Forecast: Can insurance cover the costs of climate change?

After several brutal hurricane seasons, the insurance industry is rethinking how it prices policies. Many see it as a sign that America is now grappling with the reality that global climate change is affecting the economy.

NEW YORK — The 2004 and 2005 seasons, which included Hurricane Katrina and multiple landfalls in Florida, set the insurance industry reeling.

The storms generated 5.6 million claims and insurance payouts of $81 billion. By comparison, losses from hurricanes during the previous two years were $2.2 billion.

“There was a guy in Zurich that you could call up the day after a major hurricane who could pretty accurately tell you what the losses for the company would be,” recalled Chris Walker, who at the time led the Greenhouse Gas Risk Solution Unit for Swiss Re, the world’s largest reinsurer. “He could look through the systems and see what we’ve insured in that region, see where the storm had gone, and pretty much guesstimate.”

“Where he was wrong this time is he didn’t factor in business interruption,” Walker said.

“The sheer magnitude of the devastation meant that the McDonald’s that was damaged, for instance, if everything else had been equal, the windows and roof could have been fixed within days," he said. "And it would have been operational. Now it had this extended inability to operate. Even if it was fixed, there were no customers. There were no sources for food.”

According to Chris Winans, vice president for media relations at the American International Group, the country’s largest insurance company, "the 2004 situation was four hurricanes in rapid succession hitting the same area." As a result, “you had a new risk factor being built in. It’s one thing to say how a hurricane damages a structure. It’s another thing to talk about how the second one right behind it re-damages it. At what stage are you at repairing from the first?”

To those in the industry who had been sweating the impact of global warming, the twin seasons seemed to confirm their worst fears. As early as 1992, the investor Warren Buffett had warned that “catastrophe insurers can’t simply extrapolate past experience.”

“If there is truly ‘global warming,’” he wrote, “the odds would shift, since tiny changes in atmospheric conditions can produce momentous changes in weather patterns.”

Weather-related losses had been accelerating at a rate of growth 10 times faster than premiums and the overall economy. From roughly $1 billion a year in 1970, they were reaching an average of $17 billion a year in 2003. Swiss Re keeps three climatologists on staff. In a report released just before the 2004 season, the company had predicted that another decade of global warming would hit insurers with between $30 billion and $40 billion in weather-related claims every year. And with Katrina, the industry was facing that from hurricanes alone. Had the future already arrived?

“The whole underpinning of what insurance is about is that the past is an accurate predictor of the future,” said Walker, now the North American director of the Climate Group, a coalition of businesses and government that works for action on global warming. “And if it’s no longer an accurate predictor — because climate has changed — then you’re in trouble.

“If it was a linear movement — one degree rise will equal one more storm — you could calculate and probably it would be an actuarial dream,” Walker continued. “But it’s not. In 2007, Florida had a major fire during the rainy season in every single county simultaneously. That’s pretty weird. I don’t think of Florida as being a dry place subject to forest fires. That’s out west. That’s California. I always say ‘climate change’ as opposed to ‘global warming.’ Because it’s going to be warmer some places. It’s going to be cooler some places. Some places will have more rain. Some less. If climate change changes the data that you’re relying on as an insurer, then how do you price? How do you model? And if you don’t price and model, are you only gambling?”

Droughts in Darfur and hurricanes along the Gulf Coast were all potential symptoms of a change sweeping the entire world, said Robert Muir-Wood, the chief research officer at RMS, a leading modeling firm. “There are some areas that appear to be completely immune at present, but it’s likely random which areas have been hit and which areas haven’t,” he said.

The rising rates all along the coast were simply a recognition of the increased risk.

“Our position is that we’re responding to the fact that activity is higher,” he said. “It’s not that climate change is out there in the future. It’s already happening. And the future will probably look a bit like this.”  

Forecast: The global consequences of climate change

Part 1: Why America Should Care
The Florida Keys are sinking
Can insurance cover the costs of climate change?
Who will be able to afford to live on the coast?

Part 2: The Spread of Disease
Pathogens find new habitats
Countries could backslide into poverty
How disease relates to carbon dioxide

Part 3: The Arctic Melt
Easier passage through the Arctic
A scramble for control of the Arctic
Opening the Arctic to damage

(Stephan Faris is the GlobalPost environment correspondent. Click here to buy his new book, "Forecast: The Consequences of Climate Change, from the Amazon to the Arctic, from Darfur to Napa Valley.")