The economic sector and climate change

The Stern Review, the Global Roundtable, insurance loss analyses as well as the outcome of the Nairobi summit and the US climate regulations show that the economic sector is taking climate change seriously.

The capital markets have not been spared the consequences of increasingly frequent and violent natural catastrophes. On the contrary, results and share prices are affected by resulting raw materials shortfalls, damage to production sites and business interruption.

In addition the capital markets, sectors such as agriculture, tourism and healthcare are starting to feel the gradual effects of climate change. Ultimately, economic performance as a whole suffers. The macroeconomic effects have long been under discussion.

Now, however, Sir Nicholas Stern’s climate review has provided the first comprehensive quantitative analysis of the consequences of climate change and possible courses of action.

Stern Review

In October 2006, Sir Nicholas Stern, former Chief Economist and Senior Vice President of the World Bank, presented a review commissioned by the British government on the economics of climate change. One of his central themes is that climate change constitutes the greatest market failure the world has ever seen.

Sir Nicholas predicts that, by the middle of this century, climate change will account for a loss of at least 5% in global growth (US$ 2,200bn at current values) each year. If we also take its impact on environment and health and knock-on effects into account, it could be as much as 20% of annual global GDP (around US$ 9,000bn).

By contrast, the review argues, the cost of taking action would be as little as 1% of global GDP per year (US$ 445bn). That action would enable us to avoid entering a critical threshold area where average global temperatures were 2°C higher than pre-industrial levels.

To achieve this target, we would have to stabilise the concentration of greenhouse gases in the atmosphere at or below 550ppm CO²e (climate gases are expressed in terms of CO² equivalent). Global emissions would need to peak in the next 10–20 years and subsequently fall by 1–3% per year to around 25% below current levels by 2050.

If we compare the costs of action with the costs of inaction, there is only one choice as far as the economy is concerned: we have to protect the climate.

The role of the insurance industry

As well as preventing future emissions, we must also provide the financial means for adapting to those effects that can no longer be avoided. If we follow the Stern Review’s line, this is an area where the insurance industry has a key part to play by providing insurance solutions to counter the financial losses.

Munich Re regards climate change as a major issue and, as co-founder of the Munich Climate Insurance Initiative, is devising appropriate insurance based tools. The project targets those countries and regions which are worst affected.

World climate summit in Nairobi

The political discussions at the world climate summit in Nairobi should also be seen in the light of the Stern Review. They, too, highlighted the need to finance adaptation.However, the main item on the agenda was the post-2012 phase of the Kyoto Protocol (Kyoto Plus), which the world community has to decide on by 2009 at the latest. To meet this deadline, negotiations must begin in 2007. The conference paved the way for this by giving the go-ahead for a review of the Kyoto Protocol’s effectiveness (Article 9 of the Protocol).

Now it is up to heads of government to officially launch the negotiations. The G8 + 5 Climate Change summit and the European Union, under German presidency for the first six months of 2007, would be appropriate forums for giving a clear direction.

Measures to help those regions most affected have been stepped up and poorer countries will now receive aid from an Adaptation Fund. This is financed by means of a 2% levy on Certified Emission Reduction permits generated by CDM (Clean Development Mechanism) projects, a practical device for helping to finance adaptation in developing countries. The steady growth in the number of CDM projects should boost resources considerably. However, this is no more than a first step (which will amount to around US$ 250–300m by 2012).

The EU plans to launch a risk capital fund promoting the use of climate-friendly energy technologies in Africa. It will contribute €80m to the fund over the next four years and mobilise environmentally sound investments in the order of €1.25bn Munich Re’s Kyoto Multi Risk Cover can also be seen in the context of these measures. Its object is to compensate entities which invest in CDM and JI (Joint Implementation) projects (such as banks, funds, and project sponsors) for losses sustained if a project fails to deliver the agreed number of emission rights.

next page »

Global Roundtable on Climate Change

Although progress has been moderate on the political front, climate change is certainly being treated seriously by the economic sector. This is shown by the impact of the Stern Review as well as the Global Roundtable on Climate Change, initiated by Jeffrey Sachs, a renowned economist from Columbia University in the city of New York.

The Roundtable, of which we have been a member since inception in 2005, comprises more than 150 leading international representatives from the economic, political and research sectors, together with non-governmental organisations.

Its aim is to develop a global perspective of and global solutions to the challenges of climate change, taking due account of the economic, scientific and technical issues involved. A Roundtable statement, issued in the first quarter of 2007, calls on the economic sector to promote more efficient, greenhouse-gas-neutral energy in order to maintain CO² levels in the atmosphere at or below 560 ppm.

As emission and development levels vary from country to country, the Roundtable applies the principle of common but differentiated responsibility. In order to meet the objective, carbon dioxide emissions will have to carry a world market price, along similar lines to the European Union’s Emission Trading Scheme. This would open up the door to new products, markets and investment sectors for the finance and insurance industries: renewable energy, new energy technologies such as carbon capture and storage, the financing and insuring of Kyoto mechanisms and public-private partnerships, to name only a few.

Climate protection provisions in the USA

In 2005, seven states on the east coast of the USA signed the Regional Greenhouse Gas Initiative (RGGI), under which they agreed to maintain their individual energy emission budgets at a constant level during the period 2009–2014. From 2015, they will be reduced by 2.5% per year.

Thus, emissions will be 10% lower in 2019 than in 2009, and 35% less than they would have been without such an undertaking. At the same time, a regional CO² emissions trading system will be set up. Other states have launched similar initiatives. In September 2006, Arnold Schwarzenegger, Governor of California, signed an act calling on the state, the world’s 12th largest CO² producer, to cut its emissions to 1990 levels by 2020 — a reduction of 25%.

Furthermore, by 2050, emissions are required to be 80% lower than in 1990. California and the RGGI states account for roughly a quarter of the USA’s population and approximately 30% of the US economy.

International workshop on loss trends

The insurance industry is directly affected by losses due to climate change. At an international workshop entitled "Climate Change and Disaster Losses: Understanding and Attributing Trends and Projections", which we organised together with the University of Colorado, 32 eminent experts from 13 countries examined the following issues:

• —
  What factors account for increasing costs of weather related disasters in recent decades?
• —
  What are the implications of these understandings, for both research and policy?

Participants were drawn from the scientific sector (including the DIW, PIK, Tyndall Center and Harvard Medical School), consultancy firms (RMS, Risk Frontiers), the American Meteorological Service, the WMO and the insurance industry (Swiss Re, Axa Re). The conference was held at Hohenkammer, near Munich. A paper outlining the consensus reached by the participants identifies climate change as a factor which contributes to losses.

Details of the consensus together articles written by the participants can be downloaded from the following website:

Recognising the dangers and adjusting course

The Stern Review, the Global Roundtable, insurance loss analyses as well as the outcome of the Nairobi summit and the US climate regulations show that the economic sector is taking climate change seriously. Political endeavours are gradually emerging which will provide the appropriate legislative framework.

At the same time, there are clear opportunities for new economic options. To consolidate these developments and maintain the necessary impetus, the politicians now have to reach agreement on Kyoto Plus. The insurance sector needs to take account of climate change in risk measurement and adjust its products accordingly.

This view is gaining ground at European level and a study on climate change published by the European Insurance and Reinsurance Federation (Comité Européen des Assurances), which draws on a number of our analyses, was presented to the European Parliament in January 2007 (www.cea.assur.org). This is one of a number of insurance industry initiatives aimed at increasing policymakers’ awareness of the economic effects of climate change.

« previous page