A Tale of Two Credibilities: Hurricane Sandy and Recent Extreme Weather Reports

[author: J. Wylie Donald]

It was the best of times.  It was the worst of times.  In North America, anyway.  As Hurricane Sandy looms over the Eastern seaboard, we thought it would be worthwhile to take a look at two recent reports about extreme weather.  Ceres, the investor focused “advocate for sustainability leadership,” issued in September its report:  Stormy Future for U.S. Property/Casualty Insurers:  The Growing Costs and Risks of Extreme Weather Events.  Munich Re, one of the world’s leading reinsurers, followed in early October with Severe Weather in North America.  If you want to read Severe Weather in full, it will cost you $100. If an executive summary will do, that only costs an email address.  

Ceres’ report sets up the financial climate facing insurance companies today:  historically low investment returns, a sluggish economy,  and lagging economic performance as measured by return on equity.  It then recounts the vicissitudes of recent extreme weather.  In 2011 the insurance industry suffered more than $32 billion in losses, and “suffered the most credit downgrades in a single year since 2005.”  The federal government issued a record 99 disaster declarations. To get specific:

Losses from excessive precipitation during 2008-2011 were the highest on record.
Average annual winter storm losses have nearly doubled since the 1980s.
Since 1980, wildfires burned the highest amount of acreage in 2005, 2006 and 2007; and in 2010, wildfires caused over $1 billion in damage (and in 2012 record setting wildfires occurred in Colorado and other parts of the West.).
Losses from low precipitation (drought) during 2012 will be the highest since 1988.

These cap a 30-year trend of increasingly extreme weather.  The effect of all this is, according to Ceres, a grave threat to insurers and those that rely on them.  Ceres goes on and asserts that climate change “likely” will exacerbate the effects of extreme weather.  Nevertheless, Ceres plays it cautiously:  “Connecting the linkages and impacts between rising temperatures and extreme events remains a highly technical exercise fraught with uncertainty.”  But notwithstanding the uncertainty, the cause of the potential economic problem for insurers is “increasing concentrations of insured assets, along with a changing global climate.”  Ceres' recommendations include calling for insurance companies to encourage customers to lower their carbon emissions footprint and to encourage "policymakers to take steps to reduce carbon emissions."  Is this unsupported advocacy or prudent business advice?  We conclude the former.

We start with one of the central themes of Stormy Future:  the costs of extreme weather have been rising steadily over the last 30 years.  But as the report acknowledges, some part of the increase is due to the fact that there are more people, more infrastructure, and more buildings and other property than there were 30 years ago.  Even without any new extremes of weather the costs of weather-related disasters would have increased.  But Ceres offers no more than an acknowledgment.  There are no details to flesh out the relative contribution of extreme weather as compared to the contribution of increasing coastal populations and increasing property values.

We discerned one hint.  In the last twenty years state subsidized insurance plans (so-called “residual” plans or state insurers of last resort) have expanded from $55 billion to $885 billion.  There would be no need for residual plans if people weren’t migrating to areas of higher risk, which for-profit insurers shun.   So with barely any data from Ceres, we went looking.  Professors Howard Kunreuther and his colleagues at the Wharton School had some interesting analysis in their 2009 work, At War with the Weather. Id. at 11.    When hurricanes from 1900 to 2004 are normalized for wealth (i.e., evaluating each hurricane’s impact if it had hit in 2004), the five hurricanes with the most impact occurred in 1926, 1992, 1900, 1915 and 1944. Hardly a trend for increasing extreme weather.  If Hurricane Katrina had been included, it likely would have topped the list, but that would have meant that the top five were 2005, 1926, 1992, 1900 and 1915, and still no extreme weather trend pops out.  Another researcher, Roger Pielke, Jr. has concluded similarly that there is no trend toward increasing extreme weather in the form of tornadoes.  It seems to us that Ceres should have assessed the impact of wealth concentration and population increase so that readers can reasonably conclude that climate-change-induced extreme weather is becoming an increasing substantial contributor to loss and not be forced to take Ceres at its word.

Munich Re does better.  Severe Weather relies for its data on Munich Re’s NatCatService, which contains more than 30,000 records on natural catastrophe loss.  Based on a comprehensive review Munich Re concluded that extreme weather in North America has nearly quintupled in the last 30 years.  In Asia the increase is 4 times, 2.5 in Africa, 2 in Europe and 1.5 in South America.  This has resulted in increased losses. 

Unlike Ceres, Munich Re recognized the importance of addressing the contribution of increasing concentration of wealth and population on rising losses.  The press release heralding Severe Weather  states:  “Up to now, however, the increasing losses caused by weather related natural catastrophes have been primarily driven by socio-economic factors, such as population growth, urban sprawl and increasing wealth.”  But the release goes on: 

For thunderstorm-related losses the analysis reveals increasing volatility and a significant long-term upward trend in the normalized figures over the last 40 years. These figures have been adjusted to account for factors such as increasing values, population growth and inflation. A detailed analysis of the time series indicates that the observed changes closely match the pattern of change in meteorological conditions necessary for the formation of large thunderstorm cells. Thus it is quite probable that changing climate conditions are the drivers. The climatic changes detected are in line with the modelled changes due to human-made climate change.

Munich Re concludes that this is the “ initial climate-change footprint” in US loss data from the last four decades. “Previously, there had not been such a strong chain of evidence.”  There it is:  losses are increasing independently of increases in wealth and population and climate change is a cause.

As noted above, others disagree with this conclusion.  In fact, Munich Re has been slammed in the press and in the blogosphere for over-hyping the risk in the search for profits.   What the criticism misses is that Munich Re is putting its information out into the marketplace.  Consumers are free to accept or reject it.  Those choices ultimately end up being reflected in the bottom line. 

This is our fundamental point about climate change and economic activity. Substantially all business decisions are made with some uncertainty.  Why would those involving a changing climate be any different?  The question to be asked is whether there is enough information to guide action.  Climate change is having effects.  We know this.  Why?  Simply because it is occurring.  And we also know it because of the mountains of evidence.  Prudent business people must think about how those changes will affect them.  Munich Re gives some answers.  

We would submit that business planning based on Ceres’ report would not be prudent – Ceres leaves out a fundamental analysis:  what is the effect of increasing concentrations of wealth and population on the increasing loss trends from extreme weather?  Munich Re’s report, on the other hand, gives a decision-maker a tool that addresses that uncertainty.  One chooses not to listen at one’s peril.  Hurricane Sandy is the 18th named storm of this hurricane season.  If it lives up to its hype, it will be long-remembered.  But even if it does not, that does not change the business imperative:  plan with the best information available.  We would submit that climate change should be part of that planning.