Climate Risk Michel Rochette, MBA,FSA 2007 SOA Annual MeetingEnterprise Risk Advisory, LLC
Topics• Physical Evidence of climate changes: risk drivers of environmental risk• Observed and projected physical impacts• Government and industry efforts to face climate change• Risks due to climate change• Proposed Disclosures: – Investor Network on Climate Risk – Carbon Disclosure Project – SEC Proposed Requirements
Physical Evidence of Climate Changes: Risk Drivers"Periodically, major forces dramatically reshape the business world – globalization and the information technology –. Climate change in its complexity and potential impact may rival both of them.“Michael Porter, Harvard
Physical Evidence of Climate Changes: Risk Drivers• Primary drivers: Gazes produced naturally and by mankind create the green house effect, trapping heat from the sun.• From year 1000 to 1860, concentration of Co2 has been about 300 PPM.• Since 1860, concentration has increased 36% to 382 PPM.(2000)
Physical Evidence of Climate Changes: Risk Drivers• Greenhouse Gazes (GHG): US Perspective – Carbon Diozide(CO2): 82.4% from energy, transportation, & industrial processes. – Methane(CH4): 9% mostly from waste & agriculture – Nitrous Oxides(N2O): 5.0% from waste & agriculture – HFCs (replaced CFCs) , PFCs, SFs: 2.2% from refrigeration, insulation industries – US: largest world contributor but on average when measured by head. – China will reach the US around 2025 but due to other sources of more damaging GHGs. – Source: US Energy Information Administration
Physical Evidence of Climate Changes: Risk Drivers– ALL GHG have a Global Warming Potential (GWP) measured as a ratio of CO2: • Carbon Dioxide(CO2): (1) • Methane(CH4): 21 • Nitrous Oxide(No2):310 • HFCs: 140-11 700 • PFCs: 6 500 – 9 200 • SF6: 23 900
Physical Evidence of ClimateChanges: Major Sources of GHGsCountry/ World USA Europe ChinaSource (EU 25)of GHGEnergy 40% 46% 40% 50%Trans- 24% 31% 23% 6%portationIndustry 19% 11% 15% 34% Source: 2003 WRI
Observed Physical Impacts: Global Temperature• Between year 1000 and 1860, temperature fluctuated +/- 0.5C.• Since 1860, the warmest 10 years have occurred since 1990, 2005 was the warmest ever.• Average annual increase is 0.9C over the past 30y• If trend continues, projection of an increase of global average temperature between 1.4C and 5.8C by 2100. (9 separate scientific models confirm that trend)
Observed Physical Impacts: Global Temperature• Increase could accelerate if other phenomenon interact: – Higher temperature →More intense Fires → Burn trees which store GHG – More deforestation → reduction in natural GHG sequestration by forests. – Higher temperature → thawing frozen soils → Release of GHGs as it may contain close to 30% of carbon stored in soils – Combined with other natural phenomenon like volcanoes
Observed Physical Impacts: Rising Sea Levels• Higher global temperature is causing sea levels to rise from: – Melting of polar caps and glaciers. (30% of total annual increase), especially Greenland. – Expansion of the volume of the water itself because the sea water temperature is increasing due to the higher external temperature; thus, higher water temperature causes water to expand. (70% of total annual increase)• From 1870 to 2004: global increase of 200 mm.• Currently: sea rising more rapidly at 2.6-2.7 mm +/- 0.7 mm per year globally.
Observed Physical Impacts: Rising Sea Levels• By 2100, best estimates are for sea levels to rise by about 0.3 m. (1 foot)• At that rate, sea increase would be 6 m over the next 500 years.• Consequences: – More than 4m, every coastal city inundated. – US northeast vulnerable due to low land and high population density. NY more vulnerable than CA. – Coastal erosion: Florida at risk. – Combined with wind → more storm surges → more flooding → more physical damage → more deaths and health issues.
Observed Physical Impacts:Hurricanes/Typhoons/Windstorms • Higher temperature is causing more intense hurricanes due to the warming of the oceans. • Combined with higher sea levels, more sea surges are expected. • Out of the ten strongest hurricanes ever recorder in the North Atlantic, 3 occurred in 2005. • Property exposures at risk: Florida at 79% and NY at 61%. • 15 property insurers insolvent after Andrew in FL in 1992. • EX: Katrina: – Property losses: 40.6 billion $ – Deaths over 1 200. • National Flood program will continue to exacerbate the potential impacts by "encouraging" people to live near the coast.
Observed Physical Impacts: Droughts and Fires• Droughts observed in the American West: drier weather, earlier snow melt, higher summer temp. → more frequent and longer wildfires.• Since 1980, surface burned by wildfires doubled compared to 1920-1980 period.• Ex: 1991 Oakland/Berkeley Hills fire – 2 billion $ in damage – 25 lives lost, 150 people injured.• California is the most at risk: 22 out of last 38.
Observed Physical Impacts: Precipitation and Flooding• Higher global temperatures → more water vapor in the atmosphere → more precipitation → more flooding → more damage.• More physical damage in the US but more lives lost in less developed countries: – 50 billion $ of damage in the US in 1990s. – Increase of more extreme precipitations in some areas: US western regions and Eastern regions.
Observed Physical Impacts: Other• Warmer temperature →heat waves – Extremely hot days are also three times as common now as they were 127 years ago. – Consequences: • 52 000 died in 2003 in Europe. • During the peak, 2000 dying per day in France.• Warmer temperature → spread of diseases – more mosquitoes carry malaria and Lyme – More pollen in the atmosphere – More air pollution → respiratory illnesses – More southern diseases moving north.• Ocean acidification → ocean chemistry → food chain → food for population
Government and Industry Efforts to Face Climate Change UK Stern Review stated in 2006: – Cost of doing nothing: Risk losing at least 5% of GDP every year for ever. – Cost of action: around 1% of GDP.
Government and Industry Efforts to Face Climate Change• 1992 United Nations Climate Convention: sharing of information on GHGs, setting up national policies and best practices. 191 nations.• 1997 Kyoto Protocol: – Legally binding reductions varying by countries. – Most countries have committed to 8% reductions of emissions from 1990 levels over 2008-2012. – Different approaches to hedge: • Clean development endorsement in developing nations: CER • Joint implementation: ERU • Emissions trading: EU ETS
Government and Industry Efforts to Face Climate Change• 2007 G8 Summit endorsed the idea of cuts in GHG of 50% by 2050.• Asia-Pacific Climate Partnership.• US initiative with 15 countries: 85% of emitters of GHG including China and India.• Europe adopted in 2007 a target of 20% reduction by 2020 from 1990 levels.• UK on track to reduce by 15-18% by 2010.• EU Emission Trading System (ETS) began operation in January 2005. – Cap and Trade System. – Being discussed at the US Congress right now.• Previous success: Remember acid rain.
Government and Industry Efforts to Face Climate Change• US Supreme Court in April 2007 that EPA has authority to regulate GHG emissions from cars and trucks. Considered a pollutant.• California adopted climate change legislation to reduce GHG to 1990 levels by 2020, implementing caps starting in 2012 and mandatory reporting.• Nine North East and Mid Atlantic states have signed the Regional Greenhouse Gas initiative. (RGGI): – Goal to reduce by 10% GHG to 1990 level by 2018. – 1st regional Cap and Trade by 01-2009.
Government and Industry Efforts to Face Climate Change• US Climate Action Partnership: group of business leaders: – Implement cap and trade – Development of policies to encourage zero emitting technologies• NAIC: Climate Change Task Force• AIA and Ins. Inf. Institute have published analysis papers on climate changes.• UK Climate Change Working Party where some actuaries are involved. Read Sept 07 Issue of UK The Actuary.
Climate-Induced Risk"Regulatory policy will set the rules of the game that will affect how the burden will fall.. It is time to know how you will respond. At a minimum, all companies should know their carbon footprint, where their emissions are coming from and in what amounts.“Andrew Hoffman, University of MichiganCo Author of Climate Change: What’s your business strategy?
Climate-Induced Risk• Regulatory/Compliance risk: – Fines for non compliance to new regulations on GHG including new upcoming mandatory national and regional GHG reductions as outlined. – European operations more at risk. – Miscalculation and lack of certification of carbon footprint coupled with lack of disclosure. – Less risk for US companies but: • Affected if they have international operations in countries covered by Kyoto even if US didn’t sign. • In the US, must keep track of CA and North East States. • Proposed SEC disclosures.
Climate-Induced Risk• Investment and Shareholders’ Risk: – For ins. Cos: States have the prudent person rule as it relates to investments. – For pension plans: fiduciary responsibility. – Ex. 7 Billion $ pipeline in the McKenzie Valley could be at risk if permafrost melts. – Investor Network on Climate Risk: • New risk policy model on climate risk. • Seek to asses and obtain information on how companies are managing climate related risks. • Corporate Governance Score Card on Climate Risk.
Climate-Induced Risk• Litigation risk: – When making investments, cos could be accused of not taking environmental issues into account. – Lawsuits by states for non compliance, especially for high emitters of GHGs. – Lawsuits by shareholders for lack of planning by Board of directors if companies suffer from climate changes. – Class actions suits could come when people will be more affected: Ex. Katrina. The Maldives – Big potential impact on D/O type insurance coverage.
Climate-Induced Risk• Physical risk: – Impact on property damage of clients of insurance companies as well on insurers’ own properties. – Impact business and supply chains: interruptions. – Necessitate more extreme modeling of events even for life insurers as indirect impacts of physical changes will affect both lives and health: Ex. heath waves and lack of preparedness by governments.
Climate-Induced Risk• Reputation and business risk: – Risk related to lack of climate risk preparedness/ corporate resilience/perceived inaction. – One short-term approach is to commit to be a carbon- neutral company. – Proactive: • Energy field: – BP – American Electric Power to build the 1st gasification power plant. – ConocoPhillips funding alternative fuels research.
Climate-Induced Risk• Reputation and business risk: – Proactive: • Banking: – HSBC has a set up a carbon offsetting program: electricity consumed in London offset by projects in New Zealand with wind power. – Citigroup and BOA have committed 50 billion $ and 20 billion $ of future investments be made in sustainable business activities over the next 10 years. • Insurance: – Swiss Re doing research and committing to being carbon neutral in operations by 2013. – AIG has become the 1st US company to adopt a corporate climate change policy. – Fireman Funds new “green coverage” for green buildings.
Proposed Disclosures• Global Reporting Initiative: – Principles and standards linking environmental, social and economic performance. – GOAL: Sustainability reporting which allows investors to assess the capacity of companies to create value in a resource-constrained world, including their impact on the climate.
Proposed Disclosures• Carbon Disclosure Project: – Now at CDP5: sent to 2 400 companies. – Survey by CERES undertaken for institutional investors – 280 - in order to understand the risks and opportunities of companies impacted by climate change. – Investors are now elaborating climate related ratios: Low Revenues/Co2 would indicate high climate. – See www.cdproject.net: AXA, Aetna, Aegon, Allstate, Aviva.
Proposed Disclosures– SEC: • Being pressured to issue guidelines on disclosure covering carbon disclosures and potential impact of climate changes on companies: scenarios. • Item 101 of Regulation S-K on the discharge of materials into the environment • Item 303 of Regulation S-k on disclosure around future trends likely to affect profitability. • 96% of electric utilities provide disclosure on climate risk while only 15% of property-casualty insurers do so.
Final thoughts• According to AXA in its 2005 SEC filing: "20% of the World GDP is affected by climate change while for insurance companies, climate change is more important than interest or FX risks. ““ The insurance industry will face new challenges in the coming years in increases in future claims, which will become harder to assess based on past events. "
ThanksTo Ellen Bull, librarian at the Society ofActuaries for her continued support andhelp in preparing this presentation.