliest year ever for insured catastrophe losses in this country." (Knabb et al. p. 12-13)
• "[2005], after an already poor 2004, storms caused a record $54.8 billion of insured losses, according to the Insurance Information Institute, an industry group. Of these, Hurricane Katrina alone accounted for more than $38 billion" (Economist "Price")
• Insurance companies' reactions to Katrina
• Market Exit
  
• "Stung, insurers are cutting back their exposure in coastal areas. Allstate, one of America's biggest property insurers, has stopped writing homeowners' policies in Florida, Louisiana and parts of Texas and New York. State Farm, another big insurer, has not renewed some policies. In April Poe Financial, Florida's fourth-largest personal insurer, collapsed, leaving 316,000 policyholders in need of coverage. A new report by Fitch, a credit-rating agency, calls Florida's insurance market “extremely fragile”. Further north, this month National Grange began telling customers on Cape Cod, in Massachusetts, that it would not renew their policies." (Economist "Price")
• "In America, where insurance is regulated on a state-by-state basis, caps on insurance premiums have prompted firms to withdraw coverage in high-risk areas such as Florida." (Economist "Flood")
• "If, however, the firm has a substantial stake in writing insurance in the state, the level of the state homeowners’ insurance premiums earned will be high and the firm will be more reluctant to give up that market, as is indicated by the negative effect of that state total homeowners’ premiums earned variable. The number of states in which the insurer operates has a negative effect on exit, so that while writing a large level of homeowners’ premiums increases the probability of exit, when these premiums are spread across a large number of markets the incentive to exit is reduced. The final variables indicate that firms with a mutual, reciprocal, or Lloyd’s structure each have a lower probability of exit. Restrictive state rate regulation increases the probability of exit." (Viscusi and Born p. 19)
• Premium Increases
  
• "In the face of this threat, homeowners who can get insurance coverage face sharply higher rates. Some premiums have risen by as much as 200%. Primary insurers partly blame increases in the prices charged by reinsurers (which insure them)." (Economist "Price")
• "After Mr Crist's intervention in January [2007], matters have only got worse. Premiums remain high, and insurance companies are shedding customers as fast as they can. Allstate Floridian is abandoning 226,000 customers, one-third of its total client base in the state. State Farm, one of Florida's four leading insurers, also recently announced that it is dropping 50,000 customers. “The property-insurance business here in Florida is a very difficult proposition,” says Adam Shores, a spokesman for Allstate Floridian. “The exposure we had was greater than the claims-paying capacity we had.”" (Economist "Wishing")
• "Insurers’ cumulative total profits in Florida from 1992‐2006 have been negative during the entire period. While the market price of homeowners insurance has significantly increased in coastal areas (especially in Florida), insurers are still concerned about earnings volatility and the possibility that their long‐term profits will be negative in high‐risk areas. Florida has experienced the greatest absolute increase in the average homeowners premium among the four states studied, from $723 at the start of 2002, to $1,465 in the first quarter of 2007. In coastal areas, premiums have tripled or even quadrupled for some homeowners. Nevertheless, at the end of 2006, insurers had a $11.6 billion cumulative deficit on their Florida’s homeowners business based on the period 1992‐2006. Higher insurance premiums, coupled with no hurricane losses in 2007 in Florida, have improved insurers’ long‐term performance but companies are still extremely concerned about the future of their operation in this state." (UPenn)
• Government Policy Changes in Response to Katrina
• "The slack is being picked up by a fast-growing state-run company, Citizens Property Insurance. Citizens is acting as the insurer
  of last resort, underwritten by the Florida Hurricane Catastrophe Fund, a pool financed by the state. In January [2007] the state [FL] decided it could resolve the crisis by expanding Citizens and making it more competitive with private companies. It is now by far the state's largest home-insurance provider, with 1.3m clients." (Economist "Wishing")
• Proposals for national catastrophe risk fund and other policies (see Hartwig)
  
• Threats from Climate Change
• Reputational Risk
• "Climate change is often threatening and difficult to cope with and insurers are often the messengers of change through the pricing and conditions attached to their policies. The industry can easily become associated with unwelcome messages so it
  will be important to communicate very effectively with all stakeholders" (ABI "Changing")
  
• Regulatory Risk
• Investment Risk
• investment returns (and thus firm profitability) subject to macroeconomic response to both effects of climate change and the costs of climate change mitigation and adaptation policies (Lehman II)
  
• IPCC Impacts
• Sea-level rise and human development are together contributing to losses of coastal wetlands and mangroves and increasing damage from coastal flooding in many areas
• Heavy precipitation events,which are very likely to increase in frequency, will augment flood risk
• Coasts are projected to be exposed to increasing risks, including coastal erosion, due to climate change and sea-level rise. The
  effect will be exacerbated by increasing human-induced pressures on coastal areas
• Where extreme weather events become more intense and/or more frequent, the economic and social costs of those events
  will increase, and these increases will be substantial in the areas most directly affected
• North America: Disturbances from pests, diseases and fire are projected to have increasing impacts on forests, with an extended period of high fire risk and large increases in area burned
• Since the IPCC ThirdAssessment, confidence has increased that some weather events and extremes will become more frequent,
  more widespread and/or more intense during the 21st century; and more is known about the potential effects of such changes.
• Intense tropical cyclone activity increases = Likely (66 to 90% probability)
  
• "Potential climate change is the greatest strategic risk currently facing the property/casualty insurance industry, with demographic changes taking priority for the life insurance industry, according to a new study by Ernst & Young. For the new study, Ernst & Young and Oxford Analytica interviewed more than 70 industry analysts from around the world to identify the emerging trends and uncertainties driving the performance of the global insurance sector over the next five years." (Insurance Journal)
  
• "Specific market-based risks include the following: (i) Historically based premiums that lag behind actual losses (especially for life insurers, where premiums may be fixed over long periods). (ii) Failing to foresee and keep up with changing customer needs arising from the consequences of climate change. (iii) Unanticipated changes in patterns of claims, and associated difficulty in adjusting pricing and reserve practices to maintain profitability. (iv) Responses of insurance regulators (10). (v) Reputational risks falling on insurers who do not, in the eyes of consumers, do enough to prevent losses arising from climate change. (vi) Stresses unrelated to weather but conspiring with climate change impacts to amplify the net adverse impact. These include drawdowns of reserves due to earthquakes or terrorist attacks and increased competition from self-insurance or other competing methods of risk-spreading (especially if relatively low-risk customers shift to those products)." (Mills)
  
• Weather / Cat Losses in Perspective
  
• "Over the 20-year period 1987 to 2006, hurricanes and tropical storms made up 46.3 percent of total catastrophe losses, followed by tornado losses (26.0 percent), winter storms (7.8 percent), terrorism (7.5 percent), earthquakes and other geologic events (6.4 percent), wind/hail/flood (3.1 percent) and fire (2.2 percent). Civil disorders, water damage and utility services disruption combined represented less than 1 percent. Each year about 6 percent of homeowners file claims." (III website)
• Changing Risk Profile
  
• "Financial losses from weather-related catastrophes have increased by an average of 2% per year since the 1970s, with climate change a contributing factor, according to the chief researcher of catastrophe modeler Risk Management Solutions Inc. The rate of loss increase holds true even when inflation, changes in wealth and population growth are taken into account, said Robert Muir-Wood, chief research officer of Newark, Calif.-based RMS" (Hoffman)
• "Risk Management Solutions says that insured losses in 2008 are likely to be 40 percent higher than the historical average for the Gulf Coast, Florida and the Southeast and 25-30 percent higher for the Mid-Atlantic and Northeast coastal regions" (III website)
  
• "RMS, one of the leading firms in catastrophe modelling, unveiled a completely revised model a few weeks ago. The firm says it thinks big hurricanes may hit America more often in the next five years. It has raised its projections of hurricane losses for Florida, the Gulf of Mexico region and the rest of the south-eastern United States by about 40%." (Economist "Price")
• "The hurricane season in the period 1995-2005 averaged 15 named storms per year, up from an average of 8.5 named storms from 1971-1994" (Viscusi and Born p. 4)
• "Seven of the 10 most expensive hurricanes in US history occurred in the 14 months from Aug. 2004 – Oct. 2005:
  Katrina, Rita, Wilma, Charley, Ivan, Frances & Jeanne [insured losses 2005$]" (Hartwig p. 9)
• "The impact of climate change is not clear, but is of growing concern. Some scientists have suggested that the series of major hurricanes that occurred in 2004 and 2005 might be partially attributable to the impact of a change in climate. There is a growing concern that global warming might lead to the occurrence of much more intense hurricanes hitting the coast over a shorter period of time" (UPenn)
• "Specific technical risks include the following: (i) Shortening times between loss events. (ii) Changing absolute and relative variability of losses. (iii) Changing structure of types of events. (iv) Shifting spatial distribution of events. (v) Damage functions that increase exponentially with weather intensity (e.g., wind damages rise with the cube of the speed). (vi) Abrupt or nonlinear changes in losses. (vii) Widespread geographical simultaneity of losses (e.g., from tidal surges arising from a broad die-off of protective coral reefs or disease outbreaks on multiple continents). (viii) More single events with multiple, correlated consequences." (Mills)
• Uncertainties / Doubts about Climate Change and Risk
  
• "the only hurricane to make landfall in the United States since 2005 was a Category 1 hurricane" (UPenn)
• Increasing losses from weather events also reflects population growth in at-risk areas and the rising value of at-risk property
  
• Need for Better Risk Modeling
• "In the United States, at least 7% of insurer bankruptcies are currently attributed to catastrophes" (Mills)
• "Lloyd's, London's big insurance market, issued a sober report on June 5th, arguing that the industry globally must reassess its underwriting, capital and pricing models to reflect climate change or risk “being swept away”. The sorts of catastrophe models Lloyd's is pushing are increasingly used by private insurers to help them determine which risks to cover, and at what price. Fitch notes that in 1992, before such models were widespread, ten insurers went bust as a result of Hurricane Andrew. Last year, despite the worst-ever catastrophe losses of any type (see chart), only three American insurers went out of business." (Economist "Price")
• "The evidence is consistent with insurers not fully anticipating catastrophes and being hit particularly hard by the major catastrophes that we term blockbuster catastrophes. Almost every phase of insurance operations is affected by the catastrophic risk. It is not surprising that both the losses incurred and loss ratios each rise in response to catastrophic events. What is interesting is that these natural disasters lead firms to alter their subsequent insurance rates, so that the loss ratios in the non-catastrophe years following a catastrophe are lower than they were before. In effect, the firms have updated the assessed risks of a catastrophe and addressed the rates that they charge to make writing insurance profitable in the presence of increased assessed risks." (Viscusi and Born p. 21)
• Insurance Opportunities from Climate Change
  
• "It is no surprise, then, that some of the biggest names in the business—firms such as Swiss Re, Munich Re, American International Group, Aviva and AXA—already offer an array of insurance products tied to climate change. These offerings include premium discounts for hybrid vehicles in countries including Ireland and Canada, coverage tailored to renewable energy projects. And insurance companies themselves are investing in financial products that tap into markets for tradable carbon-emission credits. Weather-derivatives contracts are meant to protect small farmers in Africa from food shortages and famines caused by drought." (Economist "Flood")
• New Areas of Insurance
  
• "New technologies emerging in response to climate change pressures, such as renewable energy assets, will require insurance." (ABI "Changing Climate")
  
• "Climate change may present new liabilities requiring insurance. For example, directors may be held responsible for the environmental impact of their businesses in future, requiring wider Directors & Officers cover." (ABI "Changing Climate")
• Managing Risk for Clean Development Mechanism (CDM) and Carbon-Trading Projects
• Climate Risk Management Services
  
• Alternative Risk Transfer Markets / Mechanisms
  
• "Alternative risk transfer markets are expanding, particularly in the USA, as customers seek cost effective ways to deal with their increasing weather exposures." (ABI "Changing Climate")
  
• "catastrophe bonds: these are financial contracts which pay out, not on proof of a loss to the insured, but on the fulfilment of a trigger condition, for example a Category-4 hurricane striking mainland USA. The benefit is that they are simple to administer, but they have proved expensive to set up. The capital is provided by investors, who receive a superior interest rate, but run the risk of losing their return, and even the capital in some contracts" (ABI "Changing")
  
• "The significant increase in reinsurance prices after the 2005 hurricane season in the U.S., along with more stringent criteria by rating agencies for providing protection against catastrophic risk, has led to historic records in catastrophe bond issuance and the development of a multi‐billion dollar market for other innovative financial instruments, such as industry loss warranties and sidecars. We provide up‐to‐date information on the evolution of this market. In 2006, twenty cat bonds were issued for $4.7 billion, compared with eleven issued in 2005, the previous record. In 2007 the total value of cat bonds issued for natural disasters alone was $7.1 billion. In 2006, a total of nineteen sidecar transactions were completed, providing over $4 billion of capacity to the insurance market; that volume decreased to $1.7 billion in 2007." (UPenn)
• "There is a need to expand catastrophe risk securitization, as it still represents a small proportion of the capital in the global insurance market today. We propose three complementary ways that could effectively trigger a much more significant volume of capital entering the insurance‐linked securities (ILS) market: (1) increasing the interest of a broader base of investors through risk tranching; (2) addressing the basis risk challenge through index‐based derivatives; and (3) developing new products such as those based on equity volatility dispersion" (UPenn)
• "The market in insurance-linked securities initially developed in response to insurers’ capital requirements in covering four traditional “peak” risks: windstorms in Europe, earthquakes in Japan, hurricanes in the US and earthquakes in California. After Hurricane Andrew in 1992 the price of catastrophe risk coverage rose considerably and coverage became increasingly scarce. Insurance-linked securities covering catastrophe – so-called “cat” bonds – provided additional capital to the insurance industry, helping it to manage catastrophe risk and prepare for the next major event. Presently, catastrophe bonds are issued to cover a range of non-peak risks, from Mexican earthquakes to floods in the United Kingdom. Subsequent transactions have further broadened insurance-linked securities. In January 2006, Swiss Re securitized US$ 252 million of credit risk linked to claims and reserves on its credit reinsurance business for underwriting years 2006 through 2008. Catastrophe securitizations – or mortality bonds – can also be used by insurers and reinsurers to hedge against the risk of increased death rates caused by a major global risk (such as a pandemic or a major terrorist attack). In all of these cases securitization improves the diversification of risk and, therefore, the risk-bearing capacity of the insurance system. As securitization grows more cost effective, insurers will be able to increasingly share cost benefits, contributing further to the risk transfer market." (WEF)
• Individual Firms (AIG, State Farm)
  

References

• "Climate Change No. 1 in Top 10 Risks Facing the Insurance Industry." 2008. Insurance Journal. <http://www.insurancejournal.com/news/national/2008/03/12/88138.htm>
  
• Dlugolecki, Andrew. 2004. "A Changing Climate for Insurance: A Summary Report for Chief Executives and Policy Makers." Prepared for the Association of British Insurers. <http://www.abi.org.uk/Display/File/Child/552/A_Changing_Climate_for_Insurance_2004.pdf>
  
• Hofmann, Mark A. 2007. "RMS Links Weather Losses, Climate Change." Business Insurance 41 (15): 20.
  
• Intergovernmental Panel on Climate Change (IPCC). 2007. "Contribution of Working Group II to the Fourth Assessment Report of the
  Intergovernmental Panel on Climate Change: Summary for Policymakers." <http://www.ipcc.ch/pdf/assessment-report/ar4/wg2/ar4-wg2-spm.pdf>
  
• Knabb, Richard D., Jamie R. Rhome, and Daniel P. Brown. 2006. "Tropical Cyclone Report: Hurricane Katrina." National Hurricane Center. <http://www.nhc.noaa.gov/pdf/TCR-AL122005_Katrina.pdf>
• Llewellyn, John. 2007. "The Business of Climate Change: Challenges and Opportunities." Lehman Brothers. <http://www.lehman.com/press/pdf_2007/TheBusinessOfClimateChange.pdf>
  
• Mills, Evan. 2005. "Insurance in a Climate of Change." Science 309 (5737): 1040-1044.
  
• "The Price of Sunshine." 2006. Economist. 8 Jun.
  
• Viscusi, W. Kip and Patricia Born. 2006. "The Catastrophic Effects of Natural Disasters on Insurance Markets." National Bureau of Economic Research Working Paper 12348. <http://www.nber.org/papers/w12348>
• Wharton Risk Management and Decision Processes Center. 2008. "Managing Large-Scale Risks in a New Era of Catastrophes: Insuring, Mitigating and Financing Recovery from Natural Disasters in the United States - Executive Summary." <http://opim.wharton.upenn.edu/risk/library/WHARTON-Managing_Large-Scale_Risks_(Exec_Summary).pdf>
• World Economic Forum. 2008. "Global Risks 2008: A Global Risk Network Report." <http://opim.wharton.upenn.edu/risk/downloads/WEF_Global_Risks_2008.pdf>
  

Other Potential Sources:

• Cat Bonds: http://gcportal.guycarp.com/portal/extranet/popup/insights/reportsPDF/2008/Cat%20Bond%202%2027.pdf
• Kovacs, P. 2006. “Hope for the Best and Prepare for the Worst: How
  Canada’s Insurers Stay a Step Ahead of Climate Change.” Policy Options,
  p. 53-56, December/January.
• Felsted, A. 2007. “Insurance: Managing the Risks of Climate Change
  Perils.” Financial Times. October 12, 2007.
• Green, M. 2006. “Preparing For the Worst.” Best’s Review,
  pp. 40-44, April.