Admittedly, there’s a lot more interest in the legal climate around insurance than the climate itself; but, that’s what some think the legal issues of the future will be about; so here’s a quick look at the current discussions.
After Hurricanes Dennis, Katrina, Rita, and Wilma, insurance companies are withdrawing from coastal markets in the United States. They fear the financially disastrous combination of severe weather trends with population growth in urban areas. One recent news report stated, “Some believe the two are creating a risk of losses so large that insurers could be pushed to the breaking point…”.
The industry has three primary methods of responding to “excessive” risk: by raising prices for what it sells; by withdrawing from product lines and markets; and by changing the financial, legal, organizational, and political practices of the industry. All three serve to protect the bottom line of insurers but may or may not serve a wider public interest.
Insurers often withdraw from a particular geographic or product market, either temporarily or permanently, when losses are too high. This leaves people and property without any recourse in a disaster except to draw on the public treasury. In coastal areas of the United States, state-backed insurance plans are being overwhelmed by new applications.
When one person loses their house and has no insurance, they must dig into their own personal resources to rebuild. But when thousands of people lose their houses in a disaster, then government must step in to provide the resources to rebuild entire communities. Insurers may raise their prices to recover from severe losses and rebuild their own reserves, but this will drive people away from purchasing insurance. Again, the gap in coverage may need to be filled by public spending.
Alternatively, insurers may pursue legal and organizational changes to limit their own losses, for instance, by shifting financial risk to other institutions, or redefining and litigating contract terms to put a bottom line beneath industry losses. In the case of environmental pollution, many insurers sought to limit their legal liability in order to avoid paying certain claims from decades-old contracts, though in most cases in the United States they lost in court.
Finally, insurers may design contract terms that provide incentives for customers to change their behavior in a way that limits the potential for losses and reduces moral hazard. For instance, the price (premium) for fire insurance will be lower for people who do not smoke cigarettes or who install smoke detectors.
All three responses are in play with regard to climate change risk, but only the last one provides a mechanism to reduce or prevent climate change itself instead of responding to its effects. Yet, for reasons that will be discussed below, the latter option is the one that has the least amount of support within the industry so far.
State insurance commissioners are leading the discussion – no doubt intended to demonstrate the strength of the current state-based regulatory system.
Insurers argued strenuously against revealing their internal efforts to address climate last week, saying the science is too vague, criticizing regulators for overstepping their role and claiming that the plan is powered by environmentalist crusaders.
The backlash came as a core group of regulators coalesced around a draft of nine disclosures that appears to be heading for adoption in September by the National Association of Insurance Commissioners. It would mark the first time U.S. insurers would face mandatory requirements to reveal their plans for potentially stronger hurricanes, more floods and frequent wildfires.
Industry representatives are wary of the plan, saying it could reveal business strategies to competitors and spur lawsuits when insurers miscalculate storm damage. One critic accused regulators of abetting environmental groups, which he said are pursuing a political campaign to “coerce” what is believed to be the world’s largest industry into advancing the notion of human-induced climate change.
- some are irate over what they see as a political stunt designed to “‘coerce’ what is believed to be the world’s largest industry into advancing the notion of human-induced climate change”;
- some are concerned that they would have to divulge proprietary or anticompetitive information;
- some fear their disclosures could be used against them in lawsuits; and
- some believe not enough is known about the effects of climate change to justify some of the questions.
The insurance industry is in a bind. More than any other segment of commerce, insurance companies understand the importance of assessing risk. Head in sand is hardly prudent risk management. They were among the first to warn of the dangers of ignoring potential global warming risks. So they feel impelled not to be seen dragging their feet. But in many ways, they mirror the range of beliefs across society at large, from abject deniers, to minimalists, to true believers that, as one put it, “This is not one risk among many, but really the pre-eminent risk facing the industry.”
NAIC representatives assert they have an obligation to protect consumers by taking steps to ensure that insurers are able to pay “rising claims related to violent weather.” The regulators will vote in September whether to propound the questions and have indicated they are willing to modify the questionnaire, broadening some questions to avoid specific disclosures of proprietary or competitively sensitive information and allowing some answers to be submitted confidentially.