Climate Change
Financial Risks to Federal and Private Insurers in Coming Decades are Potentially Significant Gao ID: GAO-07-820T May 3, 2007Weather-related events in the United States have caused tens of billions of dollars in damages annually over the past decade. A major portion of these losses is borne by private insurers and by two federal insurance programs-- the Federal Emergency Management Agency's National Flood Insurance Program (NFIP), which insures properties against flooding, and the Department of Agriculture's Federal Crop Insurance Corporation (FCIC), which insures crops against drought or other weather disasters. In this testimony, GAO (1) describes how climate change may affect future weather-related losses, (2) provides information on past insured weather-related losses, and (3) determines what major private insurers and federal insurers are doing to prepare for potential increases in such losses. This testimony is based on a report entitled Climate Change: Financial Risks to Federal and Private Insurers in Coming Decades are Potentially Significant (GAO-07-285) released on April 19, 2007.
Key scientific assessments report that the effects of climate change on weather-related events and, subsequently, insured and uninsured losses, could be significant. The global average surface temperature has increased over the past century and climate models predict even more substantial, perhaps accelerating, increases in temperature in the future. Assessments by key governmental bodies generally found that rising temperatures are expected to increase the frequency and severity of damaging weather-related events, such as flooding or drought, although the timing and magnitude are as yet undetermined. Additional research on the effect of increasing temperatures on weather events is expected in the near future. Taken together, private and federal insurers paid more than $320 billion in claims on weather-related losses from 1980 to 2005. Claims varied significantly from year to year--largely due to the effects of catastrophic weather events such as hurricanes and droughts--but have generally increased during this period. The growth in population in hazard-prone areas and resulting real estate development have generally increased liabilities for insurers, and have helped to explain the increase in losses. Due to these and other factors, federal insurers' exposure has grown substantially. Since 1980, NFIP's exposure nearly quadrupled to nearly $1 trillion in 2005, and program expansion increased FCIC's exposure 26-fold to $44 billion. Major private and federal insurers are both exposed to the effects of climate change over coming decades, but are responding differently. Many large private insurers are incorporating climate change into their annual risk management practices, and some are addressing it strategically by analyzing its potential long-term industry-wide impacts. In contrast, federal insurers have not developed and disseminated comparable information on long-term financial impacts. GAO acknowledges that the federal insurance programs are not profit-oriented, like private insurers. Nonetheless, a strategic assessment of the potential implications of climate change for the major federal insurance programs would help the Congress manage an emerging high-risk area with significant implications for the nation's growing long-term fiscal imbalance.
GAO-07-820T, Climate Change: Financial Risks to Federal and Private Insurers in Coming Decades are Potentially Significant
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Testimony:
Before the Select Committee on Energy Independence and Global Warming,
U.S. House of Representatives:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 9:30 a.m. EDT:
Thursday, May 3, 2007:
Climate Change:
Financial Risks to Federal and Private Insurers in Coming Decades are
Potentially Significant:
Statement of John B. Stephenson, Director:
Natural Resources and Environment:
GAO-07-820T:
GAO Highlights:
Highlights of GAO-07-820T, testimony before the Select Committee on
Energy Independence and Global Warming, United States House of
Representatives
Why GAO Did This Study:
Weather-related events in the United States have caused tens of
billions of dollars in damages annually over the past decade. A major
portion of these losses is borne by private insurers and by two federal
insurance programs”the Federal Emergency Management Agency‘s National
Flood Insurance Program (NFIP), which insures properties against
flooding, and the Department of Agriculture‘s Federal Crop Insurance
Corporation (FCIC), which insures crops against drought or other
weather disasters.
In this testimony, GAO (1) describes how climate change may affect
future weather-related losses, (2) provides information on past insured
weather-related losses, and (3) determines what major private insurers
and federal insurers are doing to prepare for potential increases in
such losses. This testimony is based on a report entitled Climate
Change: Financial Risks to Federal and Private Insurers in Coming
Decades are Potentially Significant (GAO-07-285) released on April 19,
2007.
What GAO Found:
Key scientific assessments report that the effects of climate change on
weather-related events and, subsequently, insured and uninsured losses,
could be significant. The global average surface temperature has
increased over the past century and climate models predict even more
substantial, perhaps accelerating, increases in temperature in the
future. Assessments by key governmental bodies generally found that
rising temperatures are expected to increase the frequency and severity
of damaging weather-related events, such as flooding or drought,
although the timing and magnitude are as yet undetermined. Additional
research on the effect of increasing temperatures on weather events is
expected in the near future.
Taken together, private and federal insurers paid more than $320
billion in claims on weather-related losses from 1980 to 2005. Claims
varied significantly from year to year”largely due to the effects of
catastrophic weather events such as hurricanes and droughts”but have
generally increased during this period. The growth in population in
hazard-prone areas and resulting real estate development have generally
increased liabilities for insurers, and have helped to explain the
increase in losses. Due to these and other factors, federal insurers‘
exposure has grown substantially. Since 1980, NFIP‘s exposure nearly
quadrupled to nearly $1 trillion in 2005, and program expansion
increased FCIC‘s exposure 26-fold to $44 billion.
Major private and federal insurers are both exposed to the effects of
climate change over coming decades, but are responding differently.
Many large private insurers are incorporating climate change into their
annual risk management practices, and some are addressing it
strategically by analyzing its potential long-term industry-wide
impacts. In contrast, federal insurers have not developed and
disseminated comparable information on long-term financial impacts. GAO
acknowledges that the federal insurance programs are not profit-
oriented, like private insurers. Nonetheless, a strategic assessment of
the potential implications of climate change for the major federal
insurance programs would help the Congress manage an emerging high-risk
area with significant implications for the nation‘s growing long-term
fiscal imbalance.
Figure: Growth in Exposure of Federal Insurance Programs ($2005):
[See PDF for Image]
Source: GAO.
[End of figure]
What GAO Recommends:
In its report, GAO recommended that the Secretaries of Agriculture and
Homeland Security analyze the potential long-term fiscal implications
of climate change for the FCIC and the NFIP, respectively, and report
their findings to the Congress. Both agencies expressed agreement with
the recommendation.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-820T.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact John Stephenson at (202)
512-3841 or stephensonj@gao.gov.
[End of section]
Mr. Chairman and Members of the Committee:
I am pleased to be here today to discuss our findings on the potential
financial implications of climate change for federal and private
insurers. My testimony is based on our report entitled Climate Change:
Financial Risks to Federal and Private Insurers in Coming Decades are
Potentially Significant, released on April 19, 2007.[Footnote 1] I also
presented the findings and recommendations from that report at a
hearing before the Senate Homeland Security and Governmental Affairs
Committee on the same day. The uncertain and potentially large losses
associated with weather-related events are among the biggest risks that
property insurers face. Virtually anything that is insured is
vulnerable to weather-related events.
The property and casualty segment of the insurance industry, spanning
both the private and public sector, bears a large portion of weather-
related losses--the dollar value of claims paid on damage attributable
to weather-related events.[Footnote 2] The private sector includes
primary insurers that insure individuals and businesses directly, and
reinsurers that insure the primary insurers. The public sector includes
federal and state programs that were established as an alternative to
disaster assistance in markets where private insurance markets did not
exist, such as for crop losses, and for losses that private insurers
had deemed uninsurable, such as flood damage. The Federal Crop
Insurance Corporation (FCIC) was established in 1938 to temper the
economic impact of the Great Depression, and was significantly expanded
in 1980 to protect farmers from the financial losses brought about by
drought, flood, or other natural disasters. The Department of
Agriculture's Risk Management Agency (RMA) administers the program in
partnership with private insurance companies, which share a percentage
of the risk of loss and the opportunity for gain associated with each
insurance policy written. The National Flood Insurance Program (NFIP)
was established in 1968 to protect communities vulnerable to flood
damage. The Federal Emergency Management Agency (FEMA), within the
Department of Homeland Security, is responsible for oversight and
management of the NFIP. Private insurers administer the program in
partnership with the federal government, but the federal government
assumes the full liability for losses.
To remain financially solvent, the insurance industry must estimate and
prepare for the potential impact of future weather-related events. Any
unanticipated changes in the frequency or severity of weather-related
events can have financial consequences at the company level and
industry-wide. Some infrequent weather-related events--drought or
hurricanes, for example--are so severe that they pose unique challenges
for insurers and reinsurers. Commonly referred to as extreme or
catastrophic events, the unpredictability and sheer size of these
events--both in terms of geography and number of insured parties
affected--have the potential to overwhelm insurers' and reinsurers'
capacity to pay claims.
The earth's climate and weather patterns are dynamic, varying on
seasonal, decadal, and longer time scales. Of particular concern, the
global average surface temperature has increased by 1.3 degrees
Fahrenheit (0.74 degrees Celsius) over the past 100 years, and the
National Academy of Sciences (NAS) and other scientific organizations
have concluded that available evidence points to continued, perhaps
accelerating, increases over the next century. Much research and policy
debate of late has centered on the extent to which human activities
have contributed to this warming and accompanying changes in climate,
and how much is due to natural variability. But in any case, climate
change, defined by the Intergovernmental Panel on Climate Change (IPCC)
as any change in the climate over time due to either natural
variability or as a result of human activity,[Footnote 3] may affect
social and economic activities in potentially profound ways--by raising
sea levels, changing precipitation patterns, and altering the frequency
or severity of weather-related events.
My testimony summarizes our report, focusing on (1) what is known about
how climate change might affect the frequency and severity of damaging
weather-related events, (2) the extent of the insured losses incurred
by private and federal insurers and reinsurers resulting from weather-
related events, and (3) what major federal agencies and private
insurers and reinsurers are doing to prepare for the potential risk of
increased losses.
To describe how climate change might affect insured and uninsured
losses, we reviewed and summarized key scientific assessments by
reputable international and national research organizations, including
the IPCC, NAS, and the multi-federal agency Climate Change Science
Program (CCSP). To determine the extent of insured losses, we analyzed
key data from 1980 through 2005 from the insurance industry and federal
agencies. Comparable data on 2006 losses were not available at the time
we completed work on our report. To determine what federal and private
insurers are doing to prepare for potential increases in losses, we
interviewed agency officials and a subset of the largest insurers and
reinsurers operating within the United States. We also interviewed
officials from catastrophe modeling firms, insurance industry
associations, the National Association of Insurance
Commissioners,[Footnote 4] and universities to provide additional
context for respondents' statements. In addition, we reviewed key
reports and publications from federal agencies, insurance experts, and
selected insurance companies. We performed our work in accordance with
generally accepted government auditing standards.
Summary:
Assessments by key governmental scientific bodies have found that the
effects of climate change on weather-related events could be
substantial. IPCC projections, endorsed by NAS and CCSP, expect warmer
surface temperatures to increase the frequency and severity of damaging
weather-related events (such as flooding or drought), although the
timing, magnitude, and duration of these changes are as yet
undetermined. Further research on the relationship between increasing
temperatures and weather events is ongoing. Of particular note, the
IPCC is in the process of releasing its Fourth Assessment Report of the
state of climate science throughout 2007, and CCSP has undertaken an
assessment of the potential changes specific to North America in a
report scheduled for release in 2008.
Taken together, private and federal insurers paid more than $320
billion in claims on weather-related losses from 1980 through 2005. In
constant 2005 dollars, private insurers paid the largest part of this
total, $243.5 billion (about 76 percent); followed by federal crop
insurance, $43.6 billion (about 14 percent); and federal flood
insurance, $34.1 billion (about 11 percent). Claims varied
significantly from year to year--largely due to the incidence and
effects of extreme weather events such as hurricanes and droughts--but
generally increased during this period. The growth in population in
hazard-prone areas, and resulting real estate development and
increasing real estate values, have increased federal and private
insurers' total coverage and have helped to explain the increase in
losses.
While both major private and federal insurers are exposed to increases
in the frequency or severity of weather-related events associated with
climate change, the two sectors are responding in different ways. Many
major private insurers are incorporating elements of climate change
into their annual and strategic risk management practices to reduce
their exposure to catastrophic risk--that is, their vulnerability to
extreme weather-related events and the associated financial losses. One
consequence is that they are transferring some of their exposure to
policyholders and to the public sector. Federal insurance programs, on
the other hand, have seen their exposure grow significantly--NFIP's
total coverage has quadrupled from 1980 to 2005, nearing $1 trillion,
and program expansion has increased FCIC's total coverage nearly 26-
fold to $44 billion. These escalating exposures to catastrophic weather
events are putting the federal government at increased financial risk,
but federal insurers have done little to develop and disseminate the
kind of information they, and other key decision-makers such as the
Congress, need to understand their programs' long-term exposure to the
increased financial risks associated with climate change.
While we acknowledge that the mandate and operating environment of the
major federal insurance programs is different from that of the private
sector, we believe that better information about the federal
government's exposure to potential changes in weather-related risk
would help the Congress identify and manage this emerging high-risk
area--one that potentially has significant implications for the
nation's growing fiscal imbalance. Accordingly, our recently released
report recommends that the Departments of Agriculture (USDA) and
Homeland Security (DHS) assess the potential long-term fiscal
implications of climate change for the FCIC and NFIP, respectively, and
report their findings to the Congress. During the April 19 hearing,
Senators Lieberman and Collins both requested that USDA and DHS notify
the Committee of how they plan to implement this recommendation, and
offered some guidance on the agencies' approaches in conducting such an
assessment.
In commenting on a draft of this report, both USDA and DHS agreed with
our recommendation, although USDA took issue with several points made
in the report. The Department of Commerce neither agreed nor disagreed
with the report's findings, but instead commented on the presentation
of several issues in the draft and offered technical comments which we
incorporated into this report as appropriate. The Department of Energy
elected not to provide comments on the draft.
Background:
Insurance is a mechanism for spreading risk over time, across large
geographical areas, and among industries and individuals. While private
insurers assume some financial risk when they write policies, they
employ various strategies to manage risk so that they earn profits,
limit potential financial exposure, and build capital needed to pay
claims. For example, insurers charge premiums for coverage and
establish underwriting standards, such as refusing to insure customers
who pose unacceptable levels of risk or limiting coverage in particular
geographic areas. Insurance companies may also purchase reinsurance to
cover specific portions of their financial risk. Reinsurers use
strategies similar to primary insurers to limit their risks.
Under certain circumstances, the private sector may determine that a
risk is uninsurable. For example, homeowner policies typically do not
cover flood damage because private insurers are unwilling to accept the
risk of potentially catastrophic losses associated with flooding. In
other instances, the private sector may be willing to insure a risk,
but at rates that are not affordable to many property owners. Without
insurance, affected property owners must rely on their own resources or
seek out disaster assistance from local, state, and federal sources.
In situations where the private sector will not insure a particular
type of risk, the public sector may create markets to ensure the
availability of insurance. The federal government operates two such
programs--the NFIP and the FCIC. NFIP provides insurance for flood
damage to homeowners and commercial property owners in more than 20,000
communities. Homeowners with mortgages from federally regulated lenders
on property in communities identified as being in high flood risk areas
are required to purchase flood insurance on their dwellings. Optional,
lower cost flood insurance is also available under the NFIP for
properties in areas of lower flood risk. NFIP offers coverage for both
the property and its contents, which may be purchased separately. FCIC
insures agricultural commodities on a crop-by-crop and county-by-county
basis based on farmer demand and the level of risk associated with the
crop in a given region. Major crops, such as grains, are covered in
almost every county where they are grown, while specialty crops such as
fruit are covered only in some areas. Participating farmers can
purchase different types of crop insurance and at different levels.
Climate Change Is Expected to Alter the Frequency or Severity of
Damaging Weather-Related Events:
Assessments by leading scientific bodies suggest that climate change
could significantly alter the frequency or severity of weather-related
events, such as drought and hurricanes. Leading scientific bodies
report that the Earth warmed during the twentieth century--1.3 degrees
Fahrenheit (0.74 degrees Celsius) from 1906 to 2005 according to a
recent IPCC report--and is projected to continue to warm for the
foreseeable future.[Footnote 5] While temperatures have varied
throughout history, triggered by natural factors such as volcanic
eruptions or changes in the earth's orbit, the key scientific
assessments we reviewed have generally concluded that the observed
increase in temperature in the past 100 years cannot be explained by
natural variability alone. In recent years, major scientific bodies
such as the IPCC, NAS, and the United Kingdom's Royal Academy have
concluded that human activities are significantly increasing the
concentrations of greenhouse gases and, in turn, global temperatures.
Assuming continued growth in atmospheric concentration of greenhouse
gases, the latest assessment of computer climate models projects that
average global temperatures will warm by an additional 3.2 to 7.2
degrees Fahrenheit (1.8 to 4.0 degrees Celsius) during the next
century.[Footnote 6]
Based on model projections and expert judgment, the IPCC reported that
future increases in the earth's temperature are likely to increase the
frequency and severity of many damaging extreme weather-related events
(summarized in table 1). The IPCC recently published summaries of two
of the three components of its Fourth Assessment Report. The first, in
which IPCC summarized the state of the physical science, reports higher
confidence in projected patterns of warming and other regional-scale
features, including changes in wind patterns, precipitation, and some
aspects of extreme events such as drought, heavy precipitation events,
and hurricanes. The second, in which IPCC addresses climate impacts and
vulnerabilities, reported that the potential societal impacts from
changes in temperature and extreme events vary widely across sector and
region. For example, although the IPCC projects moderate climate change
may increase yields for some rain-fed crops, crops that are near their
warm temperature limit or depend on highly-used water resources face
many challenges. Additionally, local crop production in any affected
area may be negatively impacted by projected increases in the frequency
of droughts or floods. Furthermore, the IPCC stated that the economic
and social costs of extreme weather events will increase as these
events become more intense and/or more frequent. Rapidly-growing
coastal areas are particularly vulnerable, and the IPCC notes that
readiness for increased exposure in these areas is low. These reports
have not been publicly released in their entirety, but are expected
sometime after May 2007.
Table 1: Selected IPCC Estimates of Confidence in Projected Changes in
Weather-Related Events:
Weather-related event: Warmer and fewer cold days and nights; warmer/
more frequent hot days and nights over most land areas;
Confidence in projected future changes, 2007: Virtually certain[A];
Examples of major projected impacts relevant to property insurers:
* Increased crop yields in colder environments;
* Decreased crop yields in warmer environments;
* Increased insect outbreaks in agriculture and forestry.
Weather-related event: Warm spells/heat waves: frequency increases over
most land areas;
Confidence in projected future changes, 2007: Very likely;
Examples of major projected impacts relevant to property insurers:
* Reduced crop yields in warmer regions due to heat stress;
* Wildfire danger increases.
Weather-related event: Heavy precipitation events: frequency increases
over most areas;
Confidence in projected future changes, 2007: Very likely;
Examples of major projected impacts relevant to property insurers:
* Damage to crops;
* Soil erosion;
* Inability to cultivate land due to excessive moisture content of
soils;
* Damage and disruption due to flooding.
Weather-related event: Area affected by drought increases;
Confidence in projected future changes, 2007: Likely;
Examples of major projected impacts relevant to property insurers:
* Land degradation, lower yields and damage or failure of crops;
* Increased livestock deaths; * Increased risk of wildfire;
* Disruptions due to water shortages.
Weather-related event: Intense tropical cyclone activity increases;
Confidence in projected future changes, 2007: Likely;
Examples of major projected impacts relevant to property insurers:
* Damage to crops and trees;
* Disruption and damage due to flooding and high winds;
* Withdrawal of private insurance from vulnerable areas.
Source: IPCC, Climate Change 2007: Impacts, Adaptation, and
Vulnerability, Summary for Policymakers, 2007.
Note: IPCC uses the following terms to indicate the assessed likelihood
of an outcome--"virtually certain" indicates a 99% probability of
occurrence; "very likely" indicates a greater than 90% probability of
occurrence; and "likely" indicates a greater than 66% probability of
occurrence.
[A] Warming of the most extreme days and nights each year.
[End of table]
In addition to the IPCC's work, CCSP is assessing potential changes in
the frequency or intensity of weather-related events specific to North
America in a report scheduled for release in 2008. According to a
National Oceanic and Atmospheric Administration official and agency
documents, the report will focus on weather extremes that have a
significant societal impact, such as extreme cold or heat spells,
tropical and extra-tropical storms, and droughts. Importantly,
officials have said the report will provide an assessment of the
observed changes in weather and climate extremes, as well as future
projections.
Weather-Related Insured Losses Totaled More Than $320 Billion between
1980 and 2005 and Appear to Be Increasing:
Based on an examination of loss data from several different sources, we
found that insurers incurred about $321.2 billion in weather-related
losses from 1980 through 2005. In particular, as illustrated in Figure
1, our analysis found that weather-related losses accounted for 88
percent of all property losses paid by insurers during this
period.[Footnote 7] All other property losses, including those
associated with earthquakes and terrorist events, accounted for the
remainder. Weather-related losses varied significantly from year to
year, ranging from just over $2 billion in 1987 to more than $75
billion in 2005.
Figure 1: Annual Weather-and Nonweather-Related Insured Losses:
[See PDF for image]
Sources: GAO analysis of PCS, NFIP, and FCIC data.
[End of figure]
Private insurers paid $243.5 billion--over 75 percent of the total
weather-related losses we reviewed. The two major federal insurance
programs--NFIP and FCIC--paid the remaining $77.7 billion of the $321.2
billion in weather-related loss payments we reviewed. NFIP paid about
$34.1 billion, or about 11 percent of the total weather-related loss
payments we reviewed during this period. As illustrated in Figure 2,
claims averaged about $1.3 billion per year, but ranged from $75.7
million in 1988 to $16.7 billion in 2005.
Figure 2: Weather-Related Losses Paid by NFIP:
[See PDF for image]
Source: GAO analysis of NFIP data.
[End of figure]
Since 1980, FCIC claims totaled $43.6 billion, or about 14 percent of
all weather-related claims during this period. As illustrated in Figure
3, FCIC losses averaged about $1.7 billion per year, ranging from
$531.8 million in 1987 to $4.2 billion in 2002.
Figure 3: Weather-Related Losses Paid by FCIC:
[See PDF for image]
Source: GAO analysis of FCIC data.
[End of figure]
The largest insured losses in the data we reviewed were associated with
catastrophic weather events. Notably, crop insurers and other property
insurers both face catastrophic weather-related risks, although the
nature of the events for each is very different. In the case of crop
insurance, drought accounted for more than 40 percent of weather-
related loss payments from 1980 to 2005, and the years with the largest
losses were associated with drought. Taken together, though, hurricanes
were the most costly event in the data we reviewed. Although the United
States experienced an average of only two hurricanes per year from 1980
through 2005, weather-related claims attributable to hurricanes totaled
more than 45 percent of all weather-related losses--more than $146
billion. Moreover, as illustrated in Table 2, these losses appear to
have increased during the past three decades.
Table 2: Insured Losses Associated with Hurricanes:
1980s;
Category 1 & 2: $807 (11);
Category 3, 4, & 5: $9,905 (6);
Total: $10,712 (17).
1990s;
Category 1 & 2: $9,039 (11);
Category 3, 4, & 5: $29,099 (8);
Total: $38,138 (19).
2000s;
Category 1 & 2: $8,072 (7);
Category 3, 4, & 5: $89,210 (7);
Total: $97,282 (14).
Total;
Category 1 & 2: $17,918 (29);
Category 3, 4, & 5: $128,214 (21);
Total: $146,132 (50).
Source: GAO analysis of PCS and NFIP data; National Oceanic and
Atmospheric Administration (hurricane severity classification).
Note: Totals in millions of 2005 dollars. Totals do not include crop
losses associated with hurricanes. Number of hurricanes associated with
losses is included in parentheses. Hurricane classification was based
on peak intensity at landfall.
[End of table]
Several recent studies have commented on the apparent increases in
hurricane losses during this time period, and weather-related disaster
losses generally, with markedly different interpretations. Some argue
that loss trends are largely explained by changes in societal and
economic factors, such as population density, cost of building
materials, and the structure of insurance policies. Others argue that
increases in losses have been driven by changes in climate. To address
the issue, Munich Re--one of the world's largest reinsurance companies-
-and the University of Colorado's Center for Science and Technology
Policy Research jointly convened a workshop in Germany in May 2006 to
assess factors leading to increasing weather-related losses.[Footnote
8] The workshop brought together a diverse group of international
experts in the fields of climatology and disaster research. Workshop
participants agreed that long-term records of disaster losses indicate
that societal change and economic development are the principal factors
explaining weather-related losses.[Footnote 9] However, participants
also agreed that changing patterns of extreme events are drivers for
recent increases in losses, and that additional increases in losses are
likely, given IPCC's projections.
The close relationship between the value of the resource exposed to
weather-related losses and the amount of damage incurred may have
ominous implications for a nation experiencing rapid growth in some of
its most disaster-prone areas. AIR Worldwide, a leading catastrophe
modeling firm, recently reported that insured losses should be expected
to double roughly every 10 years because of increases in construction
costs, increases in the number of structures, and changes in their
characteristics. AIR's research estimates that, because of exposure
growth, probable maximum catastrophe loss--an estimate of the largest
possible loss that may occur, given the worst combination of
circumstances--grew in constant 2005 dollars from $60 billion in 1995
to $110 billion in 2005, and it will likely grow to over $200 billion
during the next 10 years.
Major Private and Public Insurers Differ in How They Manage
Catastrophic Risks Associated with Climate Change:
Major private and federal insurers are responding differently to the
prospect of increasing weather-related losses associated with climate
change. Many large private insurers are incorporating both near and
longer-term elements of climatic change into their risk management
practices. On the other hand, for a variety of reasons, the federal
insurance programs have done little to develop the kind of information
needed to understand the programs' long-term exposure to climate
change.
Major Private Insurers Prospectively Manage Potential Increases in
Catastrophic Risk Associated with Climate Change:
Catastrophic weather events pose a unique financial threat to private
insurers' financial success because a single event can cause insolvency
or a precipitous drop in earnings, liquidation of assets to meet cash
needs, or a downgrade in the market ratings used to evaluate the
soundness of companies in the industry. To prevent these disruptions,
the American Academy of Actuaries (AAA)--the professional society that
establishes, maintains, and enforces standards of qualification,
practice, and conduct for actuaries in the United States--recommends,
among other steps, that insurers measure their exposure to catastrophic
weather-related risk. In particular, AAA emphasizes the shortcomings of
estimating future catastrophic risk by extrapolating solely from
historical losses, and endorses a more rigorous approach that
incorporates underlying trends and factors in weather phenomena and
current demographic, financial, and scientific data to estimate losses
associated with various weather-related events.
In our interviews with eleven of the largest private insurers operating
in the U.S. property casualty insurance market, we sought to determine
what key private insurers are doing to estimate and prepare for risks
associated with potential climatic changes arising from natural or
human factors. Representatives from each of the 11 major insurers we
interviewed told us they incorporate near-term increases in the
frequency and intensity of hurricanes into their risk estimates. Six
specifically attributed the higher frequency and intensity of
hurricanes to a 20-to 40-year climatic cycle of fluctuating
temperatures in the north Atlantic Ocean, while the remaining five
insurers did not elaborate on the elements of climatic change driving
the differences in hurricane characteristics.
In addition to managing their aggregate exposure on a near-term basis,
some of the world's largest insurers have also taken a longer-term
strategic approach to changes in catastrophic risk.[Footnote 10] Six of
the eleven private insurers we interviewed reported taking one or more
additional actions when asked if their company addresses climatic
change in their weather-related risk management processes. These
activities include monitoring scientific research (4 insurers),
simulating the impact of a large loss event on their portfolios (3
insurers), and educating others in the industry about the risks of
climatic change (3 insurers), among others. Moreover, major insurance
and reinsurance companies, such as Allianz, Swiss Re, Munich Re, and
Lloyds of London, have published reports that advocate increased
industry awareness of the potential risks of climate change, and
outline strategies to address the issue proactively.
Major Federal Insurers Have Taken Little Action to Prospectively Assess
and Disseminate Information on Potential Increases in Catastrophic Risk
Associated with Climate Change:
NFIP and FCIC have not developed information on the programs' longer-
term exposure to the potential risk of increased extreme weather events
associated with climate change as part of their risk management
practices. The goals of the key federal insurance programs are
fundamentally different from those of private insurers. Whereas private
insurers stress the financial success of their business operations, the
statutes governing the NFIP and FCIC promote affordable coverage and
broad participation by individuals at risk over the programs' financial
self-sufficiency by offering discounted or subsidized premiums. Also
unlike the private sector, the NFIP and the FCIC have access to
additional federal funds during high-loss years.[Footnote 11] Thus,
neither program is required to assess and limit its catastrophic risk
strictly within its ability to pay claims on an annual basis. Instead,
to the extent possible, each program manages its risk within the
context of its broader purposes in accordance with authorizing statutes
and implementing regulations.
Nonetheless, an improved understanding of the programs' financial
exposure is becoming increasingly important. Notably, the federal
insurance programs' liabilities have grown significantly, which leaves
the federal government increasingly vulnerable to the financial impacts
of catastrophic events. Data obtained from both the NFIP and FCIC
programs indicate the federal government has grown markedly more
exposed to weather-related losses. Figure 4 illustrates the growth of
both program's exposure from 1980 to 2005. For NFIP, the program's
total coverage increased fourfold in constant dollars during this time
from about $207 billion to $875 billion in 2005 due to increasing
property values and a doubling of the number of policies from 1.9
million to more than 4.6 million. The FCIC has effectively increased
its exposure base 26-fold during this period. In particular, the
program has significantly expanded the scope of crops covered and
increased participation. The main implication of the exposure growth
for both the programs is that the magnitude of potential claims, in
absolute terms, is much greater today than in the past.
Figure 4: Total Coverage of NFIP and FCIC, 1980-2005:
[See PDF for image]
Source: GAO analysis of NFIP and FCIC data.
[End of figure]
Neither program has assessed the implications of a potential increase
in the frequency or severity of weather-related events on program
operations, although both programs have occasionally attempted to
estimate their aggregate losses from potential catastrophic events. For
example, FCIC officials stated that they had modeled past events, such
as the 1993 Midwest Floods, using current participation levels to
inform negotiations with private crop insurers over reinsurance terms.
However, NFIP and FCIC officials explained that these efforts were
informal exercises, and were not performed on a regular basis.
Furthermore, according to NFIP and FCIC officials, both programs'
estimates of weather-related risk rely heavily on historical weather
patterns. As one NFIP official explained, the flood insurance program
is designed to assess and insure against current--not future--risks.
Over time, agency officials stated, this process has allowed their
programs to operate as intended. However, unlike private sector
insurers, neither program has conducted an analysis of the potential
impacts of an increase in the frequency or severity of weather-related
events on continued program operations in the long-term.
Information on Federal Agencies' Long-Term Exposure to Catastrophic
Risk Could Better Inform Congressional Decision-Making:
While comprehensive information on federal insurers' long-term exposure
to catastrophic risk associated with climate change may not inform the
NFIP's or FCIC's day-to-day operations, it could nonetheless provide
valuable information for the Congress and other policy-makers who need
to understand and prepare for fiscal challenges that extend well beyond
the two programs' near-term operational horizons. We have highlighted
the need for this kind of strategic information in recent reports that
have expressed concern about the looming fiscal imbalances facing the
nation. In particular, we observed that, "Our policy process will be
challenged to act with more foresight to take early action on problems
that may not constitute an urgent crisis but pose important long-term
threats to the nation's fiscal, economic, security, and societal
future."[Footnote 12] The prospect of increasing program liabilities,
coupled with expected increases in frequency and severity of weather
events associated with climate change, would appear to fit into this
category.
Agency officials identified several challenges that could complicate
their efforts to assess these impacts at the program level. Both NFIP
and FCIC officials stated there was insufficient scientific information
on projected impacts at the regional and local level to accurately
assess their impact on the flood and crop insurance programs. However,
members of the insurance industry have analyzed and identified the
potential risks climatic change poses to their business, despite
similar challenges. Moreover, as previously discussed, both the IPCC
and CCSP are expected to release significant assessments of the likely
effect of increasing temperatures on weather events in coming months.
The experience of many private insurers, who must proactively respond
to longer-term changes in weather-related risk to remain solvent,
suggests the kind of information that needs to be developed to make
sound strategic decisions. Specifically, to help ensure their future
viability, a growing number of private insurers are actively
incorporating the potential for climate change into their strategic
level analyses. In particular, some private insurers have run a variety
of simulation exercises to determine the potential business impact of
an increase in the frequency and severity of weather events. For
example, one insurer simulated the impact of multiple large weather
events occurring simultaneously. We believe a similar analysis could
provide Congress with valuable information about the potential scale of
losses facing the NFIP and FCIC in coming decades, particularly in
light of the programs' expansion over the past 25 years.
Concluding Observations:
We believe that the FCIC and NFIP are uniquely positioned to provide
strategic information on the potential impacts of climate change on
their programs--information that would be of value to key decision
makers charged with a long-term focus on the nation's fiscal health.
Most notably, in exercising its oversight responsibilities, the
Congress could use such information to examine whether the current
structure and incentives of the federal insurance programs adequately
address the challenges posed by potential increases in the frequency
and severity of catastrophic weather events. While the precise content
of these analyses can be debated, the activities of many private
insurers already suggest a number of strong possibilities that may be
applicable to assessing the potential implications of climate change on
the federal insurance programs.
Accordingly, our report recommended that the Secretary of Agriculture
and the Secretary of Homeland Security direct the Administrator of the
Risk Management Agency and the Under Secretary of Homeland Security for
Emergency Preparedness assess the potential long-term implications of
climate change for the FCIC and the NFIP, respectively, and report
their findings to the Congress. This analysis should use forthcoming
assessments from the Climate Change Science Program and the
Intergovernmental Panel on Climate Change to establish sound estimates
of expected future conditions. Both agencies expressed agreement with
this recommendation. In addition, at an April 19, 2007, hearing on our
report convened by the Senate Homeland Security and Governmental
Affairs Committee, Chairman Joseph Lieberman and Ranking Member Susan
Collins directed the agencies to provide the Committee a deadline by
which they plan to transmit this assessment to the Congress in
fulfillment of this recommendation. Chairman Lieberman also asked the
agencies to prepare and disseminate this assessment independent of any
annual reports to the Congress.
Mr. Chairman, this concludes my prepared statement. I would be happy to
respond to any questions that you or other Members of the Committee may
have.
Key Contact and Staff Acknowledgments:
For further information about this testimony, please contact me, John
Stephenson, at 202-512-3841 or stephensonj@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this statement. Contributors to this testimony
include Steve Elstein, Assistant Director; Chase Huntley; Micah
McMillan; Alison O'Neill; Kate Robertson; and Lisa Van Arsdale.
FOOTNOTES
[1] GAO, Climate Change: Financial Risks to Federal and Private
Insurers in Coming Decades are Potentially Significant, GAO-07-285
(Washington, D.C.: Mar. 16, 2007).
[2] Insurers use the term "loss" to refer to the dollar value of
approved or settled claims arising from damages incurred by a
policyholder. "Loss" does not account for premium or other income,
deductibles, co-payments, or damages in excess of coverage.
[3] More specifically, the IPCC definition refers to climate change as
a statistically significant variation in either the mean state of the
climate or in its variability, persisting for an extended period
(typically decades or longer). Climate change may be due to natural
factors (e.g., internal processes or external forcings such as solar
variations or heavy volcanic activity), or to persistent human-induced
changes in the composition of the atmosphere or land use patterns.
[4] The National Association of Insurance Commissioners is an
organization of insurance regulators from the 50 states, the District
of Columbia, and the five U.S. territories.
[5] This estimate comes from a recently released summary of a key
component of IPCC's Fourth Assessment Report of the state of climate
science, which reported an updated 100-year linear trend (1906 through
2005) of 1.3 degrees Fahrenheit--larger than the corresponding 1.0
degrees Fahrenheit (0.6 degrees Celsius) reported in the 2001 Third
Assessment Report.
[6] IPCC narrowed its range of projected warming in its recently
released summary from the corresponding range of 2.5 to 10.4 degrees
Fahrenheit (1.4 to 5.8 degrees Celsius) reported in the 2001 Third
Assessment Report. Although these two sets of projections are broadly
consistent, they are not directly comparable. IPCC notes in the summary
that the new range is more advanced in that it provides best estimates
and an assessed likelihood range. It also relies on a larger number of
climate models of increasing complexity and realism, as well as new
information regarding the nature of feedbacks from the carbon cycle and
constraints on climate response from observations.
[7] The insured loss totals used in our analysis understate total
economic damage associated with weather-related events. Due to data
limitations, we did not account for uninsured, underinsured, and self-
insured losses. According to data obtained from Munich Re, the type of
insured losses we reviewed account for no more than about 40 percent of
the total economic losses attributable to weather-related events.
Various public and private disaster relief organizations provide
assistance to communities and individuals who suffer economic losses
that are not insured. Additionally, weather-related events are also
responsible for many indirect and non-market impacts that are not
wholly accounted for in economic terms, such as environmental damage.
This issue is discussed on pages 23-25 of Climate Change: Financial
Risks to Federal and Private Insurers in Coming Decades Are Potentially
Significant (GAO-07-285).
[8] Peter Höppe and Roger Pielke, Jr., eds., Report of the Workshop on
Climate Change and Disaster Losses: Understanding and Attributing
Trends and Projections, Hohenkammer, Germany, May 25-26, 2006 (Munich,
Germany: October 2006).
[9] Consensus statements agreed to at the workshop are listed in their
entirety in appendix IV of GAO-07-285.
[10] Additionally, concern over the potential impacts of climate change
on the availability and affordability of private insurance has led the
National Association of Insurance Commissioners to establish a task
force to formally address the issue in a report expected this summer.
[11] FCIC receives additional funds for excess losses through USDA's
annual appropriations process. The NFIP is authorized to borrow
additional funds from the Treasury on an as-needed basis, and repay the
borrowed funds with interest.
[12] GAO, 21st Century Challenges: Reexamining the Base of the Federal
Government, GAO-05-325SP (Washington, D.C.: February 2005), 77.
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