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Climate Change Causes Insurers to Rethink Price of Risk After Hurricane Sandy

November 21, 2012 at 12:00 AM EDT
The insurance industry looks at historical data, old and new, in order to assess the risk for potential disasters and put a price on premiums. But when Sandy hit the Northeast, some insurance companies reconsidered if they priced insurance high enough for the greater risks brought on by climate change. Paul Solman reports.

JEFFREY BROWN: And next, we continue our coverage on the impact of superstorm Sandy — tonight, lessons being learned and how insurers are preparing for the future.

NewsHour economics correspondent Paul Solman has the story. It’s part of his ongoing reporting Making Sense of financial news.

PAUL SOLMAN: Manhattan’s totally unprepared South Street Seaport sustained some portion of the $50 billion in losses from Sandy, only $20 billion or so insured, a shock to most folks, but not to the insurance industry.

ROBERT HARTWIG, Insurance Information Institute: Unfortunately, these are not “once in a blue moon” events any more.

PAUL SOLMAN: Bob Hartwig of the Insurance Information Institute at Red, his favorite local eating hole, a real hole now, even its inventory down the drain.

ROBERT HARTWIG: We are seeing an increased frequency in the number of natural disasters, roughly tripled or quadrupled since 1980, and the costs have doubled, tripled and quadrupled as well.

PAUL SOLMAN: So, is extreme weather here to stay? And if so, have insurers priced the new level of risk into their policies?

No, says Mindy Lubber, president of Ceres, an environmental advocacy group. And she blames the new risk on global warming.

MINDY LUBBER, Ceres: Climate change is our new normal. We’re seeing more increased storms everywhere, all across the country. It is costing us tens and tens of billions of dollars, $32 billion to the insurance sector last year.

But last year, when we surveyed 88 insurance companies and asked them, do you have climate policies in place, are you acting on climate, 11 out of 88 companies had a plan to address climate risks to their bottom line.

PAUL SOLMAN: The rest didn’t. So, what is the industry’s comeback?

ROBERT HARTWIG: All insurance companies are paying very careful attention to the variability and the volatility in the climate.

You can have a big debate about what the cause of that is. But insurers use all the information at their disposal in order to ascertain the risk, measure that risk in a very scientific manner, and then assign a price to that risk.

PAUL SOLMAN: A higher price, presumably, to compensate for the greater risk. But for most primary insurers, the weather risk has now become so high, they have simply stopped writing flood insurance. So, government had to step in and is now on the hook for more than a trillion dollars in potential damages.

Re-insurers, however, are still in the game too.

ERIC SMITH, Swiss Re Americas: There’s very few things that you could ask me about that we don’t already re-insure.

PAUL SOLMAN: Eric Smith heads the Americas division of Swiss Re.

ERIC SMITH: Re-insurance is about all forms of risk, whether it’s health, or life, or your home, or your property.

The math behind it works the most effectively if you can spread the risk around the globe in all sorts of different forms.

PAUL SOLMAN: Primary insurance companies buy their own insurance, re-insurance, from huge firms like Swiss Re, which, because of their size, can afford the fullest data, plug in into the most sophisticated risk models. And doing just that, Swiss Re actually warned us of an East Coast storm like Sandy back in 2006.

After Hurricane Katrina, Swiss Re’s head of catastrophe perils, Andy Castaldi, worried aloud about warming seas and more violent storms in the Gulf, but, he told us:

ANDREW CASTALDI, Swiss Re: I’m also concerned about the New York Bay and Long Island that would be inundated by a flood due to a Category 3 storm. A storm surge could completely flood the airport at JFK. And 13 feet of seawater is not out of — or up to 17 feet is not out of the question.

PAUL SOLMAN: We interviewed Castaldi again last week, after Sandy.

So the blue is Sandy’s storm surge.

ANDY CASTALDI: That’s right. That’s the footprint of the storm surge that was produced by the superstorm Sandy. As you can see, in the center of the screen is JohnF.KennedyAirport.

And now I’m going to toggle back to the coastal flood map that we had prior to the storm, and you can see just about the same areas as the Sandy footprint we knew was exposed to a storm surge.

PAUL SOLMAN: Six years ago, you said that you thought that climate change was a major factor in recent storm activity. Do you think that more today?

ANDY CASTALDI: I can’t really attribute Sandy to climate change. It could be within the normal variability of these types of storms, but I do know that climate change is occurring. And it is starting to exaggerate some of the hazards. Most notably in this area is sea level rise.

And as the sea level rises, it stands to reason that the next storm will produce a larger storm surge, just because it has more water and the water is higher than ever before.

PAUL SOLMAN: And because more people and property at risk.

We were at the long-ago-named Water Street, for example, from here to the East River these days, landfill.

ERIC SMITH: For most of the time these storms came through, no one lived here, or very few people lived here. Now we have millions of people concentrated in — for instance, in the New York area. We have tons of infrastructure. We have important business assets that are exposed, and that’s what’s different.

PAUL SOLMAN: Yes, says Mindy Lubber, and therefore insurance companies should raise their premiums to signal the rising dangers.

MINDY LUBBER: Insurance companies could also impact all of our behavior by the way they price products. They might say the following. If you are going to build a building, and you want us to insure it, you have got to build it in a way that it’s prepared to deal with storm damage or climate-related risk.

PAUL SOLMAN: So we put the question to Castaldi of Swiss Re, a European firm known as a climate change leader.

Is climate change in this model you’re showing us?

ANDY CASTALDI: The way we build our models is that they’re based on historical data. We typically focus on the last 100 years because the data was better. If these storms are becoming more frequent and more severe, they get incorporated into our models.

PAUL SOLMAN: But Lubber thinks that’s not enough.

MINDY LUBBER: The insurance industry often develops prices and risk models based on what happened last year and the year before. And obviously we have some good data from the last couple of years.

But they also have to look at what science is telling us, that we’re going to see consistent storms happening more and more all across the country and the world and more intensely.

PAUL SOLMAN: To Castaldi, however, that would be premature.

ANDY CASTALDI: We do believe climate change is a real threat, a real risk to us, but, at this point in time, there’s not enough conclusive scientific evidence to really encourage us to make those type of changes.

PAUL SOLMAN: Even so, Swiss Re has been especially vocal about the threat of climate change. Eric Smith explained why primary insurers aren’t doing as much on the issue as re-insurers like Swiss Re.

ERIC SMITH: Climate change is still a bit of a controversial issue, especially in the U.S. And, you know, they are a business that serves consumers. They serve millions of consumers, so they have to be very sensitive to public opinion.

And public opinion is still a little bit split. So, with climate change, how quickly will it happen? And how accurate — how accurate can we be with the change each year over year?

And I think most people would argue that it’s going to be more subtle. And so for an insurance company to try to factor that in and charge people, that would be a hard position to justify.

PAUL SOLMAN: A hard position, perhaps. But if climate change is causing more extreme weather, as most experts think, it’s a position that even the most skeptical of insurance companies may be taking soon enough.