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Climate change and insurance: Enabling government and
business to collaborate on strategic opportunities
Concept Note
Author:
Alejandro Litovsky, Earth Security Initiative
alejandro@earthsecurity.org
February 2014
Summary
This concept note has been prepared by the Earth Security Initiative as a framing
document to a strategic convening of senior leaders from insurance companies and
the UK government’s foreign policy, trade and investment, which ESI is organising in
cooperation with the UK Foreign & Commonwealth Office (FCO). The meeting,
scheduled for March 11th, 2014 at the FCO will discuss the opportunities for
companies and the government to work together on financial solutions to manage the
risks of climate change around the world, with a particular focus on emerging
economies.
It is evident from the serious floods that are affecting developed countries like the
United Kingdom, or the extreme droughts hampering the economic prospects of
regions of the United States and Australia, that the threats of extreme climate risks
are not just limited to developing countries.
Emerging economies, however, present a critical area of focus for better coordination
between insurance companies and governments, for two reasons: First, insurance
markets are significantly less developed and offer both market opportunities for the
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private sector as well as market-driven risk management solutions for cash-strapped
governments.
Second, the nature of climate risks in these countries, even in large emerging
economies that are part of the G20, is connected to critical issues that will shape the
commercial and investment interests of developed countries operating in those
regions. A range of inter-dependent risks from climate change include impacts on
energy, food and water security, as climate events interact with other factors, such as
the infrastructure of public services, the ability of public institutions to respond to
complexity, energy infrastructure and foreign direct investment.
Section 1: Common interests, informed by market fundamentals
The scale of the economic losses from extreme weather is visible in both rich and
poor countries around the world – floods, hurricanes, droughts and fires; and the
subsequent damage on infrastructure and manufacturing, energy generation and
agriculture as key affected sectors – are testing the ability of financial institutions,
societies and governments to manage risks and uncertainty.
Policy-makers tasked with responding to climate change are beginning to look
towards the global insurance sector as a provider of risk management solutions.
Insurance and reinsurance companies, on the other hand, are facing a complex
landscape of risks and opportunities as climate change affects insurance markets as
well as relations between regulators and insurance companies.
Three examples illustrate this strategic agenda of climate risks and market
fundamentals:

Contested policy coverage: As the costs of climate-related risks set to expose
populations and infrastructure, governments will have the pressure to define
weather events in a way that as many people as possible will be covered by their
insurance policies, which may occur at the expense of insurance companies. For
example, in 2012, insurers faced billions of dollars of extra losses after the
United States authorities declared Super-storm Sandy a “post-tropical cyclone”
rather than a “hurricane”. The lower classification of the storm helped to benefit
homeowners and insurance companies faced up to fifty percent higher total
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losses, estimated between US$10bn – US$20bn. Eric Goldberg, vice-president
of state affairs at the American Insurance Association, said: ‘If insurers believe
that they may not be able to rely on their hurricane deductibles, they will likely
take steps to either control their exposure or to generate enough premium
revenue to make up for the increased exposure. When a regulator says: “No this
wasn’t a hurricane, all you have to do is pay your regular deductible”, all it really
does is distort the true costs of the risks associated with living in more hurricaneprone areas.’1 In the face of increased climate risks, improving the coordination
of policy-makers and industry on the terms and extent of insurance coverage
responses will be increasingly important to ensure financial mechanisms work
for as many people as possible.

Competitive market in flux: The proliferation of financial products that provide
insurance coverage against natural disasters is introducing disruptive
competition into insurance and reinsurance markets. In early 2014, Standard &
Poor’s warned global reinsurers that they are facing potential credit rating
downgrades due to mounting competition. According to the rating agency the
sector has reached a “tipping point” as primary insurers renewing their annual
reinsurance policies in 2014 secured the biggest drop in premiums in more than
a decade. Capital markets investors have helped bring prices down by injecting
funding into specialist vehicles set up by reinsurers that non-insurers can invest
in, as well as instruments such as catastrophe bonds being issued by primary
insurers. S&P warned that nearly half of the reinsurers whose creditworthiness it
rates were “significantly exposed” to pressures arising from mounting
competition. Those that provided a relatively high amount of natural disaster
coverage, which is seen as an increasingly competitive area by non-insurers and
primary insurers, would be under the greatest pressure.2 Market analysts
however expect that alternative capital providers will continue to focus mostly on
the US reinsurance business, where well-modelled risks, low entry barriers and
relatively high margins characterise the market.3 This may be an added incentive
‘Insurers pay price for Sandy’s downgrade’, Financial Times, November 8th, 2012
‘Reinsurers face ratings cuts, S&P warns’, Financial Times, January 20th 2014
3 ‘Insurance outlook for 2014/15 sees emerging markets driving premium growth, while alternative
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capital focuses on well-modelled risks’, Swiss Re, November 28th 2013, London
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for many firms to focus on emerging economies. Policy-makers may need to
improve their understanding of the financial options that are available in the
market to increase risk management and the roles that a more diversified set of
players can play in supporting policy goals of disaster preparedness.

The impact of improved scientific models: As science and technology improve
their ability to understand and anticipate the impact of extreme weather events,
the availability of new data and information poses both opportunities and
uncertainty to insurance companies, their pricing structures and market
valuation. In 2011, for example, S&P took the unusual step of placing 16
catastrophe bonds issued by insurers under review for a possible downgrade
after the disaster-modelling company that evaluated the securities changed its
model. The trigger was the release, earlier that year, of a new hurricane model
from Risk Management Solutions Inc., a leading catastrophe-modelling firm,
including new data that showed the potential damage of a hurricane. The case
showed the vast market impact that changes in the underlying modelling has on
such financial products when these imply substantial differences in the prospects
of their financial yield. The prospective downgrades where seen by market
analysts and investors in catastrophe bonds, as an indication that the hurricanes
that could cause enough damage to force a pay-out on the bonds were seen as
more likely to occur.4 Public agencies and government funds invested in R&D
and climate modelling may have a role to play in informing this area, considering
global standards for data and modelling and other measures that can help
improve the link between science and insurance in a broader policy discussion
on coverage objectives.
In sum, the ability of governments to affect the terms of policy coverage in a given
country; the capital allocation patterns into financial risk transfer mechanisms that are
re-shaping the insurance market; and a rapid innovation in scientific modelling and
their impact on premiums and pay-outs, are among critical areas that will define
whether and how insurance and reinsurance companies are able to provide the
financial mechanisms that societies, governments and businesses need to cope with
the risks of climate change. Hedging the risks, and seizing opportunities for
4
‘Catastrophe Bonds Face Possible Downgrade’, The Wall Street Journal, April 18, 2011
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insurance to accelerate its role as a climate risk management mechanism will require
that governments and companies to discuss policy frameworks, blended capital
opportunities and market incentives.
Section 2: Projected insurance market growth in emerging economies
The growth in insurance demand from emerging economies has been a key driver of
global non‐life premium growth over the last decade. The forecasts suggest that
these markets will continue to be areas of significant growth over the coming decade.
According to Swiss Re, real premium growth in the primary insurance market is
projected to be around 2% in the advanced economies, and close to 8% in the
emerging markets in 2014 (Fig.1).
Figure 1: Real premium growth rate for primary non-life insurance by region, 2010 to 2015F
(Source: Swiss Re)
In 2012, the programme by the London School of Economics and Munich Re
‘Evaluating the Economics of Climate Risks and Opportunities in the Insurance
Sector’ explored the major determinants of the demand for insurance in emerging
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economies in the context of climate change.5 Nicola Ranger and Swenja Surminski
have suggested five main determinants of this influence in emerging economies will
respond to the projections of economic growth; an evolving willingness to pay for
insurance; improved public policy and regulatory frameworks; the insurability of
natural catastrophe risks; and new opportunities associated with adaptation and
greenhouse gas mitigation.6
Kurt Karl, Swiss Re's Chief Economist recently said: "A return to economic growth in
the mature markets is a good sign for insurance and we see a positive outlook for the
next two years. Emerging markets, especially in Africa and Asia, will definitely
provide some of the more spectacular growth figures in non-life business as cities
grow and people look for financial protection for their property."
According to Swiss Re, catastrophes such as the recent Typhoon Haiyan in the
Philippines are unlikely to generate large losses for non-life insurers because of the
very low insurance penetration in the Philippines, currently at around 0.5% compared
with an emerging market average of about 1.3%.7
On the other hand, the low penetration of the insurance sector in high-risk developing
economies like the Philippines is a challenge from the point of view of climate risk
and development. The estimated US$15bn in losses caused by Typhoon Haiyan,
and the slow pace of international aid, pose a serious burden on its economy and the
security of its population.8
Therefore, considering insurance mechanisms as a country disaster risk
management instrument will require that companies go beyond mainstream market
trends and consider how business can engage in driving market innovations and
increasing penetration strategies that serve both profit as well as public objectives.
‘Insurance in emerging markets: determinants of growth and the case of climate change?’
Proceedings of the Autumn Symposium Wednesday, 21st November 2012 at the London School
of Economics and Political Science.
6 Ranger, N., and Surminski, S. March 2013, A preliminary assessment of the impact of climate
change on non-life insurance demand in the BRICS economies, International Journal of Disaster
Risk Reduction, v.3, pp.14-30.
7 ‘Swiss Re's insurance outlook for 2014/15 sees emerging markets driving premium growth,
while alternative capital focuses on well-modelled risks’, Swiss Re, November 28th 2013, London
8 ‘Typhoon Haiyan: Worse than hell’, The Economist, November 16th 2013
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Section 3: Anticipating climate and resource security risks
Climate change will impact emerging economies in different ways. The largest
emerging economies each face a unique combination of complex series from
extreme weather, according to the Earth Security Index 2014 (ESI), a framework
designed to provide a strategic direction to industry, financial institutions and
governments with regards to connected and inter-dependent resource risks.
Countries like India, Brazil, China, Indonesia, and Mexico, among others profiled in
the ESI 2014, offer both market opportunities for insurance companies as well as
growing levels of complexity (Fig.2).
Figure 2: The Earth Security Index: Risk configurations for emerging economies’ (and
Japan’s) from high exposure to climate change (Source: ESI)
This stems from the convergence of climate change with the security of vital
resources such as energy, food and water, institutional governance conditions,
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demographics and urbanization patterns, and the progressive loss of ecological
resilience of the countries.9
The case of Brazil (Fig.3), for example, is of particular relevance to the insurance
sector, according to its ESI 2014 profile:
“Brazil generates eighty percent of its electricity through hydropower
dams. A growing variability in rainfall is set to affect it power-generation
capacity. So far, the main share of Brazil’s large energy imports of
crude oil, coal and peat are used for industrial purposes, but this could
change if in the future its domestic power generation is affected by
extreme weather. In 2011, the economic losses from extreme floods in
Brazil were estimated at US$ 4.7 billion, and an average annual loss of
US$ 979 million over the last two decades.10 Tropical rainforests play a
crucial role in regulating the stability of climate conditions. Brazil lost
close to 11 million hectares in Amazonia between 2005 and 2010.11
The rate of deforestation between 2004 and 2012 slowed down by
almost eighty percent […] although 2013 figures again show a 28%
increase in deforestation with regards to 2012.12
The impact that the absolute loss of forest has over the stability of
Brazil’s water cycles is not yet fully understood. Changing rainfall
patterns are likely to affect Brazil’s security in the next decade. Despite
the uncertainties that remain between the interaction of rainforests and
weather stability, the Brazilian scientific community is able to predict
that weather extremes will grow towards 2020 — with agriculture,
hydropower and insurance being identified as the most vulnerable
9
The Earth Security Index 2014 is a country risk tool integrating data on resources and climate
change, which anticipates the complex risks of relevance to global business, finance institutions
and governments. It can be downloaded at: http://www.earthsecurity.org/the-index
10 ‘Global Climate Risk Index 2013’, Germanwatch Briefing Paper, Sven Harmeling and David
Eckstein, November 2012.
11 ‘Global Forest Resources Assessment 2010’, Food and Agriculture Organization of the United
Nations, Rome.
12 ‘Amazon destruction up by 28% in year’, BBC News, 15 November 2013
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sectors. 13 Recalibrating insurance premiums and developing new
market strategies will be necessary as insurance rates must adapt to
changing risk profiles in the affected sectors.”
The complexity of emerging economies in general, and in this case of Brazil in
particular, requires a more systematic understanding by the insurance sector of the
liabilities that will be created by the link between climate change, tropical
deforestation and energy security in electricity generation.
These three resource security priorities will shape Brazil’s climate and insurance
risks in the near term. According to the Geneva Association, these types of
catastrophic risks in emerging market context may create a cascade onto
unanticipated risks if insurance companies are made liable for mispriced or
uninsured losses.14
Figure 3: The Earth Security Index 2014 Brazil Profile: Energy security, deforestation and
exposure to extreme weather.15 (Source: ESI)
13
‘Climate Change and Extreme Events in Brazil’, Fundação Brasileira para o Desenvolvimento
Sustentável (FBDS) sponsored by Lloyd’s, November 2009.
14 ‘Climate-related Catastrophic Events in Brazil: The Challenges and Opportunities for the Insurance
Industry’, The Geneva Association and the Brazilian Academy of Sciences, Conference proceedings,
Rio de Janeiro, 26 September 2013. www.genevaassociation.org
15
Brazil Profile, Earth Security Index 2014, page 11 at: http://www.earthsecurity.org/the-index
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Section 4: Proactive development strategies
Insurance as country disaster risk management
The potential for insurance markets to form an important element of country disaster
risk management strategy is significant and evidenced by many examples of funds
for natural disasters backed by national budgets in places like the Caribbean,
Ethiopia, Mexico and Turkey. In high-risk developing countries whose governments
face budgetary constraints, these mechanisms are seen not only as a way to insure
assets and populations but also to insure public finances against natural disasters.16
The private sector is likely to have a role to play. For example, in January 2014,
global insurance companies Willis Re and Munich Re have presented a proposal to
the Philippines’ government following this logic. The Philippines Risk and Insurance
Scheme for Municipalities (PRISM) proposes a fast track way for providing budgetary
support in the aftermath of a major natural disaster. However, the $1bn scheme will
‘Insuring Public Finances Against Natural Disasters— A Survey of Options and Recent
Initiatives’, David Hofman and Patricia Brukoff, International Monetary Fund (IMF) Working
Paper, August 2006
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require that the government of the Philippines, and/or bilateral donors and
multilateral finance institutions get involved in the budgetary support of the program.
Rowan Douglas, CEO Capital, Science and Policy Practice, Willis Group, explained:
‘Contrary to traditional insurance the payment of claims is not based on actual losses
but on a pre-agreed amount when a specific trigger is met. For example, insurance
will be paid out in the event of rainfall exceeding a certain amount, or wind speed
exceeding a certain threshold.’17
As insurance and reinsurance companies prepare to develop new products and
mechanisms that will insure a country’s assets and populations, the inability of some
customers to pay may require governments or international public institutions such
as multilateral or development banks, to step in and provide public financing.
For public institutions using tax-payer’s money to support private financing products,
the challenge will be to achieve a balance between supporting emerging economies
to put in place insurance mechanisms, increasing the access to the benefits by the
poorest segments of their populations, and avoid excessive market distortions that
will benefit certain companies over others, while prizing companies that are early
movers, risk-takers and innovators.
The rise in the frequency and severity of natural catastrophes also poses the
challenge of business interruption for companies that rely on sourcing products and
materials from suppliers globally. The increasing focus of industry leaders like Allianz
on insuring global supply chain risks from climate change illustrates a growing need
to understand how natural disasters in one country will affect companies and
economies in other regions.18
New frontiers for micro-insurance
On the other side of the spectrum from these large financing mechanisms is microinsurance. Largely following the social innovation that micro-credit brought to banking
institutions, insurance companies have long been developing, prototyping and
implementing micro-insurance schemes that provide the poor in developing countries
‘Typhoon Haiyan losses trigger major new proposal on catastrophe insurance for the
Philippines’, UNISDR, January 20th 2014 http://www.unisdr.org/archive/36205
18 ‘Managing Disruptions: An insurer’s perspective on supply chain risks’, Allianz Global
Corporate & Specialty AG, 2012.
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with an affordable financial mechanism to protect their assets in the case of
disasters.
Examples include local insurance companies in countries where exposure to extreme
events drives a strong business case for companies. For example, La Positiva
Seguros in Peru has developed an insurance product for catastrophic climate risks
for smallholder farmers, which has paid out US$13 million to 145,000 smallholder
farmers over the last three years.19
All major global insurance and reinsurance companies are active in pursuing and
supporting micro-insurance innovations. The Munich Climate-Insurance Initiative
(MCII) is an example of corporate-sponsored social innovation through the
participation of companies such as Munich Re and Allianz.20
Micro-insurance initiatives led by global corporates, however, as their micro-credit
counterparts for banks, remain for now largely on the margins of mainstream markets
due to the complexity of building a finance case where markets are insufficiently
developed.
A range of public organizations, from development banks to NGOs are moving to
address the resulting gap in the exposure of the poor to climate change. For
example, the All India Disaster Mitigation Institute (AIDMI), an NGO based in
Ahmedabad, Gujarat, India, set up after the 1987–89 Gujarat droughts has been at
the forefront of developing disaster mitigation solutions for the poor in over 37 Indian
cities.21The International Labour Organisation hosts a global micro-insurance
innovation facility, which has been funded by a range of bodies including corporate
insurance foundations like Zurich Foundation.22These are some examples of a large
and rich ecosystem of innovation where corporates, NGOs, governments and
multilaterals are collaborating to improve practice. Mainstreaming micro-insurance in
insurance markets will require policy-makers and companies to identify and pursue
strategic opportunities.
‘La Positiva celebra el taller desarrollo de mercados de seguros asociados a fenómenos
climáticos’, Inese, July 18th 2013.
20 Munich Climate-Insurance Initiative http://www.climate-insurance.org/
21 All India Disaster Mitigation Institute http://www.aidmi.org/
22 Micro-insurance Innovation Facility http://www.microinsurancefacility.org
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Public-private policy cooperation
A range of policy frameworks and multilateral agencies are concerned with bridging
the gap between the insurance sector and policy-makers in different countries. They
are increasingly inter-related through key individuals and leaders that cut across all
initiatives, and offer an entry point of engagement for this agenda throughout 2014.
These include the United Nations Office for Disaster Risk Reduction (UNISDR),
which is responsible for development and adoption of a post-2015 framework for
disaster risk reduction (DRR); the Global Facility for Disaster Reduction and
Recovery (GFDRR) and the Principles for Sustainable Insurance (PSI), which is the
largest collaboration to-date between the United Nations and the Insurance Industry
to address sustainability.23
Section 5: Key workshop questions:
In light of the risks and opportunities discussed in this brief, a strategy workshop will
provide a space for industry and government leaders to discuss common interests
and explore the following questions:

How are insurance companies and foreign/trade policy experts perceiving climate
risks in emerging markets and the opportunities that will create economic value
while helping emerging economies manage climate risks?

How can trade and investment support programmes and the UK government’s
foreign policy help support insurance companies to create positive outcomes for
emerging economies and their ability to manage climate risks?

What co-financing models that blend private and public capital can be pursued
and what opportunity windows exist in 2014/2015 to leverage and support
programmes and investment strategies of companies in emerging economies?
23
United Nations Office for Disaster Risk Reduction; http://www.unisdr.org/we/coordinate/hfa;
Global Facility for Disaster Reduction and Recovery (GFDRR) https://www.gfdrr.org; and the
Principles for Sustainable Insurance; http://www.unepfi.org/psi
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