Features, May 2000 Insurers can kick-start Kyoto The time is right for the insurance industry to engage with governments to support the Kyoto Protocol. Indeed, without insurers' involvement, there is little chance of the protocol being implemented, says Stephanie Dunstan. It has been three years since the world welcomed the Kyoto Protocol, the policy document outlining measures to deal with the negative effects of climate change. This global climate treaty was signed and approved by 159 countries in December 1997 at the United Nations Framework Convention on Climate Change (FCCC) in Kyoto, Japan. It formalised an international commitment to reduce the causes of global warming. However, in the three years since Kyoto, the Protocol has achieved relatively little - it has not been ratified and greenhouse gases (GHG) emissions in most countries have increased, rather than decreased. Enormous debate rages over the value of the Protocol with scepticism rife among governments, business, non-governmental organisations, academics and even within the UN itself. The failings of Kyoto can be grouped into two framework problems; the 'Kick Start problem' and the 'Time Horizon problem'. The 'Kick Start problem' describes the lack of incentive within the Protocol for signatory nations to progress towards their commitments, while the 'Time Horizon problem' refers to the difficulties signatories face developing policies in the current political time frame and intended for implementation in the period 2008-2012. For Kyoto to be the success that it promises it must overcome both these problems. A solution to the framework problems may be the involvement of the global insurance industry in the implementation of the Protocol. It is well known that climate change threatens the financial viability of this industry. Increasing erratic weather patterns, rising sea levels and air temperatures (all characteristics of climate change) have caused an enormous increase in insured damage, especially since 1998. There is a plethora of statistics describing the drastic increase in losses associated with natural disasters around the world, particularly since 1987, (when climate change effects were first publicly acknowledged). One outstanding statistic, from Munich Re, is that annual economic losses from natural catastrophic events worldwide in the past decade have risen eight-fold, and insured losses 15-fold. Other evidence establishes a strong correlation between natural disasters, climate change and insured loss, with the ten most expensive insured natural disasters in US history occurring since 1987. The worst of these for American insurers was 'Hurricane Andrew' which hit Florida in 1992, costing an estimated $17-$25 billion. But natural disasters are not restricted to America. The late 1999 windstorms in Western Europe caused more than $7 billion in damage, and the 1994 floods in China caused an estimated $6 billion in damage and some 1,600 deaths (Flavin, 1994, p.15). The issue for insurers concerns the relationship between these losses and climate change. Are the effects of climate change contributing to the increase in insured damage? What is the extent of this relationship? The main concern for insurers is that, with increased global warming, atmospheric and oceanic systems that regulate the world's weather could be dramatically disturbed, increasing the risk of more frequent and severe natural disasters (Flavin, 1994, p.16). Under some scenarios of climate change, insurance premium rates would have to increase from $30 billion to $50 billion (at today's prices) to cover the predicted annual losses from natural disasters (Unsworth, 1997, p.19). The point here is that the insurance industry cannot afford a 'wait and see' approach to the predicted effects of climate change. Proactive insurers, such as Munich Re, have taken a precautionary approach to the impact of climate change on the nature of insurance by cautiously providing weather-related insurance while research continues. For insurers, the fact that meteorologists are debating the validity of climate change and cannot predict with certainty the extent to which it will affect their business is "neither particularly unusual nor a reason for delaying action" (Flavin, 1994, p.18). Through the adoption of the precautionary principle it is possible to see how insurers' concerns coincide with the aim of the Kyoto Protocol; to stabilise global weather. The principle is "a cornerstone for all successful insurance business activities" (Bode, 1998, p.1). The practical risk knowledge of insurers puts them in an excellent position to assess the risks of climate change while providing practical tools to minimise this risk by encouraging risk reducing behaviour from their customers. The combination of insurers' experience, knowledge and practical tools, could inject the enthusiasm needed to 'kick start' and implement the Protocol. The formal history of insurers' involvement in the climate change debate begins with a 1996 paper on climate change, authored predominantly by European and Japanese insurers and reinsurers, and presented at the Kyoto Summit the following year. This led to the 'Insurance Industry Initiative' of 1997 which laid out collective support for the Kyoto Protocol. This initiative promoted discussion and debate about climate change within the insurance sector, keeping the industry up to date with climate change policies and providing practical methodologies for insurers to cope with environmental risks. The main policy mechanism thus far of the United Nations Environment Program Insurance Industry Initiative (UNEP III) is a Statement of Environmental Commitment that voluntarily commits signatories to promoting sustainable development and the precautionary principle in their everyday business activities. The statement has received strong support from proactive insurers who see the advantages of its simplicity (language and form), fairness (the statement doesn't support one kind of climate change research over another), application of the precautionary principle (not demanding absolute certainty regarding the quantification of the effects of climate change) and its practicality (encouraging risk reducing strategies) (Robertson, 1997, p.8). At the time of writing, 84 insurers representing 27 countries had signed the UNEP III statement. CHECK However, there are different views on the role of the insurance industry in the climate change policy arena. Some argue that insurers should be the 'experts', providing analysis and data on natural resource risks, while others argue that they should be the 'activists', going beyond the traditional role to active involvement in climate policy circles (Mooney, 1998, p.43). It is in insurers' interests to side with the 'activist' side of the debate, as their support for the Kyoto Protocol will benefit insurers, providing relative stability in the world's climate patterns and reducing the amount of weather-related insurance claims. UNEP III offers a platform for insurers to lobby for the ratification of the Protocol while creating awareness and testing how insurance policies can be changed to promote environmental sustainability. An important feature of UNEP III is that it puts insurers in constant contact with a broad range of stakeholders who share similar concerns, namely environmental groups and climate scientists. But before the insurance industry can add significant value in helping implement the Kyoto Protocol, there are some hurdles to overcome. Critics point to potential difficulties in the application of insurers' traditional methods of calculating risks to calculation of the environmental risk posed by climate change. Problems arise because the characteristics of climate change do not sit well with criteria for insurability. Natural disaster insurance incorporating weather-related clauses is based on historical averages calculated on past climate trends but, as climate change becomes increasingly unpredictable, "such calculations have little value" (Flavin, 1994, p.18). Proactive insurers have accepted that a change in their methodology is needed and are investing time and money in developing a new approach. For example, the Risk Prediction Initiative (jointly established by European and American Insurers) which has $3 million annual funding, is attempting to address whether past weather events can be relied upon for future weather predictions (Hileman, 1997, p.31). The provision of large amounts of funding for such research indicates the willingness and capacity of insurers to overcome these practical problems. Furthermore, it strengthens the argument that insurers will be able to help solve the 'Time Horizon' problem by developing methods to ensure that business decisions effective for the long term can be made in the short term. Another potential problem for insurers is to recognise conflicting client demands. For example, insurers may try to enforce environmental standards upon customers in line with the requirements of the Kyoto Protocol, while also insuring hydrocarbon-intensive companies. Insurers in this situation may fall victim to a vicious cycle in which they provide the funds and capital for GHG-producing projects which then contribute to climate change events, eventually damaging insured property and resulting in economic loss from insurance payouts. Insurers' investment capacity compounds the problem as they are major buyers of shares, many of them issued by major emitters of GHGs. Julian Salt, of the UK's Loss Prevention Council says that "insurance companies gain much of their profit from investment activities in the very firms that contribute to global warming" (Salt, 1998, p.164). The big question for these firms, he adds, is establishing where the delicate balance lies between profit and loss in their business cycle. Problems may arise from the voluntary status of UNEP III. Non-binding, voluntary policy invariable attracts criticism that it is merely a public relations tool by which signatories can be seen to be doing something without having to commit to change. UNEP III could easily overcome these criticisms by changing its environmental reporting structure and learning from other voluntary environmental programs where participants are required to list all progress, successful or unsuccessful, in implementing sustainability measures in business practices. In its defense, UNEP III has been responsible for work promoting a standardised corporate carbon dioxide indicator for insurers, launched in 1997. UNEP III researched and promoted the concept of standardised corporate greenhouse gas inventories, which could lead to the development of a Global Warming Indicator (GWI), replacing the wide array of environmental reporting standards across the industry. The production of GWI will help insurers make more informed risk decisions and better manage their investment portfolios by providing environmentally accurate and relevant information. These achievements will strengthen the insurance industry's contribution to solving the 'Kick Start' and 'Time Horizon' problems of the Kyoto Protocol. If UNEP III is to be the vehicle for closer involvement and implementation of the Kyoto Protocol then it needs to provide a unanimous voice for the insurance industry. This is a difficult task given there are at least 300 major players in the insurance industry. But without an industry-wide commitment, individual proactive insurers cannot make gains in enforcing environmental standards as they risk losing clients who could switch to another insurer without environmental standards. An absence of unity will reduce the credibility of UNEP III and leave it open to claims of 'tokenistic environmentalism'. In addition, the initiative needs to overcome problems arising from insurers' lack of experience in the climate change policy arena. Bibliography: Bode, A. 'History of the United Nations Environment Program Insurance Industry Initiative', 1998, (www.unep.ch/eteu/insura/article1.htm 3.11.99) Flavin, C. 'Storm Warnings: Climate Change hits the Insurance Industry', World Watch, Nov-Dec 1994, v.7, no.6, p.10. Hileman, B. 'Storm Warning Rattle Insurers', Chemical and Engineering News, April 14 1997, v.75, no.15, pp.28-31. Leigh R, Taplin R & Walker G, 'Insurance and Climate Change: The implication for Australia with Respect to Natural Hazards', Australian Journal of Environmental Management, June 1998, v.5, pp.81-96. Lucas, P Energy User News, Oct.1 1998, p.4 Mooney, s. 'Insurers should be the experts, not the activists, the climate change debate', National Underwriter, 1998, v.102, no.23, pp.43-44. Robertson, G. 'Too Hot to Handle?', Canadian Insurance, Dec 1997, v.102, no.13, pp.8-9. Salt, J.' Kyoto and the Insurance Industry: an Insiders Perspective', Environmental Politics, v.7, no.2, Summer 1998, pp.160-165 Schmidheiny, S. Changing Course: A Global Perspective on Development and the Environment, 1992, MIT Press, Cambridge Press. Schenzenbacher, B. 'Climate Change from an Insurance Industry Perspective' 1997 (www.unep.ch/eteu/insura/evanjoin.htm 3.11.99). Unsworth, E. 'Active Insurers can cut climate losses', Business Insurance, March 24 1997, v.31, no.12, p.172. FOR THE FULL STORY EVERY MONTH, SUBSCRIBE TO ENVIRONMENTAL FINANCE, OR CONTACT info@environmental-finance.com FOR OUR BACK ISSUES SERVICE