Climate change and increased risk for the insuranc

Authors: W J W Botzen J C J M van den Bergh L M Bouwer

Publish Date: 2009/05/08

Volume: 52, Issue: 3, Pages: 577-598

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Abstract

Climate change is projected to increase the frequency and severity of extreme weather events As a consequence economic losses caused by natural catastrophes could increase significantly This will have considerable consequences for the insurance sector On the one hand increased risk from weather extremes requires assessing expected changes in damage and including adequate climate change projections in risk management On the other hand climate change can also bring new business opportunities for insurers This paper gives an overview of the consequences of climate change for the insurance sector and discusses several strategies to cope with and adapt to increased risks The particular focus is on the Dutch insurance sector as the Netherlands is extremely vulnerable to climate change especially with regard to extreme precipitation and flooding Current risk sharing arrangements for weather risks are examined while potential new business opportunities adaptation strategies and public–private partnerships are identifiedWeatherrelated catastrophe losses have been significant in the last decade posing considerable challenges to the insurance industry worldwide For example in the last decade 1996–2005 the United States experienced the second most damaging hurricane season1 of the past century in terms of damage that has been normalized for inflation and wealth Only the decade 1926–1935 suffered higher damage costs due to hurricanes Pielke et al 2008 Weatherrelated losses in Europe have been considerable as well The flooding in Germany during 2002 caused losses of about € 92 billion Munich Re 20022 England experienced two major flood events in the summer of 2007 caused by extreme precipitation Overall economic losses amounted to about four billion dollars per event of which three billion was insured The extent of economic losses suffered highlights the vulnerability of modern societies to climate extremesIt is projected by the Intergovernmental Panel on Climate Change IPCC that climate change may increase the frequency and severity of weather extremes such as extreme precipitation tropical cyclones and heat waves in certain regions The effects of climate change on other smallscale extreme weather phenomena such as lightning and hailstorms remain uncertain IPCC 2007 The potential of global warming to increase vulnerability to weather extremes is especially relevant for the insurance sector Vellinga et al 2001 The insurance industry is the world’s largest industry in terms of revenues and insurers bear a large portion of weatherrelated risks such as damage caused by floods and storms Mills 2007A study of five out of ten of the largest liability insurers and three additional insurers3 in the Netherlands concludes that climate change is not regarded as a worrisome issue de Rooij and van den Bergh 2005 Insurers argue that adjustments of premiums and levels of coverage are sufficient to accommodate changes in loss patterns Indeed the flexible nature of the industry characterized by mostly shortterm contracts which allow for fairly quick adjustment of premiums seems to assure its resilience against climate change Nevertheless the lack of concern may turn out problematic if it means that increased loss exposures are insufficiently and with considerable delay incorporated in premiums and risk management practices Adjusting premiums based on experiences of past claims may insufficiently reflect changes in the probability of extreme weather events due to their low probability natureThe relevance of weather risks for the insurance sector becomes evident by observing past trends in insured and other economic natural catastrophe losses Data of past natural catastrophe losses collected by Munich Re 2006 indicate that increased global trends in losses can already be observed The main factor behind this rise in losses has been societal change Continued economic growth economic development and population growth notably in vulnerable regions eg coastal zones combined with rapid and extreme climate change is likely to accelerate and magnify the tempo and extent of damages The influence of climate change on trends in catastrophe losses is likely to be profound since a large change in weather extremes can be expected due to a change in mean climate conditions Dlugolecki 2006 The best strategy for insurers seems to incorporate expected changes in probabilities of weather extremes in assessing exposure to and pricing and management of risk Projected changes in probabilities of extreme weather events can be obtained from regional climate models from which the Royal Dutch Meteorological Institute KNMI has developed climate scenarios for the Netherlands van den Hurk et al 2006 A clear need for adaptation measures exists to reduce risk exposure given the historical emissions of greenhouse gasses and their subsequent effect on radiative forcing in the future Pielke et al 2007 Moreover societal developments such as increased economic development in vulnerable areas eg coastal zones necessitate the undertaking of risk reduction policies in order to guarantee insurability of weather risks In addition to commonly used traditional measures to limit risks such as increasing premiums and limiting coverage the insurance sector could play an important role in stimulating and promoting climate change mitigation and adaptation policies Mills 2007Climate change projections for the Netherlands mainly indicate an increase in risk of extreme weather events van den Hurk et al 2006 Nevertheless the consequences of climate change for insurers are not only negative For example the probability of frost may decline in the future which could decrease claims on certain crop insurance policies Climate change can further present new profitable business opportunities Insurance demand for currently nonexisting insurance markets can increase in the future when economic losses of weather risks increase Botzen and van den Bergh 2009 However problems with insurability of weather risks may hamper the development of markets due to the correlated nature of these risks and the uncertainty associated with the likelihood and impact of extreme weather events Kunreuther and MichelKerjan 2007 Because of these difficulties recently public–private partnerships have been proposed to insure catastrophe losses in the USA eg Kunreuther 2006 Kunreuther and Pauly 2006 and flood risks in the Netherlands Botzen and van den Bergh 2008 Such partnerships may also be promising solutions for meeting demand to compensate weather related damages that are currently not covered by private insurance such as drought risk for the Dutch agriculture sectorThis paper will examine the current distribution of weather risks between the public and insurance sectors in the Netherlands and explores how these risks may be affected by climate change The analysis will address a wide range of weather events such as extreme precipitation and floods windstorms extreme drought and hailstorms Observed changes in climate and climate change projections for the Netherlands will be taken as a starting point Furthermore the consequences of climate change for the insurance sector are assessed and alternative arrangements are explored while several strategies the insurance sector can adopt to deal with increasing risks are investigatedThe remainder of this paper is structured as follows Sect 2 highlights the relevance of climate change for the global insurance sector and provides insight into historical developments of catastrophe losses globally Sect 3 presents both observed and projected changes in climate for the Netherlands This serves as the basis for Sect 4 which examines the effects of climate change for current risk sharing arrangements in the Netherlands Subsequently Sect 5 identifies several strategies for insurers and the government to deal with increased risks Finally Sect 6 concludes

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