Working Group II: Impacts, Adaptation and Vulnerability

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8.3.4. Adaptation

Insurance losses are paid out of premiums and from surplus (net assets). The ability to generate premiums and rebuild surpluses cannot be increased quickly in response to changes in the incidence of losses. In a developing country context, where insurance markets are nascent, this problem is particularly acute.

Insurers have many tools for reducing their financial vulnerability to losses (Mooney, 1998; Berz, 1999; Bruce et al., 1999; Unnewehr, 1999; III, 2000b). These tools include raising prices, nonrenewal of existing policies, cessation of writing new policies, limiting maximum losses claimable, paying for the depreciated value of damaged property instead of new-replacement value, or raising deductibles. The additional strategies of improved pricing and better claims-handling were reviewed in some detail in the SAR (Dlugolecki et al., 1996). Many adaptation strategies in use or under discussion make good sense for insurers irrespective of potential changes in the climate resulting from human activities (Sarewitz et al., 2000) (see Box 8-1).

Insurance prices exhibit sensitivity to disaster events (Paragon Reinsurance Risk Management Services, as cited in Klein, 1997; Edgecliffe-Johnson, 1999). Reinsurance prices rose by approximately 250% following Hurricane Andrew (see Section 15.2.7). Following the upsurge in catastrophe losses in 1999, the trend once again is toward upward pressure on prices (Mooney, 2000).

Following the period of (upward) price adjustments in response to a major natural disaster, however, insurers often enter or re-enter a battered market that offers substantial nonactuarially based discounts, resulting in inadequate prices for all players in the market (Matthews et al., 1999). Similar behavior has been observed among reinsurers (Stipp, 1997). Insurers also may reduce risk management efforts and incentives in the face of competitive pressures on prices. Competitive pressures can cause some insurers to assume greater risk to offer more attractive prices and products to consumers, through acquisitions of weakened companies and destabilizing growth rates (Matthews et al., 1999).

Favorable underwriting or investment experience may generate surpluses, but many legislatures do not permit insurers explicitly to fund pre-event catastrophe reserves to account for anticipated changes in climate and weather. Alternatively, insurers may try to raise more capital or reduce dividends paid to shareholders, but such actions will not be acceptable to financial markets if the risk-to-reward ratio is not competitive with that of other companies or sectors. The trend toward consolidation within the insurance sector is sometimes regarded as a factor that reduces insurer vulnerability to catastrophic losses.

Box 8-1. Co-Benefits that Are Relevant for the Insurance and Other Financial Services Sectors

Co-benefits are discussed elsewhere in the Third Assessment Report (TAR WGIII Chapters 3 and 8). Several adaptation mechanisms that are relevant to public and private disaster risk management possess important co-benefits, but these mechanisms are rarely accounted for in cost-effectiveness analyses. Though they normally are associated with mitigation (e.g., emissions reductions or enhanced carbon sinks), some also stand to enhance adaptive capacity or otherwise benefit insurers and other parties in the financial services sector (Sarewitz et al., 2000). Further research on this topic is merited.

  • Energy End-Use Efficiency. Various co-benefits pertaining to energy-efficient technologies have been documented (Mills and Rosenfeld, 1996; Vine et al., 1999, 2000; Changnon and Easterling, 2000; Zwirner, 2000; TAR WGIII Chapter 5). Improved insulation and equipment efficiency can reduce the vulnerability of structures to extreme temperature episodes and contribute to reduced greenhouse gas emissions. Other examples include linkages between public transit and reduced speed limits and improved highway safety (Unnewehr, 1999; TAR WGIII Chapter 9); energy-efficient ultraviolet water disinfection to conserve fuelwood and reduce deforestation (Gadgil et al., 1997); and emission reductions resulting in improved air quality and reduced respiratory disease (see Chapter 9).

  • Renewable Energy and Distributed Energy Systems. Certain renewable and distributed energy supply technologies have attributes that are relevant to risk management and disaster recovery (Mills, 1996, 1999; Mills and Knoepfel, 1997). For example, low-power/energy-efficient technologies can reduce business interruption risks by extending the reliability and operating range of backup power systems (Stauffer, 1995; Kats, 1998; Lecomte and Gahagan, 1998; Vine et al., 1999; Deering and Thornton, 2000). Substitution of biofuels for fossil fuels can yield improved air quality and reduced flood risk (IPCC, 2000; TAR WGIII Chapter 9).

  • Sustainable Forestry, Agriculture, and Wetlands Management. Enhancing organic soil content benefits crop insurance as well as contributing to improved water quality and food security. Sustainable forestry practices yield benefits of watershed management and flood/mudflow control, which are necessary foundations for establishing a modern economy (Scott, 1996; IFRC-RCS, 1999b; IPCC, 2000; Hamilton, 2000; see also Chapter 5). Wetlands restoration helps to protect against flooding and coastal erosion, although methane release from wetlands also must be considered (IPCC, 2000).

  • "Green" Financial Products. Initiatives such as innovative financing of energy-efficiency improvements, insurance products that promote better environmental management, or insurance for adaptation/mitigation projects under the U.N. Framework Convention on Climate Change (UNFCCC) can simultaneously support adaptation and mitigation objectives (Hugenschmidt and Janssen, 1999; Mills, 1999; UNEP, 1999; Zwirner, 2000). However, considerable business risk and liability may be associated with UNFCCC projects if measurement and verification are poor or issues of buyer/seller liability are not addressed by insurers in the drafting of insurance contracts
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