Post-disaster reconstruction comes at a heavy environmental cost – and there are questions over who is responsible for paying. But the risk is as much an opportunity for insurers, as Manuel Lonfat explains
Managing emissions in a transitioning world
It is almost impossible today to be tuned off to the changes our climate is going through. This global awareness has led more and more companies to commit to greenhouse gas emission reductions. Today, committing means drawing a path to a net-zero economy, a society where residual emissions correspond to a global atmospheric radiative forcing that is once again in check. Increasingly, and rightfully so, commitments come with public pressures to meet targets, which can be not only challenging but damaging to companies when they fail to reach them.
One issue that is not considered in that context today is the emission cost of disasters. Events such as hurricanes or floods invariably generate significant property damage. Reconstruction, cleaning, and other post-event activities produce new emissions, which can be very large. Climate change is further compounding this issue by producing more frequent and more severe events.
Who is responsible for those emissions? Should companies simply account for the emission variance in their sustainability reports and transition plans, and therefore risk missing their targets? Or is it an issue for governments to deal with, a contribution to their nationally determined contributions (NDCs) made under the Paris Agreement? Can these emissions leak into insurance coverages or even be covered by a new class of insurance products?
"This type of loss is likely to become a new class of transition risk for the industry"
The question as to who should pay for these emissions is inevitably going to be raised in a transitioning world. Given the role that insurers play in financing event losses, this type of loss is likely to become a new class of transition risk for the industry. A lack of a clear definition in what is covered and what is not usually results in coverage leakage and unforeseen losses for the industry. If the emissions do not leak into insurance coverages, they will represent a cost for companies incurring losses and potentially become a regulatory or a reputation risk. Insuring those emissions can then be seen as much as a business opportunity as a risk for insurers.
Below, we provide what is to our knowledge the first attempt to quantify the potential cost of post-disaster emissions. We discuss the cost in the context of potential insurance coverages. The primary mission of insurance is contributing to economic stability by helping companies and individuals mitigate risks. Covering post-catastrophe emissions is in line with that mission. Such coverage can also contribute to reducing risks for insurers themselves by reducing policy leakage risk.
How large can post-event reconstruction emissions be?
Reconstruction emissions can therefore add up 5% in loss potential to an event like Katrina
Large catastrophes can produce insurance claims in the millions, with an average loss well into the thousands of dollars. Total losses of properties are rather frequent in such events, for example in hurricanes along coastlines where the most severe winds occur alongside large storm surges. The emission cost of building a house can be as high as 100 tonnes of carbon dioxide equivalent (tCO2e), without even accounting for debris removal.
Of course, most claims are smaller than a total loss. If we assume the average emission per claim (including debris removal) stands at 10 tCO2e, a large loss event such as Hurricane Katrina, which resulted in 1.2m claims according to Verisk PCS, can result in as much as 10m to 15m tCO2e of carbon emissions. Taking the current price of carbon from the EU Emissions Trading System – approximately $75 – the emission cost of an event such as Katrina nears $1bn. Reconstruction emissions can therefore add up 5% in loss potential to an event of that size.
Such cost leakages exist across all catastrophic events, no matter their size. They represent a measurable impact not only for the largest events but in aggregate across all catastrophes. According to Moody's RMS, the current estimated annual global insured loss is more than $125bn. Therefore, the annual emission cost burden globally is likely of the order of $5bn to $10bn.
"In the wake of a catastrophe, the lack of specific coverage may then result in loss leakages for insurers"
Today, reconstruction emissions are being generated at the expense of the environment. No one pays for them. As our efforts to transition towards a green economy grow and so do the pressures on governments to meet their NDCs, post-disaster emissions will need to be addressed. In the wake of a catastrophe, the lack of specific coverage may then result in loss leakages for insurers.
Tropical Storm Sandy (2012) serves as an example. In the coastal US, policies traditionally have two deductibles (all-peril and hurricane). The hurricane deductible is higher but generally requires the occurrence of hurricane force winds to be applicable. In Sandy, the limited availability of reliable ground observations made it nearly impossible to apply hurricane deductibles, despite the nature of the event and the hurricane-like severity of its damage. Insurers could face a similar situation if the emission cost of a disaster is seen as a part of the event loss.
Insuring event emissions
Because event-related emission risk can be measured, essentially by using techniques like those used to assess the underlying property risk, it can be priced and underwritten. Last year, one reinsurance market participant structured a catastrophe (cat) bond with an emission component, but on a very small scale. As the deal is active in the market, we still have lessons to learn from it.
"An option structure could be created, where the premium paid for the option could be used to fund the generation of offsets"
As the coverage may apply directly to corporations or as a risk mitigation mechanism for insurers and reinsurers, it can be written by various market segments (similarly to traditional property cat coverage). In the context of the cat bond mentioned above, the coverage is structured as an option to purchase offsets in case of an event, for instance, which only serves to neutralise emissions when an event occurs.
A key difference with traditional property cat coverage – which also is a key opportunity for the sector – is to structure deals so the premium can have an impact upstream of an event. For example, an option structure could be created, where the premium paid for the option could be used to fund the generation of offsets, which then serve as coverage in case of an event. But interestingly, those offsets can be used elsewhere if the coverage does not trigger. Therefore, the funds invested in a deal create at a minimum a net-zero situation, but in most years a positive impact on the environment.
A risk not to be ignored
The ever-increasing need for emission reductions, transition planning and potential greenwashing puts all emission sources and reductions under increased scrutiny. Disaster-related emissions can be significant, and their attribution will therefore likely become a topic of debate. The compounding effect of climate change on the occurrence of disasters only makes it more likely that attention will be brought on these emissions. We believe that insurers can play a key role in anticipating this issue by developing coverages to mitigate the associated risks. We have started to do so and are happy to discuss with anyone interested to learn more.
Manuel Lonfat is the founder and CEO of Quambio, a Swiss firm that helps organisations achieve their sustainability objectives, and a former special advisor to the UN. He was previously a chief risk officer in the reinsurance industry and has worked on risk management and cat risk modelling for companies including AQR Re, Travelers and RMS. Email: manuel@quambio.ch
