ElectroFinance
A New Insurance Product for a Restructered Electric Market

by Joel Gordes and Jeremy Leggett2

Opponents of climate protection policies often assert that action to prevent global warming would cost too much, and suggest that world industry stands united against needless and exorbitant measures to curb greenhouse gas emissions. Yet some industries fear climate change as much if not more than the most ardent environmentalists: among these, the insurance industry stands out. (See Box 1.)

In this paper, we propose electrofinance as a product that could prove attractive to insurance and other financial service companies purely for business reasons. At the same time, electrofinance could prove immensely beneficial for environmental reasons. Simply put, electrofinance combines property-casualty insurance, electricity service, and an annuity into a single product, whereby any savings from reduced electricity bills due to aggregated demand and increased efficiency goes either into the annuity portion or to pay down a low-interest, long-term loan on a photovoltaic system.

PART I... Insurance and Financial Sector Vulnerability

The Greenpeace Report

Through the early 1990s, most insurance firms showed little interest in climate change, and most managers believed that meteorological conditions would remain relatively stable.3 In 1993, however, Greenpeace International's Climate Campaign published Climate Change and the Insurance Industry: Solidarity Among the Risk Community? This report suggested that some of the unprecedented losses suffered by the property-casualty insurance industry between 1987 and 1993 (see Figure 1) might reflect the early effects of climate change. During that period, the industry experienced its first-ever billion-dollar losses—in fact, there were 16 of them. Eleven of the events provoking those losses were windstorms.

Collectively, these events accounted for $44.2 billion lost as the result of windstorms. In 1992, global catastrophic losses ran $27.1 billion, up 87% from the previous year. As Greenpeace noted, the 10-year period 1983 to 1992 showed 10 times the insured losses as the 1960s, after adjustment for inflation.4 The report also noted that much of the increased loss reflected "proliferation and concentration of values" in more vulnerable areas.

The Greenpeace report included a number of provocative statements on climate change by some of the world's largest insurers and reinsurers. Taken as a group, these statements reflect a departure from previously held convictions regarding the near-term stability of the Earth's climate.

European Financial Community Perspectives

Since publication of the Greenpeace report, European financial institutions—and insurers in particular—have increased their active consideration of climate issues. In January 1995, for instance, Munich Reinsurance (Munich Re), one of the largest reinsurers in the world, announced that the floods in Europe may be linked to global warming and expressed fears that the worst is yet to come.5 Just prior to the second Conference of the Parties (COP II) to the Framework Convention on Climate Change in Berlin in late March 1995, Munich Re called for reductions in carbon emissions on a worldwide basis. Gerhard Berz, head of its Geoscience Research Group, pronounced that "there is no longer any doubt to us that a warming of the atmosphere and the oceans is causing an increased likelihood of storms, tidal waves, hailstorms, floods and other extreme events."6

At COP II itself, prominent insurers or reinsurers such as Lloyds of London, Munich Re, and Swiss Reinsurance (Swiss Re) combined to press for emission reductions. As one journalist ironically described it, "a chief Lloyd's underwriter, Richard Keeling, and other top European insurance executives made the rounds of leading delegations Wednesday in a newfound role as friends of the Earth."7

Following the momentum of Berlin, European and Asian insurance company positions were solidified in November 1995 when, under the auspices of the United Nations Environment Programme (UNEP), 14 insurance companies from around the world signed a Statement of Environmental Commitment to incorporate environmental considerations into risk management and to adopt best practices. Its Preamble states:

"The insurance industry recognizes that economic development needs to be compatible with human welfare and a healthy environment. To ignore this is to risk increasing social, environmental and financial cost. Our Industry plays an important role in managing and reducing environmental risk, in conjunction with governments, individuals and organizations. We are committed to work together to address key issues such as pollution reduction, the efficient use of resources, and climate change. We endeavor to identify realistic, sustainable solutions."8

Not one of the 14 initial signatories or the 6 later signatories was from the U.S. insurance industry.

In anticipation of the Third Conference of the Parties (COP III) in Kyoto in 1997, in July 1996 the group issued a stronger version of its statement. Among other things it stated: "We insist that...[i]n accordance with the precautionary principle, the negotiations for the Framework Convention on Climate Change must achieve early, substantial reductions in greenhouse gas emissions."9 This time, there was one U.S. signatory among 71 firms—Employers Reinsurance.

Just prior to the Kyoto COP, a third document reaffirmed the UNEP insurers' commitment to emissions reduction and provided support for clean energy technologies, including renewable resources. More promising (but not yet fully realized) is their pronouncement that:

"Insurance companies, pension fund managers and banks have taken the lead in creating new investment instruments which favor companies that are committed to substantially lowering their greenhouse gas emissions and demonstrate best practices in energy efficiency. However, the amount of money under management in such is still very small. Investment managers of insurance companies, pension funds and banks should work together to develop environmental reporting standards which are generally accepted and therefore used in practice besides benchmarks for profitability and security."10

In short, many European insurers have at least made several important public statements that depict climate change as a substantial risk and a threat to the world economy. One effect of this has been to call into question the frequent claims, for example by some fossil fuel and automobile firms, that climate change is an illusion, that measures to address it cost too much to contemplate, and that world industry stands united against such measures.

U.S. Insurers: Much More Conservative

Like European insurers, U.S. property-casualty insurance companies also suffered serious losses and reduced earnings between 1987 and 1993. Although American firms seem less willing to hypothesize a systemic cause of these losses, industry concern has risen. Most companies have reached modest consensus that future losses from events such as hurricanes—whatever the root cause—could have severe repercussions. For example, the Natural Disaster Coalition, based on models, estimates that a Class Five hurricane striking Miami could cause $54 billion in losses, while a Class Four storm striking New Jersey, New York, Connecticut, and Massachusetts could cost $51 billion.11

In a similar vein, Eugene Lecomte, former CEO of the Insurance Institute for Property Loss Reduction (now called the Institute for Business and Home Safety) commented that:

"There is the potentiality for one or more $50 billion losses to occur within a close time proximity of one another. That potentiality would, if it became a reality, erode a significant portion the Industry's $180 billion surplus. The Industry would then lose the capital needed to take on new risks thus, creating a severe property insurance availability crisis."12

Lecomte attributed a large part of the problem to increased amounts of high-value property in harm's way and inflationary pressures.

Much milder but potentially significant has been Allstate's position. An early statement by this industry behemoth is found in their 1998 annual report:

"The question of the magnitude of potential impacts of global climate change will be a continuing source of discussion. However, the Intergovernmental Panel on Climate Change reported that there is a discernible human influence on the climate change being observed. In light of this, Allstate continues to explore and analyze credible scientific evidence, including, but not limited to, the impact of climate change, that may affect Allstate's potential exposure under its insurance policies."13

In general, though, most observers concede that the U.S. property-casualty insurance industry has been far more reticent and noncommittal on the subject of climate change.14 There is less agreement as to why this should be so. This question begs for further research, but speculative reasons include the following:15

What seems clear is that the best way to spur the American insurance sector to action is to show them that such activities can rapidly provide a profit through new business opportunities or through loss mitigation.19 Carbon reduction must be seen only as an incidental benefit. In the past few years, many new avenues have opened for insurers to earn those profits as lines between insurance, banking, and other services begin to blur.

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Renewable Energy Policy Project