Insurability of losses

In theory, any loss which is not inevitable is insurable under a commercial contract of insurance. A classic definition of the necessary legal elements of such a contract includes the requirement that the event insured against 'should be one which involves some amount of uncertainty'. The definition continues: 'There must be either uncertainty whether the event will ever happen or not, or if the event is one which must happen at some time there must be uncertainty as to the time at which it will happen. An element of uncertainty is therefore a necessary legal requirement for a loss to be insurable.

In commercial terms, more will be required if a risk is actually to be insurable on the world insurance markets. The requirements for the insurability of a flood or inundation risk commercially have been stated to be:

1 a sufficient demand for insurance of the risk and sufficient variation in the insurer's portfolio of such risks to ensure an adequate spread of risk;
2 the random occurrence of losses, but neither too often nor too seldom;
3 the ability to restrict accumulation of losses;
4 the traceability of the causes of a loss;
5 the availability of statistical records of losses from the risk, covering sufficiently long periods of time.

The randomness or uncertainty of the event to be insured against is here again an essential element. But for commercial insurers, it is also essential to be able to select the risks that they insure and to be able to calculate realistically what premium they should charge, in order to accumulate over the long term, sufficient funds to meet losses and to make a profit.

The IPCC Working Group I concluded that even if action is taken to limit emissions, there is enough momentum in the global climate system for a rate of accelerated sea-level rise to be inevitable. Gradual flooding and inundation which may be attributable to an inevitable rise in sea level will certainly not be capable of being insured on the world insurance markets.

Even in the sphere of catastrophe insurance (which in this context refers to insurance against damage caused by storm, windstorm, hurricane, tropical cyclone, typhoon, as well as flood and inundation) events that up to the present have been regarded as fortuitous, and therefore insurable, may cease to be so regarded in the future. One insurer, in considering the impact of global warming and climate change upon catastrophe insurance, has remarked: 'There should be further examination of what constitutes an "abnormal" loss, and we will have to alter our view of what is perceived as normal.

In considering the potential for heavy increases in catastrophe losses as a result of climate change, it is important to bear in mind that the current levels of catastrophe loss represent in turn a dramatic increase over the losses of two decades ago. Considering the major natural disasters over the last three decades and extrapolating figures to 1990 prices, it can be shown in the 1980s compared with the 1960s, that: overall economic loss from major natural disasters increased by a factor of 3.1; insured losses increased by a factor of 4.8; and major catastrophes increased by a factor of 5.0.

The world's insurance and reinsurance markets will find it difficult to cope with such rapid change in the incidence of natural hazards. For example, the reinsurers of first layer catastrophe insurance covers granted to United Kingdom companies for worldwide exposures paid out between 1979 and 1988 in claims resulting from 'abnormal' weather experienced in the UK alone, more than twice the total amount received by these reinsurers in premium.

In stable climatological conditions, an insurer or reinsurer can assess the probable 'return period' of a known catastrophe peril by reference to historical events and statistical records. The premium for the risk can then be calculated with some reasonable measure of accuracy. Rapid changes in climate make the calculation of premium for natural catastrophe risks a very much more difficult and uncertain exercise. In a 1963 study, for example, it was calculated on the basis of existing records that the return period for a flood which inundated over 800 square kilometres of the east coast of England in 1953 was I in 200 years. Yet between 1963 and 1989 (26 years), the 1 in 200 year storm surge level occurred eleven times.

Given the difficulties currently facing insurers and reinsurers in basing premium calculations on past climatological records and those posed by predictions of global warming and sea level rise, insurers and reinsurers will likely become more selective and restrictive in their offered cover.

Options for insurers

The options available to insurers and reinsurers in such circumstances include:

1 impose upon the insured, in the case of original insurances, substantial deductibles per policy or risk;
2 impose a limit figure on the amount of their liability;
3 charge sufficient premium to enable adequate reserves to be accumulated;
4 exclude particular risks (such as, for example, wind storm, flood, inundation) either absolutely or in particular localities;
5 avoid insuring any catastrophic risks in particular localities or limit overall catastrophe exposure in particular localities;
6 withdraw from the insurance or reinsurance of catastrophe risks altogether;
7 redefine categories of loss which in insurance terms are at present regarded as 'abnormal' or fortuitous, and therefore ordinarily insurable, and those which are regarded as 'normal' or non-fortuitous, and ordinarily not insurable.

Additionally, insurers and reinsurers can assist and encourage the adoption of loss-prevention measures either by advice or by the introduction of conditions into policies of insurance or reinsurance. But faced with the probability of heavy increases in catastrophic losses from so-called natural causes, insurers and reinsurers will be forced to take some, if not all, of the measures mentioned if they are to continue to provide an effective and responsible service to their insurers and if they are to remain in business as insurers.

This logic suggests strongly that insurers will not cover a substantial part possibly the most substantial part - of the potential loss and damage resulting from climate change and sea-level rise. In short, such risks will be uninsurable on the world's insurance and reinsurance markets. This outcome has indeed been recognized by the insurance industry itself. One company recently stated that:

On the level of direct insurance and reinsurance, the insurance industry fortunately has a wide range of 'tools' end instruments for supervising and controlling its exposure to catastrophe risks.

These underwriting facilities . . . must however be used in full and without delay if insurers are to bring the current adverse development to a halt. At the same time these activities must be accompanied by structural loss prevention measures and suitable precautions taken by the authorities.

Wherever the national insurance industry supported by worldwide reinsurance capacity (which, ultimately, is only available if premiums, terms and conditions are adequate) is not able to cover an extreme catastrophe risk, it may become necessary for the government to assume a share in catastrophe covers, at least for losses exceeding a certain level, or to guarantee indemnification in all events, as some governments already do in the case of the risk of flood and inundation.

It is evident that even in the case of fortuitous catastrophic losses, the world insurance industry will not be able to bear the burden of providing a global spread of compensation without state intervention. And in the case of those losses which the insurance industry will have to redefine as 'normal'- for example, flooding or inundation resulting from inevitable sea level rise State funding will be the only source of compensation of those who are affected by it. Since the least developed countries are those most vulnerable to future catastrophic loss and what may come to be regarded as the inevitable consequences of climate change, any state compensation regime will have to be internationally funded.

Two internationally funded compensation schemes operate at present. These deal with oil pollution and nuclear damage. Neither case, however, is analogous exactly with loss consequent upon climate change and sea level rise. On the contrary, the incidence of oil pollution or nuclear damage is more likely to be traceable to an identifiable source and referable to a discoverable cause.

Loss or damage of the nature associated with climate change, whether of a catastrophic or 'abnormal' nature or of a 'normal' or inevitable nature, is highly unlikely ever to be conclusively attributable to any legally definable source or cause. Thus, if a compensation scheme is to form any part of a Climate Change Convention, it could probably not be based upon ordinary legal criteria of liability or responsibility. Rather, it would have to be based on a criterion of responsibility in its broadest sense.