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EXECUTIVE SUMMARY
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 human-induced 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 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.
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 segments 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 GDP in 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 constrain 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 introduction 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 unexplored 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.
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