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Insurance and Other Financial Services

Insurance and Other Financial Services

The financial services sector defined as private and public institutions that offer insurance, banking, and asset management services is a unique qualitative indicator of the potential socioeconomic impacts of climate change because the sector is sensitive to climate change and offers an integrator of effects on other sectors. 

This assessment highlights insurance and other components of the financial services sector because they represent a risk-spreading mechanism through which the costs of weather-related events are distributed among other sectors and throughout society. 

The effects of natural and humaninduced climate change on the financial services sector are likely to become manifest primarily through changes in the spatial distribution, frequencies, and intensities of ordinary and catastrophic weather events. 

There is high confidence that c l imate change and anticipated changes in weather-related events that are perceived to be linked to climate change would increase actuarial uncertainty in risk assessment and thus in the functioning of insurance markets. 

The costs of ordinary and catastrophic weather events have exhibited a rapid upward trend in recent decades. Yearly global economic losses1 from catastrophic events increased from US$4 billion in the 1950s to US$40 billion yr-1 in the 1990s (all 1999 US$). 

Including events of all sizes increases these totals by approximately two-fold. The insured portion of these losses rose from a negligible level to US$9.2 billion annually during the same period, with a significantly higher insured fraction in industrialized countries. 

As a measure of increasing insurance industry vulnerability, the ratio of global property/ casualty insurance premiums to weather-related losses an important indicator of adaptive capacity fell by a factor of three between 1985 and 1999. 

Chapter 15 discusses insurance issues for North America in depth. The costs of weather events have risen rapidly despite significant and increasing efforts at fortifying infrastructure and enhancing disaster preparedness.

These efforts dampen the observed rise in loss costs to an unknown degree, although the literature attempting to separate natural from human driving forces has not quantified this effect. Demographic and socioeconomic trends are increasing society’s exposure to weather-related losses. 

Part of the observed upward trend in historical disaster losses is linked to socioeconomic factors such as population growth, increased wealth, and urbanization in vulnerable areas, and part is linked to climatic factors such as observed changes in precipitation, flooding, and drought events (e.g., see Section 8.2.2 and Chapter 10). 

Precise attribution is complex, and there are differences in the balance of these two causes by region and by type of event. Notably, the growth rate in the damage cost of non-weather-related and anthropogenic losses was one-third that of weather-related events for the period 1960–1999 (Munich Re, 2000). 

Many of the observed upward trends in weather-related losses are consistent with what would be expected under human-induced climate change. 

Recent history has shown that weather-related losses can stress insurance companies to the point of bankruptcies, elevated consumer prices, withdrawal of insurance coverage, and elevated demand for publicly funded compensation and relief. 

Increased uncertainty regarding the frequency, intensity, and/or spatial distribution of weather-related losses will increase the vulnerability of the insurance and government sectors and complicate adaptation efforts. 

The financial services sector as a whole is expected to be able to cope with the impacts of future climate change, although low-probability, high-impact events or multiple closely spaced events could severely affect parts of the sector. 

Trends toward increasing firm size, greater diversification, greater integration of insurance with other financial services, and improved tools to transfer risk all potentially contribute to this robustness. However, the property/casualty insurance and reinsurance s e gments have greater sensitivity, and small, specialized, or undiversified companies even run the risk of bankruptcy. 

The banking industry as a provider of loans may be vulnerable to climate change under some conditions and in some regions. However, in many cases the banking sector transfers its risk back to the insurers who often purchase debt products. 

Adaptation to climate change presents complex challenges, but it also presents opportunities to the sector. [It is worth noting that the term “mitigation” often is used in the insurance and financial services sectors in much the same way that the term “adaptation” is used in the climate research and policy communities.]

Regulatory involvement in pricing, tax treatment of reserves, and the (in)ability of firms to withdraw from at-risk markets are examples of factors that influence the resilience of the sector. Management of climate-related risk varies by country and region. 

Usually it is a mixture of commercial and public arrangements and self-insurance. In the face of climate change, the relative role of each can be expected to change. Some potential response options offer co-benefits (e.g., stemming from climate change mitigation opportunities), in addition to helping the sector adapt to climate changes. 

The effects of climate change in terms of loss of life, effects on investment, and effects on the economy are expected to be greatest in developing countries. Several countries experience impacts on their GDP as a consequence of natural disasters; damages have been as high as half of GDPin one case. 

Weather disasters set back development, particularly when funds are redirected from development projects to recovery projects. Equity issues and development constraints would arise if weather-related risks become uninsurable, prices increase, or availability becomes limited.

Increased uncertainty could c o nstrain the availability of insurance and investment funds and thus development. Conversely, more-extensive penetration of or access to insurance would increase the ability of developing countries to adapt to climate change. 

More widespread i n t r oduction of microfinancing schemes and development banking also could be an effective mechanism in helping developing countries and communities adapt. 

The need for financial resources for adaptation in developing countries is addressed in the United Nations Framework Convention on Climate Change (UNFCCC) and the Kyoto Protocol. However, development of financing arrangements and analysis of the role of the financial services sector in developed and developing countries still is a relatively u n e xplored area. 

This assessment of financial services identifies some areas of improved knowledge and has corroborated and further augmented conclusions reached in the Intergovernmental Panel on Climate Change’s Second Assessment Report (Dlugolecki et al., 1996).

It also highlights many areas in which greater understanding is needed in particular, improved knowledge of future patterns of extreme weather; better analysis of economic losses to determine their causation; exploration of financial resources involved in dealing with climate change damage and adaptation; evaluation of alternative methods to generate such resources; deeper investigation of the sector’s vulnerability and resilience to a range of extreme weather event scenarios; and more research into how the sector (private and public elements) could innovate to meet the potential increase in demand for adaptation funding in developed and developing countries, both to spread and to reduce risks from climate change.

and public institutions that offer insurance, disaster preparedness/ recovery, banking, and asset management services. 

Analysis of the financial services sector provides a unique opportunity to quantify the potential socioeconomic impacts of climate change and offers a barometer of effects on other sectors (including the government sector). 

The Intergovernmental Panel on Climate Change (IPCC) Third Assessment Report ( TAR) highlights insurance and other components of the financial services sector because they represent a risk-spreading mechanism through which the costs of weather-related events are distributed among other sectors and throughout society. 

The sector also is among the world’s largest and is captured less effectively in other parts of the TAR. The financial services sector also stands to play a central part in adaptation and mitigation activities and is a major source of global and regional data on the costs of weather-related events (Mills, 1996; Changnon et al., 2000; Kunreuther, 2000). 

This chapter is about the impact of climate change on the financial services sector, as well as the way this sector can adapt and help society to adapt to climate change. Still, little can be said about the total financial cost of adapting to climate change. 

Short-term effects are likely to be felt most through changing frequencies and intensities of ordinary and catastrophic weather events. 

The Second Assessment Report (SAR) chapter on financial services concluded that “within financial services the property insurance industry is most likely to be directly affected by climate change, since it is already vulnerable to variability in extreme weather events” (Dlugolecki et al., 1996).

Experience and analyses over the past 5 years has confirmed the trend of growing w e a t h e r-related damage costs since the 1950s (see Section 8.2). The vulnerability of and challenges for the insurance sector, private and public, are addressed in Section 8.3. 

Section 8.4 discusses the implications for other financial services, such as corporate, retail, and investment banking. There is evidence that the banking and insurance industries have become more aware of opportunities and threats with regard to climate change since the SAR. 

However, little information is available on climate change impact and adaptation implications for the banking sector. Climate change impacts are expected to be greatest in the developing world. There is only limited penetration of or access to insurance in these regions. 

This situation makes these regions more vulnerable and will impair their ability to adapt. Over the past few years, several multilateral organizations and banks have taken initiatives to develop new financial schemes for coping with natural disasters in developing countries.

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