Energy Efficiency: No-Regrets Climate Change Insurance for the Insurance Industry
Lawrence Berkeley National Laboratory

Summary

The worldwide insurance industry faces great financial risks from natural disasters caused by global climate change. Insured losses from extreme weather events with potential links to climate change, such as windstorms, drought, and floods, have been steadily rising; a twenty-fold increase in annual insured losses (inflation-adjusted dollars) from windstorm damage since the 1960s is a dramatic indicator of the growing threat to insurers. The insurance industry is becoming increasingly outspoken in its concern about global climate change, as evidenced by an industry-authored report for the Intergovernmental Panel on Climate Change (IPCC) Working Group II and a declaration signed at the United Nations by 58 insurance companies from 22 countries.

The insurance industry can take a reactive approach to mitigating climate-change risk by raising deductibles or withdrawing coverage. Alternatively, the industry can take a proactive approach by, for example, encouraging actions to reduce greenhouse-gas emissions.

Energy consumption is the largest contributor to global climate change, so promoting energy efficiency is a particularly promising strategy. Many energy-efficient technologies also have the potential to reduce ordinary insured losses involving property, health, or liability. This report illustrates 60 specific ways in which targeted energy-efficiency improvements can translate into reduced risk of insured losses. The measures can reduce losses from: fire, ice, wind, and water damage; temperature extremes; occupational injuries; poor indoor air quality; equipment performance problems; and uninsured drivers. These loss-reductions translate into benefits for a variety of insurance providers, including property-casualty, professional liability, health, life, workers' compensation, business interruption, and automobile.

The insurance industry could foster increased adoption of risk-reducing energy efficiency measures in the following ways:

Adopt uniform protocols for quantifying the risk-reducing aspects of energy-efficiency measures
Develop innovative insurance products that reward energy efficiency
Make buildings owned by insurance companies more energy-efficient
Foster improved energy efficiency and indoor air quality in the process of financing and purchasing buildings
Collaborate with energy regulators and other stakeholders
Participate in the research, development, and commercialization of new energy-efficient technologies and services

By supporting strategic energy-efficiency options, the insurance industry could reduce near-term business risks while making a considerable contribution to long-term reductions in greenhouse-gas emissions which also threaten their bottom line. This represents an attractive ñno-regretsî opportunity for the insurance industry, as the risk-reducing benefits would have distinct value irrespective of the timing or extent of damages related to global climate change.

Context

The world's 1.4-trillion-dollar insurance industry is increasingly concerned about financial risks from natural disasters precipitated by global climate change. Global climate models predict an increase in the frequency and magnitude of extreme weather events as so-called"greenhouse-gas" emissions rise. Windstorms, hurricanes, wildfires, and flooding cause some of the costliest insured losses. Between 1966 and 1987 there were no disasters with insured losses of over one billion 1990 U.S. dollars; between 1987 and 1992 there were fifteen.[1,2] Average annual insured losses from windstorms increased by twenty-fold between the 1960s and 1990s (Figure 1). The insured damage from Hurricane Andrew ran up to $16 billion, pushing seven insurance companies to insolvency and causing many others to reduce their exposure or leave the market altogether. Flooding of the Mississippi River in 1993 cost $10-20, billion; federal payments to farmers for drought-related damage in 1988 reached $4 billion. According to the Reinsurance Association of America, nearly 50% of the insured losses from natural catastrophes during the past 40 years have been incurred since 1990.

Figure 1. Note that insured losses represent an increasing portion of the total, in part due to demographic trends resulting in more concentration of property and populations in high-risk (e.g. coastal) areas and growing numbers of policy holders.

The aftermath of Hurricane Andrew illustrated the complex nature of losses caused by natural disasters. About 20% of insured economic losses were related to business interruption (40% in the case of Hurricane Hugo). Considerable property losses affected people who resided far from the site of the storm (e.g., midwestern boat owners vacationing in the Caribbean), thereby impacting insurance companies that initially assumed they would be unaffected by the hurricane. In the aftermath of Hurricane Andrew, homeowner insurance premiums rose by 72% in Florida.[3] Allstate insurance company moved to cancel 50,000 residential homeowner policies since 1992 and CIGNA Corporation stopped writing new policies in South Florida.[4] Multiple disasters of this magnitude over short periods of time or in more highly populated areas could bankrupt segments of the insurance industry.

In addition to windstorms, insurance companies are at risk from climate-change impacts such as drought-related agricultural losses and adverse impacts on human health. The primary classes of anticipated health impacts are: (1) mortality and morbidity related to heatwaves and increased urban air pollution, (2) re-emergence of serious vector-borne infectious diseases, (3) spread of water-borne diseases from hydrological extremes and elevated sea surface temperatures, (4) malnutrition from threatened food supply, and (5) general public health infrastructure damage from weather disasters and sea-level rise.[5] In a scenario of doubled atmospheric CO2 concentrations, the annual incidence of malaria could rise by 50-80 million cases per year.[6]

To the insurance industry, the absence of certainty about trends and consequences in global climate is not synonymous with the absence of risk.[7] However, the industry is familiar with acting to reduce risk even before full information about a risk is known, determining loss probabilities and associated costs and making business decisions based on those calculations. Recent writings and public statements by high-level insurance industry representatives indicate a growing consensus that human-induced climate change poses a strategic threat to their industry. The most prominent expression of concern is the Statement of Environmental Commitment by the Insurance Industry signed at the United Nations in 1995 by 58 insurance companies from 22 countries.[8] The industry has also articulated its concerns in a chapter prepared for the Intergovernmental Panel on Climate Change (IPCC)[9] and in formal statements made at the Berlin Climate Summit of April 1995.

It is notable that no U.S. insurance companies have as yet signed the U.N. statement. The reasons for this are not clear, but there are several possibilities.

In Europe it is currently more advantageous to public relations for a company to represent itself as"green" than is the case in the U.S.
European insurance companies have more scientists on staff and arguably have a better grasp of the climate-change problem.
In the U.S., most flood insurance is provided by the government, thereby insulating private companies from this particular kind of risk.
Lastly and probably most importantly, European companies have more exposure to climate-related losses because the largest reinsurance companies are headquartered there.

The insurance industry can address the risk of global climate change in many ways. For example, it can de-insure high-risk customers or increase deductibles. These strategies are already being used in high-risk regions of the world (e.g., flood and windstorm insurance is increasingly hard to come by). As will be discussed at length below, the industry can also adopt a proactive approach, combining actions that establish it as a"good citizen" in the environmental arena with actions that can yield reduced risk of losses as well as near-term profit for consumers.

Some insurance is provided by governments, e.g., flood insurance in the United States. Thus, governments should share many concerns about climate change currently being articulated by private insurance companies. Furthermore, governments can influence the insurance industry through regulation. For example, regulators could consider efforts to address climate-change issues when awarding quality ratings to insurance companies.

The Energy Connection

Energy use causes more than half of the greenhouse-gas emissions to which global climate change is attributed. As described below, a variety of energy-focused strategies can simultaneously foster a more sustainable energy system while reducing the near-term probability of insured losses involving property, health, or liability.[10]

There are two broad--and complementary--means of reducing the energy-related emissions of greenhouse gases. The first is to develop renewable, zero-emission energy sources. The second is to reduce the demand for energy at the point of end-use. Although much attention has been given to the potential strategic role of renewable energy for the insurance industry, increased end-use efficiency offers comparable if not greater near-term potential. Furthermore, increased end-use efficiency is generally less expensive per unit of energy saved than is an incremental unit of new energy supply (whether it is renewable or fossil-based). Thus, increased end-use efficiency investment is consistent with sound business practices. This exemplifies the"no-regrets" nature of many energy-efficiency options; that they have quick payback times and thus benefit the decision maker--beyond the possible long-term environmental benefits.[11]

In the United States, energy efficiency has resulted in approximately 30% less energy used since the oil crises of the 1970s.[12] In contrast, renewable energy supplies about 7% of all primary energy in the U.S. Nonetheless, both strategies are underutilized and have considerable potential internationally. To achieve maximum reductions in greenhouse-gas emissions, both renewable energy sources and end-use energy reduction must be pursued, with care to optimize the timing and mix of the two families of technologies.[13,14] The fundamental objective is to provide energy services at the lowest economic and environmental cost.[15]

In order to"mine" the energy-efficiency resources in the attics of homes, under the hoods of cars, and in the furnaces of industry, it is essential to understand where the energy goes. Each end use can also be described in terms of the carbon emissions associated with it. In Figure 2, for example, we see that lighting is responsible for 14% of carbon-dioxide emissions in the U.S. buildings sector.

Figure 2. Source: U.S. Congress, Office of Technology Assessment

Formal assessments show a technical potential on the order of 75% savings from increased energy efficiency, with a cost-effective, achievable potential of 25-50%. One of the most widely noted studies was conducted by the U.S. utility industry's own Electric Power Research Institute (EPRI). The study concluded that, by the year 2000, the U.S. could save 24-44% of total projected electricity demand.[16]

Decreased energy demand has a notable side benefit to the insurance industry of reducing risky activities such as those associated with offshore oil production facilities and oil-tanker trips. In an interesting analogy, the space-heating energy saved by one factory that puts energy-efficient "low-emissivity" coatings on window glass equals the amount of energy produced by a large offshore oil platform.

Table of Contents | Technologies that Reduce the Likelihood of Insured Losses while Increasing Energy Efficiency

Climate-Insurance Page