Climatic Changes and the Insurance Industry - Essay Example

?Running head: Climatic changes and the insurance industry Climatic changes and the insurance industry Insert Insert Grade Insert Name March 30, 2011, Climatic changes and the insurance industry Introduction It is important to understand how the insurance companies operate in providing the services to their customers and why it is necessary for the individuals to obtain an insurance cover. Having obtained the basic human needs and other secondary needs, an individual would then seek to obtain some sort of security for these needs in the present situation and in the future (Anderson & Brown, 2005, p.2). This kind of economic security is threatened by the possibility of variations in the future outcomes of a particular event or activity. In order to ensure this security, a deal is entered between two parties - the insurer and the policyholder. In the agreement, there is a given amount referred to as premium that is to be paid regularly by the policyholder to the insurance organization. In return, the insurance company agrees to pay a defined amount referred to as benefit or claim payment incase a predefined loss is incurred by the policyholder (Anderson & Brown, 2005, p.2). To avoid ambiguity during compensation, the agreement has to define which losses to be covered by the insurance policies. This would include medical insurance, life insurance, property insurance and many others. The insurance companies establish the premiums for the different insurance policies based on the value of the losses to be compensated and the frequency with which the losses have been observed to occur. Insurance may seem to be expensive and a waste of resources to a policyholder who has not suffered any loss over a long period of time. However, in case the unexpected loss occurs, it will be cheaper to have the loss compensated by an insurer. It is actually a way through which risk is transferred from one party to the other (Anderson & Brown, 2005, p.3; WetFeet, 2008, p.64). The advantage that the insurers enjoy is that not all of their policyholders will suffer losses at the same time. This kind of a pooling by the different policyholders enables the few policyholders that have had some loss to be compensated without loss to the insurance company. Climatic conditions contribute to various losses incurred in various fields in the insurance industry. Poor climatic conditions can interfere with business operations, can cause damage and loss of property, can lead to increased disease infection, and increased mortality rates emanating from accidents, floods, earthquakes and other disasters. The climate unpredictability brings significant threats for insurance companies Supportive reasons The occurrences of climatic changes and the inability of insurance companies to predict this future occurrence can be a threat to the success of the organizations. Firstly, the disasters often catch the insurance companies unaware due to poor mechanisms for mitigating the catastrophes. The climatic changes may not follow a predefined pattern and an attempt to make a prediction based on the previous occurrences often leads to miscalculations (Mills, 2005, p.1). This increases the vulnerability of the insurance organizations to the disasters. It often results in an increased liability claim leading to losses by the insurance organizations. The insurers are then not able to compensate for the losses that have been incurred (Godoy, 2011). The unpredictable climatic conditions like future occurrences of floods may make an insurance company to incur losses due excessive compensation of the losses incurred by the policyholders. The climatic conditions resulting into global warming provides humble opportunities for the occurrences of other natural catastrophes like wildfire that can be of great losses to the insurance organizations. For instance, the losses that were incurred by the United State’s insurance organizations due to wildfires were valued at $6.5 billion between 1970 and 2004 (Allianz Group& World Wildlife Fund, 2006, p.18). Further billions of US dollars were lost by the insurance companies in Canada in 2005 (Harford, 2007). Besides, the insurance companies set their premiums based on the relative occurrences of losses that have been experienced and can now be predicted with some known probability. For a future climatic condition without an unpredictable probability of occurrence, the insurance companies are not in a position to establish the premium rates that are commensurate to the probability of occurrences. They may be forced to set their premiums below the supposed value most likely to attract more clients. The use of science and technology is also not developed enough to be applied for effective management of the disasters (Dlugolecki & Keykhah, 2002, p.3). Other market risks follow unpredictable weather changes. Some of the premiums are fixed for a relatively long period. The insurance companies are thus not able to adjust the premiums in response to the climatic changes. The companies are not able to identify and respond the changing needs of the customers that have been caused by the climatic changes (Mills, 2005, p.2). Climatic conditions also affect the activities in a given economy. The future climatic changes influence the economic development that shall be recorded in a given region and the how the individuals are exposed to the risks following these disasters (Mills, 2005, p.3). Adverse weather conditions are associated with various market risks. In this view, the would-be clients of an insurance company may not be able to contract with the company due to inability to constantly pay the premiums. Stability of a given economy is very crucial to the success of an insurance organization. Opposing reasons Unpredictable climatic conditions should not be a threat to an insurance organization since the organization is primarily designed to absorb risks. They should be strategically designed to manage any emerging risk-related issue. Insurance should be a way of providing an adaptive measure to the climatic changes (Mills, 2005, p.4). The companies can lobby with the governments to develop the ways of mitigating climatic changes (Labatt & White, 2002, p.127). Most of the insurance organizations include in their policy agreements the limits of the benefits that the policyholders are bound to claim in case of a loss (Anderson & Brown, 2005, p.7). Therefore, in as much as the future climate and the associated losses may not be predicted, the insurance organizations will have a boundary beyond which they shall not provide an insurance cover. Besides, most of the international insurance companies have measures that ensure maximum protection against the risks associated with disasters resulting from adverse weather conditions. They educate their policyholders on some mechanisms of reducing the effects of climatic changes (Labatt & White, 2002, p.127). They include in the policy agreement the possibility of increasing their rates with the increased risks due to the inability to predict and manage the adverse future weather conditions (Kirkland & ClimateWire 2011). The companies can then adjust the premiums according to the amount of the losses that have occurred. It has also been noted that the insurance organizations, through the wide range of data that they keep, are better placed to help in mitigating the economic risks that are likely to be caused by the climatic changes. They can then choose to offer the affordable products that are not likely to be associated with huge risks (Allianz Group& World Wildlife Fund, 2006, p.3). It is also worthwhile to note that the insurance organizations are not compelled to provide an insurance cover on all the risks associated with disasters. In fact, most of the insurance companies are aware of the risks that are associated with major catastrophes and have warned that losses exceed their available insurance capacity. A small percentage of damages related to adverse weather conditions are currently insured with a possibility of reduction in the proportion under insurance cover (Mansley & Dlugolecki, 2001, p.17). The organizations may completely avoid cover over catastrophes like floods or the associated risks can be shared among the different social and commercial communities in a given economy. The insurance organizations can make the necessary adjustments on their operational strategies to have a continued competitive advantage (WetFeet, 2008, p.64). The climate unpredictability brings significant opportunities for insurance companies Supportive reasons The unpredictability of the future climate can create some opportunities for the insurance organizations. Firstly, the unpredictability is associated with various market risks. In order to manage the risks, most of the investors will enter into deals with the insurance companies for compensation against the unexpected losses that may occur. The insurance organizations will thus have increased opportunities for investment (Mills, 2005, p.4). There will be an overwhelming increase in the demands for the insurance service. Secondly, the unanticipated climatic changes that are likely to be experienced provide the insurance companies opportunities to invest on new products. There will be need for diverse claims by the clients enabling the company to develop new products. The companies may have the opportunities to invest in ‘new-risk-management products for emissions reductions and loss prevention technologies’ (Mills, 2005, p.4). Some of the other products that can be created by climatic changes include pay-a-you-drive insurance, micro insurance, and premium credits for green building features (PricewaterhouseCoopers, n.d). The insurance organizations can also establish schemes that help in educating the public on the adaptive measures of managing the unpredictable climatic changes. Through the analysis of the past occurrences, the insurance organizations can provide excellent advisory services to the public on the ways of adapting to the weather changes (Mills, 2005, p.4). The management of future uncertain conditions may be a big challenge for an insurance organization that has not developed strategic risk management procedures. Such organizations may be forced to reduce the amount of insurance products they provide or they may completely quit the insurance industry. While this shall sound to be a threat to the organization, it will provide a good opportunity for gaining a competitive advantage by an insurance organization that had better strategies. Opposing reasons It has been pointed out earlier that the unpredictability of the effects of future climatic conditions can be managed through the adjustment of the rates of premium or through shifting to the services that are less prone to the risks and uncertainties. However, there are prevailing forces in the market that can hinder the increasing of these rates of premium by the insurance organizations (Allianz Group& World Wildlife Fund, 2006, p.27). There are regulatory measures that govern how the organizations operate and how they can increases their rates. It has been pointed out that ‘insurance regulators rarely allow price increases or expansion of reserves based on projected losses, and the price competition is stiff’ (Mills, 2005, p.4). If the organizations go against the market forces and establish rates that best suit their requirements, the effects shall be seen in the loss of market share. Secondly, the unpredictability of the climatic conditions can force some insurers to narrow down their areas of operations as a way of reducing the anticipated losses. However, the current market has high level of competition and requires some kind of diversification in order to obtain higher returns (Allianz Group& World Wildlife Fund, 2006, p.27). The unpredictability will then reduce the investment opportunities for the insurance organizations. Conclusions There may be cases of adverse losses suffered by the policyholders in a given insurance company. To manage such a situation, most of the insurance companies have predefined limits for the claim payments. There could be a restriction on the maximum policy benefit to be given or a minimum value of a loss that can be compensated by the company. The agreements often require that the policyholder also cover part of the losses. In this way, the insurance companies will not suffer losses in either way due to the unpredictability of the climatic conditions. If the conditions are favorable with very little occurrences of unpredictable losses, the company will enjoy the premiums without much claim benefits to be reimbursed. On the other hand, if the there are adverse climatic conditions that increase the probability of occurrence of losses the insurance company shall be governed by the limits of policy benefits that had been stipulated in the agreement. Besides, the insurance organizations are free to analyze the services that are more prone to risks due to changing climatic conditions and reduce or cut out such services completely. It thus stands out that the adverse effects that are caused by the unpredictable weather conditions can still be properly managed by the insurance organizations. Various insurance companies need to collaborate with each other to develop measures of mitigating the catastrophes. They should embark on various innovative and inventive measures towards managing the risks associated with the disasters. Reference List Allianz Group and World Wildlife Fund. 2006. Climate Change and Insurance: an Agenda for Action in the United States. (Online). Available from: http://www.pewclimate.org/docUploads/Allianz%20WWF%20report.pdf [Accessed March 30, 2011]. Anderson, J. and Brown, R., 2005. Risk and Insurance. Education and examination committee of the society of actuaries. (Online). Available from: http://www.soa.org/files/pdf/P-21-05.pdf [Accessed March 30, 2011]. Dlugolecki, A. and Keykhah, M., 2002. Climate Change and the Insurance Sector: Its Role in Adaptation and Mitigation. Greener Management International, Iss.39, 83-98, 16p. (Online). Available from: http://web.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=4&hid=24&sid=c7f5e4ef-9b62-4749-9677-c61fde069816%40sessionmgr13 [Accessed March 30, 2011]. Godoy, J., 2011. Climate change: Driving straight into catastrophe. Global Information Network. New York Jan 24, 2011. (Online). Available from: http://proquest.umi.com/pqdweb?index=9&did=2247054251&SrchMode=1&sid=1&Fmt=3&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1301498477&clientId=29440 [Accessed March 30, 2011]. Harford, D. 2007. A new world. Canadian business, Vol. 80, Iss.20. (Online). Available from: http://web.ebscohost.com/ehost/detail?vid=5&hid=24&sid=c7f5e4ef-9b62-4749-9677-c61fde069816%40sessionmgr13&bdata=JnNpdGU9ZWhvc3QtbGl2ZQ%3d%3d#db=a9h&AN=27090969 [Accessed March 30, 2011]. Kirkland, J. and ClimateWire. 2011. Insurance Company Ranks 2010 among Worst Years Ever for Climate Disasters. Scientific American, Feb 23, 2011. (Online). Available from: http://www.scientificamerican.com/article.cfm?id=insurance-ranks-2010-worst-for-climate-disasters [Accessed March 30, 2011]. Labatt, S. and White, R., 2002. Environmental finance: a guide to environmental risk assessment and financial products. New Jersey: John Wiley and Sons. Mansley, M. and Dlugolecki, A., 2001. Climate Change - A Risk Management Challenge for Institutional Investors. Universities Superannuation Scheme: Discussion paper Number 1. (Online). Available from: http://www.uss.co.uk/Documents/USS%20Climate%20Change%20-%20A%20Risk%20Management%20Challenge%20for%20Investors%202001.pdf [Accessed March 30, 2011]. Mills, E., 2005. Insurance in a Climate of Change. Science, Vol.309. (Online). Available from: http://eetd.lbl.gov/emills/pubs/pdf/insurance_and_climate.pdf [Accessed March 30, 2011]. PricewaterhouseCoopers. N.d. Insurance Digest: Insurance and the climate change challenge. (Online). Available from: http://www.pwc.com/gx/en/insurance/insurance-digest-2.html [Accessed March 30, 2011]. WetFeet. 2008. Industries and careers for undergraduates. San Francisco: WetFeet, Inc. (Online). Available from: http://books.google.co.ke/books?id=3PCdSm_WiRsC&pg=PA64&dq=benefits+of+unpredictable+climate+change+to+insurance+companies&hl=en&ei=XEyTTc3cFIrg4wa6m_GpAg&sa=X&oi=book_result&ct=book-preview-link&resnum=3&ved=0CD4QuwUwAg#v=onepage&q&f=true [Accessed March 30, 2011]. Read More