The Insurance Industry and Climate Change: How ACE Group Manages Climate Change Risks
Insurance companies like ACE are increasingly affected by extreme weather related events due to climate change. How is ACE managing and mitigating these environmental risks?
Property and casualty insurance companies are increasingly affected by climate change as property-related risks rise due to extreme weather related events and natural catastrophes. Most scientists agree that climate change contributes to an increased occurrence of extreme weather related events and natural catastrophes (e.g., floods, droughts, heat waves and hurricanes). According to Swiss Reinsurance Company (Swiss Re), a large reinsurance company based in Zurich, Switzerland, 189 natural catastrophes were recorded in 2014 alone and that amounted to $28 billion in insured losses ($68 billion in total losses). [1] Rising sea levels and more extreme weather events means that losses are likely on the rise. Specifically, in its July 2014 report, Corelogic identified more than “6.5 million U.S. homes at risk of storm surge damage, with a total reconstruction value of nearly $1.5 trillion.” [2] Managing the risks of climate change (and sufficiently dealing with the resulting insured losses) is intrinsically important to the insurance industry; failure to recognize the threat and manage the amount of capital available to pay out potential losses can be debilitating to insurance companies.
ACE is one of the largest global property and insurance companies to tackle climate change. It has been a leader in developing products and risk management services to address climate change. ACE’s climate change strategy is two-fold: 1) effectively manage the risks from increased weather events and 2) offer innovative products that encourage customers to reduce greenhouse gas (GHG) emissions.
ACE is developing innovative financial modeling products in order to effectively underwrite and manage its exposure to climate change risks. ACE is a leading user of catastrophe models to measure extreme weather related risks for product pricing, risk management, capital allocation and to estimate losses from hurricanes. [1] It uses models to monitor its exposure to natural catastrophes and guarantee that its capital reserves meet requirements of regulators, rating agencies and policyholders. As a result of the increased frequency of extreme weather related events, ACE does not use historical data in their catastrophe models to predict risk; instead they use a “shorter-term view of event frequency that is higher than the long-term historical frequency.” [1] Another tool that ACE began developing in 2015 following the disastrous aftermath of Hurricane Sandy is a flood risk management model to give underwriters and risk managers a more accurate model to assess flood risks. [3]
Besides effectively underwriting and managing exposures to climate change risks, ACE understands the opportunities insurers have to offer market-based solutions that assist its customers in shifting to renewable energy and reducing their GHG emissions. ACE offers two new products: Global Premises Pollution Liability (PPL) and Contractors’ Pollution Liability (CPL) policies. These two products provide both insurance and technical support to US multinational companies with the objective of reducing their environmental exposure. ACE also offers a Green Property Insurance policy that covers commercial businesses who choose to adopt “green” standards to rebuild if there is damage or loss to an existing building. “Green” standards include: energy-efficient appliances, electronics, heating and cooling systems, interior plumbing systems and lighting fixtures, etc. Another product is ACE Environmental Risk’s ACE ALERT program that in the event of natural catastrophes, dispatches “incident-response contractors and real-time monitoring of clean-up costs.” [1] This program has achieved accolades from the Business Insurance Innovation Awards Program and has proven to both reduce environmental damage and lower claim costs by 20% to 25%. [1]
Internally, ACE has also launched a corporate environmental program in order to reduce its carbon footprint. Since the program’s launch in 2006, the company reduced GHG emissions approximately 30% per employee by 2012. After reach their goal, ACE announced a new company goal to further reduce emissions 10% per employee from 2012 to 2020. ACE also reports its GHG emissions data and related activities to the CDP. [1]
ACE is well-positioned to address the environmental risks associated with climate change among its peers in the insurance industry. In fact, in a study conducted by Ceres in 2014, ACE was recognized as a leader among other insurance companies in addressing climate change risks. [2] However, ACE can further mitigate its exposure to environmental risks by charging even higher premiums for (or refusing to insure) certain risks (specifically along the US coasts) that will discourage construction there. ACE should also continue to monitor the health of its capital reserves to meet the increasing frequency of natural catastrophes.
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Sources:
[1] Ace Group. 2015. ACE Group Environment Report 2015. [ONLINE] Available at: http://www.acegroup.com/assets/attachments/ace-group-2015-environmental-report.pdf. [Accessed 2 November 2016].
[2] Ceres. 2014. Insurer Climate Risk Disclosure Survey Report & Scorecard: 2014 Findings and Recommendations. [ONLINE] Available at: https://www.ceres.org/press/press-releases/first-of-its-kind-report-ranks-u.s.-insurance-companies-on-climate-change-responses. [Accessed 2 November 2016]
[3] ACE Group. 2013. Innovations in Flood Insurance Protection. [ONLINE] Available at: http://www.acegroup.com/us-en/assets/innovations-in-flood-insurance-protection-11.13.pdf. [Accessed 3 November 2016].
Evan Mills. 2015. Responding to Climate Change – Insurace Industry Perspective. [ONLINE] Available at: http://evanmills.lbl.gov/pubs/pdf/climate-action-insurance.pdf. [Accessed 1 November 2016].
Emily Atkin. 2015. Big Insurance Companies are Warning the US to Prepare for Climate Change. [ONLINE] Available at: https://thinkprogress.org/big-insurance-companies-are-warning-the-u-s-to-prepare-for-climate-change-eb3fdf22d674#.rodqrmxl9. [Accessed 1 November 2016].
It sounds like ACE is a leader in the insurance industry on this topic. Their products give them a competitive edge, so they are unlikely to wish to engage with their peers to encourage best practices for all. However, they should engage with the reinsurance community. Most reinsurers rely on catastrophe models from one of two main providers (AIR and RMS) which rely heavily on historical data. If ACE buys reinsurance from one of the main providers, all of whom rely on historical data, and then a large enough catastrophe happens that the reinsurance firm can’t pay out its policy to ACE, ACE will be left holding the bag despite its good practices. Therefore, it should help the industry move forward.
I never even considered the impacts climate change would have on the insurance industry – you did a nice job highlighting how ACE is dealing with them. Ace’s decision to not use historcial data in their models, sounds just like some of the discussions that our section has had in Finance regarding how much historical data to include in financial models. Many of the same trade-offs are present for ACE. Going back further in time gives a model more data points to build off of, but also makes the data less relevant to current conditions.
Very interesting post. The insurance industry is not often associated with being innovative and forward thinking, but with increased competition has come increased investment (e.g., carriers are purchasing insurance technology startups that were formerly vendors). As it relates to climate change, I wonder if capital requirements have changed due to the increasing level of risk associated with extreme weather related events. Either way, as losses mount, insurers will continue to raise premiums, particularly in areas that are often hard hit by severe weather. This is an example of a negative network effect – the more people contribute to climate change to exacerbate the issue, the more it affects those who live in storm-related higher probability geographies.
Specifically related to flood, most carriers participate in the government’s National Flood Insurance Program, so the carriers aren’t bearing any of the risk. In fact, due to the increased number of severe storms, the program is currently under water (pun intended). Thus, it will be interesting to see the government’s approach to rates in the upcoming years.
How the insurance industry will adjust to climate change is a fascinating question. Already, we’ve seen the average economic damage caused by extreme weather such as storms and floods annually increase 10x in the United States from the 1980s. I’ve often wondered if this meant that in many places insurance companies would just stop writing policies – as they often do today when residential areas are reclassified flood zones. Sadly that sounds like what is happening. As you describe it, the primary response from one of the leaders in the insurance industry has been to adjust their risk models – not to use their underwriting standards to drive changes in building or infrastructure resiliency to adapt to likely future events. I really would like to hope that rather than just retreating from areas at risk some novel insurance models will evolve that could incentivize consumers to take the actions they need to harden their homes and other assets against the coming changes.