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The Actuary The magazine of the Institute & Faculty of Actuaries

Global warming and insurance products

Global warming is considered to be one of the major issues facing the human race in the 21st century. This article considers how global warming is affecting the insurance industry and whether it will change or create new markets.
Disasters inevitably create new products World War II created the bouncing bomb, the Boxing Day tsunami created tsunami warning systems in the Indian Ocean, catastrophe models were created after hurricane Andrew, and all-seater football stadiums were created after the Hillsborough disaster. The 9/11 disaster created a new market for the insurance industry US terrorism insurance. Will global warming have the same effect?

Things are heating up
The introduction of innovative green products to the insurance market is an indicator that the industry has recognised that new products can be developed as a response to demand caused by climate change worries. However, one would be naïve to assume that insurance companies would introduce products that would be beneficial for the environment but that are not profit-generating. Opposition to the new products and schemes would question whether they are actually green, or just products and schemes that appear to be green but that benefit the insurer more than the environment.
Pay-as-you-drive insurance is an insurance product that has been introduced which has been marketed as a green product. Pay-as-you-drive uses the latest global positioning system technology to calculate monthly insurance premiums based upon the habits of the consumer. The insurance cover can be considered beneficial for the environment from an ecological perspective. Pay-as-you-drive insurance may act as a disincentive and force drivers to reconsider unnecessary journeys, reducing the total level of emissions. However, drivers’ responses during UK petrol shortages illustrates how dependent drivers actually are on their vehicles and it is an evidential indicator that a change in premiums to pay-as-you-drive insurance alone will not change driving habits. Analysing the situation from the perspective of the insurer, risk mitigation is improved. The more you drive the greater the risk of damage, but this risk is backed by a greater premium.
Alongside new products, several new carbon-neutral schemes have been introduced by insurance companies. The mangrove reforestation project appears to be a goodwill gesture to the environment and several insurance companies have been entering into the scheme. The role that mangroves play in sequestering carbon dioxide, one of the primary gases responsible for global warming, has given insurance companies the chance to offset their emissions through planting mangroves in tropical regions. From one perspective it is a proactive way of raising environmental awareness. Moreover, carbon emissions are offset by the mangroves but this only defers the problem of global warming. Analysing the scheme in more detail reveals that it is in fact motivated by risk mitigation, and not by the environment. Mangroves played an important role in acting as a wave break against the Boxing Day tsunami, protecting many buildings from destruction. Strategically planting the mangroves in areas which are at risk from being hit by a tsunami could actually be a risk mitigation tool because the number of claims would be reduced if such a catastrophe occurred again. Therefore, one could argue that while the mangrove reforestation project is beneficial to the environment, it is in fact a risk mitigation tool.
Although profit is an influential motive for the introduction of new products it appears that green-labelled products are simply new risk mitigation tools for insurance companies. This is not always the case. For example, in November 2006, the first certified green building replacement and upgrade coverage was introduced. This is a new type of insurance coverage whereby if your home burns down it is rebuilt using products that are good for the environment. This is helping to build environmentally friendly buildings that are more dependent on renewable resources. It is contributing to the carbon-neutral utopia that we are warned has to exist. Is this product really green without being a new risk mitigation tool? You could argue with the sceptical view that the level of emissions from the property burning down is offset by replacing it with an eco-friendly building. Improving current properties may actually have a lower yield of emissions in comparison to rebuilding a green property.

The future
The impact of climate change has the potential to affect all segments of the insurance industry. Vulnerabilities include damages to property, pollution-related liabilities, business interruptions, supply-chain disruptions, and a spectrum of life and health consequences. Moreover, regulatory risks can also be expected to arise from disputes over pricing. It may be possible that, in the future, insurers could face litigation under the Sarbanes-Oxley Act for not adequately disclosing their own exposures to climate change. The ever-changing environment is creating opportunities for insurers, but how will the industry respond?