Contemporary Risk Management and Climate Change - Essay Example

Running Head: RISK MANAGEMENT Risk Management: Change in Climate of the of the Risk Management: Change in Climate Global warming and global climate change are critical environmental issues with major implications for the risk management and insurance industry. The debate over whether global warming is happening and whether it is being caused by human activity has largely been resolved. The debate over the potential effects of global warming and how to respond to global warming is very much alive. A wide variety of risk issues, including property, liability, environmental, regulatory, and reputational risk, is raised by global warming/climate change. The scope of these issues is international—indeed global warming/climate change may be the most international of all environmental risk problems. Many of these issues have direct implications for the risk management and insurance industry. Global Warming Global warming refers to the gradual warming of the earth’s atmosphere that has been documented over the last 150 years. Global warming can result from natural fluctuations in climate or can be induced by human causes. There had been considerable debate as to whether human activity in producing increased emissions and concentrations of greenhouse gases has been associated with the global warming trend. Greenhouse gases effectively trap the heat in the atmosphere. Greenhouse gases, principally CO2, but also ozone, methane, and nitrous oxide, are produced by burning fossil fuels like oil, coal, and natural gas. Energy producers, automobile users, manufacturers, and households all burn fossil fuels and produce greenhouse gas emissions. Positive Effects of Global Warming The rising concentrations of CO2 that are causing global warming principally come from energy production, factories, homes, automobiles, and deforestation. Rising CO2 concentrations are a symptom of expanding economies, jobs, and standards of living. Indeed these economic benefits form the most frequently sited argument for resisting the Kyoto Treaty and other control techniques. For instance, President Bush stated in rejecting the Kyoto Treaty that it would “have a negative economic impact, with layoffs of workers and price increases for consumers” (Sanger, 2005, 24). Some studies have indicated that agriculture and forestry will actually improve from global warming. For instance, the NAST report finds that U.S. crop productivity is very likely to increase over the next few decades because of global warming. While benefiting consumers, falling crop prices and competitive pressures are likely to stress some farmers. The NAST report also found that forest productivity is likely to increase over the next several decades as trees respond to higher carbon dioxide levels. Milder winters should also reduce cold-related stresses in some areas (NAST, 2004, Press). Climate Change Risks A key question involves whether global warming is causing and will cause significant climate change in the future. Of particular concern to the risk and insurance industry is the increased frequency and severity of natural disasters. Munich Reinsurance Company reports that over the last 50 years, the number of weather-related natural disasters has been steadily rising, as have total losses and insured losses (Munich Re, 2003, 4; Mills, Lecomte, and Peara, 2005, 44). In the last seven years, the United States (August ’92 hurricane), Poland (July ’97 river floods), Canada (January ’98 ice storm), Australia (April ’99 hailstorm), and France (December ’99 windstorms) have all suffered record losses from weather events (Dlugolecki, 2003, 17). Sea ice has been shrinking over the past 40 years (Lazaroff, 2005, 21), glaciers are receding (Arendt, et. al., 2004, 18), and ice stays on lakes for shorter periods of time (Magnuson, et. al., 2004, 54). While shrinking ice amounts seem to naturally flow from global warming, the connection to increasing storm levels is not so certain. The normalized insured hurricane damages adjusted actual damages to reflect inflation, housing density, wealth, and wind insurance coverage. Of these variables, the long-term increase in housing density near the coast emerged as the most important factor. Increasing coastal housing density was particularly found in Florida and it expected to continue for at least another 25 years. Ironically, coastal housing density has actually been facilitated by subsidies inherent in both the Federal Flood Insurance Program and Federal Disaster Assistance Benefits (see Anderson, 2005, 44). Based on Collins’ research, increased insured hurricane damages to date are being principally caused by increasing coastal housing density and not increasing hurricane frequency and severity. On the other hand, if hurricane frequency and severity were to increase in the future, increasing coastal housing density will magnify insured damages. The NAST report estimates that over the twenty-first century, the amount of global rainfall is likely to rise; that the observed trends toward an intensification of precipitation events are likely to continue; that peak wind speed and rainfall intensity from hurricanes are likely to rise significantly; and that sea levels are projected to increase 5 to 37 inches (13-95 cm) with a central estimate about 20 inches (50 cm) (NAST, 2004, Press). Increasing sea levels will magnify storm surge. Increasing storm intensity is particularly troublesome as the resulting damages are nonlinear; increasing the speed of a 200 kpm storm by 10 percent increases the damages by 150 percent (Dlugolecki, 2003, 20). Property insurers, catastrophe reinsurers, and risk managers and individuals with properties in vulnerable locations will need to be alert to the potential of increasing storm and flood damages. The risks of global warming include the possibility of fundamentally altering the ecosystem, which supports all living beings. It is extremely difficult to predict adverse consequences that may be irreversible and uncontrollable. A frequently cited example is the possible breakdown or southward shift of the North Atlantic circulation from the sudden influx of fresh water from melting ice caps. This could fundamentally change the moderate climate of Europe, Great Britain, and Norway, produced by the warm tropical waters of the Gulf Stream (Kron, 2004, 5). Potential Liability Exposures Discussions of global warming risks rarely involve liability. Establishing that the actions of a specific company were the proximate cause of global warming, which in turn causes injuries and damages to another party, would clearly be difficult. Making the proximate cause connection with an entire industry or a country as the negligent party may be a less difficult task. For instance, Friends of the Earth International (FoEI) is in the process of a two-year study to determine the feasibility of a lawsuit aimed at recouping financial damages caused by global warming (Hansen, 2006, 1). Fossil fuel companies and industrialized countries like the United States, which has rejected the Kyoto Treaty, would be likely targets. FoEI has already commissioned a study entitled “Gathering Storm: The Human Cost of Climate Change” (Cowell and Karas, 2003, 13), which focuses on injuries and damages. The United Nations estimates the costs of global warming at more than $300 billion a year, so the potential damages are substantial. Other environmental groups including Greenpeace, the World Wildlife Fund, the National Resources Defence Council, and U.S. Friends of the Earth are also exploring litigation strategies (Seelye, 2003, 13). Island nations such as Kiribati, Tuvalu, and the Maldives are particularly vulnerable to rising sea levels associated with global warming. All have experienced severe flooding caused by storms and high tides in recent years. The Prime Minister of Tuvalu, Koloa Talake, announced in February that Tuvalu, along with Kiribati and the Maldives, is planning to sue certain western nations and corporations for damages and loss of life and property (Moore, 2003, 33). In Alaska, melting permafrost and the beetle infestation that is destroying spruce trees are both associated with warming temperatures. Mean temperatures have risen by five degrees in summer and 10 degrees in the winter since the 1970s, far in excess of average global temperature increases. Dr. Glenn Juday, an authority on climate change at the University of Alaska at Fairbanks, states, “We’re experiencing indisputable climate warming. The positive changes from this take a long time, but the negative changes are happening real fast” (Egan, 2004, 40). The uneven distribution of global warming damages may aggravate liability claims against countries and industries associated with causing global warming. There is a sense of unfairness, of international outrage, with some peoples and countries, often the poorest with the least resources to respond, suffering a disproportionate amount of damages. Even if liability claims do not materialize, serious reputational damage could be incurred by countries like the United States, industries like the oil, coal, and automobile industries, and insurers who both insure these industries and invest in them. Risk Management and Insurance Implications The risk management and insurance issues associated with global warming risks are challenging and of expanded scope. Innovation and creativity in developing risk assessment, risk control, and risk-financing techniques to cope with global warming risks will again present substantial business challenges and opportunities. The most obvious specific risk of global warming is the property risk. Risk managers with properties in areas vulnerable to hurricanes, storms, and floods, property insurers for both homeowners and commercial properties, federal flood insurance officials, catastrophe reinsurers, and property insurance brokers and consultants all need to be alert to changing conditions associated with global warming. Appropriate mitigation and financing strategies as well as disaster planning schemes need to be put in place. Capital markets dealing with catastrophe bonds, catastrophe options and exchanges, weather derivatives, and carbon trading mechanisms all will be affected by global climate change. Life and health insurers, health care providers, and government officials will need to adjust to changes in disease patterns and temperature stress conditions. While less obvious and clear, potential liabilities could develop, particularly if substantial damages and injuries are linked to global climate change. Ethical, business, reputational, and regulatory risks of global warming could be particularly debilitating to corporations and industries. These risks affect the heart and core of the business entity—its future revenues and profits. With the exception of directors and officers liability exposures, risk financing is difficult as these risks can rarely be transferred or hedged. Avoidance and loss control are the only effective risk management tools. This set of risks is greatly affected by the increased globalization of the world economy. Corporations in the United States cannot make risk management decisions based solely on U.S. regulations, culture, and consumer preferences. Risk management strategies must incorporate the risks of all the countries and economic regions in which they operate. A recent study in Science found that climate warming is sparking disease epidemics in plants, animals, and humans (Harvell, et. al., 2007, 35). This study is based on existing global data and supports the frequently suggested scenario that pathogens and their carriers are able to spread farther and faster in warm weather. In addition, as cold winters, which normally help to control the populations, become warmer, more germs and parasites are able to survive. The adverse health conditions will most certainly result in increased health and life claims. These increased claims could be particularly burdensome for health insurers, and governments and employers that finance health coverage. These systems are at present under pressure and the aging populace will be relevant even more pressure. If any of the adverse health effects from global warming were to develop into an epidemic, the situation could become particularly serious. Conclusion If ever there were a dynamic issue, global climate change certainly qualifies for this distinction. It is international in scope. It raises a myriad of risk issues that will impact people, governments, industries, and businesses. In a previous article on environmental risk management, the author examined various issues; including global warming/climate change (see Anderson, 2005, 46). This article concentrates totally on the global warming/climate change issue as it relates to the risk management and insurance industry. In the author’s opinion, global warming/climate change may be the leading issue in environmental risk management. Besides the traditional risks of property, liability, life, and health, global warming/climate change produces a broad array of additional risks, including ethical, cultural, business/boycott, reputational, and regulatory risks. Risk transfer, financing, and hedging mechanisms for this broadened array of risks are often limited, which puts additional pressure on avoidance, loss control, and other mitigation techniques. In addition, global warming/climate change risks have the potential to damage reputations, which strike at the heart and core of business—generation of future revenues and profits. Global warming/climate change may be the leading issue in sustainable development. In his Harvard Business Review article “Beyond Greening: Strategies for a Sustainable World,” Stuart Hart states that “sustainable development will constitute one of the biggest opportunities in the history of commerce” (Hart, 2005, 18). Paul Hawken, Amory Lovins, and Hunter Lovins have expanded on these opportunities in their book Natural Capitalism (Hawken, Lovins, and Lovins, 2004, 4). These opportunities will involve risk managers and others in the risk management process, including insurers, brokers, and consultants. To date, European reinsurers have assumed the leadership position in discussions on and responses to issues raised by global warming/climate change. Increasing pressure will be brought on U.S. insurers and reinsurers and their corporate policyholders when the Kyoto treaty is ratified, which seems certain at this time. Even if the United States refuses to ratify the Kyoto Treaty, multinational corporations may choose voluntary reductions in greenhouse gases because of competitive pressures. For both insurance and non-insurance firms, a proactive stance may bring substantial competitive advantages. References Anderson, Dan R., 2005, “Environmental Risk Management—A Critical Part of Corporate Strategy,” The Geneva Papers on Risk and Insurance, April, pp. 44-46 Arendt, Anthony A., Echelmeyer, Keith A., Harrison, William D., Lingle, Craig S., and Valentine, Virginia B., 2004, “Rapid Wastage of Alaska Glaciers and Their Contribution to Rising Sea Level,” Science, pp. 17-19 Cowell, O. and Karas, J., 2003, Gathering Storm: The Human Cost of Climate Change. Amsterdam, The Netherlands: Friends of the Earth, September, pp. 11-21 Dlugolecki, A.F., 2003, “Climate Change and the Insurance Industry,” The Geneva Papers on Risk and Insurance, pp. 12-22 Egan, Timothy, 2004, “Now, in Alaska, Even the Permafrost is Melting,” The New York Times, pp. 40 Hansen, B., 2006, “Friends of the Earth Considers Legal Action to Curb Global Warming,” Environment News Service, pp. 1 Hart, S., 2005, “Beyond Green: Strategies for a Sustainable World,” Harvard Business Review, January-February, pp. 18-19 Harvell, C. Drew, Mitchell, Charles E., Ward, Jessica R., Altizer, Sonia, Dobson, Andrew P., Ostfeld, Richard S. and Samuel, Michael D., 2007, “Climate Warming and Disease Risks for Terrestrial and Marine Biota,” Science, June, pp. 33-36 Hawken, P., Lovins, A. and Lovins, L.H., 2003, Natural Capitalism. Boston MA: Little, Brown and Company, pp. 4 Kron W., 2004, “Natural Disasters: Lessons from the Past - Concerns for the Future,” The Geneva Papers on Risk and Insurance, pp. 5-7 Lazaroff, C., 2005, “Global Warming is Real, Council Tells Bush,” Environment News Service, pp. 20-30 Magnuson, John L., Robertson, Dale M., Benson, Barbara J., Wynne, Randolph H., Livingstone, David M., Arai, Tadashi, Assel, Raymond A., Barry, Roger G., Card, Virginia, Kuusisto, Esko, Granin, Nick G., Prowse, Terry D., Stewart, Kenton M., Vuglinski, Valery S., 2004, “Historical Trends in Lake and River Ice Cover in the Northern Hemisphere,” Science, 289, pp. 53-55 Mills, E., LeComte, E. and Peara, A., 2005, U.S. Insurance Industry Perspectives on Global Climate Change, Berkeley, CA: Lawrence Berkeley National Laboratory, MS90-4000, pp. 14 Moore, Kim, 2003, “Turning up the Heat,” Reactions, pp. 31-35 Munich Re, 2003, Annual Review of Natural Catastrophes, 2000, Munich, Germany: Munich Re Group, pp. 2-9 NAST - National Assessment Synthesis Team, 2004, Climate Change Impacts on the United States: The Potential Consequences of Climate Variability and Change. Report for the U.S. Global Change Research Program, Cambridge, U.K.: Cambridge University Press. Sanger, D., 2005, “Bush Will Continue to Oppose Kyoto Pact on Global Warming,” The New York Times, pp. 23-25 Seelye, K.Q., 2003, “Global Warming May Bring New Variety of Class Action,” The New York Times, pp. 13 Read More