Grand Unifying Theory of Sustainability (pt. 1)
Posted: May 21st, 2009 | Author: mfguide | Filed under: Finance, Sustainability, guts | Tags: Finance, Securitization, Sustainability | 2 Comments »Over the next few weeks, scattered amongst posts on GAO and HUD, the latest upheaval with LIHTC, and hopefully some more tales from the trenches, I’ll be attempting to outline my thoughts on what it will take for building sustainability and sustainable operations to become part of the vernacular. I’m starting with the aspect I’m actually least familiar with, insurance.
Insurance, by popular understanding, hedges against the risk of contingent loss. By varying pricing based on operations, materials, and design, insurance serves as a nudge to encourage lower risk profiles. In theory at least. We’ll leave unresolved questions about whether this risk reduction is always well reasoned or if you really get better pricing through these changes.
So it was unsurprising to read in Ceres’ new report “Risk to Opportunity” that insurers are moving from superficial PR “towards [thinking] more deeply and strategically institutionalized and embedded in the operations of companies.”
Climate change is becoming recognized as an issue of Enterprise Risk Management, spanning underwriting, asset management, and corporate governance.
One of the most constructive developments is more products and services focused on ensuring the quality of the customer’s energy or carbon savings efforts. These include performance insurance for renewable energy systems, coverage for green buildings that don’t deliver promised performance, and products that apply to carbon offset and trading activities. In all cases, loss-prevention takes the form of due-diligence, scrutiny of engineering assumptions, preventive maintenance, commissioning, measurement and verification, and other constructive interventions to help ensure project integrity and success.
Although released in April 2009, the report covers products existing or introduced in 2008. In many ways, the finding that some insurers were moving much faster than others led to the March 2009 action by state insurance commissioners to require that insurers reveal exposures and responses to climate change. How this will be enforced and what the ‘right’ answers are will be revealed when the responses are provided in March 2010.
[Note: The quote above was taken from an interview with study author Evan Mills with Climate and Insurance.org, an arm of industry advocate NAMIC, which does not like (really doesn't like) the new climate exposure mandate. Ceres retorts that "Insurance trade organizations remain relatively disengaged on climate change." Plus ça change, I suppose.]
Why does this matter? Because outside of government and its multiple layers, insurers and financial firms are best positioned to promote the systemic change in the built environment needed to achieve goals like Net Zero Energy, Architecture 2030, or multi-family specific programs like Greener Communities.
Insurers are perfectly placed to make the case for unifying “green” and “disaster-resilient”
practices across many domains (construction, energy, agriculture, land use), yet scant effort has
been exerted in this regard. It will become increasingly incumbent on insurers to demonstrate
the loss-reducing benefits of the green technologies and services that they reward. Loss-prone
infrastructure cannot be truly “sustainable”.
It’s worth recalling this recommendation from “Resilient Coasts”:
“Wise investing will involve asset managers understanding the impacts of climate change on their investments and managing that risk, especially in real estate, infrastructure and other financial instruments. Responsible banks will need to understand the levels of exposure within their investment and lending portfolios by incorporating climate risks into their due diligence.”
Change is coming in a thousand different ways from code changes, insurance, finance, builders, housing agencies, governments, and most importantly, residents. We’ll start addressing the financial world in short order.
Will –
As an insurance professional that has read the Ceres / Berkeley study that you reference above, I feel that although there is significant emphasis being placed on the importance of climate change reporting within the financial sector, the challenge will be in working within the financial services industry to make the argument that effective climate risk management will drive profitability. Sustainability advocates will consistently state that basic risk management steps taken today to address climate risk will always create long term financial profitability. However, many insurance providers are motivated by short-term financial reporting to appease hedge funds, stock analysts and their own stock options (called the iron triad of short term pressures as cited in the Corporate Design report provided by Corporation2020.org).
There needs to be a consensus within the property and casualty insurance industry to unify their efforts with the goal of creating long term stability within the market and coverage availability for those consumers most directly exposed to catastrophic loss due to climate change. These markets are typically the most challenging for insurers (i.e. hurricane, flood and quake zones) and conversely the areas of the country seeing the greatest growth in population and rapid development. Insurers are hesitant to acquire too much risk in these areas as that growth in premium volume is less profitable given the potential for significant catastrophic events. The state of Florida has its own insurance company, Citizens, that acts as a safety net for residents that are unable to secure wind coverage through private insurers. The company was created due to the rapid decline in coverage availability from private insurers seeking to cut and run due to massive losses and unprofitable results in the state.
The financial stability of the industry that protects our assets can no longer ignore the rising concerns created by global climate change. I believe that the NAIC is right in looking to proactively work with insurance providers and policyholders to address these rapidly emerging risks.
The summary on ceres.org highlights the steps the insurance industry has taken in protecting the people and property of the world. “Over the past century insurers played a key role in establishing the first public fire departments, founding Underwriters Laboratory to deal with a scourge of dangerous consumer products, mandating stronger earthquake standards in building construction, and hastening the arrival of new automobile safety equipment.” Now it is time for the insurance community to proactively address the threat of climate change induced catastrophes. For example, although Hurricane Katrina was not directly caused by global climate change, its intensity was heightened due to the warmer temperatures of the Gulf of Mexico (http://www.pewclimate.org/specialreports/katrina.cfm). The fact that the lower ninth ward of New Orleans was directly in its path was unfortunate, but it became clear very quickly that rapid, unsustainable development in densely populated urban areas made the situation worse.
The irony of insurance is that it is the only product you spend a lot of money on that you hope you never have to use. As one prestigious insurance provider has stated in their new wave of marketing material, “Insurance doesn’t matter….until it does.” These steps taken by the NAIC and various other organizations should be seen as positive steps to preserve the long-term financial stability given the rising challenge of new risks created by global climate change.
Just ask anybody in New Orleans or Florida or California how a well-written insurance policy provided by a financially stable company that can expediently settle claims amidst a catastrophe can help them get back to life as normal. However, as a resident of the midwest where our biggest catastrophes are the occasional tornado and maybe some river flooding, should we pay more so that those who choose to live in higher-risk areas can obtain coverage? The humanist in me says yes, but the realist feels that those who develop in these areas should seriously consider the increased risks and costs associated with such ventures.
Mark Rabkin
merabkin@althans.com
Mark
Thanks so much for writing a very thorough review of my post. I think we’re in agreement that the Ceres report takes an optimistic approach toward the industry’s involvement in climate change that may or may not be fully supported by observable actions.
Having many Midwestern properties in my apartment portfolio, I’ve dealt with ice damage, burst pipes, flooding (body of water sourced and body of man sourced), wind, storm, and fire, so don’t underestimate the Midwest’s capability to incur ‘charismatic’ weather. Socializing risk is perhaps the best option for pricing (and therefore encouraging) asset protection.
As a Floridian who has suffered significant hurricane damage (although only 1x in 30 years), I understand that there are some who disagree with settlement patterns. Count me as one of them. However, unless (and really, until) we are willing to support efforts to actively return settled land to a land bank or non-developed state, I think we (collectively) will continue to provide coverage in one form or another. From what I understand of Citizens, it has accepted the otherwise uninsurable as private insurance has raised rates, withdrawn from the market, or otherwise provided market indicators that risk tolerance is much lower than before.
Given the real, measurable dangers posed by climate change, I think every actor that can effect change on a systemic basis (government, insurance, finance, building science) will offer what they can.
I’m interested to see what William & Mary’s Environmental Law and Policy Review says when they publish “Climate Change Disclosure” in the next review.
As to how I felt after we dealt with the insurer on our hurricane damaged house, I’ll leave it for another time.