All posts tagged 'competitive advantage'

Ceres and a Series of Serious Thoughts About the NAIC Climate Disclosures - Part III

September 19, 2011 05:15
by J. Wylie Donald
This is the last of three parts concerning Ceres’ recently released Climate Risk Disclosures by Insurers:  Evaluating Insurer Responses to the NAIC Climate Disclosure Survey.   We already have looked at the first two Recommendations to Regulators.  Today we finish with number 3:  more clarity in disclosure expectations.  Id. at 51.  It is always easier to make apples-to-apples comparisons when everyone is speaking the same language.  Uniform and detailed disclosure requirements would help achieve that goal.  However, the down side of specifying what will be disclosed is that it assumes the specifier knows all that needs to be identified.  The scariest part of climate change is that we probably do not yet know how all the changes will interact.  Correlated risk is a prime example.  IRMI describes “correlated risk profiles” as those “that move in concert when affected by the same set of stimuli.”  Insurers run from correlated risk and the Ceres report rightly poses a troubling concern in that regard:  “If … climate change has the potential to introduce correlated risks across previously uncorrelated assets and to drive market values in ways that cannot be predicted from historical trends, the insurance industry may be poorly positioned to meet its investment objectives.”  Climate Risk Disclosures at 39.  According to the report, few companies recognize the potential for correlated losses across their business.  Id. at 43.  And the ones that do say no more than that climate change will increase insured losses and may negatively impact the businesses in which insurers invest.  Id.   We don‘t think that this is news to those who did not specifically mention correlated risks in their submissions.  What we take from all this is that no one yet knows in a meaningful way where the climate change correlated risks lie.  Or they are keeping mum (see our first posting on the Ceres report concerning competitive advantage).  So the question for a regulator is the following:  Is one better off with answers that are less-constrained and potentially more revealing, or is more specificity in the guidance more helpful?  If one is a regulator who knows all the questions that should be asked, one should opt for more specificity.  But if one does not, then one might support providing unstructured disclosure opportunities. The Ceres report, of course, is not all about recommendations, but we have gone on for too long to delve further.  Before we close, however, we did want to address the need for stronger research. The Corporate Liability section attracted our particular focus, as climate change liability suits and their insurance have been a central feature of the blog.  Those of us following this subject drop the names of the three liability damages suits, Comer, General Motors and Kivalina, and the insurance suit, Steadfast, like they were business cards.  The statement that got our dander up was this:  "Since the first suits were filed in 2003, their numbers have rapidly proliferated—more than 120 suits were filed in 2010 alone, nearly two-thirds of them in the U.S."  Id. at 11.  This is an accurate paraphrase of its source, a sentence in a short article published by the Geneva Association.   The problem is that the source, at best, is misleading.  While there may have been 120 climate change suits filed in 2010, as demonstrated by the comprehensive set of charts kept by the Climate Change group at Arnold & Porter LLP there were none filed that were seeking damages under common law theories.   Those suits continued to be the three:  Comer, GM and Kivalina. We will be the first in line to agree that the insurance industry should be concerned about climate change liability suits.  But that concern has not yet had to focus on 120 climate change liability suits, because they have not been filed yet. That being said, the Ceres report brings to the fore statements by representatives of a multi-trillion dollar industry that is in the eye of the climate change storm.  Those statements otherwise might languish in some regulator’s dark bottom drawer.  The report is a valuable resource; we look forward to next year’s reprise.

Climate Change Litigation | Insurance | Regulation

Ceres and a Series of Serious Thoughts About the NAIC Climate Disclosures - Part II

September 16, 2011 05:09
by J. Wylie Donald
We wrote yesterday to introduce Ceres’ report on the disclosure of climate risks by insurers and considered its first Recommendation to Regulators concerning mandatory and public disclosures.  We address today the second recommendation in Climate Risk Disclosures by Insurers:  Evaluating Insurer Responses to the NAIC Climate Disclosure Survey.    Ceres’ second recommendation is to "[c]reate shared resources around the implications of climate trends on enterprise risk management."  Id. at 51.  In other words, more research should be made available concerning investment risks and opportunities, correlated risks, loss modeling, the potential for loss of health and life, and customer resilience (ability to resist extreme events).  Id.  Taking modeling by way of example, Ceres discusses modeling thoroughly in Part 2 and the discussion is thought-provoking.  Several insurers are conducting climate change modeling internally.  For the rest, they rely on third-party vendors, which invokes much criticism from Ceres.  "The majority of insurers that report using catastrophe models describe them in terms that suggest their company does not have a clear understanding of how the models can or cannot be used to anticipate changing risk.  Most of the industry relies on third-party catastrophe risk models that only marginally integrate changing extreme weather."  Id. at 6.  "[I]nsurers relying entirely on third-party models may be severely unequipped to adjust pricing to incorporate emerging climate risks." Id. at 31.  "Insurers' disclosures suggest that the majority of insurers may be setting pricing based on flawed assumptions of how the industry's loss models incorporate changing climate trends."  Id. at 32. Ceres lauds those companies that can do it in-house.  But specialization and economies of scale are fundamental drivers of the market.  Were every insurer to bring modeling inside, undoubtedly there would be some new insights not presently uncovered.  But there would also be insurers who got the models grievously wrong and, in most cases, the resources spent on modeling would be more cost-effectively spent on other items necessary to delivering products or services. To be sure, reliance on EQECAT, AIR Worldwide and RMS as the sources for all climate change modeling has its flaws.  One need only think back a few years to where another triumvirate dispensing financial ratings (allegedly) misled sophisticated investors around the globe.  But in a world of constrained resources, or even an unconstrained one, third-party modelers are necessary and beneficial.  Further, a disadvantage to society from in-house modeling is that the insights developed from proprietary work may remain just that:  proprietary.  Ceres acknowledges "it is ... possible that asymmetrical information can be used by individual companies to secure a competitive edge against their peers."  Id. at 38.  Indeed, "larger insurers more readily recognize the inherent limitations of current catastrophe models in light of changing climate than do their smaller competitors or clients.  These players have a clear competitive advantage in deploying resources to build the latest climate science into their pricing models."  Id. at 37.  Third-party vendors, on the other hand, spread their best products across many insurers, in effect sharing their best research (but only to those willing to pay for it).  We wrote yesterday of the need to recognize that intellectual capital is a business asset and criticizing a goal of making climate change disclosures public available.  We think those comments apply likewise to the sharing of resources. Nevertheless, Ceres does great work in raising the bar for third-party vendors.  By pointing out to insurer-users that they may not be getting what they really need from the modeling firms, we expect the modelers will have to go out and address Ceres’ criticisms.  For example, insurers are exposed if (as Ceres asserts) "few insured perils are modeled by insurers, leaving the possibility for climate-affected perils to be underpriced."  Id. at 35.  More specifically, "recent years have demonstrated that climate change may be driving up aggregated losses from smaller events, including perils such as floods, snowstorms and hailstorms, in ways that erode insurer profitability."  Id. Tomorrow we conclude our review with a look at Ceres’ third recommendation as well as sharing some concerns about research.

Climate Change | Insurance | Regulation

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