Insured Destruction

Global Climate Change Threatens the Insurance Industry

When winds reach 120 miles per hour, houses begin to crumble, walls break and roofs fly away. With global climate change, winds like this are coming more often. In the U.S. during the last three decades, the number of weather-related natural disasters has increased five-fold. Last year was the second-hottest year since records began in 1860. This means five times as many major hurricanes and tornadoes annually touching down in places like Miami and Houston. It means 500 percent more floods, mudslides, hailstorms, drought, ice storms and wildfires. It means more wrecked cars, houses, crops and businesses.

Hurricane Camille caused widespread damage in 1969, and storms are only increasing in intensity and frequency.© National Weather Service

The industry to be hardest hit by these careening catastrophes is insurance. According to the Department of Energy, insurance losses from natural disasters have increased 15-fold since 1960, even when corrected for inflation. Asserts Carlos Joly, the chairman of the United Nations Environment Programme’s insurance industry initiative, "The threats to our economies and lifestyles from climate change are no less consequential than terrorism." He adds that the danger is much more commonly accepted among European insurers than among American providers.

Before Hurricane Hugo in 1989, no major storm had cost more than $1 billion in insurance claims. In 1992, Hurricane Andrew hit South Florida and the insurance industry paid out $15 billion. Allstate Insurance dispensed $500 million more than it had ever collected from all types of insurance in Florida. Seven other companies went bankrupt.

Franklin Nutter, president of Reinsurance Association of America, says, "The scientific community’s consensus is we’re in a period of warming and weather variability. Climate change will affect property and human lives."

In the 1960s the average was 16 "large" weather-related disasters annually in the world. Now, the average is 72. The combined insured losses, corrected for inflation, have jumped from $7 billion then to more than $90 billion now.

Since Hurricane Andrew, there have been 18 other natural disasters costing more than $1 billion each. Insurance industry profit has narrowed nearly six-fold in the last decade, sending the $2 trillion industry into shock.

Thomas Loster of the Germany-based Munich Re, one of the world’s biggest reinsurance companies, is a climate scientist, one of 35 employed by the company to better enable it to predict the future. Reinsurance companies need to make educated guesses, because they sell backup insurance to insurance companies, and a larger-than-normal disaster makes multiple claims payable at once.

"The world is warming," Loster says, adding that water evaporates more quickly in hot weather. Faster evaporation means more intense droughts, as well as more extreme rainfall, especially near mountains where humidity being forced up into colder air creates rain. "Rainfall in the mountains means landslides and flooding in the valleys," he says.

Climate scientists also note that hurricanes can only survive over water at temperatures of 80 degrees Fahrenheit (F) or warmer. As the oceans warm, hurricanes are created in more places and travel farther. When a hurricane hits a place that hasn’t had them before, the losses are more extreme because no person or building is prepared. The world’s average temperature has warmed less than half a degree F in the last 100 years, but it’s projected to warm as much as five degrees by 2050. At that point, New York would have the same average temperature as today’s Miami, and it would be just as prone to hurricanes.

Loster also points out that lightning strikes increase with warmer weather, a threat to modern electronics and forests parched by extreme heat. In 1997, after an unprecedented drought, a forest fire in Indonesia burned an area the size of South Korea. Tropical forests are normally too moist to burn. In addition, Loster notes, flooding increases in warmer weather because winter precipitation arrives as rain instead of snow. Since the still-frozen ground can’t absorb it, the water flows straight into rivers, overflowing them, increasing sewage spills and poisoning water supplies.

The scientific consensus is that natural disasters will continue to increase, both in severity and frequency. By 2050, mega-catastrophes, which used to appear once every 100 years, are predicted to occur every 25. According to the United Nation’s Intergovernmental Panel on Climate Change, insured losses will then be amplified another 900 percent. A large hurricane would no longer cost $15 billion, but $135 billion in present-day dollars. The breaking point of many human-made objects is 120 miles per hour, but if wind speed increases by just 10 percent, the damage increases 150 percent.

The insurance industry is not well prepared for these potential catastrophes, since U.S. law requires companies to base their rates on past events. The fear is that by the time a company can adjust its premiums to the potential of a $15 billion storm, it will get walloped by a $25 billion one.

The nonprofit Insurance Services Office (ISO) recently calculated the results to the industry if it lost $50 billion from, for example, a storm of Andrew’s magnitude hitting a major city such as Miami or Los Angeles. The ISO believes just one such catastrophe would drive 36 percent of American insurance companies into bankruptcy. Because of recent mergers between insurance companies and banks, a number of financial institutions could go bankrupt also, escalating the economic toll.

And the damage wouldn’t stop there. In Florida, after Hurricane Andrew, the average price of insurance almost tripled. If a mega-catastrophe hit the country and bankrupted more than a third of the companies, buying property insurance in any type of disaster-prone area would become much more expensive, representing a threat to property values. According to the Insurance Information Institute, 68 million Americans live along hurricane-prone coastlines. Add to that the people living along the flood-happy Mississippi and in the tornado-ridden Midwest, and a significant number of Americans would be affected.

In the past, the government has stepped in after a natural disaster to offer insurance to property owners at acceptable rates if private companies won"t, but this generosity might end soon. Claims on federally offered insurance have grown 600 percent in the last three decades, even when corrected for inflation. The Bush Administration is attempting to deny federal insurance to people who get hit by floods more than twice in 10 years.

Neither the government nor the insurance industry is fully prepared for the impact of a series of catastrophic natural disasters. To paraphrase an insurance executive, we’re like a person falling from a 30-story building, saying, as each floor whips by, "So far, so good."