Mills, Evan. Reinsurance Magazine, March, 1997, Volume 27, Number 12, p. 24. Part of a five-part special Technical Report on Environment, (Timothy Benn Publishing Ltd., London)

The global insurance industry faces great financial risks from natural disasters potentially caused by global climate change. Natural disasters cost the industry $9bn last year and $14bn the year before, and insured losses from extreme weather events with potential links to climate drought and floods are among the most significant areas of concern.

Insurance industry worries about climate change are not new and Franklin Nutter, president of the Reinsurance Association of America, summed up the industry's concern when he said: "The insurance business is first in line to be affected by climate could bankrupt the industry."

The insurance industry can take a reactive approach to mitigating climate change risk by raising deductibles or withdrawing coverage. Alternatively, it can take a proactive approach by, for example, encouraging actions to reduce greenhouse-gas emissions. Many public and private groups provide their own insurance, and these self insurers generally have the same interest in loss prevention as commercial insurers.

Loss Prevention

The insurance industry is no stranger to the notion of loss prevention, and often engages in efforts to reduce losses. Promoting loss prevention is not only good corporate citizenship, it directly improves payout/premium ratios — the fundamental indicator of industry profitability.

Energy consumption is the largest contributor to global climate change, so promoting energy efficiency is a particularly promising strategy.

Of particular relevance for insurers, many energy efficient technologies also have the potential to reduce ordinary insured losses involving property, health or liability. Additional insurance benefits come from improvements in indoor environmental quality that are often associated with energy efficiency measures. Around 70 specific ways in which targeted energy efficiency improvements can translate into a reduced risk of insured losses have been identified and a few of them are shown in Table 1. These loss reductions benefit a variety of insurance providers, including property/casualty, professional liability, medical, life, workers' compensation, business interruption and motor.

The extent of avoidable property, life and health losses has not been quantified. In the case of property losses from fires, some notable relevant US examples include 157,000 fires, 735 deaths and $2.5bn in insured losses stemming from heating or electrical equipment in buildings. Examples relevant to health and fire insurance include 13,000 radon-related lung cancer deaths annually and 1.500 carbon monoxide deaths (and 12,000 poisonings).

A host of strategies are available to insurers wishing to capitalize on the loss prevention potential of energy efficiency technologies and practices. These include:

  • defining and adopting uniform protocols for quantifying the loss prevention aspects of specific technologies and practices and certifying their application;
  • developing insurance products (e.g., with premium discounts) that reward safety-enhancing energy efficiency measures;
  • supporting appropriate building and appliance codes and standards;
  • financing customer efficiency improvements as a new business line;
  • supporting performance labels for buildings and energy-using devices within them;
  • establishing investment portfolios that support key energy efficiency technologies and services;
  • 'leading by example' by making buildings owned by insurance companies more energy efficient;
  • fostering improved energy efficiency and indoor air quality in the process of financing and purchasing buildings (insurance companies own and lease a considerable fraction if US building stock and provide considerable amounts of debt financing);
  • encouraging the application of loss prevention technologies during the reconstruction of buildings following losses
  • forming customer-focused partnerships with energy utilities and others in the energy efficiency market;
  • exploring the opportunities associated with the application of these concepts in the context of developing countries; supporting research, development and commercialization of new technologies.

Practical Steps

A handful of early efforts by insurers and other stakeholders in the US demonstrate that energy efficiency has begun to find a strategic position in the insurance industry:

  • Hanover Insurance Company (c.1980) gave a 10% reduction in premiums to energy efficient/solar homes, with the justification that the heating systems fired less often, resulting in a reduced fire hazard.
  • A major professional liability insurer has reviewed 12 large cases and identified numerous ways in which commissioning (an energy efficiency measure emphasizing quality control) could avoid claims. As a result, they are considering offering 10% premium credits for design and engineering firms that practice commissioning.
  • The Insurance Institute for Property Loss Reduction has endorsed the enforcement of building energy codes.
  • The Pacific Gas and Electric Company — one of the US' largest utilities — has formed an alliance with the insurance industry's Western Insurance Information Service to further encourage efficient energy use by customers. PG&E's goal is to have every energy project considered to risk management benefits.
  • In another utility-related effort, the Electric Power Research Institute has formed the Disaster Recovery Business Alliance (DRBA). DRBA will help catalyze the disaster mitigation objectives of utilities, the insurance industry, government agencies and community leaders by launching regional alliances and ensuring the cohesive deployment of relevant mitigation and socio-economic recovery technologies. The proramme involves a three-pronged approach; distributing information, fostering extensive planning among regional and local businesses and applying technologies to mitigate losses and expedite recovery. Certain energy efficiency technologies will no doubt find a place in this process.
  • The Oak Ridge National Laboratory has entered into a co-operative research and development agreement with the Roofing Industry Committee on Wind Issues, which includes all major roofing trade associations in the US and various insurance partners (the Insurance Institute for Property Loss Reduction, K2 Technologies, Risk Management Solutions and Allstate). The project will investigate energy efficient ways of making roofs more resistant to damage during windstorms.
  • The Zurich-American Insurance Group offers specialized insurance policies for third party energy service companies that implement energy efficiency technologies in exchange for a share of the savings. The policies protect the installer or building owner against not achieving contracted energy savings targets.
  • In Europe, three insurance companies have joined in with an International Energy Agency project to use the purchasing power of building owners to create markets for energy efficient copiers.
  • The recently founded Storebrand Scudder Environmental Value fund is an early example of environmental investing, to which insurance companies (Swiss Re, Gerling, Trygg-Hansa) have already contributed $70m. Energy efficiency is one of the criteria used to evaluate securities being considered for inclusion in this fund.

This list demonstrates concrete ways in which the insurance industry can engage in the energy efficiency market, but the activities have only begun to tap the potential.

Global climate concerns aside, any measure that decreases insurance losses contributes to the bottom lines of both insurers and insureds. By supporting strategic energy efficiency options, the insurance industry could reduce short-term business risks caused by insured losses and payout levels that consistently exceed premium revenues, while making a considerable contribution to reductions in greenhouse-gas emissions that also threaten their bottom line. This represents an attractive opportunity for the insurance industry, as the risk reducing benefits would have distinct value irrespective of the timing or extent of damages related to global climate change.

Table 1. Energy Efficient Technologies and the Prevention of Losses
Energy Efficiency Measure Fire & Wind Damage Ice & Water Damage Power Failures Professional Liability Heath & Safety (Lighting) Heath & Safety (Indoor)
Building Commissioning X X X X X
Daylighting X X X
Demand-controlled Ventilation X X X
Efficient Duct Systems X X X X
Efficient Windows X X
Energy Audits & Diagnosis X X X
Extra Interior Gypsum Board X
Heath-recovery Ventilation X X
Insulated Water Pipes X
LED Exit Signs X X
Natural Ventilation X X
Radiant Barriers X
Radiant Hydronic Cooling X X
Radon-resistant Housing X
Reduce Indoor Poll Sources X X X
Roof/attic Insulation X
Sealed-combustion Appliances X X X

Dr. Mills has worked in the energy field as an economist, engineer and policy analyst and now leads Lawrence Berkeley National Laboratory's Centre for Building Science in California, one of the world's top energy efficiency R&D centres.