TIM WAGNER 
NEBRASKA DIRECTOR OF INSURANCE
JUNE 15, 2006

The economic impact on the insurance industry is just the beginning and a harbinger of things to come. The reality is that without significant mitigation of carbon emissions climate change will affect our social, economic and political well-being. It is difficult for our citizens to grasp the magnitude the change and how it will affect them. Growing insurance losses are a tangible measuring stick that is discernable to the pubic in understanding the impact.

While it is impossible to attribute each and every weather event that causes insured losses to climate change, insurers and insurance regulators are reaching consensus that climate change is real and that its costs to insurers and the insuring public are increasing at an unprecedented rate. In December 2005 the National Association of Insurance Commissioners (NAIC) held a symposium that included scientists, catastrophe modelers, insurers and the investment community to assess the impact of climate change on insurers to learn about the issue.

We learned some alarming news. Seven of the 10 most expensive U. S disasters happened within the last 4 years and 6 of the 10 were hurricanes that occurred within a 14 month period. Catastrophe losses in the U. S. cost private insurers $57.7 billion last year excluding an estimated $4 – 6 billion in off shore energy losses. This followed the record set the year before of $27.5 billion. U. S. catastrophe losses were 13.8% of net premium earned which were 4.2 times the 1984-2004 average of 3.3%. Some 40 years ago when I entered the insurance business catastrophe losses were approximately 1 – 2% of premiums. Then a catastrophe loss was defined as $1 million rather than the $25 million standard that applies today. Catastrophic events have become more frequent and more intense. 

The property and casualty industry has capital of approximately $425 billion, up from about $300 billion in 2001. The $125 billion increase is primarily the result of retained earnings, unrealized capital gains and investor capital contributions of about $35 billion. Capital is the foundation for the insurance industry’s ability to accept risk by providing the financial security necessary to fulfill its promises. 

While we tend to view the capital position of the insurance industry in total, it should be noted that the capital is limited by how it is allocated in the marketplace. For instance a number of insurers engage only in personal lines and some only in certain geographic areas. In addition, capital is committed to underwriting a number of kinds of insurance such as general liability, automobile and workers compensation. Only a fraction of the insurance industry’s total capital is available to finance property and business interruption exposures in the Gulf region. I have a growing concern that when it comes to capital allocation our weakest link may be the industry’s ability to finance catastrophic risk associated with commercial exposures. Katrina commercial property and business interruption losses exceeded $18 billion.

Thankfully the industry had a very healthy capital position when Katrina hit. Had the storms we experienced in 2005 occurred in 2001 I have serious concern that the industry may not have had enough remaining capital to continue to finance all of the risk necessary to accommodate the growing needs of our economy.

The insurance industry is confronted with two challenges both of which are the result of industrialization. The first is climate change that is driven by carbon emissions. While we have moved into a service economy and an information age our reliance on carbon energy continues to increase. The advent of global warming resulting from carbon emissions has increased the probability that insurers will continue to suffer greater losses in the future. 

As yet, the scientific community has not made a direct correlation between global warming and the unprecedented number of recent hurricanes but there seems to be consensus that ocean temperature is a factor in increased hurricane intensity. Some catastrophe modelers recently reported that this change has increased their projected future cost of risk in coastal areas. While the gulf coast has been the most challenged it is very probable that powerful hurricanes will form at latitudes higher than we have experienced.

We tend to focus on large events but there is evidence that changing weather patterns are affecting our economy and the insurance industry in a number of other ways. The changes we are experiencing affect different areas in different ways. The higher levels of energy produced by increased ocean and land temperatures not only affect hurricane activity. While overall more moisture is expected it will not be distributed evenly thus flooding can be expected. In the West and Central U. S. we have been experiencing serious droughts for an extended period the intensity of which has surpassed the Dust Bowl of the 1930s. The droughts have resulted in crop failure, forest and prairie fires, additional lightning losses and unprecedented hail events that accompanied the precious few rains we receive. We are observing sinking homes in the areas previously stable on the Alaskan permafrost. Europe has experienced significant winter storms, flooding and difficult heat waves in recent years. 

The second change resulting from industrialization is demographic. While many of our citizens left the farm for the city throughout the last two centuries it is clear that coastal areas have enjoyed tremendous growth. This growth continues. The insurance industry’s exposure to loss is exacerbated by increased property values. Areas once considered uninhabitable were cleared or drained to make way for new development. This has created enormous property values in locations that are particularly susceptible to weather-related catastrophes and rising ocean levels resulting from depletion of our polar ice caps. 

It was reported that an estimated $2 trillion of property values are insured in Florida coastal areas. If a Katrina hit Miami it is estimated that the insured loss would approach $150 billion. If a hurricane that hit in 1926 were to take the same landfall today it would be a $100 billion event. The insurance industry is confronted with almost infinite exposure to loss supported only by finite unearned premium and capital. 

The insurance industry historically has priced its products based on its past loss experience relying on probabilities and statistics. Climate change has created uncertainty and ambiguity in the pricing process because what happened in the past is no longer a reliable predicator of what will happen in the future. The insurance industry has begun to rely on catastrophe models for guidance in pricing. However, catastrophe modelers find it difficult to project future losses due to changing weather dynamics resulting from climate change. 

Even with rising prices some insurers will exit those areas most exposed to risk. It will be difficult to entice the private insurance sector to continue to remain exposed in areas that are subject to extreme weather events or land movement. Insurance availability is driven by two factors – the ability to accept risk that is dictated by the capital available to finance risk and the expectation that the business written will be profitable. Without both the marketplace will find few willing participants. It is clear that the coastal areas need to focus on the question of expectation, as insurers will use their capital where their expectation of profit is the greatest. 

For those in harm’s way there are no easy answers but it’s clear that loss mitigation is necessary to reduce the cost of risk and to attract insurers into the marketplace. Even then there is no assurance that they will. Clearly, adoption of the international building code and its enforcement are important components of a loss mitigation policy. In addition, remediation of existing properties is important. Perhaps most important of all is the adoption of a strong land use policy. Without strong limitations on new construction in exposed areas the availability problems now being experienced will only increase.

Individual states have created governmental windstorm pools to accommodate risks in areas most exposed to windstorm loss. We may not have served the public well by establishing such funds that in effect have subsidized the cost of risk to those most exposed to catastrophe. Some citizens who purchase or build property in difficult areas may not have been aware of the true cost of risk due to government programs that have shifted the cost to insurers that then have been passed on to policyholders in non-subsidized areas. Had the true cost of risk been appropriately recognized these individuals might have made different buying or building decisions. 

Given the magnitude of the insurance issues the NAIC, after its December 2005 symposium on climate change, has taken two steps the growing problem of underwriting capacity and availability of insurance in affected areas.

The first step was to establish an Executive Committee Task Force on Climate Change. 
The task force is charged with:

• Documenting the consensus within the scientific community that the climate is changing,
• Preparing an overview of the potential insurance related impacts of climate change,
• Holding a public hearing to assess public awareness of climate change, and
• Preparing a report on the implications of climate change on the various segments of the insurance industry including the impact on the financial condition of insurers and the availability of insurance.

Insurance regulators are focused on the financial impact of catastrophe on property and casualty industry. The concerns relate to the:

• Possibility that a future event or events could result in some insolvencies of insurers,
• Need of insurers to liquidate investments to pay unexpected losses at times when such liquidation may not be in their best interest,
• Continued ability to meet the needs of the insurance buying public, and
• Ability to provide the necessary level of service to those policyholders who sustain loss.
The exposure to underwriting losses in the other segments, while not as significant, may merit attention. Increases in morbidity and morality are an issue. Heat waves in Europe have taken a heavy toll among the elderly. The stress of increased temperatures has put the power grid at risk. The failure to our energy network to provide temperature moderation could well result in an unforeseen loss of life and the need for increased medical care.

There is a growing need for contingent business interruption insurance as our local, regional, national and international economies are interdependent. Weather events that are local in nature can ripple through the nation’s entire economy. For example Katrina and Rita took a heavy toll on the oil production and refining capabilities of Louisiana and Mississippi. Three offshore oilrigs remain missing. Given the severe damage we are fortunate there were no shortfalls in fuel. The next time we may not be so lucky.

The entire insurance industry is subject to investment risk. For property and casualty insurers there is concern that they may be exposed to a double risk – both an underwriting risk and an investment risk as a result of single event. Climate change will result in some properties losing value simply because the true cost of risk associated with them must increase. Insurers are heavily invested in financing real estate and some mortgages will be at risk. Likewise, there will be investment opportunities in alternative energy investment some of which will bear fruit and some not.

The second step the NAIC has taken is to adopt a resolution that will soon be sent to Congress. The resolution calls for:

• Congress to establish a Federal Commission to assess the need for a federal backstop to assure that the insurance industry retains the ability to finance the growing financial risk in the event of a mega catastrophe or a series of lesser events,
• A change in our income tax code that would allow insurers to establish reserves for catastrophes, 
• Adoption of the international building code and its enforcement,
• Remediation of existing properties in areas prone to catastrophic events, and
• Development of a land use policy that would limit new construction in locations subject to catastrophe.

This concludes my prepared remarks and I look forward to a lively discussion and some challenging questions.

Thank you.

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