Trial by Fire September 2018


1 A REPORT BY THE CALIFORNIA DEPARTMENT OF INSURANCE TRIAL BY FIRE Managing Climate Risks Facing Insurers in the Golden State

2 Trial By Fire: Managing Climate Risks Facing Insurers in the Golden State California Department of Insurance | September 2018 Authorship: Evan Mills, Ted Lamm, Sadaf Sukhia, Ethan Elkind, and Aaron Ezroj Production: UC Berkeley School of Law Center for Law, Energy & the Environment Design: Emily Van Camp

3 Table of Contents Acknowledgments i ii Foreword by California Insurance Commissioner Dave Jones Executive Summary iii iv The physical and business climates are changing California on the cusp iv California is a leader in insurance-focused climate risk management vii Key findings x Recommendations xii Climate Change is Risky Business for Insurers 1 The market expects insurers to understand and help manage climate risks 5 The U.S. insurance industry absorbs half the costs of weather- and climate-related losses 6 9 Climate Change Poses Diverse Physical Risks in California Climate-related loss events are a material influence on consumer costs and insurer profitability 14 14 A mosaic of climate risks underpinned the 2017 California wildfires 20 Transitional Investment Risks Occur in Parallel with Physical Risks: Erosion of Asset Value Insurance regulators have pioneered a diversity of effective strategies to evaluate transition risks 25 Polluter Liability and Other Liability-Related Triggers May Give Rise to New Litigation Risks 30 Climate change litigation is growing but has focused on regulation and mitigation policies 33 33 Climate change tort litigation threatens insurers’ balance sheets 35 Past climate change damages suits in the United States have not resulted in liability Recent climate change damages suits in the United States present new avenues for liability 36 Historical mass tort examples offer insight into the development of liability 38 Fellow common-law countries have not developed climate liability 40 Legal academic commentary and theory suggest additional barriers to liability 41 Implications for the insurance industry are significant but details continue to emerge 42 Systemic Challenges for Markets and Consumers 45 45 Key climate risks remain uninsured in California’s private insurance market 46 Climate change reduces insurance availability, adequacy, and affordability Climate-response strategies have new and widely varying risk profiles 53 From Reactive to Proactive: A Return to the Industry’s Roots in Loss-Prevention 55 303 56 Enhancing climate resilience will reduce future losses 60 Climate science, hazard modeling, and risk assessment can be usefully integrated Bringing it all together: Stress testing and enterprise risk management 63 From Risk to Opportunity: The Greening of Products, Services, and Investment 66 Some insurers believe investment in climate solutions diversifies assets and supports emission reductions 70 Market uptake of “green” products and services 74 Actuarial and Fiscal Perspectives: Insurers Identify Win-Win Benefits from the Greening of Insurance 77 New Best Practices are Emerging 80 80 More closely monitor the insurance-relevant climate situation and responses Refine insurance pricing and contract design to more precisely reflect climate risks and incentivize mitigation efforts 81 Fortify consumer protections and resilience efforts to ensure insurance availability, adequacy, and affordability 82 Continue to champion and improve climate risk disclosure 82 Support innovation in loss modeling, data science, and stress testing 83 Identify and mitigate barriers to green insurance and risk reduction 84 Participate in climate mitigation and adaptation research and inter-agency initiatives 85 Enhance market awareness of disparate risks and insurance responses 85 Increase engagement in broader public policy discussions 86 The Way Forward 87 References 88

4 i Acknowledgments Authors: Evan Mills, Ted Lamm, Sadaf Sukhia, Ethan Elkind, and Aaron Ezroj. California Insurance Commissioner Dave Jones provided the vision and the initiative that made this report possible. Many California Department of Insurance staff members gave of their time and knowledge, including: Joel Laucher, Susan Bernard, Geoff Margolis, Ken Allen, Amorette Yang, Robert Herrell, George Yen, Lisa Strange, Melerie Michael, Amanda Bastidas, Durriya Syed, Sumeyye Tarhan, and Kelvin Chao. We would like to thank Evan Mills for his leadership in preparing this report. We would also like to thank the colleagues who provided review comments and useful conceptual discussions on drafts of this report, particularly Lindene Patton (Earth & Water Law Group). Other valuable input was offered by Edward Baker (PRI), Ophir Bruck (PRI), Ben Caldecott (University of Oxford), Geert Van Calster (KU Leuven Law), Dan Farber (UC Berkeley School of Law), Alice Hill (Hoover Institute), Robert Muir-Wood (RMS), Claudia Polsky (UC Berkeley School of Law), and Kathleen Schaefer (UC Davis). Lloyd Dixon (RAND) provided valuable data on California wildfire vulnerability under climate change and Petra Loew (Munich Re) provided comprehensive loss histories for the United States. Stan Dupre, Jakob Thoma, Tricia Jamison, Clare Murray, Tina Wang, Taylor Posey, Nils Blum-Oeste, Michael Hayne, and Klaus Hagedorn of 2 Degrees Investing Initiative performed the scenario analysis of insurer fossil-fuel investments. Alex Bernhardt, Karen Lockridge, Max Messervy, Hemant Kapoor, and Ashish Babbar of Mercer performed the threshold analysis of insurer fossil-fuel investments. Emily Van Camp managed the design for this report. UC Berkeley School of Law’s Center for Law, Energy & Environment (CLEE) hosted a day-long symposium on June 13, 2018 in support of this study that was attended by 60 individuals with relevant expertise. Information on the symposium can be found at CLEE also managed the production of this report. Emily Van Camp managed the design for this report. Recommended citation: Evan Mills, Ted Lamm, Sadaf Sukhia, Ethan Elkind, and Aaron Ezroj. 2018. “Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State.” Sacramento, CA: California Department of Insurance. Photographs in the report without captions are courtesy of Flickr’s National Park Service (cover, p. 26), Unsplash’s Jeremy Perkins (pp. iii and 41), Flickr’s Bureau of Land Management California (pp. viii and 53), Unsplash’s Dan Gold (p. 1), Flickr’s U.S. Forest Service Pacific Northwest (p. 3), Unsplash’s Tom Barrett (p. 8), Unsplash’s Rodion Kutsaev (p. 9), Unsplash’s Mourad Saadi (p. 20), Unsplash’s Lucy Chian (pp. 22 and 57), Unsplash’s Blaque X (p. 26), Unsplash’s Connor Jalbert (p. 29), Unsplash’s Jason Wong (p. 30), Unsplash’s Guillaume Bourdages (p. 32), Flickr’s (pp. 35 and 88), Unsplash’s Gerson Repreza (p. 37), Unsplash’s Michal Mancewicz (p. 43), Flickr’s Joshua Tree National Park and Cathy Bell (p. 45), Unsplash’s Karsten Würth (pp. 50 and 66), Presidio of Monterrey (p. 51), Unsplash’s Mark Doda (p. 52), Flickr’s Rob Owens (p. 55), Unsplash’s Sanjiv Nayak (p. 74), Unsplash’s Dominik Lange (p. 77), Flickr’s David Whelan (p. 80), Flickr’s Moonjazz (pp. 83 and 86), Unsplash’s Liv Bruce (p. 84), and Unsplash’s Luke Bender (p. 87). The California Department of Insurance provides this report without charge. This report is not intended to provide insurance, financial, or legal advice. All information and opinions contained herein are accurate as of the date of publication, and are subject to change without notice. While the California Department of Insurance cites sources throughout this report, it is not liable for errors and omissions in these sources.

5 ii Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State Foreword Climate change presents risks for insurance policyholders, markets, and companies. This includes physical, transi - tion, and liability risks, which may have consequences for insurers’ underwriting and the investing of their reserves. With regard to insurers’ core underwriting business, the physical impacts of climate change pose risks. Climate scien - tists say that rising global temperatures are contributing to severe weather events – fires, hurricanes, droughts, and floods – some of which are causing or may cause loss of life, injuries, property damage, and economic disruptions. In - surers writing insurance for the people, property, and economies affected by severe weather events are already seeing - increasing losses. For example, in 2017, California was hit with some of the most destructive wildfires in recorded his tory. Climate scientists have attributed the rise in destructive wildfires in part to climate change. Insured losses were $12.6 billion. The Caribbean and Gulf Coast were also pummeled by a series of Category 4 and 5 hurricanes whose severity was attributed to warmer ocean waters. And wildfires hit California again in 2018 – the Carr Fire caused an extremely rare “fire tornado” while the Mendocino Complex Fire became the largest in California history. Insurers collectively hold and invest trillions of dollars in their reserves, and thus face climate-related financial transi - tion risks to those investments. These risks manifest if markets, consumers, and governments transition away from reliance on fossil fuels and a carbon-based economy in order to reduce climate change causing greenhouse gas emis - sions, and the value of such investments declines in response. There are also climate-related liability risks. It is possible that the law will eventually provide that greenhouse gas emitters are liable for climate-related damages, which in turn insurers might be obligated to pay for. As Insurance Commissioner, I am responsible for monitoring the financial condition of insurers, including both their assets and their liabilities and risks thereto, and helping maintain the availability, affordability, and adequacy of insurance for consumers. Given the climate-related risks faced by insurers, I have required insurers since 2011 to identify whether and how they are considering the impact of climate change in their business operations, underwrit - ing, and reserving. In 2016, after concluding there are additional potential transition risks to insurer investments, I required insurers to disclose their investments in fossil fuel enterprises and utilities that rely on fossil fuels and asked that they divest from thermal coal investments because of the risk that such investments are or will become a stranded asset on the insurers’ books. And, in 2018, I was the first United States financial regulator to undertake climate-related scenario stress testing of insurers’ reserves. Disclosure of climate-related risks to the financial sector is important for the sustainability of the global and United States financial systems generally, and the insurance sector in particular. In 2017, the G-20 Financial Stability Board’s Task Force on Climate-related Financial Disclosures issued its recommendations for climate risk disclosures for each economic sector, including the insurance sector. Insurers, investors, policyholders, and regulators should all support and implement these recommendations. I asked that this report be prepared in order to more fully identify climate risks and to discuss how insurers, regu - lators, and policymakers are responding. Thanks to Dr. Evan Mills, principal author, the climate policy experts at Berkeley Law’s Center for Law, Energy & the Environment, and our staff in the Office of Climate Risk Initiatives, this report makes an important contribution to a better understanding of the challenges and opportunities associated with climate risk and climate change, and insurance. Dave Jones Insurance Commissioner State of California

6 iii Executive Summary The science is settled; an industry is vulnerable. Human activity is far and away the primary driver of observed global climate changes, overlaying economic and legal concerns onto physical risks (IPCC 2014; USGCRP 2017). Climate change will increase the frequency and intensity of extreme weather events and their impacts; in fact those effects are already underway. Exemplifying the individual and cascading risks that will become more common, California has experienced its worst drought in 1,200 years. The drought in turn laid the groundwork for the largest wildfire in the state’s recorded history, which was part of a string of fires that amounted to record-breaking wildfire losses in 2017. Those fires were immediately followed by one-in-200-year “Pineapple Express” torrential rains, which resulted in what may be the state’s costliest mudslide on record. Further record-breaking wildfires have followed in 2018. The problem is compounded by the mismanagement of ecosystems and expansion of human settlements into harm’s way. Many of the losses resulting from these events are insured. The added litigation events arising out of these and other climate-related events are creating liability exposure for the insurance industry of a magnitude that could ultimately swamp the property losses. Moreover, insurers’ own assets (accumulated to pay claims and shareholders) are vulnerable to climate impacts as well, creating the potential for serious systemic risks. Climate change has thus become a multi-faceted material risk for the $4.6-trillion global insurance industry. Many insurers and reinsurers have fashioned a range of responses, some focused on reducing their exposures and others on disclosing vulnerabilities and mitigating the root causes of climate change through actions in the core business of underwriting as well as asset management, but preparedness must be further improved.

7 iv Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “Whether one believes that it is caused primarily by humankind’s collective actions, as I do, or not, the reality is that for insurers or insurance regulators to ignore climate change is to commit professional malpractice.” California Insurance Commissioner Dave Jones arising from climate and weather events. Yet The physical and business major surprises continue to roil the industry as climates are changing its customers continue to move into harm’s way and as the risk landscape changes in sometimes The Earth’s natural environment is changing in unpredictable ways. ways that are less evident in our daily lives. For example, the Sahara desert has grown by 10% Californ ia on the cusp (Gabbatiss 2018) while we are losing nearly 150 cubic miles of land-based ice to the seas each year, which are consequently rising (NASA 2012). California – the world’s fifth largest economy – According to Pentagon-funded research, sea-level sits at the edge of a continent and at a crossroads rise will make more than a thousand tropical for slow- and fast-onset natural hazards that are islands uninhabitable in the next few decades, already arising from climate change. With a GDP displacing civilian populations and swamping of $2.7 trillion and a population of nearly 40 military infrastructure (Mooney and Dennis million residents, much is at stake. Meanwhile, 2018; Storlazzi et al. 2018). The implications the Golden State is a pioneer in developing and of sea-level rise are particularly worrisome for bringing to scale technologies essential to reducing California’s San Francisco Bay Area. These changes greenhouse gas emissions (and achieving climate are rigorously attributed to human activities that adaptation) and a champion of forward-looking overwhelm natural variability in the climate policies and programs to speed emission reduction system. In fact, some natural phenomena such and adaptation to otherwise unavoidable impacts. as sunspot cycles would actually be cooling the climate at this point in history were it not for California is the nation’s largest insurance human-caused greenhouse gas emissions. market, with over 1,300 insurance companies collecting $310 billion in premiums annually and As evidenced by analyses from the World holding $5 trillion in assets under management. Economic Forum, the business community has Public insurers assuming most crop and flood come to anticipate a warming world as well, risks collect an additional $500 million each year placing climate change and the associated types in premiums in the California marketplace alone. of events befalling the world economy at the very top of their list of concerns on the global risk The insurance market provides a clarion call for landscape. Climate change is usefully viewed by both registering the effects of climate change and the scientific community and business leaders shaping the responses. The industry is at once alike as a problem of risk management. highly vulnerable to the losses that result from heightened weather- and climate-related events Indeed, in its core business, the insurance and to market dislocation caused by a changing industry has long played a major role in helping economy yet also perfectly placed to play a key society quantify and spread the risk of losses role in supporting innovative responses and

8 v “The headlines are naturally dominated by the escalation of tensions and conflicts, or high-level political events. But the truth is that the most systemic threat to humankind remains climate change...” UN Secretary General Antonio Guterres Press conference, New York, March 29, 2018. the broader societal context in which many other enhancing resilience to climate change. stakeholders – including insurance consumers themselves In California, as in much of the world, insurance play essential parts. – is part of the “DNA” of the broader economy. It serves an essential role of spreading risk, Insurers face myriad risks in this warming world, and those doing business in California often helping homeowners and businesses manage losses that would otherwise be crippling. This assume climate risks in other markets as well (for reference, California represents about 7% of the risk spreading in turn alleviates the exposures of global insurance market). These risks exist across the financing community, enabling it to provide capital knowing that the underlying collateral is the insurance enterprise, from underwriting, to reasonably secure. Insurance also fosters peace of functioning in the field post-event, to disputed mind on the part of homeowners and businesses, claims, to asset management, to liability assuming that insurers honor their role in paying for insurers’ own actions or inactions (e.g., approaches to safeguarding shareholder value). claims and remain solvent in the face of major The challenges fall into four broad categories: loss events. Indeed, the availability of insurance in and of itself is part of society’s capacity to 1. adapt to climate change. That said, the disparity The physical risks of climate and weather between total economic losses from weather and extremes to insurance customers impact the climate extremes and those covered by insurance built environment as well as health. Beyond is widening. This differential, commonly referred these considerations are more complex systems-level risks such as those arising to as the “protection gap,” may be compounded by new stresses that climate change imposes. when power grids or supply chains are disrupted leading to business interruption insurance claims. Ecosystem disruptions As an advanced economy, California hosts an such as fishery collapse or abrupt reductions insurance market that is well-developed and in crop yields can rapidly manifest in systemic stands to be an innovator in efforts to analyze, underwrite, and mitigate the risks associated socioeconomic impacts. with certain climate impacts. Its customers want no less. Meanwhile, from an insurance regulator’s 2. A diverse set of considerations encompass perspective, the risks climate change poses transition what have come to be known as risks to insurers must not threaten the solvency of , which include the reverberation of physical losses into insurer assets and individual companies or the availability, adequacy, and (to the degree possible) affordability of reserves (equities, bonds, and real estate) as well as new risks that may accompany insurance to homes and businesses. The specter efforts to address climate change (such of climate change challenges both insurers and as untested technologies and deliberate their regulators to take an increasingly expansive climate modifications that may backfire). and proactive view of their missions and roles in

9 vi Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State o C world is not insurable.” “A + 4 Thomas Buberl, CEO, AXA Remarks, One Planet Summit, Paris, December 12, 2017. More broadly, transition risks reflect securities prices while triggering a wave of the uncertainty of financial markets in a property/casualty and life/health insurance potentially carbon-constrained world. claims as well as litigation. While technical uncertainties in projecting 3. Climate changes also precipitate a diversity litigation risks the timing and location of climate change , including claims for of impacts are at times held up as a rationale for damages against producers of fossil fuels, other business interests found to be inaction, uncertainty is in fact at the heart of inadequately prepared to avert the impacts the insurance industry’s business. As observed of climate change, or insurers themselves by the International Actuarial Association: over disputed contractual obligations. The enormous uncertainty associated 4. with climate change is in and of itself an The broader reverberations of climate actuarial problem ... it creates forecast risk. change impact the economy as a whole, with Since increased risk has an economic cost, the potential for knock-on reductions in uncertainty in future forecasts will likely the availability of or demand for insurance, increase the risk of errors and inevitably the which in turn can erode property values cost of such programs... [I]t is incumbent on or cities’ credit ratings, along with other adverse consequences. Insurance markets the profession to lead the debate on the likely can contract when consumers retreat or impacts ... rather than let it passively emerge become less able to afford insurance or when as an implicit “experience item” in annual insurers themselves deem risks uninsurable reconciliations of actual versus expected (as is evident in the U.S. government crop experience (IAA 2017). and flood insurance programs, residual Global total and insured losses from weather- insurance markets, and the evolution of the Florida market). These responses can be related catastrophes broke all records for total undesirable mal-adaptations to the climate and insured losses in 2017: $330 billion and problem, reducing consumers’ peace of mind $136 billion, respectively (Munich Re). These and failing to capture the socio-economic losses mark a potential turning point in thinking – and acting – about climate change that may benefits of risk-spreading. Public insurance systems of last resort are vulnerable to well surpass the momentum of prior moments political vagaries or insolvency, once again following events such as Hurricanes Andrew shifting risk back to individual consumers. (1992) and Katrina (2005). Yet headlines featuring abrupt, catastrophic events reflect Cutt ing across these sources of risk are extensive only the tip of the iceberg in terms of climate potential correlations among risks, a top concern risk. Many hazards are sufficiently small or expressed by industry analysts (Moody’s 2018). localized (such as lightning and soil subsidence) For example, a major hurricane striking a key but highly replicated, or sufficiently diffuse and financial center can simultaneously affect slow-moving (such as drought, sea-level rise, or

10 vii “We must, above all, shift from a culture of reaction to a culture of prevention. Prevention is not only more humane than cure; it is also much cheaper... Above all, let us not forget that disaster prevention is a moral imperative, no less than reducing the risks of war.” Daniel Stander, Managing Director, RMS Keynote, RMS Exceedance Conference, Miami, April 28, 2015. predictability of extreme weather events and weather-related vehicle accidents) that they receive related impact/loss profiles is now further less attention. Further layers of risk that experts confounded by climate change forecasts. This consider even less often include wide-ranging complicates an already tough question of how impacts such as ecosystem collapse, food-borne much money should be included in the charged disease correlated with higher temperatures, or rate today to pay for a well-defined future kidney disease correlated with dehydration. loss in a non-mandatory market where asset ownership may also change during the return Economists often bemoan the presence of period. Charging adequate rates to provide “externalities” that result in societal costs (such for expected ex-post outcomes in a manner as those from climate change), which are not consistent with an ex-ante finance instrument reflected in the prices consumers pay for goods where the return period for the event/named peril loss cycle exceeds the instrument/policy and services. With the potential to address one 1 period can drastically impact affordability. such set of externalities, insurance can be the messenger of climate risk, serving an important Ironically, and further complicating matters, by role in telegraphing the cost of that risk to buyers protecting consumers from the most significant of insurance across all sectors, including housing, economic impacts of climate change, insurance business, industry, and agriculture. This dynamic can unintentionally minimize the perceived need extends from property coverages to liabilities for resilience and mitigation and cause unintended such as those facing polluters as well as entities mal-adaptations. responsible for foreseeing, disclosing, and proactively averting the adverse impacts of climate California is well positioned to build on its existing change. Conversely, as insurers refine their pricing base of institutional and analytical preparedness. to better reflect risks, they have an improved This report documents existing efforts on the ability to participate in or reward consumers for part of Commissioner Jones and others and improving their resilience. Moreover, as new points the way to deepening their impact. technologies and practices emerge for combating climate change, insurers can participate in those markets through their core business by crafting California is a leader in related products and services or through their insurance-focused climate risk investment practices. management However, complications arise if the historical loss California has a vibrant institutional and experience used to establish pricing fails to capture analytical ecosystem for mitigating climate risks the actual cyclical nature of climate extremes: and enhancing resilience. The state is particularly Insurance is an ex-ante finance instrument 1. Lindene Patton, Earth & Water Law Group, private communica - (pricing based on estimated expected future tion on June 15, 2018, following June 13, 2018 symposium pres - entation. losses); however, the already challenging

11 viii Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State vulnerable to the ravages of climate change and In a more recent example, California is one of the few states where insurers have deemed has become a hub for litigation against producers of products that ultimately result in greenhouse that homes in compliance with the National Fire Protection Agency’s “Firesafe” guidelines gas emissions. But it has also long been a can receive premium credits, which can in turn leader in efforts to get in front of the problem. These efforts extend into the insurance sector. inspire non-insurer investment in risk reduction. The Applied research on risk: California’s Forward-looking insurance regulation: California Department of Insurance (CDI), under universities, national laboratories, and non- governmental organizations have long been in the leadership of Commissioner Jones, has taken the vanguard of assessing climate risk at the a number of forward-looking regulatory actions global and local levels and performing insurance- to focus insurers on the risks of climate change. CDI has led in the administration of a national relevant assessments. As a case in point, the survey by state insurance regulators of insurers California-based think tank RAND Corporation regarding their responses to climate change. CDI has recently conducted a detailed assessment of has asked insurers to divest voluntarily their climate change on insured wildfire risk (Dixon investments in thermal coal, in light of the risk et al. 2018). The state’s brain trust also includes deep legal scholarship on climate change that those investments will become “stranded litigation. assets” on the books of insurers as and if markets reduce demand for (and governments restrict use of) thermal coal as an energy source. More Insurers doing business Innovative insurers: than 200 insurers in California’s market have in California have developed products and divested $4.1 billion in thermal coal and other services aimed at reducing climate risks. fossil fuels and made commitments for further Foremost among these are the first North American “green buildings” policies for homes divestment. CDI has required insurers to disclose publicly their climate risks and fossil fuel and and businesses, which reward the better risk profiles of these facilities with lower premiums utility investments and undertaken first-in-the- nation “two degree scenario testing” of insurers’ and help rebuild damaged properties to a reserves to ascertain their potential exposure higher level of energy efficiency. In another example, eight companies have fielded mileage- to a transition away from use of fossil fuels, consistent with keeping global temperature based insurance products in California that increases below two degrees Celsius. reward reduced driving with lower premiums, consistent with reduced roadway risks incurred by these drivers. CDI co-chairs the high-level National Association of Insurance Commissioners (NAIC) committee on climate change, which has led national-level Insurance partnerships to leverage private efforts at climate risk disclosure among insurers. Insurers cannot single-handedly investment: CDI has supported innovative efforts to develop address the risks of climate change, but they can exert considerable leverage and make insurance products that address emissions and meaningful progress through partnerships with has participated in climate change preparedness initiatives at the national and international other stakeholders. Identifying risk-reducing level. Table 1 provides a more detailed listing of actions that policyholders can take is consistent CDI’s past and current activities. with the commercial and social role insurance has played in the United States since the Great Chicago Fire and the advent of the steam boiler.

12 ix TABLE 1 A decade of climate change activities at the California Department of Insurance. | Sponsored first-in-the-nation “green insurance” legislation allowing Californians to use their personal vehicles in car-sharing pools 2009 without invalidating their auto insurance (Assembly Bill 1871 [Jones, Chapter 454, Statutes of 2010]). Promulgated regulations allowing (but not requiring) insurers to offer mileage-based automobile insurance products in the 2009 California market; eight companies have brought products to the California market as of mid-2018. Helped develop the NAIC Insurer Climate Risk Disclosure Survey. California subsequently became one of only 20 states implementing a voluntary NAIC Insurer Climate Risk Disclosure Survey, and one of only four making it mandatory and requiring 2010 public dissemination of the responses in 2011. California broadened participation by lowering the threshold for participation from $300 million in annual premiums nationally to $100 million with nearly 1000 insurers responding to the survey in 2016. Reinvigorated a program crediting insurers for making investments in green infrastructure under the California Organized 2011 Investment Network (COIN) program, resulting in $7 billion in investment by 2016. Hosted the Green Insurance Summit, a forum led by California Insurance Commissioner Dave Jones to offer advice, insight, and recommendations on the impact of climate change on the insurance industry, the availability of green insurance products and 2011 investments, transparency and disclosure, and other issues where insurance and the environment intersect. Commissioner Jones served as Vice Chair for the NAIC Climate Change Working Group, articulating the need to address climate 2011-2018 change impacts. 2012 Signed an MOU with Cal Fire and began meeting bimonthly to coordinate efforts concerning wildfire. 2015 Joined California’s Tree Mortality Task Force, working specifically with the Insurance Subgroup. Commissioner Jones attended the United Nations World Climate Conference (COP 21). 2015 Became a signatory of the United Nations Principles for Sustainable Insurance (PSI), positioning CDI for international collaborations 2015 to address climate change impacts. Launched the Climate Risk Carbon Initiative with the CDI Thermal Coal Divestment Request and CDI Fossil Fuel Data Call, resulting 2016 in $4.1 billion in divestment as of mid-2016. Co-hosted the inaugural meeting of the United Nations Sustainable Insurance Forum (SIF) with Commissioner Jones becoming the 2016 first Chair. 2017 Participated in Second Meeting of SIF, where workstreams were advanced and membership increased. Participated in Third Meeting of SIF, where membership decided to support the recommendations of the Task Force on Climate- 2017 related Financial Disclosures (TCFD). Commissioner Jones wrote the Chair of the International Association of Insurance Supervisor (IAIS), asking that the IAIS formally 2017 support recommendations of the TCFD. Participated in a PSI and reinsurer symposium on the development of sustainable insurance products. 2017 After holding a claims workshop in an area impacted by severe wildfires, Commissioner Jones issued a notice asking insurers to simplify the claims process for California wildfire survivors who were overwhelmed with the task of navigating the claims process, 2017 provide relief from completing detailed home inventories, and follow the lead of insurers providing up to 100% of contents (personal property) coverage limits without a detailed inventory. Participated in California’s Fourth Climate Change Assessment, supporting RAND’s research on the increased wildfire risks in the 2017-2018 wildland-urban interface and providing guidance on the availability and affordability of insurance coverage in these areas. Commissioner Jones spoke at a Legislative Committee Hearing on Drought, Climate Change and Fire during which he asked the 2018 Legislature to take action so that consumers have available and affordable fire coverage. 2018 Shared strategies for addressing climate risk at the Climate Risk Conference for Supervisors. Conducted a first-in-the-nation stress test to determine climate-related risk to insurance industry investments, demonstrating that 2018 thermal coal still presents a great risk to insurers. 2018 Spoke on scenario analysis at the Fourth Meeting of SIF and a PSI conference. Participated in a symposium on insurance and climate risk, hosted by Berkeley Law’s Center for Law, Energy & the Environment, 2018 identifying best practices within the insurance sector. Spoke on scenario analysis at United Nations-supported Principles for Responsible Investment (PRI) events, discussing the benefits 2018 of the analysis to supervisors and insurers.

13 x Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “It is clear that a societal response is required – from legal and regulatory issues to corporate responsibility – to address the liabilities and the opportunities presented by climate change. Climate change will also require a more holistic or comprehensive risk management approach.” Chubb (2016) California insurance market are currently under Key findings stress with respect to wildfire risks, and pressure on consumers will only increase under climate California insurers have diverse underwriting change. Encouragement can be taken from the vulnerabilities to climate change, and CDI and fact that aggressive efforts to reduce greenhouse insurers, together with other stakeholders, gas emissions can materially reduce the likelihood have achieved significant progress in identifying of such events in the future, benefitting insurers and responding to these risks. However, the and their customers in particular. full dimension of climate risks has yet to be quantified. Certainly much more can be done. A wide range of health risks occur in parallel with the better-known property risks. These The physical risks facing insurers and the broader risks range from extreme heat stress to a host California economy have been starkly illustrated of cardio-respiratory concerns and vector-borne – with clear evidence that they can accumulate in diseases, which have been largely unassessed and a series of cascading perils – by the convergence unaddressed by the insurance community. The of a multi-year drought deemed the worst in implications extend to disruptions in the delivery more than a millennium, ended by devastating of healthcare following catastrophes. rainfall and flooding, in turn followed by the largest wildfire in the state’s history, immediately Financial vulnerabilities extending beyond followed by landfall of a one-in-200-year pacific direct insurance losses include transition risks, Pineapple Express storm upon the highest- which largely manifest in investments and the valued settlement adjacent to that fire zone. The asset management side of the industry. Insurers resulting combined insured wildfire losses were operating in California have about $528 billion $12.6 billion, plus $658 million for the subsequent in fossil-fuel-related investments in various mudslides. One third of the structures lost in the sectors and asset classes. Adverse impacts on fires were uninsured and the total societal costs the climate and resultant competitive risks from are as yet un-tabulated. As this report goes to clean energy technologies in combination with an press in summer 2018, the Mendocino Complex adverse economic and regulatory environment fire has become the largest wildfire in records can present financial uncertainties for these California history, a record previously held by investments (McHale and Spivey 2016). the Tubb fire in Santa Rosa. Meanwhile, the also raging Carr Fire in Redding has destroyed While litigation against emitters of pollutants 1,077 homes, 22 commerical structures, and 500 contributing to climate change has as yet been outbuildings have been destroyed and at least six unsuccessful, a recent wave of challenges in people killed, an ominous development in keeping California courts based primarily on tort and with the trend towards a “new normal” under nuisance claims and the costs that climate change climate change (Cal Fire 2018a). Segments of the impacts are imposing on municipalities may

14 xi “By increasing incentives for reduced driving, the building of ‘green buildings,’ investments in energy efficiency improvements and renewable energy projects, and the conservation of natural resources, the insurance industry can help reduce greenhouse gas emissions.” California Assembly Bill 1011 (Jones, Chapter 418, Statutes of 2010) result in extremely large insurance liabilities or and services. These appear to have had mixed settlements. market reception, with many agents as well as consumers unaware of their existence. In certain Society’s responses to climate change also bring cases, however, uptake has been appreciable, although the current deficiencies in terms of serious new risks, particularly concerning the last-ditch efforts being discussed to “engineer the product distribution are significant. climate” itself, for example by reducing sunlight reaching the Earth. The potentially serious A key and largely untapped area for innovation insurance implications of this trend have not been is in enhancing resilience. For insurers to play a examined. However, other strategies that focus on greater role requires better models and better loss data, which is made possible by recent advances using energy more efficiently and decarbonizing in science, remote sensing, and “big data” analysis the energy supply with renewable sources, often techniques. Science-based processes of identifying improve climate resilience or reduce insured risks and quantifying climate risk (both in space and in other ways. time) can support more sophisticated actuarial analyses and tailoring of insurance products and The aforementioned risks can intersect and services to pinpointing risk and incentivizing risk compound one another in ways that are rarely reduction. A conceptual model for this may be evaluated. Their combined and sometimes cascading effect in a given underwriting year obtained by borrowing a page from the “highly represents the full impact of climate change on an protected risk” side of the industry, where premium insurer’s business. Climate change – particularly revenues are targeted towards loss prevention with with the many simultaneous and correlated risks it the goal of drastically reducing the risk of future payouts. Third party stakeholders such as local presents – is thus more daunting than traditional governments, non-governmental organizations hazards. (NGOs), and the academic community also clearly A range of actions from insurers, regulators, have roles to play in such a process. Institutional arrangements for organizing and financing such lawmakers, and consumers will be necessary in order to preserve insurance availability, adequacy, ambitious undertakings are not currently in place. Insurers also lack incentives to engage in analysis or and affordability as climate change worsens. implementation of large-scale resilience measures. While current legislative proposals seek to address the specific problems raised by recent wildfires, The most effective approaches will embrace an insurers will face even greater systemic barriers enterprise-wide perspective, integrating the core to offering affordable insurance statewide as risks underwriting business with asset management. The grow and combine. Increased regulation will help industry has already begun to respond in myriad residents obtain and maintain insurance coverage. innovative ways. Approximately 1,500 innovative Among the efforts to be proactive, many insurers activities have been pursued by over 500 insurers have fielded a range of green insurance products

15 xii Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “I do not want to sit by and then discover in the near future that insurance companies’ books are filled with stranded assets that have lost their value because of a shift away from the carbon-based economy, jeopardizing their financial stability and ability to meet their obligations, including paying claims to policyholders.” California Insurance Commissioner Dave Jones California Department of Insurance Press Release, Huntington Beach, January 25, 2016. the national and international stage. Among the and associated entities across 50 countries, with significant market uptake in some cases (Mills potential future directions that regulators can take and EA). These span a range of activities including to broaden as well deepen these efforts are: innovative products and services (e.g., insurance for green buildings), leadership by example in • Continue to monitor the insurance-relevant “greening” their own operations, disclosing climate situation and responses • Refine insurance pricing and contract design risks, promoting loss prevention, engaging in climate science and communications, direct to more precisely reflect climate risks and incentivize mitigation efforts investment or financing of climate-change • solutions, and expressions in public policy Fortify consumer protections and resilience efforts fora. On the asset side, insurers’ divestment of coal has been coupled with strong growth in • Continue to champion and improve climate risk investment in clean energy technologies and disclosure other climate change mitigation strategies. • Support innovation in loss modeling, data science, and stress testing Over $60 billion in such investments have Identify and mitigate barriers to green insurance been identified globally. Meanwhile, following • divestment decisions, some insurers have ceased and risk reduction to underwrite or finance coal-based companies Participate in climate mitigation and adaptation • research and inter-agency initiatives and projects. While current levels of “climate- • friendly” investment and divestment represent Enhance market awareness of disparate risks and insurance responses a vanishingly small proportion of total insurer assets, stated ambitions for further initiatives • Increase engagement in broader public policy remain high. discussions Recommendations The evolution of society’s ability to identify and respond to climate-change risks is essential to The CDI’s goals regarding climate change are the ability of the insurance industry to reach its informed by its mission to protect insurers and economic potential while maintaining its own solvency together with the availability, adequacy, consumers from this immense set of emerging risks. Over the past decade, CDI has championed and affordability of insurance for consumers. The effort is a collective one, involving all segments of green insurance initiatives, increased the economy in partnership with regulators, the transparency regarding insurers’ perception and response to climate risk, led climate-related scientific community, and other stakeholders. disclosure efforts, worked with other agencies to advance resilience and loss-prevention, and participated in related industry dialogue on

16 1 Climate Change is Risky Business for Insurers Weather-related events underlie approximately 90% of natural disasters and their costs in an average year (Munich Re). The year 2017 broke global cost records for such events: $320 billion globally, of which $133 billion (42%) were insured. The vast majority of these impacts (93% of total insured losses) were in North America, an atypically high proportion in the global context. Total economic losses caused by hurricanes were nearly five times the average of the prior 16 years, those for other types of severe storms were 60% higher, and those for wildfire were four times higher (Aon Benfield 2018). The United States endured 16 individual events each exceeding $1 billion in damages. Among these, the Tubbs Fire in the Napa Valley was the costliest wildfire in the global insurance industry’s history (Aon Benfield 2018) and the largest urban conflagration since the fire following the 1906 San Francisco earthquake. These trends and loss events reflect an interaction between intensifying hazards and populations that continue to move into harm’s way. The results are material for property insurers: global losses in 2017 shifted industry-estimated return on equity from a healthy 11% the year before to negative 4% (Swiss Re 2017). While average conditions seem to be changing only modestly, scientists have firmly established that climate change will increase the frequency and intensity of extreme weather events (USGCRP 2017) (Figure 1). The business community has come to accept this fact as well, as evidenced in the World Economic Forum’s ranking of such events as the greatest risk on the global landscape – with potential impacts on par with those of weapons of mass destruction – yet the likelihood of extreme weather events is far higher (Figure 2). Climate change is deemed the largest driving trend influencing the

17 2 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “Climate change creates significant challenges for the property and casualty (P&C) insurance and reinsurance sectors and has a net negative credit impact on the industry...” Moody’s (2018) entire array of risks, some of which are very directly related to one another, such as food and water crises. In light of these findings, it is not surprising that the failure of climate change mitigation and adaptation is ranked the fifth highest risk by Extreme weather events become | FIGURE 1 likelihood. Notably, the insurance industry (Marsh the new normal under climate change. & McLennan Companies and Zurich Insurance Group) played leading roles in assembling this analysis (WEF 2018). The risks of climate change are myriad. From an insurance vantage point, they can be broadly grouped into underwriting risks (property and casualty) and risks to the assets that insurers develop to fund losses and provide a return to investors. In the core business, weather- and climate-related losses can affect physical assets such as buildings, as well as vehicles, crops, life, and health. Risks to the values of assets constitute transition risks. The acts of those responsible for greenhouse-gas pollution are increasingly leading to litigation, which, in turn, can involve insurers. The significance of this latter trend is reinforced by the increasing ability to probabilistically attribute climate events to human activity (Marjanac and Patton 2018). Recent assessments have concluded that the multiplicity of simultaneous and correlated climate risks are expected to magnify current volatility levels and adversely impact credit within the industry, with smaller or more geographically concentrated insurers most at risk (Moody’s 2018). Source: IPCC (2001). It is encouraging that reduced greenhouse-gas- emission trajectories hold the promise of material reductions in insurance risks. Emission reductions could have tangible benefits if they are substantial enough to move the planet to a lower-emissions

18 3 scenario. Examples of this include: The projected increase in acreage burned in • some high-risk parts of California doubles by the end of the century under lower-emissions scenarios, while it quadruples for high- emissions scenarios (Dixon et al. 2018). • There is a nearly four-fold variation in potential inundation around the San Francisco Bay Area under climate change, depending on emissions pathway (Shirzaei and Burgmann 2018). The frequency of conditions like those • occurring in the most extreme insured crop- loss years (1988 and 1993) would double under anticipated climate change (Beach et al. 2010). While these individual nodes of risk are serious in their own right, the very real correlations among them are perhaps the greatest threat to the vitality of the insurance industry as a whole (Mills 2005; Moody’s 2018). Not only do individual physical risks often correlate with one another, but the underlying hazards can trigger losses in unexpected ways across multiple insurance lines that compose the broader core business. More significantly, weather and climate extremes also stand to simultaneously trigger losses in the asset side of the industry, while further adversely impacting the broader economy in which insurance consumers must function. At the level of individual events, a major hurricane striking one of the world’s major financial centers is one example. In practice, a wide range of events occur in any given underwriting year and parallel major losses can prove more deeply destabilizing, particularly in an increasingly interconnected global economy. It is important to consider global exposures even when focusing on insurance vulnerability in a specific market such as California. Most insurers operate in multiple markets and multiple countries. An insurer operating in California may face climate risks half a world away.

19 4 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State FIGURE 2 | Extreme weather events are ranked as the number-one concern by the World Economic Forum, followed by natural disasters. Note: Survey respondents were asked to assess the likelihood of the individual global risk on a scale of 1 to 5, 1 representing a risk that is very unlikely to happen and 5 a risk that is very likely to occur. They also assess the impact on each global risk on a scale of 1 to 5 (1: minimal impact, 2: minor impact, 3: moderate impact, 4: severe impact, and 5: catastrophic impact). Label, symbol sizes, and color saturation are proportional to the combination of likelihood and impact. To ensure legibility, the names of the global risks are abbreviated. The survey was administered to over approximately 1,000 constituents from World Economic Forum (WEF)’s network in business, government, civil society, and experts. Source: WEF (2018).

20 5 Almost two thirds of customers think their insurers should act on climate change. | FIGURE 3 What Insurers Should Do Source: AXA/Ipsos (2012). The survey was administered to over approximately 1,000 constituents from WEF’s network in business, government, civil society, and experts. Source: WEF (2018). an industry with a business model dependent on The market expects insurers to being able to identify, anticipate, and forecast risks, understand and help manage and quantify potential losses and the associated climate risks uncertainties. To make risk more visible, insureds as well as investors are increasingly focusing Vast swaths of the business community and general on the need for climate risk disclosure and risk public see climate change as a palpable risk, and management. seek to participate in collective efforts to reduce greenhouse-gas emissions to the extent possible Insurance customers care about these issues while preparing for otherwise unavoidable impacts. as well. More than 90% of 13,000 surveyed Investors see emerging risks in their portfolios, insurance consumers in North America, Europe, real-estate holdings, and other assets. They also and Asia believe the climate is changing and are see opportunity in clean energy investments. Non- concerned about how it will affect them (AXA/ insurer members of the financial services sector Ipsos 2012). Almost 80% of the respondents think from view insurance as protecting their collateral their insurance coverage will be affected by climate risk that they choose not to or are not permitted change and 61% expect insurance to play a role in . by law to underwrite against, exclude, or price responding, beyond simply providing insurance products (Figure 3). They expect insurers to All parties see the value proposition of insurance offer green products, provide climate-change as a source of peace of mind and loss prevention/ information, promote relevant research, support recovery. With insurance premium volumes of environmentally conscious behaviors, and build about $300 billion each year in California alone, partnerships with national and local authorities. and $5 trillion in assets under management, Hiscox conducted a similar survey of 610 insurers serving the California marketplace are customers, with analogous findings (ClimateWise capable of making a difference. 2017a). The specter of climate change is unsettling for

21 6 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State The degree of U.S. insurance coverage varies widely by type of catastrophe: | FIGURE 4 1980-2017. Source: Munich Reinsurance Company, Geo Risks Research, NatCatSERVICE. Note: most of the insured flood losses were paid through the publicly funded NFIP. Source: Munich Reinsurance Company, Geo Risks Research, NatCatSERVICE, used with permission. will likely grow, both in absolute and percentage The U.S. insurance industry terms, unless insurers expand their coverages absorbs half the costs of commensurately. Moreover, consumers have been weather- and climate-related observed to buy flood insurance following major loss events but then allow it to lapse after just a few losses years (a phenomenon termed the “flood memory half-life” by Pinter et al. [2017]). Uninsured losses Insurers are long-standing stakeholders in the are absorbed by governments and, ultimately, broader economy, and consumers are encouraged individual consumers and businesses. to view them as agents of safety and peace of mind. Insurers have seen steadily rising claims globally, In the United States, the vast majority (93%) of and California is no exception. all catastrophe losses are weather-and climate- related. Insurance has absorbed about half of the However, according to global statistics gathered and total losses in the United States between 1980 tracked by Munich Re for nearly four decades, only and 2017 (Figure 4), ranging from 32% to 79%, about half of total economic losses from weather- somewhat higher than the rest of the world. and climate-related events are insured (Munich Re). In some areas, the protection gap is far larger, The uninsured portion of these events, which has particularly for flood losses, 80% of which were come to be known as the protection gap, has averaged uninsured between 1980 and 2017. The vast almost $100 billion per year in the past decade. In majority of the insured portion was paid by NFIP. North America, the gap has averaged $15 billion Yet, even for large wildfire events in California, per year, spiking to $42 billion in 2017 (excluding 20% to 40% of total historic economic losses are losses paid under the National Flood Insurance uninsured (Munich Re). Program [NFIP]). Under climate change this gap

22 7 While insurers can generally count on steady and doing so misses a more pervasive pattern of risk incremental changes in loss trends, one source and exposure evident when focusing on broader of uncertainty with weather- and climate-related systems affected by these events. These include power grids, supply chains, communications events is that loss patterns can change abruptly (Figure 5 A-F), unlike the far more steady loss networks, and transportation systems. Damages patterns familiar to life insurers. This is illustrated to these systems can in turn lead to cascading casualty insurance losses in the form of business by the fire and heat-event losses in 2017. Losses in interruption. Further, should loss events caused that year (almost all of which were in California) by extreme weather (e.g., a hazardous pollution were on par with total losses in the preceding four decades. release) be deemed to have occurred due to a failure to take adequate measures to protect against harm to others from foreseeable losses, While it is important to analyze the direct property loss outcomes of individual perils such as wildfire, then additional casualty/liability claims may arise FIGURE 5 A-F | Volatile trends in U.S. natural catastrophe losses: 1980-2017. Total Losses Insured Losses Note: most of the insured flood losses were paid through the publicly funded NFIP. Source: Munich Reinsurance Company, Geo Risks Research, NatCatSERVICE, used with permission.

23 8 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State in volumes that swamp property claims. From this vantage point, the relevant geographic scale also enlarges significantly, typically stretching beyond state and even national borders. Among the many non-insured economic impacts are lost tax revenues (sales, income, and property), examples of which are noted for the 2017 and 2018 Santa Barbara floods and mudslides in the next section. In a particularly California-relevant example of the complexity of impacts, warmer and drier winters will adversely affect the winter sports industry, which has an important role in the California economy. One estimate puts the costs of a warm winter for winter sports tourism at $1 billion for the country as a whole (Hagenstad et al. 2018). California ski resorts have litigated with their insurers over whether their business interruption insurance will cover disrupted ski seasons (Cronheim 2012).

24 9 Climate Change Poses Diverse Physical Risks in California Mirroring observed impacts elsewhere in the world, many indicators confirm the changing climate and its impacts within California (Cal EPA 2018). These effects include rising statewide average temperatures, more common heatwaves, increasingly severe drought conditions, more variable precipitation patterns, declining runoff from major rivers, receding glaciers, rising sea levels, increasing lake and ocean temperatures, more damaging wildfires, and many indicators of ecosystem disturbances. With its diverse geography and microclimates, virtually every aspect of California’s social and economic landscape has a degree of vulnerability to climate extremes, well beyond the more obvious exposures faced by buildings and other infrastructure. The events triggered by primary climate drivers are diverse. They include large and abrupt disasters such as storms as well as small-scale and wide-area phenomena such as lightning, soil subsidence, and gradual coastal inundation. Individual properties (homes and other buildings) are vulnerable as is larger infrastructure such as energy, water, and transportation systems. An estimated two million homes (15% of the overall housing stock) across the state are categorized as having “High” or “Extreme” risk of wildfire (Verisk).

25 10 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State A more nuanced view of vulnerability must consider pave the way for insured losses to infrastructure. correlations among these hazards (e.g., drought Examples include loss of coral reefs due to ocean paving the way for wildfire and wildfire paving the temperature increases and acidification, and the consequent loss of storm-surge protection for way for mudslides). And changing geographies together with the increasing scale of the events buildings near shorelines. can drive impacts into new areas (e.g., wild fires penetrating deep into urban settlements, as seen Events linked to climate change can conspire with in Santa Rosa in 2017, Figure 6 A-C). Moreover, non-weather-related ones to compound damages and economic losses. Examples of the latter at larger scales, degradation of ecosystems can FIGURE 6 A-C | The year 2017 saw the then-largest wildfire in the state’s history with other major fires extending outside of areas deemed to be risky. Credits: Coffey park in Santa Rosa Tubbs fire (upper right): California National Guard via Flickr; Thomas fire in Santa Barbara County (upper left): Pacific Southwest Region 5 via Flickr. Map showing Tubbs fire (Muir-Wood 2018).

26 11 FIGURE 7 A-E | Multiple corridors of mudflow carrying boulders and debris inundated neighborhoods and roads in Montecito following the Thomas Fire. Thomas Fire burn zone extends northward at top of frame, immediately adjacent to origin of mud flows. Sources: Top: Prepared by ESRI for Santa Barbara County (Mike Eliason and Santa Barbara County), used with permission. Bottom: before/after images from Google Maps.

27 12 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State A wide range of critical infrastructure along include wild fires increasing the risk of mudslides as California’s coast is also at increased risk, occurred in California in 2018 (Figure 7 A-E) or soil including nearly 140 schools; 34 police and subsidence caused by human activity compounding fire stations; 55 healthcare facilities; more the inundation created by sea-level rise. The latter than 330 U.S. Environmental Protection example is an important factor in the damages Agency regulated hazardous waste sites; facing infrastructure inundated by sea-level rise 3,500 miles of roads and highways; 280 miles around the San Francisco Bay Area in the coming of railways; 30 coastal power plants, with decades (Figure 8 A-C). The latest assessments a combined capacity of more than 10,000 project 48 to 166 square miles of inundation along megawatts; 28 wastewater treatment plants; the San Francisco Bay alone, depending on the and both the San Francisco and Oakland emissions scenario (Shirzaei and Burgmann 2018). airports. Overall, nearly $100 billion worth This represents a large uncertainty with which of California property is at risk of flooding insurers must cope. Superimposing earthquake event with a 1.4 m sea-level from a 100‐year events upon buildings already compromised rise if no adaptation actions are taken (Gleick by sea-level rise and subsidence could yield yet 2017, citing Heberger et al. 2011). higher thresholds of damage. California’s Pacific Institute estimates that $100 billion of California infrastructure is at risk from sea-level rise: Range of scenarios for land inundation under sea-level rise together with soil subsidence | FIGURE 8 A-C by the year 2100 around the San Francisco Bay. Inundation map at 2100 given the lower Inundation map at 2100 given the SLR bound of the likely range of SLR projection projection under H++ scenario. An area of 2 2 429 km under RCP 2.6 Scenario. An area of 98 km will be vulnerable to inundation considering both SLR and LLS as opposed will be vulnerable to inundatin considring 2 2 to 413 km considering SLR alone. both SLR and LLS as opposed to 51 km considering SLR alone. San Francisco Bay Area ocean inundation at (a) the lower bound of the likely range of lower-emissions scenario (emissions scenario RCP 2.6, representing attainment of the goals of United Nations Framework Convention on Climate Changes 2015 Paris agreement) resulting in 38 square miles of land area around the San Francisco Bay vulnerable to inundation versus (b) under the H++ emissions scenario, representing a high-emissions scenario resulting in 166 square miles of land area vulnerable to inundation. Attribution to sea-level rise (SLR) and local land subsidence (LLS) coloredseparately. The area pictured in panels a and b is 37 miles x 37 miles. Panel c shows replacement value of buildings and contents vulnerable to sea-level rise of 1.4 meters under a 100-year coastal flood event in year-2000 dollars across a somewhat broader area. Sources: Sea-level rise imaging (Shirzaei and Burgmann 2018); Values at risk (Pacific Institute 2009).

28 13 Climate-related losses “could materially and adversely affect our results of operations, our financial position and/or liquidity, and could adversely impact our ratings, our ability to raise capital and the availability and cost of reinsurance.” Travelers Insurance Annu al Report (SEC Form 10-K) 2014. Roadway safety is strongly influenced by weather becoming quite vulnerable. The influence of climate change as a driver of losses in California is conditions, which impact visibility, pavement compounded by increasing values at risk and the friction, and driving behavior. The Federal Highway Administration reports that 22% of roadway tendency for people to move into high-risk areas (coastlines, the wildland-urban interface, and accidents (about 1.2 million per year) are weather- floodplains). related, with approximately 6,000 people killed and 445,000 injured in these accidents in an average year Leading insurers note that climate change is a risk (FHA). Climate change is widely expected to lead to increased precipitation, particularly torrential rain to both the property/casualty and life/health sides of their business (Chubb 2016). The most apparent events, with one of the likely consequences being climate-related concerns arise from severe-weather worsened roadway safety in a state with 400,000 disasters. Additional risk factors stem from miles of roads. air pollution, disease transmission, increasing allergens, extreme heat, food and water supply, California produces over 400 agricultural water quality, and environmental degradation. The commodities, including more than one third of the World Health Organization projects 250,000 extra nation’s vegetables and two-thirds of the nation’s deaths each year due to climate change between fruits and nuts, at a value of over $45 billion each year (Pathak et al. 2018), of which $20 billion is 2030 and 2050, increasing significantly thereafter for export, the largest of any state (CDFA 2018). (WHO 2014). Far more cases of non-fatal illness Key climate-related hazards for agriculture are (morbidity) are expected as well, and some will affect insurers doing business in California. summertime temperature extremes as well as reduction of wintertime “chill hours” necessary for Of particular relevance in California are the fruit-setting; changes in precipitation, snowpack consequences of heatwaves (CEHTP 2018; Guirguis et al. 2014), kidney disease related to increased and stored water availability, and drought; extreme temperatures and dehydration (Brikowski et al. weather events; and changes in crop pests and 2008), and spiking hospital admissions related to diseases. Even modest and gradual changes in these conditions can lead to abrupt changes in respiratory health that often accompanies major wildfires (UC Irvine 2008; UCSF 2017). yields (Beach et al. 2010). For example, researchers foresee reductions in yields ranging from 5% to over 40% for grapes, almonds, oranges, walnuts, and avocados in California by the year 2060 2018). Predicted climate changes will (Pathak et al. result in disturbances outside those of even highly experienced farmers in the state. As noted previously, specialized parts of the economy, such as California ski resorts, are also

29 14 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State California acreage burned in wildfires correlates with multiple peril homeowners | FIGURE 9 insurance profitability: 1991-2017. Sources: Wildfire acreage from Cal Fire (excludes other jurisdictions) (Cal Fire). Combined ratio is for homeowners multiple peril insurance line [(losses incurred + expenses)/premiums earned] from CDI. Loss development values for the late-2017 fires are as of May 2018. Potential future recoveries if utility liability is established may improve the net results for insurance companies. Source: CDI data. risk geographies. Aggressive emission-reduction Climate-related loss events are a efforts could stabilize the rate of wildfire acreage material influence on consumer burned by the mid-century, but not sooner. costs and insurer profitability While many factors influence insurer losses and Wildfire has become a leading concern for California profitability in any given year, homeowner insurer even prior to the events of 2017. Under a project profitability in California is consistently influenced for the California Natural Resources Agency (as a by wildfire losses and severity (Figure 9). The contribution to the state’s major Fourth Climate 2017 season was (to date) an extreme outlier Change Assessment), RAND researchers closely with insurers paying out more than twice their analyzed the wildfire-related challenges facing the premium income for the homeowner segment of state insurance market under projected climate the insurance market. While smaller (by acreage), change (Dixon et al. 2018). They have estimated the 1991 Oakland Hills Fire burned large, high- that annual acreage burned by wildfires in the value residential areas. California Sierra Nevada region (most of Nevada, Placer, and El Dorado counties) will quadruple A mosaic of climate risks this century under a business-as-usual emissions underpinned the 2017 scenario. RAND has found that these areas are California wildfires already facing higher premiums and rates of non-renewal than elsewhere in the state. Under The ways in which changes to environmental and anticipated business-as-usual climate changes in extreme weather conditions, triggered by climate these areas by the end of this century, technical change, create a web of interconnected impacts residential premiums are projected to increase 51% relevant to insurance are illustrated by a mosaic of for the highest structure risk category and higher-

30 15 occurred. Lastly, smoke from larger fires created an factors preceding and following the catastrophic array of health risks over and above the immediate California wildfires of 2017 (Figure 10). risks to health and life presented by fires and Climate drivers leading up to the fires included mudslides themselves. Each of the hazards, in heat, wind, and rain and lightning storms. While turn, triggered various types of insurance claims. not directly involving people and property, In time it will be seen whether further knock- intermediate ecosystem impacts during the period on insurance costs materialize through liability preceding the fires created abnormally large fuel loads, the causes of which ranged from extreme claims being levied against electric utilities for temperatures and drying followed by excess not adequately maintaining their transmission system (which possibly contributed to some fire rainfall creating particularly tall, and flammable ignitions). Some utility executives have even grasses to temperature-related explosions of pine beetle populations that killed off large swaths of suggested that the cause of the downed wires is climate change (Chediak 2018). forest. Notably, there are now an estimated 100 million dead trees across the state due to drought 2018), and reduction More was at play than the unfortunate sequencing and beetles (Stephens et al. of these hazards. Extraordinarily rare events took of vegetation in some areas that retains soil on steep slopes. The drought that begins this story is place almost simultaneously. The initial drought was record-breaking in several respects. The storm estimated to be the worst facing the state in 1,200 system that finally broke the drought was known years (WHO 2014), followed by torrential rains and ignition of wildfires by lightning. The fires were by climatologists as an “Atmospheric River” compounded by above-average heat and winds. (AR) generated through an intensive period of When subsequent deluges of rain followed shortly evaporation from the oceans. Atmospheric rivers after fires in areas with steep slopes, mudslides can transport as much water as the Amazon River FIGURE 10 | A mosaic of factors preceded and followed the California wildfires of 2017. Photo credits: Flickr (William Brawle, California National Guard, Mary Cernicek , Jenny Downing, Everglades NPS, Kari Greer), Unsplash (Mahkeo), Air National Guard (Sgt. Cristian Meyers), USGS (N. Stephenson), iStock.

31 16 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State The otherwise welcome precipitation resulted in | A 1-in-200-year Pineapple FIGURE 11 increased fuel growth which dried as the following Express (atmospheric river) hit California in summer arrived and record-breaking temperatures early 2018. set in. A variety of triggers both human and natural (such as lightning, itself expected to increase under climate change) triggered numerous fires across California (Mariani et al. 2018). Among these was the Thomas Fire in Ventura County, which burned for nearly six weeks, consumed more than a quarter of a million acres, and infamously became the largest fire in California recorded history. A second Pineapple Express storm arrived shortly after the Thomas Fire had been extinguished, bringing as much as four inches of rain in a twenty- four-hour period. The storm made landfall directly on the epicenter of the affluent community of Atmospheric rivers are relatively long, narrow regions in the atmosphere – like rivers in the sky – that transport most of the Montecito, California, immediately adjacent to the water vapor outside of the tropics. When an atmospheric river steep slopes where the Thomas Fire had burned makes landfall, extreme precipitation and flooding can often result. The picture features a natural-color image of conditions over the (Figure 12). The fires laid to waste vast areas of northeastern Pacific of a similar storm to that hitting California steep terrain, which, by destabilizing the soils, set in January 2018 which triggered highly destructive mudslides The visualization was generated by Jesse Allen in Montecito, CA. the stage for what are likely the worst mudflows (NASA Earth Observatory) using data from the Visible Infrared and debris flows in California recorded history in Imaging Radiometer Suite (VIIRS) on the Suomi National Polar- orbiting Partnership (NPP) satellite. Source: NASA, used with terms of property damage and loss of life. Twelve- permission. foot-deep flows also closed all six lanes of interstate Highway 101 for almost two weeks (Dolan 2018a). (USGCRP 2017). When they make landfall on the These events resulted in abrupt loss of life, with Pacific coast, such storms are more commonly 43 fatalities from the fires and 21 fatalities from called a Pineapple Express. The storm that brought the mudslides (Dolan 2018b). Experts compared massive rains to California in early 2018 (Figure the poor air quality during the 2017 wildfires to 11) ended the drought (at least temporarily), but that in Beijing, vastly exceeding safety standards; brought massive flooding, as parts of the state in just one week of the California fires as much were stricken with as much rain in a single storm unhealthful particulate matter was lofted into the as they normally would receive in the preceding air as from a year of driving statewide (Santiago five-month period. This particular storm is said and Scutti 2017). No comprehensive information et to have been a once-in-200-year event (Serna yet exists on long-term injuries or other health al. 2018). Citing multiple prior peer-reviewed impacts. Previous large California wildfires have studies, the U.S. Global Change Research Program resulted in significant spikes in hospital admissions (USGCRP 2017) concluded that “studies have during wildfires (UC Irvine 2008). The fires in 2017 uniformly shown that ARs are likely to become also affected healthcare services in many parts of more frequent and intense in the future,” with the state, including hospital evacuations in some increases of between 50% and six-fold in the areas. The lone available detailed study focused on number of days when ARs are present (Gao et al. the 82,000-acre Detwiler fire in Mariposa County 2015) and with high confidence that the frequency (CDPH and MCHD 2018), in which calls related of these storms will increase.

32 17 Epicenter of the January 2018 Pineapple Express storm in Montecito, | FIGURE 12 CA, adjacent to the Thomas Fire burn area, with rainfall occurring in a 24-hour period. Source: NOAA/National Weather Service, used with permission. to respiratory conditions, anxiety, psychiatric (Multiple Peril and Fire Lines) for the period of 2001-2017 were $4.1 billion (Dixon et al. 2018). emergency, and behavioral health were more frequent. An encouraging finding is that lower-emissions climate scenarios for California would materially reduce these kinds of impacts. Taken together, the wildfires together with the massive mudslide and debris flow resulted in 56,000 insurance claims and $13.3 billion in Mudslides are normally exempted from insurance losses, including 7,384 complete losses of insured coverage, but where the “efficient proximate structures, and 9,978 claims for vehicles and other cause” is an insured hazard (e.g., a wildfire), then the resulting losses are insured (CDI 2018). For miscellaneous damages. the Montecito mudslide event, a total of 2,837 Counting up the insured losses from the fires, $12.6 claims were made for a combined amount of billion in claims were filed as of May 2018 (Figure $658 million as of May 2018 (Figure 14 A-B). As , 13 A-B). Over 39,000 insured homes were damaged was the case for the fires, the majority of claims were for residences, but a remarkable 329 affected of which 6,885 were complete losses. About 5,000 – commercial properties were insured and filed $102 insured non-residential buildings were damaged representing – of which 343 were complete losses million in claims. About 144 homes were total losses, together with 12 commercial properties. $1.6 billion in claims. In addition, claims for cars, There were over 750 personal automobile claims, boats, planes, and other miscellaneous equipment with an insured loss of $8 million. An addition 80 and structures amounted to about $350 million. miscellaneous claims amounted to $7 million. In Santa Rosa alone, 3,000 homes (5% of the city’s housing stock) were lost. To put these losses in Certainly not all of the aforementioned fire- perspective, cumulative underwriting profits to the homeowners insurance industry in California and mudslide-related losses are commercially

33 18 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State FIGURE 13 A-B | 2017 California wildfires: 53,000 insurance claims, amounting to $12.6 billion statewide. Source: CDI estimates as of May 21, 2018. FIGURE 14 A-B | 2017 mud and debris flow proximate to the Thomas fire: Nearly 2,900 insurance claims, amounting to $658 million in Montecito. Source: CDI estimates as of May 21, 2018.

34 19 Oil wells at the foot of steep, eroding slopes at risk of future FIGURE 15 | floods and mudflows, with recently burned vegetation in the drainage area. View across Amphitheater Canyon in San Miguelito Oil Field, with oil wells circled. Source: WERT 2018, used with permission. costs topped $700 million (Cooper 2018), with insured. Uninsured amounts include losses to those for the Thomas fire alone estimated at $177 homeowners and businesses lacking insurance, the deductibles and excess losses by those who are million, and the U.S. Army Corps of Engineers spent $110 million on debris cleanup and removal carrying insurance, damages to public facilities and infrastructure, publicly insured crop damages following the Montecito mudslides (Rupert 2018). (at least 57 wineries in the state were affected This complex cascading chain of losses may still be in process. Loss of groundcover and accumulation [Hodgins 2017; Orlin and Steade 2017]), as well of debris in drainages increases the risks associated as firefighting and cleanup costs. The 2017 fires with future torrential rains. In-depth post event resulted in a total of more than 10,800 structures, a third of which were not insured (Tierney 2018). investigations have revealed significant oil production infrastructure (idle and active wells, Among largely uninsured non-residential impacts pipelines, tanks, and processing facilities) within were agricultural losses estimated at $189 million and near the fire and mudflow zones, which will be (Bloch 2018), and diverse damages to publicly owned (in some cases self-insured) infrastructure, in harm’s way if additional sloping areas succumb to future mudslides (Figure 15). The Watershed together with response costs absorbed by public entities, and, ultimately the taxpayers. The county Emergency Response Team (WERT) report of Santa Barbara’s initial estimate of their own identified and classified 63 specific pieces of oil costs was $55 million (Magnoli 2018). Other infrastructure in and around the Thomas Fire zone uninsured losses include $9 million to the City as vulnerable (WERT 2018). Such events would of Santa Barbara, $15 million in lost sales to risk not only the loss of valuable infrastructure, businesses, and $25 to $30 million in lost wages and downslope residential and commercial due to transportation disruptions and reductions structures, but also releases of flammable and in tourism to this popular destination (RDN 2018). otherwise hazardous oil onto the landscape and Clearing debris from Highway 101 cost the state perhaps into the adjacent Pacific Ocean. $11 million (Aston 2018). Statewide firefighting

35 20 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State Transitional Investment Risks Occur in Parallel with Physical Risks: Erosion of Asset Value California’s admitted insurers hold $5 trillion in investment under management, including a significant amount of fossil fuel-related investments. Altogether, insurers that CDI surveyed in 2016 who do business in California have $528 billion in fossil fuel-related investments, which includes investments in coal, oil, gas, and utilities that rely on these fuels to generate electricity. The significant majority of these investments are in oil, gas, and utilities. Surveyed insurers reported holding a total of $10.5 billion in investments in thermal-coal enterprises (CDI a). A principal area of concern for CDI is whether insurers are recognizing what Financial Stability Board Chair Mark Carney identified as a “transition risk” with respect to fossil fuel-related investments. This transition is the significant potential risk that nations, states, local governments, private companies, consumers, and markets will sufficiently restrict or reduce the use of fossil fuels or that

36 21 FIGURE 16 | Growing number of cap-and-trade systems for greenhouse-gas emissions and carbon taxes. Source: I4CE – Institute for Climate Economics with data from ICAP, World Bank, government officials, and public information, used with permission. market forces alone will devalue these companies, reserves, a third of oil reserves, and half of gas which in turn presents a risk to linked insurer reserves cannot be used between 2010 and 2050 investments. Commissioner Jones believes (McGlade and Ekins 2015). that financial institutions, including insurance companies, should recognize and address Some ways that these entities are seeking to reach the COP 21 targets or achieve related objectives potentially significant climate-related risks facing include the following, all of which reduce the their investments in these vulnerable industries. demand for fossil fuels: Significant national, state, and local government • Developing cap-and-trade systems, such as the efforts are pushing a transition to a low-carbon- European Union’s Emission Trading System intensive economy. This effort includes the and California’s cap-and-trade system which various commitments made by nearly all national was recently renewed until 2030 (Assembly governments as a part of the United Nations COP Bill 398 [E. Garcia, Chapter 135, Statutes of 21 Agreement and state and local commitments 2017]), and carbon taxes. made in association with COP 21. It has been projected that in order for countries to meet the COP 21 targets for not exceeding a two degrees • Implementing clean air laws and regulations Celsius temperature rise, more than 80% of coal that have the effect of reducing the ability

37 22 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “[Transition risks are] the financial risks which could result from the process of adjustment towards a lower-carbon economy. Changes in policy, technology and physical risks could prompt a reassessment of the value of a large range of assets as costs and opportunities become apparent.” Bank of England Governor Mark Carney Remarks, Lloyd’s of London, September 29, 2015. to burn carbon (e.g., the Clean Power Plan, which is now being reviewed by the U.S. Environmental Protection Agency (EPA), and the California Global Warming Solutions Act of 2006). • Requiring utilities to rely less on carbon- based and more on renewable sources, such as California’s renewable portfolio standard that requires utilities to derive 50% of their energy from renewables by 2030 (Senate Bill 350 [De Leon, Chapter 547, Statutes of 2015]). • Building smart grid energy technologies that allow for further incorporation of intermittent renewable energy sources (e.g., the Energy Independence and Security Act of 2007, P.L. 110-140). • Advancing voluntary and mandatory energy efficiency initiatives, such as increasing auto emissions and fuel efficiency standards to reduce demand for fossil fuels and even restricting the sale of vehicles with solely combustible engines. Even without government efforts aimed at curbing carbon emissions or otherwise limiting the use of fossil fuels, the decreasing cost of renewable energy threatens the value of carbon investments. Renewable energy has become more competitive, with solar costs dropping 85% from 2008 to 2016 (Houser et al. 2018) and wind costs falling 36% in that same period (ClimateNexus 2017). Solar is already at least as cheap as coal

38 23 | U.S. consumers waited in line for hours, some spending the night so Figure 17 that they could make a deposit on an electric vehicle. Source: Licensed from AP. also announced their intention to accelerate in the United States, Germany, Australia, Spain, the transition away from vehicles with solely and Italy, and is expected to drop another 66% combustible engines to vehicles with electric by 2040. By 2021, solar is projected to be cheaper motors. For instance, Volvo announced that than coal in China, India, Mexico, the U.K., and Brazil as well. The cost is expected to continue to electric motors will be included in all cars that the manufacturer makes from 2019 moving forward decline as technology improves (BNEF 2017). (Pham 2017). Consumer energy demand trends are also further Coal industry losses are already a reality. Over motivating a transition to a low-carbon-intensity economy. Energy efficiency improvements the last decade, demand for coal has dropped dramatically. Coal has gone from generating between 2000 and 2016 reduced global coal nearly half of U.S. electricity to approximately consumption by an amount equivalent to all coal use in the United States (IEA 2017a), or about one- 30%, a share that continues to decline (Figure 18). This downturn in demand has directly affected fifth of global coal use. While absolute numbers are still small, global sales of electric vehicles grew companies mining and selling coal. Three dozen by 40% in 2016 (IEA 2017b). When Tesla made U.S. coal companies went bankrupt in three years it possible to order an economy version of their (SNL 2015). Utilities in the United States are electric vehicle, U.S. consumers lined up for hours, shutting down thermal coal power plants before the end of their economic lifetimes, and none some spending the night in line (Figure 17) to be among the first to pay a deposit to purchase such are building any new ones (although the current presidential administration has sought to reverse a vehicle a year or more in the future (McFarland 2016). Recently, large car manufacturers have this trend through emergency orders). Major

39 24 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State Some insurers have ceased to write policies for banks have ceased or otherwise reduced lending companies whose profits depend on coal. Allianz to fund new coal infrastructure (e.g., Citigroup, plans to no longer underwrite individual coal- Bank of America, Wells Fargo & Company, and Morgan Stanley) (Nussbaum 2015). Global fired power plants or coal mines, and plans to phase out all underwriting to coal interests by insurers such as AXA, Allianz, Aegon, and Swiss Re announced that they are divesting or not making 2040 (Jergler 2018). The reinsurer Swiss Re no longer underwrites mining companies that derive new investments in thermal coal (Ferguson 2017; more than 30% of revenues from thermal coal Insurance Journal 2018). After the California State Teachers Retirement System and the or utilities that generate 30% of their electricity California Public Employees’ Retirement System, from thermal coal (Insurance Journal 2018). the largest pension funds in terms of assets in the Also among insurer assets are $1.2 trillion in United States, lost a combined $5.1 billion in oil, direct and indirect real estate investments (Figure gas, and coal investments in 2014-2015 (Trillium 19) that could be vulnerable to the impacts of 2015), the state Legislature directed them to climate change. Life insurers hold about 80% of consider divesting from thermal coal. Moreover, these investments. Uninsured hazard peril in while there have been some recent short-term residential mortgage-backed securities (22% of gains, the Dow Jones U.S. Coal Index decreased 92.9% from April 1, 2011 through June 20, 2017. total real estate investments) could exemplify These and other developments create risk that a systemic risk in the event of large real-estate losses (e.g., due to wildfire) in underinsured investments in coal and other fossil fuels may markets with corresponding investments owned become “stranded assets” of diminishing value. by insurers. It has been argued that life and annuity insurers have the largest exposures, given their “buy-and- hold” philosophies (Messervy and McHale 2016). | Decreasing use of coal by U.S. electric utilities from one-half to one-third of total. FIGURE 18 Source: Data from USEIA (2018).

40 25 | U.S. insurer real-estate-related investment exposures. FIGURE 19 Commercial values as of 2015; residential values as of 2014. Source: NAIC (2017) and NAIC (2015). For all these reasons, it is important for profit organization comprised of the world’s largest insurance companies, insurance regulators, institutional investors, prepared and distributed and the public to better understand the scope globally to all industries. The NAIC survey consists of eight questions regarding insurance of insurer investments in fossil fuels and the scope of their associated transition risk. companies’ responses to climate change, covering topics such as investment, mitigation, financial solvency, carbon footprint measurements, and Insurance regulators have consumer engagement. CDI, along with insurance pioneered a diversity of regulators in New York, New Mexico, Connecticut, effective strategies to evaluate Minnesota, and Washington, has collaborated in administering the survey to insurers licensed transition risks in each of their states with over $100 million in annual premiums nationally. In 2016, the survey Following Hurricane Katrina in 2005, U.S. insurance was sent to nearly 1,000 insurance companies regulators began to look more seriously at climate whose combined premiums account for more risks. In 2008, the NAIC developed a white paper than 70% of the total premium written in the U.S. entitled “The Potential Impact of Climate Change insurance market. CDI posts survey responses and Insurance Regulation” (NAIC 2008). This paper on its survey web page which remains one of the initiated a set of meetings and initiatives on the world’s most extensive datasets documenting topic. Foremost among the follow-up activities was how financial institutions are addressing climate the development of a national climate change and risks (CDI b). risk disclosure efforts. In particular, it developed the original Insurer Climate Risk Disclosure Survey In-depth review of a large subset of these (NAIC survey), adopted in 2010. responses found improvement in disclosure practices compared to prior response cycles, yet A major cornerstone of CDI’s efforts has been the majority of respondents show “an overall lack working to ensure transparency. CDI championed of focus in addressing climate risks and related NAIC’s development of the NAIC survey, modeled opportunities” (Messervy and McHale 2016). after a voluntary questionnaire that CDP, a non-

41 26 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “Increasing transparency makes markets more efficient, and economies more stable and resilient.” Michael Bloomberg Final Report, Task Force on Climate-related Financial Disclosures, 2017 Using metrics similar to those employed internally Only 16% of the respondents received “High by AXA and Allianz, Commissioner Jones asked all Quality” ratings, while two-thirds received “Low insurers doing business in California to consider Quality” or “Minimal” ratings. Quality responses were dominated by property and casualty divesting from thermal coal investments, defined as investments in companies that generate insurers, with health insurers lagging noticeably. No health insurer earned a “High Quality” rating, 30% or more of their revenue from ownership, exploration, mining or refining of thermal coal, with 89% earning “Low Quality” ratings. Based on survey responses, a principal area of concern and from utilities that generate 30% or more of the energy they produce using thermal coal. for CDI is whether insurers are recognizing the “Thermal coal” was defined as lignite, bituminous significant potential risk that nations, states, local governments, private companies, consumers, and coal with an ash percentage greater than 35%, as well as anthracite. markets will further restrict or reduce use of fossil fuels, which in turn presents a risk to the value of oil, gas, coal, and utility investments. CDI collected information from insurers operating in California to document what CDI believes that insurers should recognize and insurers have already done to divest from fossil address potentially significant climate-related fuels and whether they planned to further divest risks facing their investments in coal, oil, gas, and of thermal coal holdings and refrain from making utilities. In light of this concern, CDI launched future investments. CDI learned that around 200 surveyed insurers doing business in California had the Climate Risk Carbon Initiative in 2016, with the aim of more deeply addressing the climate- already divested $4.1 billion dollars of fossil fuel related transition risk to insurer investments in investments by mid-2016. Sixty-seven insurers further pledged to divest from thermal coal which these areas. When launched, this Initiative had altogether would account for $944 million worth two components: the Thermal Coal Divestment Request and the Fossil Fuel database. of coal divestment at the time pledged. Moreover,

42 27 “[A]ll organizations exposed to climate-related risks should consider (1) using scenario analysis to help inform their strategic and financial planning processes and (2) disclosing how resilient their strategies are to a range of plausible climate-related scenarios.” Task Force on Climate-related Financial Disclosures (2017) 325 insurers also pledged to refrain from making (revenue threshold) and the fossil fuel type used 2 future investments in thermal coal (Figure 20). by energy utility companies to generate their electricity (power generation threshold). This CDI also collected information on current fossil ensured the use of practical metrics to measure fuel holdings for insurers operating in California and manage climate-related risks, and revenue- based thresholds as a consistent measurable basis and the CDI website displays the coal, oil, gas, to identify fossil fuel investments. Disclosed data and power-generating utility investments. Using was cross checked for accuracy and results were metrics similar to the threshold approach of the divestment request, CDI defined oil and gas posted on a searchable database which, as with the NAIC survey database, is one of the world’s most investments as direct investments in enterprises extensive data sets of its kind. that generate 50% or more of their revenues from oil and gas. Investments into utilities included investments that generate 30% or more of their In 2018, CDI updated its methodology for electricity from thermal coal or utilities that evaluating fossil fuel investments by incorporating generate 50% or more of their electricity from the recommendations of the Task Force on mixed fossil fuels, which included thermal coal, Climate-related Financial Disclosures (TCFD). In particular, CDI has incorporated scenario analysis oil, and natural gas. As a reporting threshold, CDI used the amount of annual revenue a into its efforts. fossil fuel enterprise derived by fossil fuel type CDI partnered with 2 Degrees Investing Initiative (2Dii) to conduct a scenario analysis on the . Other efforts along these lines globally are tracked at https:// 2 California investments of insurers operating in FIGURE 20 | Sixty-six insurers agreed to divest from thermal coal and 325 to refrain from future investment. Source: CDI.

43 28 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State | Forward-looking carbon intensity index of aggregate fossil-fuel investments for insurers FIGURE 21 operating in California with over 100 million in annual premiums. Left: Colored shadings indicate forward-looking trends in economy- wide carbon intensity needed to cap global temperature increases at various thresholds (per IEA scenarios), while the curves show actual trends for the debt and equity market portfolios held by insurers operating in California with over $100 million in annual premiums. 1. Oil. 2. Natural gas. 3. Locked-in coal capacity by utilities (excluding capacity forecasts). Solid lines represent aggregate portfolios of insurers operating in California; dotted lines represent broader market benchmarks. Source: CDI, 2Dii analysis, used with permission.

44 29 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State with over $100 million in premiums nationally. CDI and 2Dii recently released aggregate findings which CDI posted on its website and have been shared at United Nations Principles for Sustainable Insurance (PSI) and Sustainable Insurance Forum (SIF) conferences. Of note, the aggregate data shows that in order for investments in utilities to be aligned with a scenario in which the global temperature does not exceed a two degrees Celsius increase from the baseline, there is significant need for coal-fired power plant retirements (Figure 21). This affirms the importance of the Commissioner Jones’ request for divestment from thermal coal as further coal-fired power plant retirements would further decrease demand for thermal coal. The aggregate data also shows that the trajectory for oil and gas production investments is currently aligned with a two degrees scenario over the next five years (Figure 21), but not every insurer analyzed is necessarily aligned and some may face greater exposure to transition risks compared to their peers. Assumptions underlying the International Energy Agency results used to generate these scenarios will evolve with energy prices and other factors. Thus, exposure to transition risk will vary over time and such analyses should continue to be performed. Commissioner Jones sent individual reports to the CEOs of the 100 analyzed insurers with the largest investment portfolios and analyzed insurers that are most exposed to thermal coal risk. The reports were accompanied by a letter from Commissioner Jones asking CEOs to incorporate scenario analysis into their decision making about investments. CDI expects insurers to use the forward-looking scenario analysis to evaluate and address the climate-related financial risks to their reserves and investments, including especially those risks to investments in fossil fuels and utilities. CDI also expects insurers to probe investments in other ways that they may find useful, such as running further scenario analyses with varying metrics and benchmarks. To this end, CDI participated in United Nations-supported Principles for Responsible Investment (PRI) events where PRI launched their and 2Dii’s dynamic scenario analysis tool, which was created as an adaptation of the tool used for the CDI analysis.

45 30 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State Polluter Liability and Other Liability- Related Triggers May Give Rise to New Litigation Risks In addition to physical and transition risks, climate change poses significant and broad liability-related risks to insurers. As climate change impacts proliferate, those who suffer property damage, economic loss, or personal harm will increasingly turn to the courts for redress that legislation and regulation have not been able to offer (UNEP 2017). Perhaps the primary and most publicly prominent examples of this litigation have been lawsuits that seek to force governments to regulate greenhouse gas emissions under existing constitutional or statutory provisions; this group includes the most well-known U.S. climate change case, Massachusetts v. EPA , which initiated regulation of greenhouse gas emissions by the federal government pursuant to the Clean Air Act. However, while policy-forcing litigation may have had the greatest impact to date, a number of other types of litigation present more salient risks to the insurance industry:

46 31 “Identifying the human influence in events once known as ‘acts of God’ is likely to inform litigation relating to claims and liability for damages... [F]oreseeability of damage is an important requirement to establish a duty of care in many legal systems.” Marjanac et al. 2017) ( Damages and tort suits. • • Individuals and In common-law countries Professionals. like the United States, professionals such local governments in the United States as engineers and planners owe heightened have sued fossil fuel companies, electricity legal duties to those who use, benefit from, generators, and automobile manufacturers or reasonably expect protection from their seeking compensation for the damages work. As climate change impacts threaten the caused by climate change-induced sea- viability and safety of construction designs level rise, extreme storms, and more that are linked to emissions they generate. and urban plans, these professionals may be held responsible for resulting personal or . California’s devastating 2017 Utilities • property damage if it can be shown that their wildfire season, which included major fires designs were negligent in light of increasing scientific certainty about where and when that are believed to potentially have been those impacts will occur (Ross et al. 2007). sparked by electrical utility infrastructure, has raised the specter of significant liability New mitigation and geoengineering and • for the state’s utilities as climate change If exacerbates annual wildfire risks. Senate climate engineering technologies. Bill 1088 (Dodd 2018) has been proposed to mitigation becomes more difficult to achieve via standard emission reduction methods, insulate utilities that follow certain standards, companies and governments may turn among a number of other bills seeking increasingly to techniques such as atmospheric to protect utility viability in the future. carbon removal and solar radiation Shareholder Directors and Officers. • interference. Employing these strategies on the global scale necessary to achieve the activism on climate change has increased intended effect could result in significant significantly in recent years, with dozens liability if unintended consequences occur of shareholder resolutions in 2018 alone (Mills 2012a). pressing fossil fuel companies and electric utilities to disclose risk assessments and transition to cleaner energy sources While damages and tort litigation, which are (Hasemyer 2018) and over 20 Securities discussed in detail later in this section, have received substantial attention in California and Exchange Commission filings or other complaints (including suits initiated by the and may threaten the greatest potential losses, Massachusetts and New York attorneys lawsuits implicating a heightened duty of care or general) in the past 10 years relating to climate legal obligation to consumers or the general public disclosure (CLSSC). As these shareholder – such as those of corporate directors and officers, actions develop they may entail liabilities that licensed professionals, and electrical utilities – are are covered by directors and officers policies. most likely to result in near-term liability that is or may be covered by existing policies. Directors

47 32 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State and officers liability presents perhaps the most widely discussed and potentially disruptive litigation risk for the insurance industry. Insurers and commentators have warned for over a decade that shareholders could initiate derivative actions and other major lawsuits if climate change- related incidents harm stock values and were not previously disclosed (Roberts 2006). Such suits have not developed in the intervening years, and climate change risk disclosure has increased significantly, but experts and some insurers still anticipate that shareholders will seek redress against directors and officers for climate impacts to profitability that were inadequately disclosed and believe that these suits would be covered – Board (FSB)’s industry-led TCFD (Swiss Re 2016; by directors and officers policies (Messervy et SIF 2017). The FSB was established in the wake of al. 2014; Greenwald 2017). Similarly, a leading the 2007-2008 financial crises in order to prevent legal opinion in Australia, a fellow common-law future instability to the financial sector. The FSB country, has found that corporate directors may has determined climate change to be a risk that be required to consider climate change risks threatens the global financial sector. The TCFD as part of their duties of care and diligence in was established to develop recommendations the future (Hutley and Hartford-Davis 2016). for the financial sector and all economic sectors While the opinion does not have the effect of with regard to disclosing and addressing climate- law or court precedent, legal experts view it as related financial risks. The recommendations a potential indication of how liability standards include disclosure of risk management measures, may evolve due to the author’s expertise and corporate metrics and targets used to measure status as a Senior Counsel of the Australian Bar climate change-related risks and opportunities, (Barker 2018). However, respondents to the actual and potential impacts on operations 2016 NAIC survey, when asked whether their and strategy, and governance and oversight companies have considered potential climate (TCFD 2017). Such disclosure could satisfy change exposure through directors and officers board obligations to shareholders under existing policies, almost uniformly did not identify these securities regulatory regimes, but the nature and 3 policies as potential sources of risk. extent of those obligations are still unclear (Gelles 2016). Nonetheless, industry actors have begun to encourage proactive measures around corporate These issues are still in the earliest stages of climate-related responsibility and disclosure development and have not been tried in court. that may address shareholder concerns and As a result, it is nearly impossible to predict how limit exposure under directors and officers they may be resolved and what the impact of policies. Some insurers have publicly adopted the that resolution may be on insurers. A threshold recommendations of the G-20 Financial Stability issue, yet to be tested in court, is whether pollution exclusions – originally introduced to cover traditional soil and water contamination 3 . Survey results are available at - by toxic and hazardous substances – will apply to mateSurvey/.

48 33 focus on mitigation and adaptation policies (UNEP greenhouse gas emissions, which are classified as , which Massachusetts v. EPA 2017). For example, a pollutant under the Clean Air Act (Marsh 2016). involved claims against the federal government Further development of attribution science, which seeking regulation of greenhouse gases under is already highly robust but relatively untested the Clean Air Act, ultimately prompted statutory in the legal sphere, will be necessary for the compliance but not legal liability for emissions. In development of causal links adequate to support some countries, plaintiffs have begun to challenge liability, whether in the tort, professional, or federal constitutional provisions, project shareholder context (Marjanac and Patton 2018). Where the defendants are licensed professionals approvals and lease sales related to resource or corporate officers with distinct duties of care extraction on the basis of harm to the climate. But under existing law, and plaintiffs sue over not to date, no court has yet issued a clear decision in plaintiffs’ favor in these cases (UNEP 2017). emissions generated but the failure to account Governments could also be held liable for wetland for or disclose known climate risks in violation of and waterway management actions that may these duties, such barriers to establishing liability exacerbate flooding and other climate change- could be far less significant. But climate change is related impacts, as has been unsuccessfully alleged clearly driving a new crop of litigation risks that St. Bernard Parish Government v. United States in insurers will be forced to confront in the near In re Katrina Canal Breaches Litigation (2018) and future. (2015); or for failure to regulate emissions so as to internalize their negative externalities, Climate change litigation is such as the public trust doctrine claims made ; Juliana v. United States in the current case of growing but has focused on but no such claim has yet been successful (Van regulation and mitigation Calster 2016). Within the relatively small policies number of cases seeking to impose liability on private actors and entities, only a subset of those According to most comprehensive estimates, will result in claims under existing insurance nearly 1,000 climate change-related claims have policies, while others may be expressly excluded been brought in the United States, including or may be brought against self-insured entities. claims under federal statutory law, federal Nonetheless, this growing field of litigation constitutional law, state statutory and common will present an increasing threat as the range of law, public trust doctrine, securities regulations defendants and legal theories employed grows. and more (CLSSC). According to United Nations estimates, over 230 cases have been filed in an Climate change tort litigation additional 24 countries and the European Union (UNEP 2017). Of these, many have been brought threatens insurers’ balance in fellow common-law countries: over 100 in sheets Australia and New Zealand, nearly 50 in the United Kingdom, and at least 10 in Canada. Litigation based on the impacts of climate change poses multiple risks to insurers. In particular, While the total number of lawsuits involving lawsuits seeking to impose damages on fossil fuel climate change-related claims is quite high, only companies and major greenhouse gas emitters for a small subset are immediately relevant in the sea-level rise, flood, wildfire, extreme weather, and insurance context. Most climate change cases are other events could result in hundreds of billions filed against state and national governments and

49 34 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State of dollars in liabilities. For example, in their 2017 been named as defendants thus far. And even if any entities are ultimately deemed liable, the nuisance and trespass claims filed against five top insurance industry lacks clarity on whether their fossil fuel producers, the cities of San Francisco policies would have to cover climate damages. and Oakland estimate potential real property But these lawsuits ultimately represent one of losses due to sea-level rise of approximately $50 the greatest potential threats to the insurance billion and $40 billion respectively, along with industry in California and beyond. A number of billions of dollars in seawall improvements, noteworthy focal points have already emerged: hundreds of millions in infrastructure upgrades and protection, and other significant costs for Climate change damages suits are on • which they seek recovery (People of the State the rise . Governments in California and of California v. BP p.l.c). Any entities found liable in such litigation could face catastrophic multiple other states have recently sued fossil fuel producers for damages associated losses that could materially affect any insurance with sea-level rise, flooding, wildfires, and company investments. Entities defending against other events associated with climate change. such litigation could invoke existing commercial These suits are likely to increase in the general liability policies or advocate for litigation- future, particularly if regulatory solutions specific policies to insulate themselves from continue to falter in the United States. liability (Davis and Paul 2017). While the largest fossil fuel companies (which are the primary Liability may revolve around whether • defendants in current cases) may be largely self- climate change-related harms were insured, smaller companies without the capacity foreseeable and whether defendants’ to self-insure, and entities in other industries, As a result, could be equally vulnerable to the development actions were unreasonable. of liability for emissions, with the same risk the growing certainty of climate science of major losses implicating insurance policies. and viability of non-emitting energy sources may increase the likelihood Moreover, insurers’ duty to defend under existing broader than the duty to indemnify – policies of successful climate litigation, which – otherwise falls outside existing legal models. may be implicated long before liability for emissions or a failure to meet a professional • or corporate duty of care is firmly established, Tobacco and asbestos litigation provide some historical guidance. with many suits likely to involve multiple Public pressure, defendants and competing cross-claims, long the development of alternatives, and the direct timelines and counsel lists, and attendant costs involvement of governments in litigation (similar, for example, to Superfund litigation). helped lead to liability or mass settlement. But causation of individual health harms is simpler To be sure, this field of climate-change-related to prove than climate change-related damages. litigation is in its infancy, and significant questions remain open as to whether any court will impose The litigation that could have the most liability. Current damages litigation for generation immediate and significant implications for the of emissions focuses on fossil fuel companies, insurance industry are cases that involve claims while prior cases have involved electricity for damages, such as common-law nuisance, generators and automobile manufacturers. trespass, and negligence, that might form a Entities responsible for agricultural, industrial, basis for monetary liability for the impacts of deforestation, or other emissions have not climate change. Such liability may be covered by

50 35 commercial general liability policies, and could revocation of permits, or constitutional also materially affect the value of fossil fuel- remedies. The leading common-law cases against greenhouse emitters, all unsuccessful, have been: related assets held by insurers to the extent share prices are affected by legal outcomes. American Electric Power v. Connecticut • , 564 U.S. 410 (2011). Eight states sued a Past climate change damages group of electricity generators seeking a suits in the United States have cap on emissions, based on a common-law nuisance claim that the emissions from their not resulted in liability facilities contributed to climate change. The To date, there have been no successful claims United States Supreme Court rejected the in the United States alleging that greenhouse claim, holding that the federal Clean Air Act gas emitters are responsible for climate change- preempted federal common-law claims, since related damages or common-law claims (UNEP Massachusetts v. under the Court’s ruling in 2017). This record mirrors international the act expressly delegated to EPA complete EPA experience to date, with claims in Germany, authority to regulate carbon dioxide emissions. Peru, and the Philippines also unsuccessful (a Urgenda Foundation v. landmark 2015 ruling in Kivalina v. ExxonMobil , 696 F.3d 849 (9th • Kingdom of the Netherlands ordered the national Cir. 2012). Residents of a coastal Alaska town government to reduce emissions 25% by 2020 to sued fossil fuel companies and electricity mitigate climate impacts, but did not find liability generators for damages due to the companies’ for those emissions). In the United States, courts contribution to climate change, which have typically not allowed cases to proceed to causes sea-level rise that was destroying the the merits, finding them to be preempted by town and required plaintiffs to move. The legislation or political questions not appropriate case was dismissed as a political question for court rulings. The primary barriers to not capable of resolution in federal court. success for these claims have been preemption and plaintiffs’ inability to prove legal causation , 607 F.3d 1049 • Comer v. Murphy Oil sufficient to establish liability. (5th Cir. 2010). Mississippi residents sued fossil fuel companies for property damage According to the Sabin Center for Climate caused by Hurricane Katrina, which was Change Law at Columbia Law School, of the exacerbated by climate change caused hundreds of climate change claims filed in the by defendants’ emissions. The claim was United States, approximately 20 have been ultimately dismissed for a lack of standing common-law claims. Common-law claims (i.e., the legal right to bring a claim based on involve damages, as opposed to those seeking having suffered a harm that may be redressed enforcement of statutory requirements, by a court), as the court held that plaintiffs

51 36 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State greenhouse gas emitters. However, as aggressive could not establish a connection between EPA action has become less likely and as the the emissions and the harm they suffered. physical impacts of climate change in the United States have become more tangible, plaintiffs California v. General Motors • , No. C06- 05755 (N.D. Cal. 2007). The state sued a have begun to seek new avenues for redress. group of automakers on basis that they were responsible for greenhouse emissions that caused a public nuisance in the form Recent climate change of environmental impacts such as reduced damages suits in the United snowpack, sea-level rise, and longer heat waves. States present new avenues for The claim was dismissed as a political question. liability As these key cases demonstrate, U.S. courts (and federal courts in particular) have not been A number of new common-law cases have been receptive to date to large-scale climate change filed in the United States between 2017 and mid- damages suits against major sources of emissions, 2018. In this new crop of litigation, the plaintiffs identifying statutory preemption, political are all local governments, while the defendants considerations, and causation issues as barriers are all fossil fuel companies. While not uniform to a finding of liability. Beginning over a decade in underlying facts or legal theories, these cases ago, they have set a provisional but consistent share a common thread of public-scale property precedent disfavoring claims for damages against and infrastructure damages and claims made a range of defendants, including fossil fuel under state law. Please note that each of these producers, electricity generators, and automobile cases was in progress as of the date of publication manufacturers. (Importantly, these holdings in of this report, and dismissal, removal, appeal, favor of defendants have not meant that insurers or other developments may have taken place. were unaffected; a number of insurers were initially named as defendants in Comer v. Murphy • (N.D. People of State of California v. BP , and defendants in the other cases surely Oil Cal., Docket No. 3:17-cv-06011). The cities involved their insurers where possible throughout of San Francisco and Oakland sued five oil the costly litigation process.) As a result, they and gas companies based on state nuisance likely limited the number of suits filed over that law. The federal district court dismissed same period. In particular, the Supreme Court’s the suit in late June 2018, on grounds unanimous 2011 decision in AEP v. Connecticut that the plaintiffs’ claims were displaced may have had a strong dampening effect on by the Clean Air Act as well as separation- common-law claims. That case followed the of-powers and foreign policy concerns. requiring Massachusetts v. EPA Court’s ruling in the EPA to regulate greenhouse gas emissions • County of Santa Cruz v. Chevron (N.D. and was issued at a time when the EPA under Cal., Docket No. 5:18-cv-00450) . The City President Obama had finalized initial greenhouse and County of Santa Cruz sued 29 fossil fuel gas emission limitations for automobiles. In companies for damages related to nuisance, addition, the EPA was crafting regulations for new trespass, failure to warn, and negligence. and existing power plants. In that context, AEP appeared to firmly establish that v. Connecticut • County of San Mateo v. Chevron (N.D. the Clean Air Act displaced these claims against Cal., Docket No. 3:17-cv-04929-MEJ).

52 37 The counties of San Mateo and Marin and the City of Imperial Beach sued fossil fuel companies under nuisance, negligence, strict liability, and trespass standards. City of New York v. BP (S.D.N.Y., Docket • No. 1:18-cv-00182). The city sued the five largest fossil fuel companies claiming that the production, marketing, and sale of their products caused public and private nuisance and trespass damages. The case was dismissed in July 2018 on common-law claims for damages against large political question and similar grounds. groups of major fossil fuel companies, but not electricity generators or automakers. The claims City of Richmond v. Chevron • (Cal. Super. Ct., allege a full suite of tort claims including nuisance, Docket No. C18-00055). The city sued 29 fossil negligence, trespass, failure to warn, and strict fuel companies for damages related to nuisance, liability, and they reach the production, sale, and trespass, failure to warn, and negligence. marketing of the fuels, including concealment of climate change science. The claims seek damages • Board of County Commissioners of for a broad range of applicable climate change- Boulder County v. Suncor Energy (Colo. related harms, including sea-level rise, heat waves, Dist. Ct., Docket No. 2018CV030349). Two wildfires, extreme weather events, flooding, counties and the City of Boulder sued Exxon spread of invasive species and drought, which the and Suncor for nuisance, trespass, and plaintiffs allege have caused and will cause them to violations of state consumer protection law. incur costs to protect public and private property, upgrade infrastructure, preserve public health, (Wash. Super. Ct., King County v. BP • and conduct scientific analyses. The second trend Docket No.18-2-11859-0). The county is that defendants are attempting to remove these sued five major fossil fuel companies in a claims from state court to federal court, in order California complaint similar to that filed in decision will AEP v. Connecticut to argue that the v. BP , also highlighting the risks that be applied and the Clean Air Act will preempt the climate change-driven ocean acidification suits. To date the defendants have been mostly poses to the region’s shellfish industry. successful in this strategy, earning a dismissal of California v. BP as noted above, but the claims in (R.I. Super. Ct., Rhode Island v. Chevron • appeal is likely and some removal actions are still Docket No. PC-2018-4716). The state sued a ). pending (appeal is also likely in New York v. BP group of fossil fuel companies for damages to state-owned facilities and real estate. The claims by the cities of San Francisco and were limited solely to Oakland in California v. BP While none of these cases has been fully resolved, public nuisance and seek no punitive damages, (those that have been dismissed are subject to requesting billions of dollars solely to fund climate further appeal) two trends have emerged. The adaptation projects and not to compensate for first is the common traits of the claims. Primarily past harm (Drugmand 2017). This strategy was coastal jurisdictions are bringing comprehensive

53 38 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State designed to keep the case in state court based Historical mass tort examples on recent lead paint litigation, People of State offer insight into the of California v. ConAgra (Santa Clara Co. Super. development of liability Ct. 2017, No. H040880), that employed a similar strategy in winning an award against a group While the field of climate change damages of manufacturers who were required to pay $1 litigation is still relatively young and has not billion into an abatement fund. The decision yet resulted in any decisions on the merits of was seen as an expansion of the public nuisance liability, two examples provide perhaps the doctrine under California law as the court found clearest guidance for how tort liability might liability for actions dating back many decades, emerge in this context. United States courts have which may have driven the increase in public previously developed mass tort liability regimes nuisance-based climate claims filed in late 2017 in the context of tobacco and asbestos, in each and early 2018 (Coppinger et al. 2017). This case decades after the first links of harm were California v. BP when strategy was obviated in identified and scientific attribution was robust the defendants were successful in removing the and well understood. Tort liability for climate case to federal court (where the California court change may similarly rely on the development of precedent may not apply), but one or more of the attribution science and public acknowledgment other suits may remain in state court. Keeping of direct links between greenhouse gas claims in state court may also ease the burden of emissions and specific harms to life or property. standing, which can be easier to establish under California law than under federal law. Tobacco Given the similarities across these common-law The decades-long litigation over the health effects cases, the global nature of the impacts of climate of tobacco use may offer the most valuable parallel change (with some regional variation affecting to climate change claims. Science identifying the the precise list of damages claimed), and the harms of tobacco smoke was established by the fact that the cases were filed within a very 1950s, and lawsuits seeking damages against narrow timeframe, more coastal jurisdictions tobacco companies began at the same time. in California, the Pacific Northwest, and the Yet the industry was able to shield itself from Northeast will likely file similar state common- liability on the basis that the science was not law claims against the same defendants. As the conclusively established. Similar to the climate Boulder County case demonstrates, however, change context, it was later learned that industry non-coastal jurisdictions may also begin to file leaders had far more conclusive understanding their own claims as climate change impacts of that science than they publicly divulged. After become more diverse and directly affect more the 1964 Surgeon General’s report definitively geographies. And adjacent legal developments, linked smoking to cancer risk (USDHEW 1964), , may such as that in California v. ConAgra the defendants were initially able to shift blame shape innovative approaches or drive yet more to plaintiffs based on the doctrine of assumption jurisdictions to file similar suits. of risk. Only in the 1990s did the liability risk become so significant that the tobacco companies eventually agreed to enter into a $200 billion mass settlement with 46 state governments (Meier 1998).

54 39 Three key factors drove this development. First, Asbestos the public had understood smoking as a public health risk for over 30 years, with the agreement The development of liability in the asbestos and support of federal and state governments that context provides another example that may be sponsored some of the leading medical research relevant to climate change litigants. From the and sponsored public health and education 1930s to the 1960s, scientists developed clear programs. Second, states, rather than individual links between asbestos and health harms. Then plaintiffs, sought recovery for public health care in the early 1970s, the Occupational Safety and costs related to smoking, reducing the difficulty of Health Administration officially recognized the proving causation and other factors that exist in link and issued protective regulations, leading individual cases and increasing the political power to a rapid reduction in production and use of and litigation capacity of the plaintiffs (Olszynski the material. Between the 1980s and 2000s, et al. 2018). Finally, evidence grew regarding the hundreds of thousands of individual plaintiffs tobacco companies’ knowledge of harmful effects sued for billions of dollars in damages, with the and deceptive efforts to hide them from the public, vast majority settling in an aggregate amount allowing claims under unfair trade practices laws. exceeding $50 billion. These settlements and the prospect of total liability drove the industry into – the progress of climate Each of these factors mass bankruptcy. science, the rise of government-level plaintiffs, are – and evidence of public misinformation Two key factors influenced the findings of liability. apparent in the climate change context. However, The development of science and the decades-long the cases have a number of key distinctions. First, incubation period of disease meant that after the damages caused by tobacco consumption are the initial discovery of risks in the 1930s, the individual, not global. Tort law was not initially scientific community took decades to identify the well suited to smokers’ claims for evidentiary link between exposure, asbestosis, mesothelioma, reasons, but the nature of the harm suffered was and lung cancer, in large part as a result of the amenable to resolution under traditional tort progressive aging of a significant population of principles. By contrast, climate change impacts workers who had been exposed to the substance. are not directly related to the end-user of the And since primary exposure to harmful levels emitting products and services. Second, damages of asbestos took place in the workplace, which to particular plaintiffs could generally be traced to is subject to heightened regulation, oversight, particular defendants i.e., the type of cigarettes ( and record-keeping regarding substances and and even when aggregated, state- smoked ) quantities used, plaintiffs could more easily level claims could reasonably address all liable establish causation. parties. But climate change is the result of global emissions. Finally, political consensus around the As with the tobacco analogy, some key distinctions harms of climate change has not yet matched the exist when compared to climate change liability. scientific consensus. Each of these differences, First, like tobacco, asbestos created an individual while surmountable, presents a barrier to liability. health harm that scientists could trace to specific (In plaintiffs’ favor, the doctrine of assumption of products and behaviors. Second, the industry which long barred smokers’ claims – likely – risk developed alternatives to asbestos that possessed would not apply in the climate change context). its fire and heat resistance without its harmful side effects. Such alternatives also exist in the context of energy production, but not all of the

55 40 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State technology is yet at market scale, which may the product was fungible and 2) a substantial affect an analysis of whether defendants’ actions share of the manufacturers were named as are reasonable: so long as fossil fuels remain defendants. The nature of the problem that gave necessary to provide much of the world’s power, the plaintiff ’s – rise to the market share theory courts may hesitate to deem their production inability to prove which manufacturer produced unreasonable merely because some quantity of aligns with the inability – the drugs in question of climate change litigants to link specific harms an emissions-free alternative exists. to any individual emitter. Similarly, the concept Within both tobacco and asbestos cases, the – of fungibility the essentially interchangeable development and public acceptance of scientific overlaps with the – nature of a commodity conclusions regarding causation of harm was common measurement of climate impacts in essential to the establishment of tort liability carbon-dioxide-equivalent units regardless of sufficient to motivate settlements. In addition, greenhouse gas emitted (although this deals with experts could link each substance in question fungibility of outputs, rather than the initial directly to individual human health damages. fossil fuels). While the market share liability These analogies present a challenging picture concept has rarely, if ever, been extended beyond for climate change liability, as scientists cannot the narrow context of pharmaceuticals, and it link greenhouse gas emissions definitively to any would require expanded interpretation to apply individual impacts, and because large segments to the climate change context, its principles of the public and various governments do not may provide a framework for future litigants. accept the established science regarding impacts. In order for tort liability to emerge with respect Fellow common-law countries to climate change-driven harms, the scientific have not developed climate and political communities may need to more liability frequently and conclusively establish the ability to link an individual destructive event or set The national governments of other common-law of events to greenhouse gas emissions. But countries do not appear to be expressing any alternative forms of liability, such as those related anticipation of or plans for liability for greenhouse to fossil fuel companies’ public information and gas emissions. Leading government reports and marketing campaigns under unfair trade practices the websites of government environment and laws, could persist even if traditional tort liability climate agencies, including the UK Committee is not established. on Climate Change’s 2017 Report to Parliament, the Pan-Canadian Framework on Clean Growth One potentially instructive concept is the principle and Climate Change, the Australian Department of market share liability, which was introduced in of Environment and Energy’s 2017 Review of Sindell California pharmaceuticals litigation. In Climate Change Policies, and the New Zealand v. Abbott Laboratories (1980), the California Government’s Action on Climate Change report Supreme Court held that where a plaintiff could all focus on carbon pricing, emission reduction, prove that a product manufactured by a group adaptation and resilience, and clean technology of defendants (but not definitively linked to innovation, with no mention of proposed or any individual one of them) had caused her anticipated liability schemes or litigation. Available actual damages, those defendants could each be legal analyses indicate skepticism that liability held liable to the plaintiff in proportion to their might be imposed in these countries under current market share for the product, provided that 1)

56 41 legal standards, and no other countries appear to on the merits based on nuisance (Grossman 2003). have enacted statutory law imposing liability for In addition, they have reasoned that a nuisance- damages caused by greenhouse gas emissions based climate claim does not represent a political question that cannot be resolved in court and that (Pepper 2017; Williams 2017; Day 2017). the issue of proof of damages will be resolved over time as the science develops (Farber 2008). On the In addition to the lack of government action negative side for plaintiffs, they have argued that on climate liability, damages litigation in other common-law countries has been far less robust a climate change litigant in the general population likely lacks common-law basis for standing (Mank even than in the United States. Only one case appears to have been tried: In a 2011 Australian 2005). They also have predicted that climate tort claims will continue to fail on the merits, until case, Macquerie Generation v. Hodgson , the court damages become so significant and widespread rejected a claim that an electricity generator’s that courts are forced to fundamentally alter the permit contained an implied condition limiting tort system (Kysar 2011). carbon emissions to a level exercising reasonable care for the environment. The court also indicated These arguments represent only a small cross- skepticism regarding common-law nuisance claims section of the extensive legal academic literature, in the same context (UNEP 2017). Of the other but they demonstrate the extent to which scholars climate change-related cases identified in Australia, Canada, New Zealand, and the United Kingdom, have long predicted the rise of tort litigation based on damages caused by climate change, but failed none apparently involved a claim for damages against an emitting entity (CLSSC). However, to predict the direction that the United States as noted earlier, Australia may be on the path to Massachusetts v. EPA from to Supreme Court – and other courts would take – AEP v. Connecticut recognizing liability in connection with corporate directors and officers duties toward shareholders. in decisions regarding the bases for liability. The recent group of local government-initiated cases described earlier is the first significant attempt Legal academic commentary AEP v. Connecticut at establishing liability since , and theory suggest additional and the interim period was filled largely by the ty barriers to liabili Obama Administration’s now-stalled effort to regulate greenhouse gases under the Clean Air Legal scholars have been discussing and predicting Act. As a result, scholarship on the topic has the development of climate change-based tort slowed somewhat since 2011. litigation risks for more than a decade, including scenarios both good and bad for plaintiffs. For However, an analysis of the basic elements example, on the favorable side, they have argued of tort liability that must be established in a that climate change tort liability would likely not be successful claim of damages against an emitter preempted by the Clean Air Act and could survive reveals two key insights for a prospective view

57 42 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State of the risk faced by fossil fuel companies (or causation fall, these two factors could determine other large-scale emitters, such as power the nature of climate change-related tort liability generators, that have been involved in past suits): going forward. At the same time, cases against professional builders or engineers and corporate • A claim for damages will likely not succeed directors and officers, alleging losses related to violations of their duties to protect and inform without showing that the defendant emitters’ actions presented an unreasonable risk of consumers and shareholders, could begin to form foreseeable injury. This need, in turn, will the basis of tort liability as the field progresses. require showing that the emitters were aware of climate science and the harm caused by Implications for the insurance their products (a claim the recent cases all industry are significant but make, and which is fairly well established). details continue to emerge But litigants may also need to prove that alternative means are available and affordable The field of climate change-based litigation is – i.e., that non-emitting technologies are a relatively young, and few of the claims filed to cost-effective choice for the defendants. These date have sought damages under common-law alternatives are now, increasingly, becoming theories. But these common-law claims could viable for generators of electricity with present a major threat to the insurance industry, renewable energy but not yet for automakers since liability for even a small portion of the sea- or oil companies with mass-market, level rise, flooding, wildfires, extreme weather ubiquitous zero-emission vehicles and fuels (or events, and other impacts of climate change equivalents that are sufficiently low-emitting could be immense. The National Oceanic and as to not contribute to harmful warming). Atmospheric Administration estimated that the 2017 California wildfires alone caused nearly $20 In claims for mass damages, courts often apply • billion in damage, while hurricanes Harvey, Irma, an industry standard approach. Thus, suits and Maria totaled over $250 billion throughout against comprehensive groups of emitters – the Southeast and Caribbean (NOAA). These the current norm – may yield to suits against by events have been linked to climate change – companies who continue to lag behind the one estimate Hurricane Harvey’s rainfall was 38% field as the emitting industries begin to shift – and even greater due to anthropogenic warming away from fossil fuel-reliant technologies a small apportionment of liability for similar past (Hunter and Salzman 2007). and future events, given increasing severity and frequency, could result in unsupportable costs to These two additional factors the need – insurers (Risser and Wehner 2017). As attribution for a viable, non-emitting alternatives to science develops, the likelihood of liability and current energy production methods, and the certainty of apportionment will increase as well. go – vulnerability of worst-performing actors In particular, advances in attribution science will beyond attribution science and regulatory address the threshold legal question of causation, schemes to a basic proposition that courts will both by establishing conclusively that climate resist imposing liability that could force industry change is a factual or “but-for” cause of extreme transformation on too broad a scale. Even if weather events, sea-level rise, and other harms, and as barriers relating to political question, and by demonstrating that climate change is a legal statutory preemption and scientific proof of

58 43 of the action in question; the degree of certainty of causation; the relationship between the parties; and, in some cases, whether insurance is available (Hunter and Salzman 2007). Each of these factors could be a major barrier for individuals or local governments seeking to hold fossil fuel companies or major greenhouse gas emitters or governments liable for climate change-induced harms: apportionment of harm may be distinctly challenging in the climate or “proximate” cause of those harms, foreseeable change context, fossil fuel activities continue to fossil fuel emitters and extractors (Marjanac to drive much of the global economy (and their and Patton 2018). consumption continues to hold social utility), extractors and emitters may owe a minimal While each of the common-law theories underlying duty of care to the public, and the links between the current California, Colorado, New York, Rhode specific plaintiffs and defendants are difficult to Island, and Washington cases – such as private establish. Plaintiffs may be able to recast their and public nuisance, trespass, and negligence claims to make the implications of liability less – requires a different set of factors to establish radical – for example, by seeking only damages liability, a common standard of reasonableness for emissions that were unreasonably high outlines them. For example, in a public nuisance due to the marketing of SUVs over other cars – claim, the plaintiff must establish an unreasonable and thus more likely to survive in court. More interference with a right common to the public, broadly, climate science will continue to develop while in a private nuisance claim the plaintiff must and sharpen, and the social utility of fossil fuels show a substantial and unreasonable interference will likely diminish as non-emitting alternatives with the use and enjoyment of land: in either become more viable. But it is unclear whether case, the defendant need not have behaved liability is a significant likelihood in the near negligently or been “at fault,” but simply have term. taken actions of insufficient social utility to justify the infringement of public or property rights. In However, should liability arise, the defendants a negligence claim, the plaintiff must establish – currently multinational fossil fuel companies, four tradi tional factors: a duty of care owed by the but potentially including automotive and defendant to the plaintiff, a breach of that duty, energy generation companies, other commercial causation (both factual and legal/proximate), and generators of greenhouse gas emissions such harm to the plaintiff. The issue of breach is often as airlines and industrial facilities, corporate evaluated by weighing the likelihood and severity directors and officers, and licensed professionals of harm against the burden of avoiding it (i.e., – certainly hold extensive and diverse forms of the utility and reasonableness of the behavior insurance. The defendants would likely seek in question) (Hodas 1999; Hunter and Salzman to recover to the maximum extent possible 2007). Courts employ differing interpretations of under their existing policies. Most companies’ reasonableness, and their analysis will be tailored commercial general liability policies cover to the specific common-law theory in question. judgments for personal injury and property But they typically evaluate similar factors: the damage, which would likely include climate likelihood and severity of harm; the social utility

59 44 responsible for interpreting or managing their change-related tort damages based on sea-level rise, flooding, wildfires, and public health costs impacts. And as more companies begin to engage like those sought in the cases recently filed in in thorough climate change risk disclosure, an California and elsewhere (Davis and Paul 2017). As industry standard may develop against which deficient disclosure could be readily apparent. discussed earlier, corporate directors and officers Proactive measures such as adopting (Swiss policies and professional license-related policies Re 2016) or guiding policyholders through are also likely to be implicated in future litigation. the implementation of (Aon 2017) climate However, just as numerous hurdles to establishing liability for climate change damages exist, so risk disclosure recommendations may limit do hurdles to establishing covera ge obligations. exposure to directors’ and officers’ liability, Most insurance policies include policy exclusions and independent organizations such as the for damages expected to result from intentional Sustainability Accounting Standards Board and others provide additional frameworks that can conduct. In this case, the conduct of extracting and burning fossil fuels is certainly intentional further build institutional standards. Other and general climate effects foreseeable, while the concepts such as an insurance levy on fossil fuel extent to which specific, litigable climate change- producers to fund adaptation programs and related harms can be anticipated is a matter of reduce litigation risk by building goodwill may be less appealing and feasible, but they indicate ongoing scientific and legal inquiry. Similarly, the type of measures the industry may need to some issuers may be able to exclude liabilities contemplate in a future of climate litigation of which the policyholder knew or should have (Webster and Clarke 2017). As claims proliferate known at the time the policy was purchased. and the total amount of damages sought becomes While extensive evidence exists that fossil fuel companies have understood climate change for more apparent, insurers may respond to new decades, the link between that understanding and risks by withdrawing from market segments, and regulators may be called upon to assist in the specific harms is much less clear. Many commercial formation of new coverage arrangements. The general liability policies also contain exclusions for pollution liabilities, although it is unclear if evolution of legal theories implicating sources of emissions, directors of corporations affected by both greenhouse gas emissions and core business physical and transition risks, utilities involved operations (such as resource extraction or power generation, as opposed to an accidental spill) can in large wildfires, and engineers and planners responsible for building resilient homes and fall within those exclusions (Marsh 2016). communities may force the industry to confront and, ideally, engage constructively with – the – This additional layer of questions further complicates the picture of potential liability in possibility of significant liability losses alongside climate change lawsuits. But insurers will likely be the physical losses and investment risks that are heavily involved in this growing field of litigation, likely to occur. particularly as advances in attribution science and an increasing diversity of climate change-related harms make the causal links between insureds’ activities and plaintiffs’ damages ever clearer. Furthermore, if a plaintiff ever is successful, the cohort of defendants may expand to incorporate the full panoply of major emitting activities worldwide, as well as professionals and others

60 45 Systemic Challenges for Markets and Consumers Key climate risks remain uninsured in California’s private insurance market The impact of climate change on the economics of the insurance industry has some historical analogies, such as the 1930s Dust Bowl and the rise of international terrorist threats in the early 2000s. However, while these historical circumstances affected how particular sections of the industry (such as crop insurers) operated, or reorganized how the broader industry approached particular groups of risks, none had the potential scale or size of impact that climate change presents. This unprecedented risk may pose significant challenges to insurance availability and affordability that will demand action from insurers, insureds, regulators and legislators. Not all weather- and climate-related risks are deemed commercially insurable, and catastrophic events often drive public solutions. The great drought and Dust Bowl of the 1930s led to the formation of a federal crop insurance program, and the record-breaking floods of the 1950s and 1960s, some of the largest of which occurred in California, led to the advent of the publicly managed NFIP. Seen as variants of the standard flood risk, the private market has largely withdrawn from insuring mud and debris flows as well as damages from soil subsidence. Today, less than 10% of crop and flood losses are underwritten by the private insurance market. Conventional private insurance contracts only respond to these hazards when the proximate cause is a different insured peril, for example if a wildfire (insured) predisposes a landscape to subsequent flooding, mudflow, debris flow, mudslide, or landslide (CDI 2018).

61 46 Private crop insurance claims in California over Sea-level rise poses one of the costliest the years 2014 to 2017 were $60 million, or 3% of potential risks to the California property the $1.8 billion in federal crop insurance payouts and infrastructure, yet resulting losses for homeowners will tend to fall under the rubric in California over the same period (Figure 22 A). of federal flood insurance. Many commercial The total value of insured and uninsured crop properties either purchase flood insurance or losses in California is not available, and so the have coverage under their general property protection gap in unknown. policies, but total market penetration is unclear. In an example of the allocation of loss burden and risk-spreading for flooding, the California floods of Climate change reduces February 2017 are estimated by National Oceanic insurance availability, and Atmospheric Administration (NOAA) to have adequacy, and affordability an aggregate cost of $1.5 billion, of which only $47 million (3%) was insured under the NFIP, and As the physical risks of climate change become $7.6 million (0.5%) via private insurance (Figure more apparent and more severe, insurers may 22b) (NOAA). respond by increasing the cost of coverage for FIGURE 22 A-B | Public vs. private payouts for crop and flood insurance: California. Source: CDI, and federal insurance program data. Private and NFIP values provided by CDI. Prior years’ data not available.

62 47 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State those risks or removing coverage from the cross-subsidization and bundling of products marketplace altogether. Observers have long and resilience measures to dampen the cost of anticipated that the impacts of climate change will catastrophes for insurers and insureds alike. Finally, drive up insurance claims and costs, potentially legislators could enact new laws addressing coverage withdrawals and price increases (or strengthening leading to higher premiums and deductibles, lower policy limits and restrictions of coverage regulators’ existing ability to do so) and promoting resilient development practices to help maintain (Mills et al. 2006). These concerns have already actuarial validity of lower rates. Elements of this begun to materialize. In response to devastating wildfire seasons in recent years, major insurers approach have been applied for decades in Florida, in California have begun to withdraw from beginning in the wake of Hurricane Andrew. covering properties and significantly increase premiums in the wildland-urban interface area Climate change threatens the basic where destructive wildfires are most prevalent functioning of insurance markets (CDI 2017; Dixon et al. 2018). Insurers have Extreme weather events have been correlated also sought to increase deductibles, with the CDI recently approving “split” deductibles that with the reduction in availability, adequacy, and affordability of commercial insurance in many are higher for wildfire damage than for other damage (CDI 2016a). In other parts of the markets around the world. These reductions are country, premiums have increased radically market responses that climate analysts would refer to as “mal-adaptations,” simply replacing following major unanticipated windstorm losses. one problem with another rather than addressing Some analysts doubt the ability of existing public root causes (Cremades et al. 2018). As a result, and private flood insurance regimes to offer affordable policies in light of the anticipated insurers are experiencing a declining role in helping increased frequency and severity of major storm society manage climate risk. A growing amount of weather- and climate-related losses are not covered and flood events, which the United States may by insurers. Today this protection gap represents be already experiencing (Lamond and Penning- Rowsell 2014, Van Marter et al. 2018; UCS 2014). approximately 50% of losses from weather- and climate-related events globally (ClimateWise 2016). In May 2018, a “1-in-1,000-year” flood hit the same Maryland town twice in two years (Bacon Emerging risks such as those arising from climate engineering and geo-engineering are unlikely to be 2018). accepted by the private insurance market. Reforms both within the insurance industry In California, the effects of climate change on and beyond – including building, land-use, and will be necessary in the availability and affordability of insurance are – policyholder measures order to preserve availability and affordability as on display in the aftermath of the 2017 wildfire 2018). season. Over four million California homes are climate change worsens (Cremades et al. located in the wildland-urban interface, and over These reforms may take many shapes. Planning one million of those are considered high- or very and building code improvements can reduce high-risk for wildfire (Martinuzzi et al. 2010; CDI policyholders’ vulnerability to climate risks, 2017). As the state’s population continues to grow, while action to reduce greenhouse gas emissions these numbers are expected to increase significantly can help reduce the underlying insured perils. Meanwhile, insurers and their regulators could (Mann et al. 2014). CDI reviewed availability and work with local flood control agencies to increase affordability following the record-setting 2017 climate-related data collection and improve risk wildfires and identified a number of problematic modeling and together to incentivize increased trends in the wildland-urban interface, including:

63 48 “For Chubb to continue to offer coverage under climate change conditions, pricing must always be set at sound actuarial rates...” Chubb (2016) et al. 2017). The NFIP, operated under the Federal Reduction in the issuance of new policies and • Emergency Management Agency, provides renewal of existing policies; highly limited homeowners coverage capped at • Significant increases in premiums and $250,000 per claim for a structure and $100,000 wildfire surcharges; • for personal possessions. Commercial coverages Failure to account for homeowners’ are also limited to small businesses, with caps at mitigation measures; Insufficient data and use of best-available • $500,000 each for a structure and the same for models; and contents (FEMA 2017). Insufficient regulatory authority over • Analysis of the NFIP suggests significant insurers’ wildfire risk models and non- renewals (CDI 2017). economic inefficiency and muted progress toward the program’s original goal of reducing flood risk Not only did homeowners insurance non-renewals (Pinter et al. 2017). Nationally, the NFIP takes in $3.3 billion in premiums each year to provide increase in nearly every high-risk California over $1.25 trillion in flood insurance coverage. As county between 2015 and 2016, but consumer complaints regarding insurer renewals and a result of cumulative losses exceeding premiums, premium hikes increased over 200% between 2010 the program was $25 billion in debt by the end of 2016 with an uncertain future. Remarkably, and 2016, demonstrating the long-term nature of these trends (CDI 2017). For one leading insurer, 19% of claims made to NFIP are outside even total catastrophe losses worldwide (including but the 500-year floodplain, which is consistent with not limited to wildfire, flood, drought, and severe long-standing concerns that flood-risk mapping weather, occurring largely in the United States) is seriously outdated and not reflective of current have increased by over 5% more than inflation science. since 2000, a trend which necessarily will be The program has arguably fostered mal- reflected in commensurate premium increases in adaptations, with over 10% of payments ($5.5 order to protect solvency, and which is likely to grow as climate change progresses (Aon Benfield billion) having been made to properties with multiple sequential losses (i.e., four or more 2018). Premiums and deductibles are projected to increase and the market share of admitted claims of $5,000 more or two claims equal to or insurers in many areas of California is expected to exceeding the entire structure’s value). The worst decline under a business-as-usual climate change case on record was 40 claims for a single structure. scenario (Dixon et al. 2018). That a third of premiums are taken as fees by private insurers administering the program In California, more than $500 billion of buildings further compounds the inefficiencies. The federal government continues to subsidize flood insurance and public infrastructure are at risk from flood more heavily than loss prevention. damage, and more than half of Major Disaster Declarations over the past 65 years in the state have involved flood events (CDWR 2013; Pinter California has 240,000 NFIP policies in force,

64 49 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State | Aggregate premiums exceeded B FIGURE 23 | Between 1994 and 2015, FIGURE 23 A only one California county received flood payouts by over $3.5 billion during this period. payouts in excess of insurance premiums. Source: Pinter et al. (2017), with permission. corresponding to about $190 million each year Climate change presents a chronic in premiums, providing coverage for $83 billion challenge to insurability in assets. These values represent around 5% of NFIP policies, assets, and premiums nationally. In a functioning voluntary insurance market, three Between 1994 and 2015, NFIP damage payouts factors define the availability and affordability of in the state amounted to only 14% of premiums insurance: an insurable risk that is quantifiable collected (Figure 23 A), corresponding to over $3 and distributed, an insurable population that is billion paid in excess of claims. In only one year aware of the risk and is willing to insure, and a (1995) during this period did payouts exceed solvent insurer that is willing to insure and can premiums. In aggregate, only Sonoma County has afford to pay claims (Mills et al. 2006; Lamond and exhibited payouts exceeding premiums (Figure Penning-Rowsell 2014). Climate change threatens 23 B). While California has thus historically all three of these conditions. First, it presents subsidized flood risk in other parts of the country, physical risks that may combine or accelerate in rare catastrophic events in the state could result unprecedented ways. Second, political division in unprecedented claims. In any case, given and long time horizons may cloud consumers’ fiscal challenges, the future of NFIP is uncertain, understanding of risk. Finally, potentially massive resulting in risk for state policymakers reliant and sustained losses may stretch insurers’ capacity on federal support for financing these losses. to cover. And as climate change increases the need The additive stress of climate change which is – to maintain insurance coverage, for example by predicted to increase the frequency of torrential increasing the range of wildfires (Cal Fire 2018b), rain events together with storm-surges due to sea- it also increases the cost of that coverage (Mills et – will further challenge NFIP’s viability. level rise al. 2006). In a separate but related phenomenon,

65 50 based reforms that sustain the insurance market must support policyholders while protecting the long-term solvency of the industry. As a primary and ongoing means for achieving these goals, governments and insurers can take action to improve data collection and modeling (in support of more precise risk-based pricing, and to better understand economic losses and risks to uninsured assets) and increase risk management. These efforts will intersect with broader efforts occurring throughout government and markets to understand and limit the impacts of climate change. Such actions would include more thorough analysis of loss data in the aftermath of climate change-driven disasters (such as the ongoing claims climate change not only directly increases cost process following the 2017 wildfires) and linking and need, but it also complicates insurers’ ability of more routine weather events to second-order to model and predict aggregate losses from impacts, such as vehicle accidents. They could also multiple perils over longer time horizons and include improved land-use planning and building their practices for distributing those losses across codes to reduce vulnerability and greenhouse gas parties and time. Climate impacts can shorten the emissions, thereby limiting increases in frequency time between loss events, change the geography and severity of harm (Mills et al. 2006). Existing of catastrophic events, and multiply the correlated insurance models for highly protected risks consequences of individual events (Mills et al. such as energy generation facilities and large 2006). As a result, the increasing exogenous risk manufacturing plants, which can obtain increased to the insurance business model necessarily drives policy limits in exchange for instituting industry- insurers to reduce risk through other means. standard protective measures, may provide an example of how to address increased climate Regulators, insurers, and change-related risks. While these measures may insureds can take actions to protect call on actors beyond the insurance industry and its themselves and the marketplace regulators, improving the physical and locational resilience of structures and communities will be Insurance regulators are concerned about essential to preventing the risks of climate change the availability, adequacy, and affordability from becoming altogether uninsurable. of insurance as the effects of climate change materialize on an increasingly regular basis. Even A separate and more directly applicable set as California and other governments take bold of solutions for insurance regulators involves action to reduce greenhouse gas emissions and requiring or incentivizing increased cross- increase the adaptability and resilience of cities and subsidization and spreading of climate risks. communities, millions of residents and businesses Because increased threats will often concentrate will need to be able to purchase insurance policies in particular areas, sharing risk across low- and that can insulate them from both traditional losses high-risk regions could be employed to moderate and the unprecedented risks posed by climate the most drastic price increases. Better integrating change. The regulatory, information, and market-

66 51 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State flood and fire insurance coverages with other insurance products, or developing community- scale insurance programs may help address issues of availability, adequacy, and affordability (Lamond and Penning-Rowsell 2014). Any such measures, however, could lead to market failure by artificially lowering the cost of building structures in high-risk areas, inadvertently resulting in more high-risk development to the detriment of the state and the insurance industry. Thus, any cross- subsidization or bundling measures would need to be limited to the extent necessary to preserve availability, adequacy, and affordability for current residents without promoting additional coming years, the FAIR Plan model may become undesirable development. Concepts such as an even more essential component of the private the “split” deductible, which allows consumers insurance system to the extent that marketplace to obtain affordable coverage without sending reforms are unable to close the gap between counterproductive price signals on fire risk, are consumers’ needs and insurers’ bottom lines. To instructive in this regard. that end, Senate Bill 1032 (McGuire, Chapter 543, Statutes of 2016) requires insurers to direct holders Legislative solutions may be needed of cancelled and non-renewed policies to the FAIR to preserve availability, adequacy, and Plan, and CDI has acted to require the FAIR Plan affordability to continue issuing policies through recent wildfire events. However, since the FAIR Plan is backed by The California Fair Access to Insurance the potential for assessments on private insurers Requirements (FAIR) Plan, created by the based on their share of the voluntary market, Legislature in 1968, is a private “insurer of last increasing reliance on the part of underserved resort” for Californians who are unable to obtain consumers can have the same net impact on property insurance in the private market due insurers’ solvency, although with the added benefit to factors beyond their control (Cal Ins. Code of pooling risk across all carriers. As with all forms § 10091 et seq.). The FAIR Plan is comprised of insurance, if premiums do not reflect risk, mal- which – of all property insurers in the state adaptations can result. but is are required by statute to participate – subject to regulation by CDI. Similar FAIR Plans In response to the devastating 2017 wildfire season have proliferated around the country as states in California, and anticipated increased risk of seek means to ensure that private insurance is property losses due to climate change impacts in available to all residents. While they provide a coming years, a number of legislative proposals key backstop, experts often characterize them as have been sponsored by CDI to further protect having high premiums reflective of higher risk. consumers in the insurance claims process, which As a result, they effectively solve for availability as of summer 2018 include: but not affordability (Mills et al. 2006). Between 2014 and 2017 the number of FAIR Plan policies (Dodd 2018) would require • Senate Bill 894 in California increased by 36% (Laucher 2018). insurers to a) offer to renew policies for at least As wildfire risk increases in scope and severity in

67 52 Assembly Bill 1799 (Levine 2018, Chapter 24 months after a total property loss; b) offer • 69, Statutes of 2018), signed into law in July at least 36 months to recover living expenses 2018) requires insurers to provide a copy of that are subject to a dollar limit within a policy; complete policy documents to insureds upon and c) allow insureds who have suffered losses request. from declared disasters to combine their policy limits for primary dwellings, other structures, contents, and living possessions and use the • Assembly Bill 1800 (Levine 2018) would require insurers to cover replacement costs combined amount for any covered purposes for a destroyed home even if the policyholder decides to buy or build the new home in a • Senate Bill 897 (McGuire 2018) would different location from the one originally require insurers to offer a payment of at covered by the policy. least 80% of the policy limit for personal belongings without demanding an itemized • (Wood 2018) would Assembly Bill 1875 claim for insureds who have suffered losses require an insurer that does not provide at from declared disasters least 50% extended replacement cost coverage to help direct the consumer to an insurer that • Senate Bill 1291 (Dodd 2018) would require California to implement exam, does. fingerprint-based background check, and continuing education requirements for (Limon 2018) would • Assembly Bill 1923 insurance adjusters, addressing consumer require insurers to facilitate participation in a consolidated debris removal program after a complaints about insurer misrepresentations of the law in the months following the 2017 declared disaster. wildfires. Assembly Bill 2594 • (Friedman 2018) • (Aguiar-Curry 2018) would increase the statute of limitations for Assembly Bill 1772 would require insurers to offer at least 36 policyholder claims against insurers from 12 months to 24 months following a declared months to recover the full replacement cost disasters. of a loss caused by a declared disaster. • (Obernolte 2018) would Assembly Bill 1797 (Levine 2018) would • Assembly Bill 2611 require insurers to provide an updated establish a consumer appeal process for insurer determinations made pursuant to a building replacement cost estimate when a property insurance policy renewal offer is wildfire risk model. issued.

68 53 In addition, Senate Bill 824 (Lara 2018), which CDI supports, would prohibit insurers from canceling or refusing to renew property insurance policies within 12 months after a declared disaster based on the location of the property in an area struck by the disaster, except if the insurer faces insolvency. CDI has also proposed a set of legislative reforms designed to improve the availability and adequacy of insurance in high risk fire areas, including: • Requiring insurers to issue or renew property insurance policies for residents in state- wildfire and other impacts of climate change, identified high-fire risk zones “if the property some combination of these proposed reforms meets specific mitigation and defensible- will be necessary to ensure that all residents and space criteria and any other underwriting businesses have access to affordable insurance. guidelines” which would be issued by CDI; • Offering insurance premium credits to Climate-response strategies policyholders who face significant premium have new and widely varying increases due to wildfire risk and who meet risk profiles mitigation and defensible-space criteria; and Most experts agree that the greatest risk Approving insurers’ wildfire-risk models (used • associated with climate change is procrastination to determine availability and premium levels) or pretending that the problem does not exist. But only if they properly account for property- efforts to secure a transition to a world with less area factors like fuel density, ground slope, risk from climate change also necessarily entail accessibility to emergency responders, and adoption of new technologies and strategies. mitigation efforts (CDI 2017). This transition includes both measures to reduce greenhouse gas emissions and measures to As these numerous proposals demonstrate, no single manipulate the climate itself. The prospective solution exists to address the issue of availability, availability, adequacy, or affordability of insurance adequacy, and affordability in the context of for the latter set of measures is unknown. climate change. Rather, a suite of approaches will likely be necessary, including the non-cancellation The options are not equal in terms of the balance and renewal policies of SB 824 and SB 894, the of potential risks and benefits they entail location-shifting concept of AB 1800, and the (Mills 2012a), an issue that has received little required renewal and premium credits proposed by consideration from the insurance community. CDI. A key common trait among these proposals Public discourse tends to focus on the most is that they not only protect consumers but also optimistic scenarios for implementing new drive risk-reducing behavior through incentives technologies and to downplay not only the to meet mitigation criteria and the easing of potential downsides but also the non-climate- insurance-based restrictions on homeowners related benefits associated with some approaches. moving away from the most vulnerable areas. A more cohesive analysis framework is attainable. As the state continues to experience increased

69 54 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “The traditional insurance model – to evaluate risks and pay-out following a disaster – may no longer be sustainable in a climate-changed world. Exposure to climate risk could simply render large customer segments uninsurable without adaptation.” ClimateWise (2017a) technologies improving resilience to wind and fire Climate mitigation strategies currently undergo hazards. economic and engineering analyses, but they are not consistently subjected to rigorous risk Other “upstream” approaches to climate change assessment and risk management. Assessments by the insurance industry are critically important mitigation involve removing greenhouse gases in this process because insurers can provide a at the point of release or extracting them from dispassionate view and internalize the costs the air. One of the geoengineering strategies that some leaders advocate involves dumping massive of risk through pricing. Insurer engagement quantities of iron filings into the oceans so as to is also desirable, as the public sector may be “fertilize” algae blooms that would in turn absorb forced to assume many of the risks associated carbon dioxide and sink with it to the bottom of with emerging technologies if insurers opt out. the sea. The practice of capturing carbon dioxide After all, a century of dangerously blending technological enthusiasm with lack of care in when it is created at power plants and injecting it into the earth for long-term storage has been assessing the comparative risks of energy and under development for decades and deployed land-use choices ushered in today’s climate crisis. Continued inattention threatens to saddle society at scale in some cases. Insurers have cautiously assessed the many risks associated with drinking with new risks from poorly prioritized efforts to solve the climate problem. water contamination or accidental release in connection with this process and have guardedly A strong industry has emerged to deploy proposed criteria under which the practice can and cannot be insured. It is not yet clear that the emission-reduction efforts on the energy market will respond. demand side, focusing on everything from energy efficient technologies to solar panels. Hundreds broadly termed of billions of dollars are already being spent The most herculean approaches – seek to cool the – and invested annually in these pursuits. While “Solar Radiation Management” climate by, for example, continuously injecting specific new risks introduced in this process are large amounts of particles high in the atmosphere broadly deemed insurable (and indeed create new to dim the Sun’s energy. The risks are numerous market opportunities for insurers), it is prudent and significant, such as curtailing the yields of to heed unintended adverse outcomes such as American agriculture or disrupting the Asian moisture problems created by improperly applied monsoon and drying out water supplies for insulation or air-sealing strategies. Meanwhile, there is a large body of evidence that many hundreds of millions of people. While insurers are green technologies in fact enhance resilience unlikely to deem the risks insurable, they will be (Mills 2012a). Examples include battery-backed saddled with the downstream losses and broader solar systems keeping power on during grid market disruptions that could ensue, which, in turn could trigger property, professional liability, outages, occupants of efficient buildings being less susceptible to urban heat mortality or or directors and officers liability claims. morbidity, and certain efficient building envelope

70 55 From Reactive to Proactive: A Return to the Industry’s Roots in Loss-Prevention The risk landscape is as old as insurance itself, but it has become more challenging with larger scales and less predictability of hazards posed by climate change. Insurance loss prevention goes back to the founding of the industry (Mills et al. 2001). For example, Lloyds of London was founded around the goal of preventing piracy and other mishaps at sea. Early home insurers also founded fire departments and dispatched firetrucks to insured locations when needed in addition to providing risk management advice. More recently, insurers have engaged as proponents of improved building codes and zoning. Underwriters Laboratory (which was supported by the insurance industry in its early days) tests and rates consumer products to help mitigate electrical hazards, while the Insurance Institute for Highway Safety studies airbag design and other driving safety strategies. Insurers clearly have the tools to address risk well beyond the insurance product itself. Climate change – particularly with the many simultaneous and correlated risks it presents – is more daunting than traditional hazards. Many early insurer responses are highly reactive in nature (hollowing out coverages, expanding exclusions, raising premiums, and withdrawing from markets) rather than working to eliminate the roots of losses.

71 56 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “With increased resilience fewer assets are likely to become uninsurable, thereby helping to maintain or improve overall insurance penetration...” CISL (2016) Proactive efforts being taken by the most forward- Enhancing climate resilience looking insurers and insurance organizations focus will reduce future losses more on anticipating these risks and proactively implementing physical (as distinct from financial) While the roles insurers might play in addressing upstream loss prevention, primarily in the case of the causes of climate change by reducing commercial risks. greenhouse gas emissions have long been discussed, only relatively recently has the focus The broad categories of potential insurer response expanded to include large-scale improvements begin with engaging in fundamental and applied in resilience to impacts that will not be avoidable climate science and modeling to better define (CISL 2017). Insurers are well aware that resilience climate risks and pathways to adaptation. This is highly relevant to their core business and that, informs the process of identifying and making indeed, it is critical to maintaining insurability in more transparent the risks themselves as well as the face of increasing hazards and uncertainty due efforts to address them through a formal disclosure to climate change. Industry thought leaders based processes. These are increasingly followed by efforts largely in Europe have produced assessments of to “decarbonize” insurer investment portfolios resilience and the opportunities for enhancing it and other assets, which some insurers believe (CISL 2016). brings the dual benefits of accelerating the clean energy revolution while lowering the risk of assets Acting alone, insurers are constrained when becoming “stranded.” Insurers and their regulators it comes to enhancing resilience. They do not are slowly working to integrate risk analysis into build infrastructure or make proactive day- financial stress testing to, in turn, help quantify to-day operational decisions regarding hazard the imperative for loss prevention. With this management. Nor do they have responsibility for information in hand, insurers are returning to promulgating building codes or land-use planning their roots and embarking on efforts in their core or constructing defenses against hazards. business to proactively improve climate resilience. Nonetheless, insurers are major stakeholders, Many insurers have also introduced “green” and have many skills and resources that could be approaches into their core products and services. brought to bear together with their significant Most of the promising efforts involve partnerships influence in the marketplace through their with other stakeholders. European and Asian core business and central role in global asset insurers are the primary centers of innovation, management. as well as U.S. subsidiaries to offshore insurers. Addressing investment portfolios is arguably Insurers are taking progressive steps to help better easier within the insurance business model, as they assess and enhance resilience, typically triggered are a “shared service” across the enterprise with by unexpectedly large loss events (Cremades et more centralized decision-making. Innovation al. 2018). These begin with efforts such as more in underwriting is more decentralized and more precisely mapping risk; identifying resilience institutionally challenging.

72 57 strategies that can help minimize impacts on insurance availability, adequacy, and affordability; and collaborating with public and private stakeholders to develop innovative responses. An important caveat is that complacency can follow these steps as a false sense of security creeps in, leading to a repeat of the cycle. and other technical capabilities improve, practical applications are emerging for differentiating risk The diversity of resilience vulnerabilities (and at the level of individual properties. Credit rating corresponding opportunities for fortification) agencies are signaling similar concerns at the city is overwhelming, ranging from the scale of scale, as they take climate change vulnerability into individual buildings to entire urban landscapes, account (Moody’s 2017). to communications systems, to ecosystems from which economic (and often insured) resources or At the same time, individuals and institutions services are obtained. Often those impacted are face similar barriers to building resilience as they not those who were in a position to avoid the do energy efficiency. These include large upfront hazard in the first place. Benefits of resilience investment for uncertain gain, lack of financing, improvements accrue to policyholders and non- dual-agent issues such as owners and occupants of policyholders, creating a sort of “tragedy of properties having conflicting objectives, and the the commons” dynamic that has undermined general hazards of complacency and the invisibility many other environmentally and public health- of risk. and safety-oriented initiatives. There can be a misperception that insurers face an economic Through the Cambridge Institute for Sustainability tension between the lower losses that resilience Leadership (CISL), forward-looking insurers have may achieve and the correspondingly lower proposed a combination of augmenting existing premiums that reduced risk invites (CISL 2016), know-how and expertise with resilience-enhancing when in fact loss-prevention is a core principle service delivery (CISL 2016). They propose in insurance and risk management practice and leveraging existing industry expertise to provide pricing. Particularly in the face of climate change, novel resilience services, such as: risks are rising and prices cannot necessarily remain in step without erosion of market Core business penetration and thus profitability for insurers. Thus, investments in resilience can maintain Appraisals to identify issues upfront and • market size and scope for insurers as much as they reward improved valuation, for example via manage physical risk for insureds. In addition to premium credits which induce insureds to mitigating losses and averting potential market invest directly in enhancing the resilience of contraction, resilient investments stand to their own properties diversify an insurer’s portfolio and build good will Rebuilding to a higher level of resilience • in the marketplace. following loss (fortifying and/or relocating), rewarded with risk-adjusted premiums The issue has not gone unnoticed by the real Mutual insurance pools where members share • estate appraisal industry, which has begun to both profits and losses, allowing multi-year recognize that hazard exposure coupled with financing and confidence that premiums poor resilience can erode property values (Curry reflect losses et al. 2016, Finlay et al. 2018). As remote sensing

73 58 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State climate risks and associated loss-prevention Asset management strategies (with a primary focus on electricity Screening security and bond investments for • sector as a common risk to virtually every type vulnerability/resilience attributes, investing/ of business). An analogous U.S.-based example divesting as appropriate is the RainReady program offered by the Center Directly investing in resilience enhancements • for Neighborhood Technology to address flood to human settlements and drought risks at a community scale. To have • Developing and/or investing in green bonds material impact, such initiatives must be highly to finance resilience scalable. Customer interaction There is also evidence of this thinking within the public insurance programs and by outside Customer education • observers (Pinter et al. 2017). The NFIP has Developing a definitive resilience rating • demonstrated an ability to utilize premium system with multiple applications reductions to reward loss-prevention efforts. The • Providing data and services to assess community of Avalon, New Jersey was awarded vulnerability/resilience a 25% average reduction in flood insurance premiums in recognition of extensive efforts While these proposals offer the potential to to improve resilience recognized by NFIP’s improve the market environment, fundamental Community Rating System (CRS), which are questions of funding and finance, risk assumption, expected to translate to over about $1,500 per year and regulation remain. per household (ABN 2013). Roseville, California was the first jurisdiction to receive a CRS Class-1 Insurers are pursuing a variety of climate- rating – the highest rating possible, corresponding adaptation areas that focus on research and to nearly $1,000 per year per household in average analysis. A long-standing example is Swiss Re’s premium reductions – while Sacramento County “Economic Analysis of Climate Adaptation” achieved a Class-2 rating and $400 per household activity (Swiss Re 2009) which models location- per year reductions (FEMA 2017). These ratings specific options for individual firms or regions were achieved in part because the state adopted and ranks them by cost-effectiveness. In another the International Building Codes. example, Canadian insurer Intact Financial (the largest property and casualty insurer in the Insurers’ asset management practices have country) opened the Intact Centre on Climate traditionally been decoupled from goals of the Adaptation in 2015 as a collaboration with the core business (other than avoiding correlated University of Waterloo. Intact describes the risks). The most innovative insurer climate initiative’s focus as “de-risking Canada from the risk-reduction strategies focus on finance, not financial, physical, and social impacts of climate underwriting. Significant capital is required to change by providing cost effective guidance to enhance resilience, both at the individual customer Canadians on how to adapt to extreme weather” level as well as at much larger scales. One proposal (Intact). Specific activities include on-site involves “Forest Resilience Impact Bonds,” which assessments to help homeowners identify and would fund restoration and management of mitigate basement flooding risks, developing forests in the western United States with the a national wetlands retention and restoration goal of minimizing wildfire risk and improving program to reduce community-level flood risk, watershed management (Madsbjerg and Connaker and a program to engage businesses in identifying 2015). Under the proposal, the U.S. Forest Service

74 59 “[T]he Company’s catastrophe models may be less reliable due to the increased unpredictability, frequency and severity of severe weather events or a delay in the recognition of recent changes in climate conditions.” Travelers Insurance Annual Report (SEC Form 10-K) 2014. One of the greatest climate risks faced in would pay a fee based on the projected savings in firefighting costs and water and electric utilities California and many other parts of the world is torrential rain followed by flood. Combining would pay fees based on benefits accrued to them. Unfortunately, these types of projects may have risk reduction (as in the Yucatán example) with insurance could reduce risk in the California excessive correlated risks for property insurers across the underwriting and asset-management context. Researchers point to a body of thinking sides of the companies. However, the risks for life that, when unified, could link modeling with in- insurers should be sufficiently independent from field sensor networks in support of parametric those in their core business to allow investment insurance products placed at the community scale with risk spreading to the property and casualty (with claims paid when measurable event trigger business. Insurers could engage as designers, levels are surpassed) together with proactive issuers, and investors in such instruments. finance of resilience enhancements that could provide enhanced flood risk management at One example of a coastal resilience project focuses lower cost than today (Schaefer 2017). Such on storm surge risk reduction via coral reef enhancements could include wetlands protection and restoration, forest management to reduce protection and restoration. Coral reefs provide – important “ecosystem services” by protecting runoff, or flood defenses. Resilience bonds beaches and land-based infrastructure from storm coupled with reduced insurance premiums thanks surges, estimated to avoid $4 billion in flood to the loss reduction potential of investments made with the bonds – could be placed to fund damages each year globally, while also providing a base for tourism in many areas (Beck et al. loss-prevention investments at the community 2018). Public and private interests along a 60- scale, helping to achieve insurability at a cost- 4 km stretch of the Yucatán Peninsula of Mexico, effective level (Vajjhala and Rhodes 2015). which includes the major resort city of Cancún, established the Coastal Zone Management Trust In California, mudflows and landslides are to fund projects to protect coral reefs and others sometimes insured through publicly managed geologic hazard abatement districts (GHADs), to help restore them after damaging storms. Tourism brings $10 billion per year into the 35 of which have been created across the state in area. Some of the funds will be used to buy a response to the lack of conventional insurance availability. GHADs place strong emphasis on new parametric insurance product designed by pre-event risk mitigation, funded through special Swiss Re, with payouts triggered by storm events property-tax assessments. exceeding specified wind speeds (around Category 4) in designated areas. Participants include local It has been proposed that resilience bonds be used in tandem 4. hotel owners and other segments of the tourism with catastrophe (CAT) bonds such that the CAT bond holds funds in a collateral account in the event of a major loss event, industry, The Nature Conservancy, scientific paying interest and coupons to the owner and being returned to experts, and state government. Restoration will the owner if no such event occurs. When coupled with a resilience bond, the CAT bond payments made by the potential beneficiary reduce beach erosion during future storms and are reduced (a “resilience rebate”) and that amount redirected to resiliency investments. protect coastal infrastructure as well (TNC 2018).

75 60 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State | Three scenarios of California grid disruption due to thunderstorm. FIGURE 24 A-C. 1:100 event - 1:200 event - 1:200 event - 609k people without power 935k people without power 935k people without power Shading density represents the fraction of a given ZIP code without power in the model results. Hartford Steam Boiler / Munich Re. Source: – An important precedent in the industry for these created over time from hurricane, to electrical sorts of proactive loss-prevention approaches is blackout, to pandemic – thanks to improvements commonly referred to as a “highly protected risk” in computing power, event-based databases, and more. Insurers and policymakers use the results business model, in which the insurer provides detailed and customized loss-prevention advisory of these increasingly robust models to better services to the insured, together with preferential understand underwriting risks. However, leading rates for implementing approved best practices. insurers still perceive “non-modeled” gaps in climate-change-related risk assessment (e.g., Expanding this approach to a larger scale, in concerning perils such as flooding, sovereign credit which property-level as well as community-level risk, shared infrastructure failure, and business resilience enhancements are made in partnership interruption [Chubb 2016]). Climate change only with insurers, may be an opportunity for adds uncertainty to the modeling process. insurers and insureds to increase resilience. In any case, appropriate reserves would need to be maintained for rare, catastrophic loss events. Power outages have been shown to produce high insured losses, both for homeowner and commercial lines policies (Mills and Jones 2016). Hartford Climate science, hazard Steam Boiler Inspection and Insurance Company has developed special-purpose models that simulate modeling, and risk the impacts of extreme weather on grid reliability assessment can be usefully at the zip-code level. Results for California show integrated the potential for over a million people without power from events such as thunderstorms (Figure Over the past few decades, private modeling 24 A-C). This type of analysis is notable in that firms and actuarial departments of the insurance it characterizes risk at scales useful to planners industry have developed powerful catastrophe and policymakers. Applications for insurers occur (CAT) models. Peril-specific models have been when a specific book of business is assessed within

76 61 “Climate change represents a long-term peril to our planet... A pragmatic current message for actuaries is for them to recognize that climate change represents an additional source of uncertainty in future mortality rates and to consider its implications for the assumptions they make and communication of the associated uncertainty to their clients.” International Actuarial Association (2017) the overall risk landscape and evaluated with wildfire models used by insurers in the California context revealed a number of specific concerns respect to the type of impacts and nature of losses (e.g., property versus business interruption). (CDI 2017). Among these, the models did not accurately characterize vulnerability of the building stock and the extent of mitigation around given Leading modelers have engaged with the climate science community and are striving to incorporate properties or broader community-scale efforts to manage risk. Thus, underwriting and rate-setting emerging research in their models. However, regulators generally do not allow forward-looking may be done with inadequate levels of precision, projections to be used in ratemaking, thus which can prompt overly conservative decisions limiting the perceived utility of forward-looking on the part of insurers about whether or not to modeling to insurers. Other stakeholders with retain a given customer. There are no mechanisms in place to ensure wildfire model quality. Further longer time horizons, such as urban planners and complicating matters, that individual insurers emergency relief organizations, have clear use for such analyses. issue limited numbers of policies in some at-risk areas erodes their ability to accurately quantify risks based on loss experience. The scientific community continues to find deficiencies in models. For example, researchers Efforts to improve these models are ongoing. have shown how the failure to include soil More transparency and independent peer review subsidence in sea-level rise modeling severely underestimates the risk (Shirzaei and Burgmann can improve models, as has been pursued for 2018). Following Superstorm Sandy in 2012, hurricane models in Florida and South Carolina analysis showed that some of the greatest health (SCDOI). Florida has gone a step further to create and welfare impacts were caused by factors that a public hurricane model (FLOIR b). Swiss Re has noted that it currently depends on U.S. flood officials had not modeled, such as the vulnerability models that are not sufficiently maintained and of electricity generators that were below sea level updated (Ball 2015). It has since developed a (IAA 2017). higher resolution model and with it is offering private insurance and reinsurance (Swiss Re). Over-reliance on imperfect models can create Chubb is developing flood risk management tools blind spots. In the California context, this is (Chubb 2016). particularly important with respect to wildfire and its consequential impacts. The 1991 Oakland It is important to note that non-insurers also Hills and 2017 Coffey Park fires were not only develop powerful natural hazard models. For outliers (Figure 9) in terms of insured losses, they example, the State of California, through the were also not anticipated in the wildfire models Central Valley Flood Evaluation and Delineation prevailing at the time (Daniels 2018; Muir-Wood Program (CVFED), has invested millions dollars 2018), likely a reflection that windblown embers were not well characterized in the prevailing in modeling the flood risk associated with the State Plan of Flood Control levees. models (Muir-Wood 2018). Examination of the

77 62 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “What we will need are forward-looking stress tests assessing the comprehensive interaction between climate change and assets and liabilities.” Bank of France Governor Villeroy de Galhau Financial Times Interview, , April 8, 2018 Insurers and their actuarial societies are 2001), and helped gather data and case studies contributing expertise on climate change impacts and mitigations. Four North American actuarial societies Insurers have also engaged directly in climate have developed a climate index which they science and analysis. For example, Munich Re has for decades amassed and made publicly update quarterly (Figure 25). This is based on a methodology that combines indicators for available unique data on regional and global insured and uninsured losses from climate and temperatures, rainfall, soil moisture, wind, and weather extremes (examples are seen in Figures sea levels (AmAA et al. 2018). The group is now developing a second index relating extreme events 4 and 5). The U.S.-based Insurance Services Office provides similar data for the United States on a to impacts with insurance relevance. proprietary basis. Some insurers have conducted or funded climate-related research and have Other actuarial organizations have examined the implications of climate change for the life/ participated in the work of the Intergovernmental health side of the insurance industry (IAA 2017). Panel on Climate Change (Vellinga et al. FIGURE 25 | Insurance-relevant climate index developed by actuarial societies for the United States and Canada. Source: Actuaries Climate Index (, sponsored by the American Academy of Actuaries, Canadian Institute of Actuaries, Casualty Actuarial Society and Society of Actuaries, used with permission.

78 63 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “We believe that the annual probability of a U.S. mega-catastrophe causing $400 billion or more of insured losses is about 2%... much – indeed, perhaps most – of the p/c world would be out of business.” Warren Buffett 24, 2018. Berkshire Hathaway Annual Letter to Shareholders, February correction. Rare years of extreme weather events Bringing it all together: could also coincide with major non-climate-related Stress testing and enterprise loss events such as earthquakes or pandemics risk management imposing large healthcare costs. Stress testing is essential to understanding While the magnitude of probable worst-case losses risk, particularly when underlying hazards are has progressively been revised upwards over time, in flux. Underwriting and modeling are used by the industry has not always been fast to support insurance regulators and insurance companies greater analysis. A report commissioned in 1986 to identify and quantify current and prospective by the All-Insurance Research Advisory Council risks and to develop mitigation practices. Stress (AIRAC, now the Insurance Research Council) to testing compares expected losses to collected estimate the industry-wide effect of two $7 billion and reserved premium funds and investment hurricanes (AIRAC 1986) was considered by some practices in order to ensure that adequate funds to be a frivolous exercise (Mills et al. 2001). Today are sufficient in both amount and liquidity to such storms are regarded as relatively standard pay losses at the point in time when they are events, although it is remarkable that subsequent forecast to manifest. Designing an effective publicly available industry-wide studies like stress-testing methodology and implementing AIRAC’s have not been conducted over the ensuing it requires scenario analysis, stress modeling, 30 years. investigating and developing clear definitions of risks, recording and reporting data, and open The types of risks that need to be taken into discussion with internal and external parties. consideration in stress tests are underwriting risks; catastrophic risks related to exposure Ideally, stress tests reflect all simultaneous and resulting claims; externalities including stresses across the insurance enterprise but not limited to market risks in terms of price and the multiple geographies in which shifts and economic downturns; credit risks of they operate, including broader market all types; liquidity risks of all types; operational conditions influencing the insurance business risks if systems fail or procedures in place are environment. A hypothetical example would not adequate; and finally group risks associated be one or more consecutive years with record- with membership of certain parties resulting in breaking wildfires in the West, coupled with an liabilities and obligations being unfulfilled (IAIS occurrence such as multiple hurricanes making 2003). A drought stress-test model applied to landfall in major cities along the Gulf Coast, nineteen industry sectors in the United States and large losses associated with climate change other countries found erosion of creditworthiness litigation decisions, the introduction of new of bank loans and increased default risks (NCFA carbon taxes, or a major downward stock market 2017). Affected industries included water supply,

79 64 the annual ORSA modeling process, HealthNow agriculture, power generation, food and beverage performs stress testing on the company’s top production, and petroleum refining. Insurance enterprise risks, but does not count climate industry modeler Risk Management Solutions change among these. Another company, (RMS) participated in the work. HealthPartners, has identified three specific risks that climate changes could pose to its business. In 2013 the North American Chief Risk Officer (CRO) Council, the CRO Forum and the • International Actuarial Association published a The proliferation of pandemic pathogens that could result in additional member volume on stress testing (PwC 2016). According to claims and employees becoming too ill to PwC, “[f]rom a regulatory perspective, the NAIC Own Risk and Solvency Assessment (ORSA) calls process claims. A large influx in claims arising from tornados • for a prospective solvency assessment to ascertain or other catastrophic weather events. that an insurer has the necessary available • capital to meet current and projected risk capital An growth in cases of asthma or other chronic illnesses (NAIC survey results 2016, requirements under both normal and stressed Q.6, Row 1175). environments.” PwC conducted a survey with 55 U.S. insurers and concluded that stress testing This response suggests that the company would greatly benefit from additional efforts. One recommendation is a more robust stress testing monitors changing health patterns of its members and takes these patterns into account platform (PwC 2016). during underwriting and product development, but no computer modeling or actual stress testing In North America, stress testing practices remain somewhat opaque. Only a handful of insurers appears to be involved. responding to the NAIC survey offered substantive insights into their stress-testing practices with A number of other insurers’ responses to the respect to climate change. None were robustly 2016 NAIC survey offer insight into the range of stress testing activities currently in practice. responsive to the spirit of the questions. There may exist real or perceived conflicts of interest The Hartford Insurance Company of Illinois established a committee to assess and manage in disclosing in-house stress modeling details the company’s risks at multiple levels (NAIC to regulators, which in turn may affect the availability and transparency of data in making survey results 2016, Q.6, Row 1052). informed decisions by other parties such as A good example of the use of computer modeling investors. However, in many ways the practice is no different than that followed by accountants to with respect to stress testing is Utica First Insurance Company. It uses catastrophe modeling certify financials for the purpose of reporting to shareholders and regulators. to evaluate risk aggregation using distance from the coast as criteria. For stress testing, the Some health insurance companies consider company specifically assesses the overall impact themselves least likely to be affected by climate of two, 1-in-100 year hurricanes taking place in the same year as the company’s largest climate- changes, although some insurers may be starting to model or test the risks. According to the 2016 related loss exposure. NAIC survey, HealthNow has implemented an incident triage team as part of the business An elaborate stress testing model was developed continuity program, and can invoke established by Metropolitan Life Insurance Company disaster recovery plans and tactics. Also, through (MetLife). MetLife uses three independent

80 65 catastrophic models. To begin with, the company The Florida Office of Insurance Regulation issued uses precise property locations, with geo-coding a data call for catastrophe stress test analysis to street locations in nearly all circumstances. The in 2015 which evaluated insurance companies’ company reviews both historical and anticipated ability to absorb specified hurricane scenarios. The near-term hurricanes with and without demand participating insurance companies were required surge and storm surge. All three models generate to provide data showing how their surplus position results for five distinct hurricane regions. The would be affected by one or more historical storm company reviews results for deterministic events scenarios in terms of a company’s capital and surplus (FLOIR a). and stochastic events for high return periods If more state regulators follow ranging from 1-in-100-year to 1-in-2000-year the example set by California and Florida, insurers may begin to engage in more consistent stress probabilities. These events typically produce higher losses than losses that have previously testing and related analyses. resulted from storms. With this in mind, the company manages with the assumption of conservative return periods and obtains property catastrophe reinsurance based on near-term expected losses (NAIC survey results 2016, Q.6, Row 384). Riverport Insurance Company investigates the possibility of “model miss” within vendor catastrophe models. For instance, the company compares modeled industry losses to revalued historic losses. The company investigates separate sub-components in the model. It also evaluates stress testing components related to the frequency and severity of occurances (NAIC survey results 2016, Q.6, Row 382). This is a very constructive use of the stress testing paradigm. The potential devaluation of assets (i.e., transition risk) is not mentioned in NAIC disclosure responses regarding stress testing. Similarly, minimal indication is provided of health impacts being assessed.

81 66 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State From Risk to Opportunity: The Greening of Products, Services, and Investment For the past several decades insurers have, somewhat quietly, been fielding an array of “green” activities (Mills 2012b). The Green Insurance Data Service is the largest repository of this information and has been updated to reflect recent innovations by 504 insurers and associated entities in 51 5 countries, which collectively number over 1,500 initiatives globally. These efforts span a range of activities, including innovative products and services, leadership by example in “greening” operations, disclosing risks, promoting loss prevention, engaging in climate science and communications, direct investment in or financing of climate-change solutions, and expressions in public policy forums. Many of these efforts have been spurred by technology developments such as the advent of new energy-efficient and renewable technologies, telematics for tracking vehicle data, distributed sensors, GPS and sophisticated satellite data acquisition, the Internet of Things, and drones. CDI’s Climate Risk Carbon Initiative and the NAIC survey both create opportunities for insurers to provide information not only on risks and vulnerabilities, but also on proactive efforts being made to respond to climate risk. We draw from these and other sources for the following discussion. Table 2 outlines in greater detail the constellation of ways that insurers around the world have engaged in the assessment and development of responses to the risks of climate change and Figure 26 A-B indicates the level of engagement for the U.S.-based insurers (most of whom do business in California) compared to those in the rest of the world. U.S. insurers are 5. To access the database, see

82 67 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State reasonably well represented among those crafting innovative insurance products and in-house energy savings programs and have far outnumbered global insurers in the divestment of fossil fuel investments. They have been under-represented in areas such as public commitments to substantive goals, voluntary 6 engaging in climate science, investing in climate-change solutions, and providing climate risk disclosure, finance for customer-side emission-reduction projects. Categorization of insurer climate-response strategies. TABLE 2 | An increase in chronic illness such as asthma (NAIC survey results 2016, Q.6, Row 1175) • • Cross-cutting corporate initiatives Public Commitments to Institution of an enterprise risk management approach to climate change mitigation and adaptation • Substantive Goals Participation in industry consortia to advance best practices • Corporate Social Responsibility (CSR) and Environmental, Social and Governance (ESG) reporting • Analyzing loss trends and assessing vulnerabilities to future climate change • Engaging in Integrating climate change into traditional catastrophe modeling • Climate Science and • Performing technical or market research on green technologies and climate change solutions Communications • Traditional risk management approaches to reducing climate risks, like improved building codes • Improving land-use planning vis-a-vis changing climate risks • Integrating energy management and risk management perspectives Promoting Loss Prevention • Better management of forestry, agriculture, and wetlands and Adaption “Rebuilding right” following losses • Technology development • • Mileage-based vehicle insurance Incentivizing use of public transportation • Rewarding Risk-Reduction Assigning directors and officers liability with respect to climate risk • Through Policy Terms • Recognizing and rewarding correlations between sustainable building practices and a low risk profiles • New insurance products for energy service providers Energy-savings insurance • • Innovative renewable energy project insurance Crafting Innovative • Green-buildings insurance Insurance Products • Preferential terms for low-emission vehicles • Insurance for the developing world (e.g., micro-insurance) • Sustainable energy system technology warranties • Energy audits or carbon-footprinting services Providing Technical • Engineering services for project development Services Performance benchmarking and rating • Climate risk management services • • Carbon trading risk management Offering Carbon Risk • Managing risk for Clean Development Mechanism (CDM) and carbon-offset projects Management or Offsets • Enabling customers to purchase carbon offsets • Targeted lending for carbon-reducing projects or resilience enhancement Enhanced Customer • Targeted lending for resilience enhancements Projects Investment in capital projects that reduce greenhouse gas emissions • • Investment in bonds or equities that are screened to include climate change solutions Investments in Climate • Divesting from polluting industries Change Solutions • Green buildings development Disinvesting from Fossil- Fuel Investments Un-Insuring Fossil-Fuel Risks • Providing climate change information and education Building Awareness and Participating in the formulation of public policy • Participating in Public • Endorsing voluntary energy-saving policies Policy • Promoting energy-efficiency codes and standards Leading by Example: In- In-house energy/carbon management • House Carbon and Energy Sustainable operations • Management • Disclosure to regulatory agencies: CDI and the U.S. Securities and Exchange Commission (SEC) Disclosing Clinate Risks • Disclosure to investors: CDP, ShareAction, PRI, and more Source: Mills and EA 6. These refer to the global CDP and other similar surveys. Mandatory disclosure has subsequently been required in California and several other states.

83 68 Insurer activities in assessing and responding to climate change risk (top) and | FIGURE 26 A-B detail on innovative products and services (bottom). Source: Mills and EA. Green products and services create business the overall dollar value of such investments (Mills opportunities and emission reductions. Among 2012b, with updates for this report). these, U.S.-based insurers have engaged in more than half of green buildings activities globally, and The global insurance industry’s relative emphasis are relatively well represented when it comes to on these types of products and services is indicated mileage-based insurance products and specialized in Figure 26 B, which also shows the focus of insurance for renewable energy projects. Conversely, U.S.-based insurers, indicating a strong focus they are virtually unrepresented in offering finance on technology and energy, with less on climate of customer-side climate mitigation improvements change adaptation. A cross-cutting theme that can be observed is a trend toward the provision and in micro-insurance for emerging markets. While their level of direct investment in climate of services as distinct from isolated products or solutions is low by count, they represent a very changes to insurance terms and conditions. substantial portion (approximately one-third) of

84 69 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “I believe there is an urgent need to address the current mismatch between the need for sustainable investment activities on the one hand, and a limiting regulatory environment on the other.” Stephen Catlin, Special Advisor to XL’s Chief Executive Officer, XL Group plc ClimateWise Insurance Advisory Council website. Some broad categories of green products and Insuring performance of clean energy • systems: services that have been brought to market include: A major barrier to the market penetration of solutions for reducing • Rebuilding to a higher level of energy greenhouse gas emissions is uncertainty Through the performance following loss: about the energy output of renewable energy payment of claims, insurers in effect finance systems (such as wind, solar, and geothermal) hundreds of billions of dollars each year in or energy savings achieved by major energy retrofits in buildings and industry. Hartford restoring damaged property, much of which can be improved and made more energy efficient Steam Boiler and Allianz are among the upon reconstruction. The former Fireman’s insurers who have brought products to market that indemnify for losses related Fund (absorbed into Allianz), Chubb (owned to output, delivery, or performance failure by ACE), The Hartford, Travelers, Farmers (owned by Zurich Financial), and many other in energy markets. Performance insurance can improve credit ratings for project carriers have offered “green reinstatement” developers, thus reducing borrowing costs. coverages, which can include green building elements as well as ancillary costs such as those • Aligning terms and conditions with for design or certification of green features. Green practices can be less reduced risk: prone to loss. Mileage-based insurance (also • Energy and carbon risk management services: known as pay-as-you-drive insurance or Insurers have fielded a variety of PAYD) and premium credits for using public services to provide support for climate change mitigation and adaptation. Broad categories transportation are two examples in which driving risk aligns with environmental of such efforts include clean energy system benefits. Companies offering mileage- opportunity assessment, design, carbon based insurance in California include: footprinting, risk assessment, and financing. AAA, Allstate, CSE Safeguard, Esurance, Among U.S.-based insurers, Allstate offers an online home energy calculator, ACE offers Metromile, Pacific Property and Casualty, Sequoia, and State Farm. Vehicle monitoring green building certification and carbon technology (“telematics”) can also enable footprint calculation, Hartford Steam Boiler/Solomon offers energy benchmarking more precision pricing as a function of day for oil refineries, Chubb offers infrared versus night driving, patterns of braking camera scans to find energy loss and fire and accelerating, and speed. Estimates of the potential for national gasoline savings hazards, Marsh offers geothermal energy exploration risk advisory, Chubb offers due to mileage-based insurance programs range from 8% to 20%, which could achieve biofuel project risk assessment, and Chartis 140 to 257 million metric tons of carbon offers wind turbine loss-prevention services. dioxide emission reductions annually in the United States depending on the scale of policy

85 70 change. For example, coverages are available to implementation (Greenberg and Evans 2017). individuals and businesses that: replace ENERGY STAR or equivalent energy efficient materials; • Climate resilience services and financing: provide rebuilding costs for Leadership in Scaling up traditional localized loss-prevention Energy and Environmental Design (LEED®) practices such as safety inspections, leading certified and non LEED certified buildings and insurers are developing offerings at the city mobile energy properties; address the unique and regional scales. Their roles can range from risks faced by homeowners who generate their modeling and risk assessment to advice on own power and feed surplus energy back into adaptation measures to financing through the local power grid – including lost income instruments such as catastrophe bonds generated from selling surplus energy back to formally linked to resilience investments. the grid; and, compensate for direct physical loss A case in point is Santam Insurance’s or damage of a physical asset that is collected partnership with various NGOs to address to create carbon offset credits. Additionally, rising fire, flood, and coastal risks by providing professional liability coverages are available for community-level education and awareness registries that track, confirm, and verify carbon programs across multiple municipalities, offset credits as well as for claims which may donating firefighting equipment, and arise from greenhouse gas consulting services supporting improved flood-risk mapping or emission reduction verification services. in South Africa (ClimateWise 2017b). Protection and repair of ecosystems • Some insurers believe Swiss Re is damaged by climate change: investment in climate solutions working with public and private stakeholders diversifies assets and supports to craft insurance products to rebuild coral reefs after major storms, which in turn protect emission reductions coastal settlements and the tourism industry. It remains to be seen whether these types of While significant focus has been placed upon projects will be scaled and replicated. assessing climate risk in the asset side of insurance companies, some insurers have also elected to AIG’s summary of their current offerings (per invest in activities and industries poised to help their response to Question 6 of the 2016 NAIC address climate change. This practice began among survey) illustrates the breadth of ways in which a European insurers in the mid-1990s and gradually single insurer can engage: spread to Asia and North America. With the global industry’s $30 trillion under management, there is As part of AIG’s vision to contribute to enormous potential for aligning asset management the growth of sustainable, prosperous with risk management in the core business (CISL communities, one of its initiatives is to increase 2016). social resilience against extreme weather events by developing and implementing insurance An early example was AXA’s CleanTech fund, which solutions... AIG provides a range of products invested in companies developing technologies, and services across all lines of insurance that products, or services having a positive impact on help clients respond to the “greening” of the global warming, the environment, and linked economy, expand natural disaster resilience, concerns such as pollution, overpopulation, reduce greenhouse gas emissions and support desertification, deforestation, and diminishing proactive action against the threat of climate natural resources. One criterion for inclusion in

86 71 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State FIGURE 27 | TIAA-CREF is an investor in the Catalina Solar Plant in the Mojave Desert, California. This 143-megawatt facility is a mile in length and contains over one million solar panels, providing enough power for 35,000 homes and offsetting 250,000 metric tons of greenhouse gas emissions each year. Source: CDI (2016b) and Google Maps. benefits. Seventeen insurers self-identified as the fund was that the companies be active in having made investments in renewable energy renewable energy, water treatment, pollution projects in 2012 (the last year of the data call). control, waste treatment, or energy efficiency. The Bulletin Program analyzes insurer • Green investment has been a focus in California investments that will provide some type of as well. In 2010, California Assembly Bill 1011, social or environmental benefit. COIN-qualified written by now-Commissioner Jones, increased green investment (in renewable energy, transit the ability of insurers to make green investments. oriented development, economic development, The bill expanded the COIN program to provide and affordable housing focused on infill sites tax credits to insurers who invest in qualifying 7 so as to reduce automobile dependency) among green community development investments: insurers earning over $100M in premium increased seven-fold to $8 billion after the • The Data Call Program (now concluded) 8 program began in 2011 (CDI 2016b). evaluated investments that provide a benefit to low-to-moderate-income populations, • The Tax Credit Program (now concluded) focus on rural areas, or achieve environmental offered institutional and individual investors 7. Cal. Ins. Code §§ 926.1, 926.2, 12939. “Green investments” are - defined as “investments that emphasize renewable energy pro a 20% tax credit if they invested through jects, economic development, and affordable housing focused on a Community Development Finance infill sites so as to reduce the degree of automobile dependency and promote the use and reuse of existing urbanized lands sup - Institution that would provide some plied with infrastructure for the purpose of accommodating new type of social or environmental benefit. growth and jobs. ‘Green investments’ also means investments that can help communities grow through new capital investment in the maintenance and rehabilitation of existing infrastructure so that the reuse and reinvention of city centers and existing transporta - One investment performed under COIN is the tion corridors and community space, including projects offering Catalina Solar plant in California’s Mojave Desert energy efficiency improvements and renewable energy genera - tion, including, but not limited to, solar and wind power, mixed- (Figure 27). use development, affordable housing opportunities, multimodal transportation systems, and transit-oriented development, can 8. Overall investment was $21 billion in the low-income and rural advance economic development, jobs, and housing.” § 926.1(e). area investment categories.

87 72 Growth of ESG and climate-friendly investing by the world’s insurance industry. | FIGURE 28 Values are posted as of the year of investment or reported valuation, with no effort made to further track the funds as they may increase or decline in value over time. Sources are company announcements, disclosure reports, and third-party reports. Source: Mills and EA. created a program for customers in various markets An emerging instrument is green bonds, which (including North America) to direct a portion of support a diversity of projects ranging from their premiums to green investments: $453 million greenhouse gas emission reductions to improving resilience to natural hazards. The scope is illustrated had been thus mobilized as of 2017 (QBE 2018). by the World Bank’s $300 million “Kangaroo Green Figure 28 tabulates 73 such investments on the part of 30 insurers around the world, valued at Bond,” which finances projects in Australia such as: $66 billion in 2018 dollars. U.S.-based insurance companies have made $19 billion of this total • Rehabilitation of power plants to lower their direct investment, substantially more than the greenhouse gas emissions; Solar and wind installations; $7.2 billion in renewable energy investment by • U.S. insurers tabulated in earlier studies (McHale Funding for development of new low-emission • and Spivey 2016). Two broad categories of technologies; Building greater efficiency into transportation • investment are represented in this compilation: those targeted to energy and climate change (fuel-switching and mass transport); issues (approximately 85% of the total) and Reduction of methane emissions from waste- • those more broadly defined as supporting ESG disposal sites; purposes (which include but are not limited to • Construction of energy efficient buildings; • Reforestation and avoided deforestation; and, environmental issues such related to climate change). Direct investments include capital Resilience projects including protection against • allocations for large renewable energy projects flooding and stress-resilient agriculture such as wind farms or industrial energy efficiency systems (World Bank 2014). projects. Prominent examples among those included in Figure 28 and involving U.S. insurers Twenty percent of the investors in this par ticular include: instrument were insurers (Insurance Journal 2014). One of these was QBE insurance, which has also

88 73 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “There’s mass confusion in the industry... a lot are not aware that these types of [green] coverage really exist... If insurance companies could help in that education the results would be better...” Travis Pearson, Head, Real Estate Practice, CMR Risk & Insurance Services Inc. (Wells 2013) projects spanning 13 states. The 1,300-megawatt : $2 billion for renewable energy projects AIG • electrical capacity of these facilities matches including 15 wind projects totaling 5,100 MW, seven solar projects totaling 2500 MW; that of about two typical fossil fuel power plants • (Surran 2017). Non-U.S. insurers have also readily Allstate : $300 million for renewable energy invested in clean-energy projects in the United projects; Chartis • : $600 million for debt financing for States. Notable among these are a 324-megawatt green projects; wind farm along the New Mexico-Texas border, which is one of five U.S. wind farms that Allianz Hartford : • $475 million for solar, wind, and has invested in thus far out of a total of 76 wind hydro projects; : $3 billion for farms and seven solar facilities around the world Manulife – John Hancock • (Allianz 2017). renewable energy projects and finance; MetLife • : $2.6 billion for 37 wind and solar Notably, this compilation does not attempt to farms and 56 LEED-certified properties; value the significant insurer investments in green $1 billion for renewable energy New York Life: • projects; buildings. For example, as of 2016, Prudential’s : $3.8 billion for wind, solar, hydro, real estate arm managed 34.9 million square feet • Prudential of LEED-certified building space, which was valued geothermal, and biofuels projects; and, at $17.7 billion (Prudential). $1.15 billion for Voya Financial: • wind, solar, hydro, and geothermal projects. Insurers have also taken initiative via their participation in coalitions of institutional investors While current levels of “climate-friendly” seeking to develop investment practices aligned investment are a vanishingly small proportion with sustainability principles. Ceres’ Investor Network on Climate Risk and Sustainability of total insurer assets, ambitions for further investment remain high. For example, in its (INCRS) is one example, which currently comprises 161 institutional investors with $25 trillion 2016 NAIC survey disclosure, AXA committed to under management. Sixty-one insurance industry a total investment in renewables of $15 billion by 2020, a nearly four-fold increase from their entitites are PRI signatories, some of which are U.S.-based (PRI). total investment as of 2017. In one of the more prominent examples of rising ambition, Swiss Re recently announced its plan to realign its entire $130 billion portfolio with ESG principles (WEF 2017). In a particularly large investment by a U.S. insurer, John Hancock Life purchased a 49% stake ($400 million) in a portfolio of 30 different wind and solar

89 74 Market uptake of “green” products and services Ensuring that insurance markets function well and that consumers are equipped with adequate information about their insurance options and coverages is a key role of insurance regulators. Consumers can benefit from increased availability and awareness of green products and services. On the other hand, the offerings should have veracity and be represented clearly. CDI’s long-standing support of transparency and disclosure is fully aligned with these goals. However, the distribution and regulatory structure of the insurance industry itself and the 2008 financial crash have thus far impaired the actual uptake of sustainable and resilient insurance products. A U.S. insurance trade magazine polled 200 of factors including insurer-side product design insurance agents and brokers with the question: and the effectiveness of marketing efforts, “Has the green insurance revolution been together with how customers perceive value. It is oversold?” (Toops 2011). The answers were problematic that no independent system exists split evenly. Only a quarter of the respondents for tracking the market uptake of green insurance confirmed that their agencies were even writing products. However, there are isolated indications green products or services. A full 15% were unsure, that these initiatives can gain market traction. while 60% answered in the negative and only 13% For example, as of 2015, Munich Re’s Green Tech were looking to this as an area for future growth. Solutions group reported $100 million in premiums Types of products represented included new and from green-oriented products (Ball 2015). Allianz existing green buildings property risks, carbon reports its 151 “Green Solutions” (products and capture or carbon sequestration, executive liability services) in 29 countries are generating $1.4 and political risk, professional liability, and billion per year as of 2015 (Allianz). However, the automotive. Less than one in five had experienced allocation of these activities is not disclosed, and increased demand for the products in the 2010 to is presumably dominated by insurance for large- 2011 timeframe. Reasons given for less-than-ideal scale renewable energy projects. It is appropriate uptake ranged widely, including pricing, skepticism – for regulators to track and indeed to recognize about greenwashing, broader economic downturn, – these accomplishments, while also being lack of demand, owner-tenant split incentives, interested in initiatives that do not meet with outmoded products, lack of sync with the latest success, particularly if barriers to adoption exist green practices, and lack of broker, agent, and that are possible and appropriate for regulators client education. to address. There is currently no requirement or format for insurers to report the impact of their What these numbers do not illuminate is actual green products, services, or other initiatives. market uptake, which reflects a diverse combination

90 75 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State | Fireman’s Fund green-buildings insurance saw considerable uptake FIGURE 29 in the U.S. market between 2006 and 2010 (Fireman’s Fund green policies). Source: Steve Bushnell/Fireman’s Fund, used with permission. Significant information is available on green penetration is likely lower today (Bushnell 2018). buildings insurance. Fireman’s Fund founded Some information on uptake of energy performance insurance products is also available from Hartford the original green buildings insurance products in North America and shared data on uptake Steam Boiler. Energy Efficiency Insurance (EEI), which makes building owners and investors whole over the initial 2006 to 2010 period of sale. The if energy savings fall short of agreed targets, has original two products for commercial buildings featured premium discounts for green-rated been discussed for over a decade but only recently buildings and “upgrade-to-green” and payouts to has demonstrated traction in the market. The key cover rebuilding to a higher level of performance has been the economy of scale achieved when following loss. Figure 29 shows that Fireman’s applying the offering to large portfolios of projects Fund placed nearly 2,000 large commercial policies rather than to individual buildings. Since launch and premium volume peaking at approximately in 2015, Hartford Steam Boiler’s EEI product has $160 million per year. This represented a been applied to 220,000 square feet of residential sizeable 60% uptake among its commercial lines buildings, 1.2 million square feet of commercial customers. Similar coverages were extended to all buildings, and 736,000 square feet of industrial residential customers, nearly 46,000 policies in 36 buildings in six states, including California. states totaling $87 million in premiums. Notably, Hartford Steam Boiler’s Solar Shortfall product, both products resulted in higher profits to the brought to market in 2013, has been applied to insurer than the comparable traditional products, 1.25 gigawatts of projects – the equivalent of five with loss ratios for certified green buildings of – large conventional electric power plants in 13 about 20 points lower and those with green- states (including California) and Ontario, Canada upgrade coverage between 10 and 40 points lower. (Jones 2018). With the sale of Fireman’s Fund, the visibility of its green product line diminished and market Affordable telematics have become a highly

91 76 “You can’t have sustainability without resiliency.” Chubb Chubb Green Buildings Website impactful technology development for vehicle could pose a barrier, echoing much broader insurance, able to track vehicle travel distance current societal discussions about personal data ownership. Engineering analyses can on and an array of other driving behaviors. This development, in turn, has made it possible to rate occasion substitute for loss-experience data. individual drivers for insurance premium-setting purposes. Where climate change is concerned, Some consumer protection groups have • telematics make it possible to tailor insurance opposed usage-based insurance on the premiums to distance driven, and this mileage- basis that it invades privacy, although at based insurance can incentivize energy savings least a third of surveyed consumers say while making the premium more accurately risk- they would join such a program if there based. The NAIC has gathered national data on were cost savings (Karapiperis et al. 2015). market uptake (Karapiperis et al. 2015). It found While questions have been raised as to whether • that by mid-2014, 8.5% of U.S. consumers had telematics-based vehicle insurance (which may costs for mileage-based insurance would rise or may not measure distance driven among a for low-income consumers who must drive variety of usage-based activities deemed relevant long distances to work, data actually show that current net subsidies flow from lower- to insurance), nearly double that from 18 months earlier, and cite predictions that this will grow to income drivers to higher-income drivers. 36% by 2020 (with 70% of insurers offering such products). As of 2015, Progressive, the largest In an example of lifting barriers, CDI was first • provider of expressly mileage-based insurance at insurance regulator in the nation to allow Californians to share their personal vehicles the time, reported $2 billion in premiums from two in car-sharing pools without invalidating their million customers nationwide. NAIC reports that more than half of U.S. insurers offered a telematics- auto insurance (Assembly Bill 1871 [Jones, based insurance product as of 2015 (an undefined Chapter 454, Statutes of 2010]). proportion of which use distance driven as an underwriting factor). These data are not collected As seen in the previous section, green investments are relatively well characterized, although the at the state level. existing disclosure processes are relatively Barriers exist to further creation of innovative unstructured and results are time-consuming to insurance products linked to emerging green retrieve. The European Commission is trying to practices and technologies. Some examples, and specifically ensure the transparency and quality of green investment documentation by developing corresponding solutions, include: a taxonomy through the European Union Action • By definition, innovations have no loss history, Plan on sustainable finance. a problem that is compounded by lack of subsequent data collection or public availability of such data for academic analysis. Insurers’ unwillingness to transfer data to other providers

92 77 Actuarial and Fiscal Perspectives: Insurers Identify Win- Win Benefits from the Greening of Insurance Some argue that the value of insurer initiatives that reduce greenhouse gas emissions is muted given the time it takes for those benefits to materialize in the form of reduced climate extremes. While this is dubious logic given the long-term view that insurance might be expected to have, there exist a parallel set of extremely near-term co- benefits for certain measures that reinforce their value proposition. Foremost among these are ways in which certain green practices also mitigate ordinary insurance losses and/or address other social and public policy objectives in the insurance marketplace. There are many instances of alignment between more energy- efficient infrastructure and insurance loss reduction (Mills 2012b). Among these is the emerging trend toward on-site storage of solar power that reduces vulnerability to power outages which can otherwise pose significant insurance costs (Mills and Jones 2016). Other measures operate at the urban scale, most notably by lightening the color of streets and rooftops to reduce the urban heat island effect (of benefit during heat waves) which simultaneously reduces air-conditioning energy needs. There are other ways in which individual “green buildings” are more resilient in the face of natural hazards. That said, while a green building is not necessarily

93 78 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State efficiency thus results in quantifiable health a disaster-resilient one (Figure 30), neither is benefits while reducing greenhouse gas emissions. a disaster-resilient building necessarily green or fully “sustainable.” Insurers are in a position to advance a more sophisticated notion of In another prominent example of insurance- climate co-benefits, the telematics-based PAYD sustainability where both of these principles are insurance pricing approach for vehicles is far more considered and integrated. actuarially accurate than “bulk pricing.” Driving This thinking extends beyond property risk is strongly related to the amount of driving, meaning PAYD approaches can identify the most protection to life and health. The combustion of appropriate rate for each individual driver, while fossil fuels in vehicles, buildings, and industry creates significant airborne emissions in other risk factors like driving history can also be incorporated in pricing, as can risks of vandalism addition to greenhouse gases. These pollutants, in turn, are tied to multiple health effects, often or theft (separate risk pools such as urban and rural groups can also be defined). Pricing insurance involving respiratory ailments (Hayes and Kubes based on mileage also eliminates regressive cross- 2018). In particular, much of the unhealthy subsidies from populations that drive less than air pollution to which 125 million Americans (American Lung Association 2017) are exposed average to those who drive more (Bordoff and Noel 2008; Hymel 2014). Low-mileage drivers comes from electric power plants. Energy FIGURE 30 | A home with solar panels crushed in the early-2018 Montecito mudslides. Source: (Photo: Marcio Jose Sanchez, AP. Licensed from AP).

94 79 | Mangrove forests. FIGURE 31 Source: (Photo: dronepicr via flickr). insurer Tokio Marine Group. Mangrove forests have tend to be in lower income groups as well, so the mileage-based approach enhances insurance dual benefits with respect to climate change. First, affordability and is economically progressive. If they remove carbon-dioxide from the atmosphere as they grow, thereby offsetting a proportionate insurance becomes more affordable as a result, the proportion of uninsured drivers should decline, amount of emissions (Figure 31). Second, they reduce the risk of storm surge and coastal erosion which is societally desirable. Additional benefits of telematics include the elimination of errors in in areas where they grow, as Tokio Marine observed self-reporting mileage. With proper consideration along the Thailand coastline following the 2004 Indian Ocean Earthquake and Tsunami. Tokio given to privacy issues, this technology can also Marine began its mangrove planting project in 1999 provide benefits such as tracking stolen vehicles, supporting navigation, and providing feedback and as of March 2017 had established 25,000 acres (about 40 square miles) of these forests across nine on driving behavior. Additional social benefits countries, primarily in Asia (Tokio Marine 2017). include reduced congestion and accidents/ The company describes this as a 100-year program. injuries (VTPI 2018), which are in turn of value in the life and health insurance sector. Co-benefits also accrue from larger-scale insurer initiatives. One of the earliest and longest-running efforts to improve resilience is the restoration of coastal mangrove forests by the large Japanese

95 80 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State New Best Practices are Emerging This report concludes by taking stock of emerging strategies worth consideration by insurance regulators. Each merits further assessment and consideration of its relevance and applicability in specific markets. More closely monitor the insurance- relevant climate situation and responses Climate change is one of the most dynamic risks facing the insurance marketplace. It behooves regulators to continually monitor loss trends and their drivers. Basic data on climate- and weather-related losses are not always readily available (particularly for events that are not regarded as catastrophic but rather are chronic or slow-onset and yet have large losses in the aggregate) or are proprietary. For example, while winter and non-convective storms (i.e., those other than hurricanes) are one of the largest categories of insurance losses year over year nationally (Figure 5), and are most clearly rising, no comprehensive California-specific data is available in the public domain. Despite their aggregate losses, the relatively small size and distributed nature of these events results in less attention than headline-grabbing catastrophes. Another example of data gaps are multiple-peril flood-related losses for commercial buildings outside the NFIP. Regulators should examine new initiatives to gather and mobilize such basic data in the public domain for the benefit of policymakers and consumers.

96 81 “[T]here is an increasing risk that pricing trends could consistently lag actual loss experience, which may force the industry to play ‘catch up’ in raising premiums to match increasing losses.” Moody’s (2018) Insurers currently have little incentive to fund subsidies are not only inequitable but can also original climate research and deep analysis. While reduce incentives to write insurance in higher-risk areas, impede insurers’ ability to give mitigation there is a vibrant ongoing stream of climate science discounts, and reduce the incentive of homeowners and research, it is not typically organized with to invest in loss-prevention (Dixon et al. 2018). insurers in mind. Effort is needed to continuously translate the latest research into a form that is understandable and applicable to insurers and Overseas insurers such as Aviva have brought state-of-the art “big data” to bear in more precisely their regulators. pricing homeowners’ insurance, which has the potential to improve market function by providing It is also important to monitor the progress of an economic incentive to mitigate risk. U.S.-based insurance innovations (green products, services, USAA Insurance is among the insurers providing and investments). Considerable innovation is premium credits for wildfire mitigation per National underway in this arena but is not systematically Fire Protection Association guidelines in California tracked or analyzed by regulators, and the loss- and several other states (NFPA). However, in cases experience associated with these technologies and practices are not always known. of powerful, fast-moving fires it is the larger-area vulnerability as opposed to that in the immediate vicinity of a given property that most strongly The give-and-take between public and private insurance is continually in play. In the United determine outcomes. States, the NFIP is in flux and faces increasing Rates based on averaged multi-decade loss histories solvency challenges. It is timely for regulators and commercial insurers to continue looking for dampen recent signals that climate change may be providing. To the extent that rates are based market-based solutions to manage these risks . on historical loss experience, it is important that recent trends are detected and considered in Refine insurance pricing setting premiums. To the extent that premiums can reflect the outlook on future loss expectations, and contract design to more they will send a price signal consistent with precisely reflect climate risks improving resilience. The California prior approval and incentivize mitigation process allows for variances which include using efforts a very recent loss trend in projecting future rates. Loss-prevention efforts are poorly reflected in Imprecise underwriting may lead to considerable ratemaking, which dilutes the economic incentive unintended cross-subsidization of risk in some for insureds to enhance the resilience of their parts of the market, and can reduce the impetus properties. Conversely, however, potential changes to invest in mitigation. Consider the specificity in losses under climate change should not be used of the way drivers and their cars are rated in to “game” the system by seeking unjustified rate comparison to that of homes. Unintended cross- increases.

97 82 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State “We believe strongly to address the rising risks of climate related natural disasters, and to close the insurance protection gap, governments, regulators, academics, private sector firms and other leaders must collaborate.” Steve Weinstein, Group General Counsel and Chair, RenaissanceRe RenaissanceRe Risk Sciences Foundation, ClimateWise Insurance Advisory Council website Second, CDI wants a mitigation premium credit Fortify consumer protections for communities and homeowners that make and resilience efforts to property more defensible. Third, CDI wants an ensure insurance availability, appeals process for homeowners to appeal non- renewals. Fourth, CDI wants insurers to file adequacy, and affordability underwriting criteria for wildfires and allow CDI an opportunity to review this criteria. Fifth, As climate change progresses, consumer protection CDI wants to be authorized to collect industry- will become even more challenging for insurance wide loss data because some insurers do not regulators. It is thus incumbent on regulators to have access to good loss data and are instead track and mitigate insurance availability, adequacy, forced to rely on third-party data that is from and affordability issues together with any specific outside California or from dissimilar events. equity issues that arise for particular segments of the market such as low-income consumers. Continue to champion and More exhaustive data should be readily available. improve climate risk disclosure The means for doing this at times lay outside the formal insurance sector, as illustrated by the roles of building code officials, city- and land-use Disclosure has proven to be feasible and highly planners, lenders, disaster preparedness agencies, informative, although many disclosure efforts thus and academics. Insurance regulators will need to far have focused on predominantly open-ended increasingly engage with these other decision- questions about climate risk and on the carbon- makers, seeking areas of aligned goals. Consumers intensity of certain invested financial assets. More are the ultimate stakeholders. comprehensive disclosure processes must also look at assets vulnerable to climate change. These In 2018, Commissioner Jones spoke at a Legislative include real estate as well as investment sectors Committee Hearing on Drought, Climate Change, that are particularly vulnerable to climate change, and Fire. He stressed several recommendations for such as agriculture, water, and tourism. legislative reform that would address all or most of the issues that have come to light with CDI’s work Within existing disclosure surveys, further pointed in addressing climate-related wildfire risks. First, questions may elicit more substantive and usable CDI wants legislation that requires insurers to responses (Leurig 2011). If adding questions provide coverage if homeowners make appropriate to the NAIC survey is infeasible, regulators improvements or that requires insurers to at least implementing the survey could instead update offer a minimum of differences and conditions guidelines to indicate that such information is coverages when such improvements are made. being sought (CDI 2016c). Furthermore, surveys

98 83 could allow for discrete inputs to facilitate truer database functionality. For instance, insurer responses to the NAIC survey include the reporting of many billions of dollars in gross market value of “green real estate,” rather than the more relevant incremental investment made to achieve this goal. Other insurers appropriately exclude real estate from their tallies of green investments. Disclosure need not focus only on downside risks. For example, insurer responses to the NAIC survey appear to include very few responses discussing stress testing or green insurance products and related innovations. Additional questions on these topics could elicit information on best practices in these areas. convergence of earth-science and economic- impacts modeling is essential for improved Commissioner Jones has recommended that accuracy and relevance. More emphasis could be the TCFD, the FSB, and the G-20 take concrete placed on maximum probable aggregate annual steps toward mandatory insurer disclosure of losses (in addition to narrow per-event modeling), portfolio risks. Outreach efforts should involve in both the property and casualty and the life and major mainstream financial filings agencies, such health lines. Enterprise-wide risks range from as the U.S. Securities and Exchange Commission property, to liability, to health, to assets. (SEC), and encouraging them to incorporate by rulemaking or other mechanisms the TCFD In light of issues regarding the conflict between recommendations (the SEC has previously data ownership and IP on the one hand and model recognized standards by an outside organization transparency and peer review on the other, some in an interpretive release). The TCFD rates the states have discussed creating public models that 80 largest global insurers on their approach to are more open for peer review. Considerable scope climate-related risks and opportunities. In the exists for doing so, particularly by building off of 2018 ratings, no U.S. insurers fell in the categories the already enormous ongoing public investment B to AAA band, three fell in the categories C in climate model development together with to CC band, 18 fell in the “D” band, and three that by state and federal agencies for issues such fell in the “X” (lowest) band (AODP 2018). as agricultural and fire risks. The industry’s own non-profit Oasis Loss Modelling Framework Support innovation in loss is attempting something similar for emerging modeling, data science, and 9 Integration of earth-science market applications. modeling practices with economic analysis can stress testing yield models that better pinpoint potential industry stresses as well as prudent resilience Insurance loss modeling has been improving for investments. decades, and this process will no doubt continue. A changing climate and associated risk landscape present constant challenges to modelers. Further 9. For more information, see

99 84 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State Identify and mitigate barriers to green insurance and risk reduction While the desirability of mitigating climate change is uncontroversial, the process of transition can be costly or otherwise socially and politically difficult. New practices also bear risks for insurers. Regulators must be aware of these challenges and seek to minimize barriers and provide inducements where appropriate. An example of the latter (noted previously) were CDI’s COIN tax credits for green-infrastructure investment that was awarded for a period of time to insurers. Another illustration of the possibilities is the appropriate state agencies awarding carpool lane access for mileage-based insurance policy holders. On the other hand, regulations can also form barriers. As observed by the NAIC in the case of mileage-based insurance offerings: Many states require insurers to obtain Stress testing can become more nuanced in its approval for the use of new rating plans. ability to incorporate climate stresses across Rate filings usually must include statistical the insurance enterprise (underwriting and data that supports the proposed new rating asset management). Techniques should be structure. Although there are general studies standardized. As most insurers have exposures demonstrating the link between mileage and in multiple markets, it is essential that regulators risk, individual driving data and UBI [usage- coordinate efforts, such as through the based insurance] plan specifics are considered “International Colleges” wherein regulators from proprietary information of the insurer. This multiple countries collaborate in assessing cross- can make it difficult for an insurer who does not cutting issues. have past UBI experience. Other requirements that could prevent certain UBI programs Insurance regulators could have more input include the need for continuous insurance into the setting of publicly funded climate coverage, upfront statement of premium research agendas to inform stress testing and charge, set expiration date, and guaranteed otherwise ensure relevance and usability of renewability (NAIC 2018). the results. Among the important frontiers are better modeling the benefits of adaptation These issues were overcome in the case of investments, improved spatial and temporal California’s admission of usage-based insurance resolution on the costs of climate change, and products. more developed risk profiles of the disparate strategies for reducing climate change.

100 85 Even where insurers may be inclined to innovate, How can climate modeling be made more • the business case may be lacking. Decades ago, relevant to insurance community? utility regulators (initially through their national • What are the long-term health insurance organization) effectively addressed the problem impacts of wildfire smoke? of underinvestment in customer-side energy What will be the effect of changing weather • efficiency improvements that were less expensive conditions on vehicle accidents? than building new energy production capacity and thus socially desirable. They did so by incorporating What is the optimal pay-as-you-drive price • utility investments in customer-side energy structure to maximize market uptake and efficiency into rates and their return on investment. driving response, and does the practice This unleashed billions of dollars in such decrease the numbers of uninsured drivers? investment each year, which continues to this day. • What are the risk profiles and associated loss experience of “green technologies” compared Participate in climate to conventional ones? mitigation and adaptation • Can a resilience rating system be developed research and inter-agency to help standardize assessment and underwriting? initiatives What is the elasticity of demand for resilience • Many California agencies and programs would investments to the cost of insurance? benefit from engagement by the insurance How will climate change differentially impact • industry and its regulators. Note that the the availability, adequacy, and affordability of California Climate Action Team’s board is insurance for disadvantaged groups? populated by heads of a wide range of agencies, without formal representation from the insurance A key challenge is that institutional arrangements community. These include expected units such as for organizing and financing such ambitious the California Energy Commission, the California research needs are not currently in place. Air Resources Board, the California EPA, Caltrans, the Governor’s Office of Planning and Research, Enhance market awareness of the California Natural Resources Agency, Cal disparate risks and insurance Fire, and the California Department of Water Resources, but also a much broader coalition responses including the Governor’s Office of Business and Economic Development, the California Business, Markets cannot function properly without Consumer Services and Housing Agency, the information and education, much of which California Department of Food and Agriculture, is presently lacking in the climate-insurance the California Health and Human Services Agency, nexus. Many stakeholders, including consumers, the California Government Operations Agency, insurers, brokers and agents, and even regulators and the Strategic Growth Council. are often not well enough equipped to make the best decisions. One useful trend is that real Illustrative questions that the broader research estate appraisal practices are evolving to better community is well-equipped to take up, but which incorporate consideration of climate risk in the are not necessarily within the mandate of other property valuation process, thus standing to send agencies include: better market signals of the cost of vulnerability and value of resilience.

101 86 Trial by Fire: Managing Climate Risks Facing Insurers in the Golden State Most consumers are unaware of the diversity of climate-related exposures that they face (physical and health), options for enhanced resilience, or the range of solutions available to them. Among these needs, the International Actuarial Association strongly argues for the need for insurer involvement in better communication of climate-change health hazards (IAA 2017). Improved risk awareness may also be called for among professionals. For example, standards of care may be evolving such that it will become incumbent on designers and builders of structures, to ensure in the position to moderate this process through rethinking of siting and resilience to changing non-proprietary commercial consumer education. climate- and weather-related hazards. Indeed, there is precedent in California, under the doctrine of strict liability, for builders of tract homes to be held Increase engagement Oliver accountable for defective construction (e.g., in broader public policy v. Superior Court [Regis Builders, Inc.] [Cal. App. discussions 4th 1989]). Insurers have for decades been engaged in public Existing disclosure systems (with improvements, policy discussions on climate change, particularly as discussed previously) can serve the valuable in Europe and Asia. Prior to the recent formation function of gathering raw information, but of the SIF, insurance regulators have been far further work is needed to analyze and make that less engaged. There is ample room for insurance information available to various constituencies regulators at the table. Among the very key that stand to benefit from it. issues today are the relative roles of public and private insurance and risk-sharing. Under climate Consumers are also poorly equipped to identify or change, public insurance systems will come under to judge the caliber of green insurance products increased solvency stress, and the data, skills, and and services, or the potential efficacy of resiliency risk management insights of private insurers (and enhancement strategies offered to them. Insurance their regulators) may be called upon. regulators, in their role of consumer protection, are

102 87 The Way Forward Insurers are messengers of climate risk. In collaboration with regulators, insurers may be able to support and transform the “externality” of otherwise un-costed climate risks and their prospective impacts into tangible prices in the market. This incorporation of externalities can be a productive process insofar as the price signal can prompt prudent loss-prevention. Yet serious availability, adequacy, and affordability considerations raise equally worrisome policy challenges. This tension can be moderated where insurers play a proactive role in helping their customers physically manage these risks (not only by financing post-loss rebuilding costs) while participating in a much broader economic movement to trim the emissions of dangerous greenhouse gases. While significant advancements in climate science have occurred in recent years, the insurance community’s underwriting, transitional, and legal vulnerabilities to climate change are not well enough understood, and the factors driving them are in a state of complex flux as the climate continues to change. Better economic data and related modeling are needed to inform improved practices. Enormous investment and intellectual capital has been devoted to modeling natural hazards and their consequences for insurance and the broader economy, yet history continues to present significantly unanticipated outcomes in terms of the scale and nature of weather- and climate-related catastrophes, as well as slower-moving and spatially distributed change. A call to action is needed to redouble efforts to integrate earth science and physical and economic vulnerability assessment. Only by doing so can markets remain vibrant in a changing world and consumers remain able to adequately spread and manage risk. Efforts to better understand risk can be productively coupled with continued innovation in the core business of insurance: innovative insurance products and services can serve as new sources of revenue for the industry while aligning the insurance process with broader technological and economic pathways towards reduced greenhouse gas emissions and enhancing resilience. Ongoing technology innovations in energy management and production, telematics for tracking vehicle data, distributed sensors, GPS and sophisticated satellite data acquisition, the Internet of Things, drones, and other areas continue to open up new possibilities. Beyond physical risk, the effects of climate change (and associated policies) on investments and liability-related risks must be better characterized and managed. Resilience must be stimulated and supported on all fronts. This outcome is likely only possible with a rebalancing of capital allocation in the direction of proactive loss prevention, as distinct from a more traditional reactive approach to financing rather than preventing losses. Insurers are essential players in this process, although by no means are they capable of addressing these problems in isolation. In overcoming California’s trial by fire, consumers, the private sector, governments, NGOs, and academia will all play essential roles.

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