4.6. Insurance and Other Financial Services

The financial services sector -- broadly defined as private and public institutions that offer insurance and disaster relief, banking, and asset management services -- is a unique indicator of potential socioeconomic impacts of climate change because it is sensitive to climate change and it integrates effects on other sectors. The sector is a key agent of adaptation (e.g., through support of building codes and, to a limited extent, land-use planning), and financial services represent risk-spreading mechanisms through which the costs of weather-related events are distributed among other sectors and throughout society. However, insurance, whether provided by public or private entities, also can encourage complacency and maladaptation by fostering development in at-risk areas such as U.S. floodplains or coastal zones. The effects of climate change on the financial services sector are likely to manifest primarily through changes in spatial distribution, frequencies, and intensities of extreme weather events (Table TS-4). [8.1, 8.2, 15.2.7]

Table TS-4: Extreme climate-related phenomena and their effects on the insurance industry: observed changes and projected changes during 21st century (after Table 3-10; see also Table 8-1).
Changes in Extreme Climate Phenomena	Observed Changes	Projected Changes	Type of Event Relevant to Insurance Sector	Relevant Time Scale	Sensitive Sectors/Activities	Sensitive Insurance Branches
	Likelihood
Temperature Extremes
Higher maximum temperatures, more hot days and heat wavesb over nearly all land areas	Likelya (mixed trends for heat waves in several regions)	Very likelya	Heat wave	Daily-weekly maximum	Electric reliability, human settlements	Health, life, property, business interruption
			Heat wave, droughts	Monthly-seasonal maximum	Forests (tree health), natural resources, agriculture, water resources, electricity demand and reliability, industry, health, tourism	Health, crop, business interruption
Higher (increasing) minimum temperatures, fewer cold days, frost days, and cold wavesb over nearly all land areas	Very likelya (cold waves not treated by WGI)	Very likelya	Frost, frost heave	Daily-monthly minimum	Agriculture, energy demand, health, transport, human settlements	Health, crop, property, business interruption, vehicle
Rainfall/Precipitation Extremes
cold wavesb over nearly all land areas More intense precipitation events	Likelya over many Northern Hemisphere mid- to high-latitude land areas	Very likelya over many areas	Flash flood	Hourly-daily maximum	Human settlements	Property, flood, vehicle, business interruption, life, health
			Flood, inundation, mudslide	Weekly-monthly maximum	Agriculture, forests, transport, water quality, human settlements, tourism	Property, flood, crop, marine, business interruption
Increased summer drying and associated risk of drought	Likelya in a few areas	Likelya over most mid-latitude continental interiors (lack of consistent projections in other areas)	Summer drought, land subsidence, wildfire	Monthly-seasonal minimum	Forests (tree health), natural resources, agriculture, water resources, (hydro)energy supply, human settlements	Crop, property, health
Increased intensity of mid-latitude stormsc	Medium likelihooda of increase in Northern Hemisphere, decrease in Southern Hemisphere	Little agreement among current models	Snowstorm, ice storm, avalanche	Hourly-weekly	Forests, agriculture, energy distribution and reliability, human settlements, mortality, tourism	Property, crop, vehicle, aviation, life, business interruption
			Hailstorm	Hourly	Agriculture, property	Crop, vehicle, property, aviation
Intensified droughts and floods associated with El Niño events in many different regions (see also droughts and extreme precipitation events)	Inconclusive information	Likelya	Drought and floods	Various	Forests (tree health), natural resources, agriculture, water resources, (hydro)energy supply, human settlements	Property, flood, vehicle, crop, marine, business interruption, life, health
Wind Extremes
Increased intensity of mid-latitude stormsb	No compelling evidence for change	Little agreement among current models	Mid-latitude windstorm	Hourly-daily	Forests, electricity distribution and reliability, human settlements	Property, vehicle, aviation, marine, business interruption, life
			Tornadoes	Hourly	Forests, electricity distribution and reliability, human settlements	Property, vehicle, aviation, marine, business interruption
Increase in tropical cyclone peak wind intensities, mean and peak precipitation intensitiesc	Wind extremes not observed in the few analyses available; insufficient data for precipitation	Likelya over some areas	Tropical storms, including cyclones, hurricanes, and typhoons	Hourly-weekly	Forests, electricity distribution and reliability, human settlements, agriculture	Property, vehicle, aviation, marine, business interruption, life
Other Extremes
Refer to entries above for higher temperatures, increased tropical and mid-latitude storms	Refer to relevant entries above	Refer to relevant entries above	Lightning	Instant-aneous	Electricity distribution and reliability, human settlements, wildfire	Life, property, vehicle, aviation, marine, business interruption
Refer to entries above for increased tropical cyclones, Asian summer monsoon, and intensity of mid-latitude storms	Refer to relevant entries above	Refer to relevant entries above	Tidal surge (associated with onshore gales), coastal inundation	Daily	Coastal zone infrastructure, agriculture and industry, tourism	Life, marine, property, crop
Increased Asian summer monsoon precipitation variability	Not treated by WGI	Likelya	Flood and drought	Seasonal	Agriculture, human settlements	Crop, property, health, life
a Likelihood refers to judgmental estimates of confidence used by Working Group I: very likely (90-99% chance); likely (66-90% chance). Unless otherwise stated, information on climate phenomena is taken from Working Group I's Summary for Policymakers and Technical Summary. These likelihoods refer to observed and projected changes in extreme climate phenomena and likelihood shown in first three columns of table. b Information from Working Group I, Technical Summary, Section F.5. c Changes in regional distribution of tropical cyclones are possible but have not been established.

The costs of extreme weather events have exhibited a rapid upward trend in recent decades. Yearly global economic losses from large events increased from US$3.9 billion yr^-1 in the 1950s to US$40 billion yr^-1 in the 1990s (all 1999 US$, uncorrected for purchasing power parity). Approximately one-quarter of the losses occurred in developing countries. The insured portion of these losses rose from a negligible level to US$9.2 billion annually during the same period. Including events of all sizes doubles these loss totals (see Figure TS-5). The costs of weather events have risen rapidly, despite significant and increasing efforts at fortifying infrastructure and enhancing disaster preparedness. These efforts dampen to an unknown degree the observed rise in loss costs, although the literature attempting to separate natural from human driving forces has not quantified this effect. 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. [8.3]

Figure TS-5: The costs of catastrophic weather events have exhibited a rapid upward trend in recent decades. Yearly economic losses from large events increased 10.3-fold from US$4 billion yr -1 in the 1950s to US$40 billion yr -1 in the 1990s (all in 1999 US$). The insured portion of these losses rose from a negligible level to US$9.2 billion annually during the same period, and the ratio of premiums to catastrophe losses fell by two-thirds. Notably, costs are larger by a factor of 2 when losses from ordinary, noncatastrophic weather-related events are included. The numbers generally include "captive" self-insurers but not the less-formal types of self-insurance.

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. Precise attribution is complex, and there are differences in the balance of these two causes by region and by type of event. Many of the observed trends in weather-related losses are consistent with what would be expected under climate change. Notably, the growth rate in human-induced and non-weather-related losses has been far lower than that of weather-related events. [8.2.2]

Recent history has shown that weather-related losses can stress insurance companies to the point of impaired profitability, consumer price increases, withdrawal of coverage, and elevated demand for publicly funded compensation and relief. Increased uncertainty will increase the vulnerability of the insurance and government sectors and complicate adaptation and disaster relief efforts under climate change. [8.3, 15.2.7]

The financial services sector as a whole is expected to be able to cope with the impacts of future climate change, although the historic record shows that low-probability, high-impact events or multiple closely spaced events severely affect parts of the sector, especially if adaptive capacity happens to be simultaneously depleted by nonclimate factors (e.g., adverse market conditions that can deplete insurer loss reserves by eroding the value of securities and other insurer assets). There is high confidence that climate 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. Such developments would place upward pressure on premiums and/or could cause certain risks to be reclassified as uninsurable, with subsequent withdrawal of coverage. This, in turn, would place increased pressure on government-based insurance and relief systems, which already are showing strain in many regions and are attempting to limit their exposures (e.g., by raising deductibles and/or placing caps on maximum claims payable).

Trends toward increasing firm size, diversification, and integration of insurance with other financial services, as well as improved tools to transfer risk, all potentially contribute to robustness. However, the property/casualty insurance and reinsurance segments have greater sensitivity, and individual companies already have experienced catastrophe-related bankruptcies triggered by weather events. Under some conditions and in some regions, the banking industry as a provider of loans also may be vulnerable to climate change. In many cases, however, the banking sector transfers risk back to insurers, who often purchase their debt products. [8.3, 8.4, 15.2.7]

Adaptation² to climate change presents complex challenges, as well as opportunities, for the financial services sector. 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 that support sustainable development and climate change mitigation objectives (e.g., energy-efficiency measures that also make buildings more resilient to natural disasters, in addition to helping the sector adapt to climate changes). [8.3.4, 8.4.2]

The effects of climate change are expected to be greatest in developing countries (especially those that rely on primary production as a major source of income) in terms of loss of life, effects on investment, and effects on the economy. Damages from natural disasters have been as high as half of the gross domestic product (GDP) in one case. Weather disasters set back development, particularly when funds are redirected from development projects to disaster-recovery efforts. [8.5]

Equity issues and development constraints would arise if weather-related risks become uninsurable, insurance prices increase, or the availability of insurance or financing becomes limited. Thus, increased uncertainty could constrain development. Conversely, more extensive penetration of or access to insurance and disaster preparedness/recovery resources would increase the ability of developing countries to adapt to climate change. More widespread introduction of microfinancing schemes and development banking also could be an effective mechanism to help developing countries and communities adapt. [8.3]

This assessment of financial services has identified some areas of improved knowledge and has corroborated and further augmented conclusions reached in the SAR. It also has highlighted many areas where greater understanding is needed -- in particular, better analysis of economic losses to determine their causation, assessment 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, to spread and reduce risks from climate change. [8.7]

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