May 25th, 2009

Climate Change, Part I: A Contested Point You Need to Understand

Posted at 1:00 AM ET

klein_chris_bioChristopher Klein, Head of Global Business Intelligence

Climate change is happening. Or is it? It is caused by human action. Or is it? The arguments are bantered back and forth in a crossfire of disagreement over an issue that holds political, social, and emotional significance around the world. For every position there are sympathetic experts willing to present supporting evidence, which, in turn, is inevitably skewered by those holding a contrary view.

In danger of being lost in the heat of this postulation, however, is a critical issue that could significantly affect the (re)insurance industry. Carriers need not take a side to consider climate change from a risk-assessment perspective, free from political baggage. Indeed, they should not wait for a resolution to form before they take action.

The presence of the probability of loss is incontestable, even if the underlying issue of climate change is debatable. The chance of both expensive and expansive losses resulting from climate change can be factored into the calculation of risk. That potential ought to be understood by the prudent (re)insurer.

Lessons in the Debate

Three fundamental positions characterize the debate on climate change. Some firmly believe that this phenomenon does not exist. Others acknowledge that climate change is, in fact, occurring, but believe that it is both natural and unstoppable. The third position holds that climate change exists primarily as the result of human activity (e.g., via carbon emissions) and may be slowed through changes in behavior — from the micro (e.g., limiting personal energy consumption) to the macro (e.g., the formation of national and international energy policy).

The debate between these factions has led to more than fierce fighting. Research and insight into the potential losses linked to climate change present important considerations for (re)insurers. The results are rich in that actuarial gem: probability. For example, a recent report offers probabilities on specific events, such as the chances that the Greenland ice sheet could melt — which could raise seas levels by 23 feet in the extreme — or the el NiƱo effect becomes permanent - which could change rainfalls and temperatures. Another academic group created probability wheels that depict the chance of particular temperature changes during the next century, with and without the implementation of policy to reduce greenhouse gas emissions.

Collected data has also revealed an increase in storm landfall, frequency, and severity. Other potential hazards remain unexplored, such as variations in intense rainfall and flooding, winter freeze, intense wintertime low pressure systems, hail storms, and extreme temperatures. The chance of these perils occurring makes the issue of climate change’s likelihood a critical part of risk management decisions. And beyond the property damage and loss of life that could affect the (re)insurance industry, blame for climate change is a liability already on the table, as climate change lawsuits make their way through the court systems — and resolve in significant settlements.

Take a Stance on Risk

Skepticism may be cast on research results and methodology, but although the debate on climate change is nowhere near a resolution, the potential risk to (re)insurers is real enough to be calculated. Regardless of an individual or organizational stance, the (re)insurance industry relies on the power of probability, and the issue of climate change is rife with material on which to base the necessary actuarial assumptions, modeling, and risk management decision-making. A closer look at the issue, its potential repercussions, and the numbers behind it will enable more informed business decisions and better management of that potential risk.

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