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Global warming, the challenge for the insurance sector

Finance Blogger: Anthony Harrington Anthony Harrington

The fear that our world will be subjected to increasingly violent weather events is one of the major drivers prompting the nations of the world to work together to mitigate the risks of climate change. That global warming will cause more violent storms and create havoc is also, of course, of major concern to the world’s insurance companies, who write billions of dollars of business in fire and flood insurance.

The challenges facing the sector form the subject of the QFINANCE contribution by Stephen Haddrill, director general of the Association of British Insurers, entitled Climate Change and Insurance.

Global leaders are even now preparing for the Copenhagen climate change conference in six weeks. To help their thinking, the UK Government published a global map on October 22nd, at the Science Museum, detailing the anticipated impact of a 4°C rise in global temperatures—something the UK Met Office said could happen by 2060 without urgent action to reduce global carbon emissions. The hope is that through action to cut emissions the world can limit the rise in  temperature to just 2°C.

Insurance companies, not surprisingly, are enthusiastic supporters of anything that lowers some of their major business risks. They are in the risk business, of course, but as any insurance practitioner will tell you, the industry is all about insuring against risk, not about compensating Joe Public or anyone else for losses that are absolutely certain to occur.  Put simply, they’ll insure your house against destruction by fire, but not if your roof is ablaze.

The sector’s challenge, with global warming, is trying to quantify what it means in terms of risk in specific areas. This topic is currently exercising a number of academics, including researchers at the London School of Economics. Writing in the LSE’s Risk and Regulation magazine, Michael Huber points out that one of the challenges in applying traditional risk metrics to climate change is that “the concept of risk is restricted by global warming not being a single event, but a bundle of partially unknown and unknowable effects.” As he puts it, “With the rising frequency of natural hazards, risk prediction tend to become less accurate and consequently, assessments of insurability less reliable.

One of the points Huber’s essay drives home is that what the Belgians call a “flood” (a water event that causes at least £930,000 worth of damage) is very different to what the US calls a flood (water damage to two or more neighbouring properties). As, if and when global warming starts to bite, studies like Huber’s suggest that we can expect the insurance sector to adjust its definitions and its view of risk according. We can also expect specialist providers within the sector to fine tune their view of specific risks in specific geographic areas. Plus the insurance sector is already widening the net to bring in other investors in the wider money markets to take some of its risk (much like a bookmaker laying off bets on the favourite, “just in case…”).

Tags: climate change , global warming , insurance , international differences , risk
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