Market-based mechanisms for climate change adaptation Final Report John McAneney, Ryan Crompton, Delphine McAneney, Rade Musulin, George Walker and Roger Pielke Jr. MARKET-BASED MECHANISMS FOR CLIMATE CHANGE ADAPTATION Assessing the potential for and limits to insurance and market-based mechanisms for encouraging climate change adaptation AUTHORS John McAneney (Risk Frontiers, Macquarie University) Ryan Crompton (Risk Frontiers, Macquarie University) Delphine McAneney (Risk Frontiers, Macquarie University) Rade Musulin (Aon Benfield Analytics Asia Pacific) George Walker (Aon Benfield Analytics Asia Pacific) Roger Pielke Jr. (University of Colorado, Boulder, USA) Published by the National Climate Change Adaptation Research Facility ISBN: 978-1-925039-46-7 NCCARF Publication 75/13 © 2013 CSIRO and the National Climate Change Adaptation Research Facility This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the copyright holders. Important disclaimer CSIRO advises that the information contained in this publication comprises general statements based on scientific research. The reader is advised and needs to be aware that such information may be incomplete or unable to be used in any specific situation. No reliance or actions must therefore be made on that information without seeking prior expert professional, scientific and technical advice. To the extent permitted by law, CSIRO (including its employees and consultants) excludes all liability to any person for any consequences, including but not limited to all losses, damages, costs, expenses and any other compensation, arising directly or indirectly from using this publication (in part or in whole) and any information or material contained in it. Please cite this report as: McAneney, J, Crompton, R, McAneney, D, Musulin, R, Walker , G, Pielke, R 2013 Market-based mechanisms for climate change adaptation: Assessing the potential for and limits to insurance and market based mechanisms for encouraging climate change adaptation, National Climate Change Adaptation Research Facility, Gold Coast, pp. 100. Acknowledgement This work was carried out with financial support from the Australian Government (Department of Climate Change and Energy Efficiency) and the National Climate Change Adaptation Research Facility. The role of NCCARF is to lead the research community in a national interdisciplinary effort to generate the information needed by decision makers in government, business and in vulnerable sectors and communities to manage the risk of climate change impacts. The views expressed herein are not necessarily the views of the Commonwealth or NCCARF, and neither the Commonwealth nor NCCARF accept responsibility for information or advice contained herein. Cover image/s © Don Shearman Internal photos: Unless otherwise stated, all photos within the report were taken by Risk Frontiers staff and associates. TABLE OF CONTENTS ABSTRACT .................................................................................................................. 1 1. EXECUTIVE SUMMARY .................................................................................. 3 2. OBJECTIVES OF THE RESEARCH ................................................................. 5 3. THE RISING COST OF DISASTER LOSSES AND ITS IMPACT ON THE INSURANCE SECTOR ..................................................................................... 6 3.1 Abstract ............................................................................................................. 6 3.2 Introduction ........................................................................................................ 6 3.3 Loss normalisation ............................................................................................. 8 3.4 Future loss sensitivity ....................................................................................... 14 3.5 Timescale at which an anthropogenic climate change signal might be observed in US tropical cyclone loss data ........................................................ 16 3.6 The disaster mitigation challenge ..................................................................... 20 3.7 Global risk financing in coming decades .......................................................... 21 3.8 Integrating the financial management of disasters as part of a national strategy ............................................................................................................ 22 3.9 Conclusions ..................................................................................................... 22 4. GOVERNMENT INVOLVEMENT IN THE INSURANCE MARKET AND ITS POTENTIAL TO DRIVE CLIMATE CHANGE ................................................. 23 4.1 Abstract ............................................................................................................ 23 4.2 Introduction ...................................................................................................... 24 4.3 Principles of insurance ..................................................................................... 25 4.4 In brief: Differences between Private Insurance and Government Insurance Pools ............................................................................................... 27 4.5 Examples of Government involvement in insurance for catastrophe risks ........ 28 4.5.1 National Flood Insurance Program (NFIP) .................................................... 28 4.5.2 Texas Wind (TWIA, formerly TCPIA) ............................................................ 31 4.5.3 Florida – Hurricane Windstorm Coverage - FWUA; JUA; Citizens and FHCF 37 4.5.4 California Earthquake Authority (CEA) .......................................................... 43 4.5.5 New Zealand’s Earthquake Commission (EQC) ........................................... 47 4.5.6 Spain - Concorcio de Compensacion de Seguros (CCS) .............................. 51 4.5.7 France – the Caisse Centrale de Reassurance (CCR) .................................. 52 4.5.8 Flood Insurance in the United Kingdom ........................................................ 55 4.5.9 The Netherlands ........................................................................................... 57 Market-based mechanisms for climate change adaptation - Contents 4.6 Influence of Residual Market Mechanisms in effecting Mitigation and Risk Reducing Behaviours ....................................................................................... 59 4.6.1 Cyclone and flood insurance in Fiji. ............................................................... 59 4.6.2 National Flood Insurance Plan ...................................................................... 59 4.6.3 The Texas Wind Storm Insurance scheme ................................................... 60 4.6.4 The British flood insurance contract .............................................................. 60 4.6.5 EQC .............................................................................................................. 61 4.7 Discussion ........................................................................................................ 61 4.8 Implications for Climate Change Adaptation ..................................................... 64 5. SECURITISING INSURED NATURAL HAZARD RISKS – A HYPOTHETICAL SYDNEY FLOOD CASTROPHE BOND CASE STUDY ...... 65 5.1 Abstract ............................................................................................................ 65 5.2 Introduction ...................................................................................................... 66 5.3 Catastrophe Bonds ........................................................................................... 67 5.3.1 Securitisation of Insurance Risk: Introduction to Catastrophe Bonds ............ 67 5.3.2 Securitisation of Insurance Risk: Investors Perspective ................................ 70 5.4. Flood Modelling ................................................................................................ 71 5.4.1 The National Flood Information Database (NFID) ......................................... 71 5.4.2 Validation of NFID ......................................................................................... 73 5.5 Risk Frontiers’ FloodAUS Riverine Flood Loss Model....................................... 75 5.6 Development of National Residential Portfolio .................................................. 75 5.7 Hawkesbury River Basin .................................................................................. 76 5.8. Hypothetical Sydney flood CAT Bond ............................................................... 81 5.9 Conclusions ...................................................................................................... 83 6. GAPS AND FUTURE RESEARCH DIRECTIONS .................................................. 85 REFERENCES ........................................................................................................... 86 APPENDIX 1: THE COST OF CAPITAL .................................................................... 95 APPENDIX 2: JUNE 1867 HAWKESBURY RIVER FLOOD ...................................... 97 Market-based mechanisms for climate change adaptation - Contents LIST OF FIGURES Figure 1: (a) number of fatalities arising from natural perils in Australia since 1900; (b) as for (a) but with numbers of fatalities normalised by population