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The Actuary The magazine of the Institute & Faculty of Actuaries
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Climate change: Transferring risk

At the recent climate summit in CancÚn, world leaders vowed to tackle global warming. At a time when public interest in the topic seems to be waning, their pledges are an important signal. The sooner the world acts to cut greenhouse gases, the better its chances of averting the worst impacts of climate change. Even if all nations agree to curb carbon emissions immediately, changes to our climate will continue to affect communities around the world. Without further adaptation measures, many will face far greater economic damage from climate change.

The mounting costs of climate change
The statistics are telling. Since 1970, insured losses from weather-related disasters have risen five-fold (1), from an annual average of US$5.1bn between 1970 and 1989 to US$27bn over the last two decades. In Europe, damage from storm surge could cost coastal communities along the North Sea (2) up to €2.6bn per year by the end of this century. That is an astounding increase from an annual average of €600m today.

Yet the most vulnerable and least equipped economies are in the developing world. In some developing countries, climate-related disasters could shave off up to 19% from annual national income by 2030, according to studies on the economics of climate adaptation (ECA) (3) in different parts of the world. The risks they face span from more frequent and severe storms, floods, droughts and other natural hazards to sea-level rise, crop failures and water shortages. In some cases, one single large disaster can set back years of development gains.

The case for preventive action
But amid all the gloomy estimates, the ECA studies also draw some very encouraging conclusions. Analyses conducted by the ECA working group (4) — a consortium of public and private partners — in locations ranging from Maharashtra in India to Florida and Northern England show that up to 68% of expected losses resulting from climate change can in fact be prevented through cost-effective initiatives. Measures include improved construction codes, better drainage and irrigation systems, flood barriers, vegetative buffer zones and information campaigns to raise catastrophe awareness. These provisions are not only affordable, but their economic benefits also far outweigh their implementation costs.

And yet, while cost-effective prevention measures are available in different locations, no society can afford to prevent losses from every conceivable risk event. This is especially true for risks that are unlikely to occur or that can only be averted at an enormous cost. For example, annual losses from hurricanes in southern Florida (5) are expected to reach a whopping US$33bn by 2030, equivalent to about 10% of the region’s entire GDP. While around 40% of the damage could be averted cost-effectively, 60% of potential losses remain virtually impossible to prevent in a cost-efficient manner.

The benefits of insurance
Some of the expected residual loss can be addressed through the kinds of risk transfer solutions that the insurance and reinsurance industry offers. Innovative insurance solutions, often involving partners from the public and private sectors, can provide a powerful means to protect societies against the financial consequences of a disaster before it strikes, making them more resilient in cases of emergency. By capping losses suffered by individuals, firms and governments, insurance not only secures the livelihoods of those affected by natural hazards, but also strengthens the willingness of decisionmakers to invest in economic development.

The UK may be better prepared to deal with climate risks than many other countries, but extreme weather has the potential to cause significant damage. When flooding struck the British Isles in the summer of 2007, for example, some 35,000 people in Hull were evacuated from their homes, and scores of houses, businesses and public buildings were damaged. Due to its coastal location at the confluence of two rivers, the city of Hull (6) is already under threat from freshwater flooding, wind storms and sea-level rise. Climate change is projected to heighten the risks even more.

For local officials, this means that while Hull will benefit from improved physical defences, securing the city’s regeneration path will require precautions against the full set of hazards and a range of possible climate change scenarios, even the most extreme. For disasters with a very low frequency, transferring risk to insurance and capital markets rather than directly preventing the expected loss is likely to be the most cost-effective component of the city’s local adaptation portfolio. These measures include improving insurance penetration of public buildings and expanding an existing City Council scheme to encourage tenants in public housing to take on personal household insurance.

The right mix of risk prevention and risk transfer measures
Synergies can be achieved through a co-ordinated balance between prevention and risk transfer. Insurance is an indispensable component of any adaptation strategy. However, it is equally important to keep insurance premiums under control by minimising residual risk through preventive measures. This dual approach reduces exposure to climate risks while at the same time ensuring that risk transfer options for less common but more severe disasters remain affordable. Reasonable insurance premiums then become a strong incentive to invest in preventive measures that promise to yield economic rewards.

Striking the right balance between loss prevention and risk transfer measures is a key challenge for those given the task of developing a risk management approach. In practice, collecting and analysing the data needed to make an informed choice requires a high degree of co-operation between the relevant public and privatesector entities. The appointment of a central figure to lead and co-ordinate these efforts could greatly facilitate the process.

The role of public-private partnerships
As a result of climate change, risks are becoming more complex and interconnected, and insurance against those risks is becoming more expensive and sometimes too costly. In those instances, public-private partnerships are the only way to provide adequate coverage against large natural disasters. Such partnerships have led to a number of innovative transactions (7). Among them are index-based weather solutions for farmers in Africa and India, catastrophe bonds in Mexico and parametric hurricane and earthquake covers in the Caribbean and the southern United States.

Many of these solutions can be redeployed in other regions of the world and adapted to their specific risk exposure. However, since no approach fits all circumstances, constant innovation is essential to protect local populations against the unpredictable effects of climate change. The specific resources and expertise that public and private institutions have can make an important contribution towards these efforts.

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1 www.swissre.com/rethinking/climate/Weathering_climate_change.html

2 www.swissre.com/rethinking/climate/the_effects_of_climate_change.html

3 www.swissre.com/rethinking/climate/
Strengthening_climate_resilience.html


4 www.swissre.com/rethinking/climate/shaping_
climate_resilient_development.html


5 www.swissre.com/rethinking/climate/Southern_Florida_USA
_Getting_a_hold_on_hurricane_risks.html


6 www.swissre.com/rethinking/climate/Hull_United_Kingdom_
A_holistic_approach_to_multiple_hazards.html


7 www.swissre.com/rethinking/
Innovative_risk_transfer_solutions_for_more_resilient_societies.html


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David Bresch is director of sustainability and emerging risk management at Swiss Re