Climate Change: Financial Risks to Federal and Private Insurers  
in Coming Decades are Potentially Significant (19-APR-07,	 
GAO-07-760T).							 
                                                                 
Weather-related events in the United States have caused tens of  
billions of dollars in damages annually over the past decade. A  
major portion of these losses is borne by private insurers and by
two federal insurance programs-- the Federal Emergency Management
Agency's National Flood Insurance Program (NFIP), which insures  
properties against flooding, and the Department of Agriculture's 
Federal Crop Insurance Corporation (FCIC), which insures crops	 
against drought or other weather disasters. In this testimony,	 
GAO (1) describes how climate change may affect future		 
weather-related losses, (2) provides information on past insured 
weather-related losses, and (3) determines what major private	 
insurers and federal insurers are doing to prepare for potential 
increases in such losses. This testimony is based on a report	 
entitled Climate Change: Financial Risks to Federal and Private  
Insurers in Coming Decades are Potentially Significant		 
(GAO-07-285) being released today.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-760T					        
    ACCNO:   A68465						        
  TITLE:     Climate Change: Financial Risks to Federal and Private   
Insurers in Coming Decades are Potentially Significant		 
     DATE:   04/19/2007 
  SUBJECT:   Climatic change					 
	     Droughts						 
	     Federal property					 
	     Flood insurance					 
	     Hurricanes 					 
	     Insurance claims					 
	     Insurance losses					 
	     Interagency relations				 
	     Losses						 
	     Program evaluation 				 
	     Risk management					 
	     Strategic planning 				 
	     Weather						 
	     Weather modification				 
	     Climate Change Science Program			 
	     Federal Crop Insurance Program			 
	     National Flood Insurance Program			 

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GAO-07-760T

                 United States Government Accountability Office

Testimony

GAO

Before the Committee on Homeland Security and Governmental Affairs, U.S. Senate

For Release on Delivery                                    
Expected at 9:00 a.m. EDT                                                  
Thursday, April 19, 2007 

                             CLIMATE CHANGE                                                    
                             Financial Risks to Federal 
                             and Private Insurers in                          
                             Coming Decades are Potentially Significant       
                             Statement of John B. Stephenson, Director        
                             Natural Resources and Environment                

GAO-07-760T

CLIMATE CHANGE

Financial Risks to Federal and Private Insurers in Coming Decades Are
Potentially Significant

  What GAO Found

Key scientific assessments report that the effects of climate change on
weather-related events and, subsequently, insured and uninsured losses,
could be significant. The global average surface temperature has increased
over the past century and climate models predict even more substantial,
perhaps accelerating, increases in temperature in the future. Assessments
by key governmental bodies generally found that rising temperatures are
expected to increase the frequency and severity of damaging
weather-related events, such as flooding or drought, although the timing
and magnitude are as yet undetermined. Additional research on the effect
of increasing temperatures on weather events is expected in the near
future.

Taken together, private and federal insurers paid more than $320 billion
in claims on weather-related losses from 1980 to 2005. Claims varied
significantly from year to year--largely due to the effects of
catastrophic weather events such as hurricanes and droughts--but have
generally increased during this period. The growth in population in
hazard-prone areas and resulting real estate development have generally
increased liabilities for insurers, and have helped to explain the
increase in losses. Due to these and other factors, federal insurers'
exposure has grown substantially. Since 1980, NFIP's exposure nearly
quadrupled to nearly $1 trillion in 2005, and program expansion increased
FCIC's exposure 26-fold to $44 billion.

Major private and federal insurers are both exposed to the effects of
climate change over coming decades, but are responding differently. Many
large private insurers are incorporating climate change into their annual
risk management practices, and some are addressing it strategically by
assessing its potential long-term industry-wide impacts. In contrast,
federal insurers have not developed and disseminated comparable
information on long-term financial impacts. GAO acknowledges that the
federal insurance programs are not profit-oriented, like private insurers.
Nonetheless, a strategic analysis of the potential implications of climate
change for the major federal insurance programs would help the Congress
manage an emerging high-risk area with significant implications for the
nation's growing long-term fiscal imbalance.

            Growth in Exposure of Federal Insurance Programs ($2005)

                 United States Government Accountability Office

Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss our findings on the potential
financial implications of climate change for federal and private insurers.
My testimony is based on our report being released today entitled Climate
Change: Financial Risks to Federal and Private Insurers in Coming Decades
are Potentially Significant. ^[188]1 The uncertain and potentially large
losses associated with weather-related events are among the biggest risks
that property insurers face. Virtually anything that is insured is
vulnerable to weather-related events.

The property and casualty segment of the insurance industry, spanning both
the private and public sector, bears a large portion of weather-related
losses--the dollar value of claims paid on damage attributable to
weatherrelated events. ^[189]2 The private sector includes primary
insurers that insure individuals and businesses directly, and reinsurers
that insure the primary insurers. The public sector includes federal and
state programs that were established as an alternative to disaster
assistance in markets where private insurance markets did not exist, such
as for crop losses, and for losses that private insurers had deemed
uninsurable, such as flood damage. The Federal Crop Insurance Corporation
(FCIC) was established in 1938 to temper the economic impact of the great
Depression, and was significantly expanded in 1980 to protect farmers from
the financial losses brought about by drought, flood, or other natural
disasters. The Department of Agriculture's Risk Management Agency (RMA)
administers the program in partnership with private insurance companies,
which share a percentage of the risk of loss and the opportunity for gain
associated with each insurance policy written. The National Flood
Insurance Program (NFIP) was established in 1968 to protect communities
vulnerable to flood damage. The Federal Emergency Management Agency
(FEMA), within the Department of Homeland Security, is responsible for
oversight and management of the NFIP. Private insurers administer the
program in partnership with the federal government, but the federal
government assumes the full liability for losses.

^1GAO, Climate Change: Financial Risks to Federal and Private Insurers in
Coming Decades are Potentially Significant [190], GAO-07-285 (Washington,
D.C.: Mar. 16, 2007).

^2Insurers use the term "loss" to refer to the dollar value of approved or
settled claims arising from damages incurred by a policyholder. "Loss"
does not account for premium or other income, deductibles, co-payments, or
damages in excess of coverage.

To remain financially solvent, the insurance industry must estimate and
prepare for the potential impact of future weather-related events. Any
unanticipated changes in the frequency or severity of weather-related
events can have financial consequences at the company level and
industrywide. Some infrequent weather-related events--drought or
hurricanes, for example--are so severe that they pose unique challenges
for insurers and reinsurers. Commonly referred to as extreme or
catastrophic events, the unpredictability and sheer size of these
events--both in terms of geography and number of insured parties
affected--have the potential to overwhelm insurers' and reinsurers'
capacity to pay claims.

The earth's climate and weather patterns are dynamic, varying on seasonal,
decadal, and longer time scales. Of particular concern, the global average
surface temperature has increased by 1.3 degrees Fahrenheit (0.74 degrees
Celsius) over the past 100 years, and the National Academy of Sciences
(NAS) and other scientific organizations have concluded that available
evidence points to continued, perhaps accelerating, increases over the
next century. Much research and policy debate of late has centered on the
extent to which human activities have contributed to this warming and
accompanying changes in climate, and how much is due to natural
variability. But in any case, climate change, defined by the
Intergovernmental Panel on Climate Change (IPCC) as any change in the
climate over time due to either natural variability or as a result of
human activity, ^[191]3 may affect social and economic activities in
potentially profound ways--by raising sea levels, changing precipitation
patterns, and altering the frequency or severity of weather-related
events.

My testimony summarizes our report, focusing on (1) what is known about
how climate change might affect the frequency and severity of damaging
weather-related events, (2) the extent of the insured losses incurred by
private and federal insurers and reinsurers resulting from weather-related
events, and (3) what major federal agencies and private insurers and
reinsurers are doing to prepare for the potential risk of increased
losses.

^3More specifically, the IPCC definition refers to climate change as a
statistically significant variation in either the mean state of the
climate or in its variability, persisting for an extended period
(typically decades or longer). Climate change may be due to natural
factors (e.g., internal processes or external forcings such as solar
variations or heavy volcanic activity), or to persistent human-induced
changes in the composition of the atmosphere or land use patterns.

To describe how climate change might affect insured and uninsured losses,
we reviewed and summarized key scientific assessments by reputable
international and national research organizations, including the IPCC,
NAS, and the multi-federal agency Climate Change Science Program (CCSP).
To determine the extent of insured losses, we analyzed key data from 1980
through 2005 from the insurance industry and federal agencies. Comparable
data on 2006 losses were not available at the time we completed work on
our report. To determine what federal and private insurers are doing to
prepare for potential increases in losses, we interviewed agency officials
and a subset of the largest insurers and reinsurers operating within the
United States. We also interviewed officials from catastrophe modeling
firms, insurance industry associations, the National Association of
Insurance Commissioners, ^[192]4 and universities to provide additional
context for respondents' statements. In addition, we reviewed key reports
and publications from federal agencies, insurance experts, and selected
insurance companies. We performed our work in accordance with generally
accepted government auditing standards.

                                    Summary
									
Assessments by key governmental scientific bodies have found that the
effects of climate change on weather-related events could be substantial.
IPCC projections, endorsed by NAS and CCSP, expect warmer surface
temperatures to increase the frequency and severity of damaging
weatherrelated events (such as flooding or drought), although the timing,
magnitude, and duration of these changes are as yet undetermined. Further
research on the relationship between increasing temperatures and weather
events is ongoing. Of particular note, the IPCC is in the process of
releasing its Fourth Assessment Report of the state of climate science
throughout 2007, and CCSP has undertaken an assessment of the potential
changes specific to North America in a report scheduled for release in
2008.

Taken together, private and federal insurers paid more than $320 billion
in claims on weather-related losses from 1980 through 2005. In constant
dollars, private insurers paid the largest part of this total, $243.5
billion (about 76 percent); followed by federal crop insurance, $43.6
billion (about 14 percent); and federal flood insurance, $34.1 billion
(about 11 percent). Claims varied significantly from year to year--largely
due to the
incidence and effects of extreme weather events such as hurricanes and
droughts--but generally increased during this period. The growth in
population in hazard-prone areas, and resulting real estate development
and increasing real estate values, have increased federal and private
insurers' total coverage and have helped to explain the increase in
losses.

^4The National Association of Insurance Commissioners is an organization  of
insurance regulators from the 50 states, the District of Columbia, and the
five U.S. territories.

While both major private and federal insurers are exposed to increases in
the frequency or severity of weather-related events associated with
climate change, the two sectors are responding in different ways. Many
major private insurers are incorporating elements of climate change into
their annual and strategic risk management practices to reduce their
exposure to catastrophic risk--that is, their vulnerability to extreme
weather-related events and the associated financial losses. One
consequence is that they are transferring some of their exposure to
policyholders and to the public sector. Federal insurance programs, on the
other hand, have seen their exposure grow significantly--NFIP's total
coverage has quadrupled from 1980 to 2005, nearing $1 trillion, and
program expansion has increased FCIC's total coverage nearly 26-fold to
$44 billion. These escalating exposures to catastrophic weather events are
putting the federal government at increased financial risk, but federal
insurers have done little to develop and disseminate the kind of
information they, and other key decision-makers such as the Congress, need
to understand their programs' long-term exposure to the increased
financial risks associated with climate change.

While we acknowledge that the mandate and operating environment of the
major federal insurance programs is different from that of the private
sector, we believe that better information about the federal government's
exposure to potential changes in weather-related risk would help the
Congress identify and manage this emerging high-risk area--one that
potentially has significant implications for the nation's growing fiscal
imbalance. Accordingly, our report being released today recommends that
the Departments of Agriculture (USDA) and Homeland Security (DHS) analyze
the potential long-term fiscal implications of climate change for the FCIC
and NFIP, respectively, and report their findings to the Congress.

In commenting on a draft of this report, both USDA and DHS agreed with our
recommendation, although USDA took issue with several points made in the
report. The Department of Commerce neither agreed nor disagreed with the
report's findings, but instead commented on the presentation of several
issues in the draft and offered technical comments which we incorporated
into this report as appropriate. The Department of Energy elected not to
provide comments on the draft.

Background

Insurance is a mechanism for spreading risk over time, across large
geographical areas, and among industries and individuals. While private
insurers assume some financial risk when they write policies, they employ
various strategies to manage risk so that they earn profits, limit
potential financial exposure, and build capital needed to pay claims. For
example, insurers charge premiums for coverage and establish underwriting
standards, such as refusing to insure customers who pose unacceptable
levels of risk or limiting coverage in particular geographic areas.
Insurance companies may also purchase reinsurance to cover specific
portions of their financial risk. Reinsurers use similar strategies as
primary insurers to limit their risks.

Under certain circumstances, the private sector may determine that a risk
is uninsurable. For example, homeowner policies typically do not cover
flood damage because private insurers are unwilling to accept the risk of
potentially catastrophic losses associated with flooding. In other
instances, the private sector may be willing to insure a risk, but at
rates that are not affordable to many property owners. Without insurance,
affected property owners must rely on their own resources or seek out
disaster assistance from local, state, and federal sources.

In situations where the private sector will not insure a particular type
of risk, the public sector may create markets to ensure the availability
of insurance. The federal government operates two such programs--the NFIP
and the FCIC. NFIP provides insurance for flood damage to homeowners and
commercial property owners in more than 20,000 communities. Homeowners
with mortgages from federally regulated lenders on property in communities
identified as being in high flood risk areas are required to purchase
flood insurance on their dwellings. Optional, lower cost flood insurance
is also available under the NFIP for properties in areas of lower flood
risk. NFIP offers coverage for both the property and its contents, which
may be purchased separately. FCIC insures agricultural commodities on a
crop-by-crop and county-by-county basis based on farmer demand and the
level of risk associated with the crop in a given region. Major crops,
such as grains, are covered in almost every county where they are grown,
while specialty crops such as fruit are covered only in some areas.
Participating farmers can purchase different types of crop insurance and
at different levels.

Climate Change Is Expected to Alter the Frequency or Severity of Damaging
Weather-Related Events

Assessments by leading scientific bodies suggest that climate change could
significantly alter the frequency or severity of weather-related events,
such as drought and hurricanes. Leading scientific bodies report that the
Earth warmed during the twentieth century-- 1.3 degrees Fahrenheit (0.74
degrees Celsius) from 1906 to 2005 according to a recent IPCC report--and
is projected to continue to warm for the foreseeable future. ^[193]5 While
temperatures have varied throughout history, triggered by natural factors
such as volcanic eruptions or changes in the earth's orbit, the key
scientific assessments we reviewed have generally concluded that the
observed increase in temperature in the past 100 years cannot be explained
by natural variability alone. In recent years, major scientific bodies
such as the IPCC, NAS, and the United Kingdom's Royal Academy have
concluded that human activities are significantly increasing the
concentrations of greenhouse gases and, in turn, global temperatures.
Assuming continued growth in atmospheric concentration of greenhouse
gases, the latest assessment of computer climate models projects that
average global temperatures will warm by an additional 3.2 to 7.2 degrees
Fahrenheit (1.8 to 4.0 degrees Celsius) during the next century. ^[194]6

Based on model projections and expert judgment, the IPCC reported that
future increases in the earth's temperature are likely to increase the
frequency and severity of many damaging extreme weather-related events
(summarized in table 1). The IPCC recently published summaries of two of
the three components of its Fourth Assessment Report. The first, in which
IPCC summarized the state of the physical science, reports higher
confidence in projected patterns of warming and other regional-scale
features, including changes in wind patterns, precipitation, and some
aspects of extreme events such as drought, heavy precipitation events, and
hurricanes. The second, in which IPCC addresses climate impacts and
vulnerabilities, reported that the potential societal impacts from changes
in temperature and extreme events vary widely across sector and region.
For example, although the IPCC projects moderate climate change may
increase yields for some rain-fed crops, crops that are near their warm
temperature limit or depend on highly-used water resources face many
challenges. Additionally, local crop production in any affected area may
be negatively impacted by projected increases in the frequency of droughts
or floods. Furthermore, the IPCC stated that the economic and social costs
of extreme weather events will increase as these events become more
intense and/or more frequent. Rapidly-growing coastal areas are
particularly vulnerable, and the IPCC notes that readiness for increased
exposure in these areas is low. These reports have not been publicly
released in their entirety, but are expected sometime after May 2007.

^5This estimate comes from a recently released summary of a key component of
IPCC's Fourth Assessment Report of the state of climate science, which
reported an updated 100year linear trend (1906 through 2005) of 1.3
degrees Fahrenheit--larger than the corresponding 1.0 degrees Fahrenheit
(0.6 degrees Celsius) reported in the 2001 Third Assessment Report.

^6IPCC narrowed its range of projected warming in its recently released
summary from the corresponding range of 2.5 to 10.4 degrees Fahrenheit
(1.4 to 5.8 degrees Celsius) reported in the 2001 Third Assessment Report.
Although these two sets of projections are broadly consistent, they are
not directly comparable. IPCC notes in the summary that the new range is
more advanced in that it provides best estimates and an assessed
likelihood range. It also relies on a larger number of climate models of
increasing complexity and realism, as well as new information regarding
the nature of feedbacks from the carbon cycle and constraints on climate
response from observations.

     Table 1: Selected IPCC Estimates of Confidence in Projected Changes in
                             Weather-Related Events

    Confidence in

projected future Examples of major projected impacts relevant to  property
Weather-related event changes, 2007 insurers

aWarmer and fewer cold days Virtually certain and nights; warmer/more
frequent hot days and nights

o Increased crop yields in colder environments  o Decreased crop yields in
warmer environments  o Increased insect outbreaks in agriculture and
forestry

over most land areas

Warm spells/heat  waves: Very  likely   o Reduced  crop yields  in  warmer
regions due to  heat stress frequency  increases over   o Wildfire  danger
increases

most land areas

Heavy precipitation events: Very likely  o Damage to crops frequency
increases over  o Soil erosion most areas

     o Inability to cultivate land due to excessive moisture content of soils
     o Damage and disruption due to flooding

Area affected by  drought Likely   o  Land degradation,  lower yields  and
damage or failure of crops increases  o Increased livestock deaths

     o Increased risk of wildfire
     o Disruptions due to water shortages

Intense tropical cyclone Likely  o Damage to crops and trees activity
increases  o Disruption and damage due to flooding and high winds

o Withdrawal of private insurance from vulnerable areas

Source: IPCC, Climate Change 2007: Impacts, Adaptation, and Vulnerability,
Summary for Policymakers, 2007.

Note: IPCC used the following terms to indicated the assessed likelihood
of an outcome--"virtually certain," which indicates a 99% probability of
occurrence; "very likely" indicates a greater than 90% probability of
occurrence; and "likely" indicates a greater than 66% probability of
occurrence.

aWarming of the most extreme days and nights each year.

Weather-Related Insured Losses Totaled More Than $320 Billion between 1980
and 2005 and Appear to Be Increasing

In addition to the IPCC's work, CCSP is assessing potential changes in the
frequency or intensity of weather-related events specific to North America
in a report scheduled for release in 2008. According to a National Oceanic
and Atmospheric Administration official and agency documents, the report
will focus on weather extremes that have a significant societal impact,
such as extreme cold or heat spells, tropical and extra-tropical storms,
and droughts. Importantly, officials have said the report will provide an
assessment of the observed changes in weather and climate extremes, as
well as future projections.

Weather-Related Insured Losses Totaled More Than $320 Billion between
1980 and 2005 and Appear to Be Increasing

Based on an examination of loss data from several different sources, we
found that insurers incurred about $321.2 billion in weather-related
losses from 1980 through 2005. In particular, as illustrated in Figure 1,
our analysis found that weather-related losses accounted for 88 percent of
all property losses paid by insurers during this period. All other
property losses, including those associated with earthquakes and terrorist
events, accounted for the remainder. Weather-related losses varied
significantly from year to year, ranging from just over $2 billion in 1987
to more than $75 billion in 2005.

Figure 1: Annual Weather- and Nonweather-Related Insured Losses

Private insurers paid $243.5 billion--over 75 percent of the total
weatherrelated losses we reviewed. The two major federal insurance
programs-- NFIP and FCIC--paid the remaining $77.7 billion of the $321.2
billion in weather-related loss payments we reviewed. NFIP paid about
$34.1 billion, or about 11 percent of the total weather-related loss
payments we reviewed during this period. As illustrated in Figure 2,
claims averaged about $1.3 billion per year, but ranged from $75.7 million
in 1988 to $16.7 billion in 2005.

Figure 2: Weather-Related Losses Paid by NFIP

Since 1980, FCIC claims totaled $43.6 billion, or about 14 percent of all
weather-related claims during this period. As illustrated in Figure 3,
FCIC losses averaged about $1.7 billion per year, ranging from $531.8
million in 1987 to $4.2 billion in 2002.

Figure 3: Weather-Related Losses Paid by FCIC

      Dollars in millions

4,500 1980 1981 1982 19831984 1985 1986 1987 1988 1989 1990 1991 1992
19931994 1995 1996 1997 1998 1999 2000 2001 2002 20032004 2005 Years

Source: GAO analysis of FCIC data.

The largest insured losses in the data we reviewed were associated with
catastrophic weather events. Notably, crop insurers and other property
insurers both face catastrophic weather-related risks, although the nature
of the events for each is very different. In the case of crop insurance,
drought accounted for more than 40 percent of weather-related loss
payments from 1980 to 2005, and the years with the largest losses were
associated with drought. Taken together, though, hurricanes were the most
costly event in the data we reviewed. Although the United States
experienced an average of only two hurricanes per year from 1980 through
2005, weather-related claims attributable to hurricanes totaled more than
45 percent of all weather-related losses--almost $146.8 billion. Moreover,
as illustrated in Table 2, these losses appear to have increased during
the past three decades.

Table 2: Insured Losses Associated with Hurricanes
                    Category 1 & 2       Category 3, 4, & 5             Total 
1980s                     $807 (11)              $9,905 (6)   $10,712 (17) 
1990s                   $9,039 (11)             $29,099 (8)   $38,138 (19) 
2000s                    $8,072 (7)             $89,210 (7)   $97,282 (14) 
Total             $17,918 (29)                $128,214 (21)  $146,132 (50) 

Source: GAO analysis of PCS and NFIP data; National Oceanic and
Atmospheric Administration (hurricane severity classification).

Note: Totals in millions of 2005 dollars. Totals do not include crop
losses associated with hurricanes. Number of hurricanes associated with
losses is included in parentheses. Hurricane classification was based on
peak intensity at landfall.

Several recent studies have commented on the apparent increases in
hurricane losses during this time period, and weather-related disaster
losses generally, with markedly different interpretations. Some argue that
loss trends are largely explained by changes in societal and economic
factors, such as population density, cost of building materials, and the
structure of insurance policies. Others argue that increases in losses
have been driven by changes in climate. To address the issue, Munich
Re--one of the world's largest reinsurance companies--and the University
of Colorado's Center for Science and Technology Policy Research jointly
convened a workshop in Germany in May 2006 to assess factors leading to
increasing weather-related losses. ^[195]7 The workshop brought together a
diverse group of international experts in the fields of climatology and
disaster research. Workshop participants agreed that long-term records of
disaster losses indicate that societal change and economic development are
the principal factors explaining weather-related losses. ^[196]8 However,
participants also agreed that changing patterns of extreme events are
drivers for recent increases in losses, and that additional increases in
losses are likely, given IPCC's projections.

The close relationship between the value of the resource exposed to
weather-related losses and the amount of damage incurred may have ominous
implications for a nation experiencing rapid growth in some of its most
disaster-prone areas. AIR Worldwide, a leading catastrophe modeling
firm, recently reported that insured losses should be expected to double
roughly every 10 years because of increases in construction costs,
increases in the number of structures, and changes in their
characteristics. AIR's research estimates that, because of exposure
growth, probable maximum catastrophe loss--an estimate of the largest
possible loss that may occur, given the worst combination of
circumstances--grew in constant 2005 dollars from $60 billion in 1995 to
$110 billion in 2005, and it will likely grow to over $200 billion during
the next 10 years.

^7Peter Hoeppe and Roger Pielke, Jr., eds., Report of the Workshop on
Climate Change and Disaster Losses: Understanding and Attributing Trends
and Projections, Hohenkammer, Germany, May 25-26, 2006 (Munich, Germany:
October 2006).

^8Consensus statements agreed to at the workshop are listed in their
entirety in appendix IV of [197]GAO-07-285.

Major Private and Public Insurers Differ in How They Manage Catastrophic
Risks Associated with Climate Change

Major private and federal insurers are responding differently to the
prospect of increasing weather-related losses associated with climate
change. Many large private insurers are incorporating both near and
longer-term elements of climatic change into their risk management
practices. On the other hand, for a variety of reasons, the federal
insurance programs have done little to develop the kind of information
needed to understand the programs' long-term exposure to climate change.

Major Private Insurers Prospectively Manage Potential Increases in
Catastrophic Risk Associated with Climate Change

Catastrophic weather events pose a unique financial threat to private
insurers' financial success because a single event can cause insolvency or
a precipitous drop in earnings, liquidation of assets to meet cash needs,
or a downgrade in the market ratings used to evaluate the soundness of
companies in the industry. To prevent these disruptions, the American
Academy of Actuaries (AAA)--the professional society that establishes,
maintains, and enforces standards of qualification, practice, and conduct
for actuaries in the United States--recommends, among other steps, that
insurers measure their exposure to catastrophic weather-related risk. In
particular, AAA emphasizes the shortcomings of estimating future
catastrophic risk by extrapolating solely from historical losses, and
endorses a more rigorous approach that incorporates underlying trends and
factors in weather phenomena and current demographic, financial, and
scientific data to estimate losses associated with various weatherrelated
events.

In our interviews with eleven of the largest private insurers operating in
the U.S. property casualty insurance market, we sought to determine what
key private insurers are doing to estimate and prepare for risks
associated with potential climatic changes arising from natural or human
factors. Representatives from each of the 11 major insurers we interviewed
told us they incorporate near-term increases in the frequency and
intensity of
hurricanes into their risk estimates. Six specifically attributed the
higher frequency and intensity of hurricanes to a 20- to 40-year climatic
cycle of fluctuating temperatures in the north Atlantic Ocean, while the
remaining five insurers did not elaborate on the elements of climatic
change driving the differences in hurricane characteristics.

In addition to managing their aggregate exposure on a near-term basis,
some of the world's largest insurers have also taken a longer-term
strategic approach to changes in catastrophic risk. ^[198]9 Six of the
eleven private insurers we interviewed reported taking one or more
additional actions when asked if their company addresses climatic change
in their weather-related risk management processes. These activities
include monitoring scientific research (4 insurers), simulating the impact
of a large loss event on their portfolios (3 insurers), and educating
others in the industry about the risks of climatic change (3 insurers),
among others. Moreover, major insurance and reinsurance companies, such as
Allianz, Swiss Re, Munich Re, and Lloyds of London, have published reports
that advocate increased industry awareness of the potential risks of
climate change, and outline strategies to address the issue proactively.

Major Federal Insurers Have Taken Little Action to Prospectively Assess
and Disseminate Information on Potential Increases in Catastrophic
Risk Associated with Climate Change

NFIP and FCIC have not developed information on the programs' longerterm
exposure to the potential risk of increased extreme weather events
associated with climate change as part of their risk management practices.
The goals of the key federal insurance programs are fundamentally
different from those of private insurers. Whereas private insurers stress
the financial success of their business operations, the statutes governing
the NFIP and FCIC promote affordable coverage and broad participation by
individuals at risk over the programs' financial self-sufficiency by
offering discounted or subsidized premiums. Also unlike the private
sector, the NFIP and the FCIC have access to additional federal funds
during high-loss years. ^[199]10 Thus, neither program is required to
assess and limit its catastrophic risk strictly within its ability to pay
claims on an annual basis. Instead, to the extent possible, each program
manages its
risk within the context of its broader purposes in accordance with
authorizing statutes and implementing regulations.

^9Additionally, concern over the potential impacts of climate change on the
availability and affordability of private insurance has led the National
Association of Insurance Commissioners to establish a task force to
formally address the issue in a report expected this summer.

^10FCIC receives additional funds for excess losses through USDA's annual
appropriations process. The NFIP is authorized to borrow additional funds
from the Treasury on an asneeded basis, and repay the borrowed funds with
interest.

Nonetheless, an improved understanding of the programs' financial exposure
is becoming increasingly important. Notably, the federal insurance
programs' liabilities have grown significantly, which leaves the federal
government increasingly vulnerable to the financial impacts of
catastrophic events. Data obtained from both the NFIP and FCIC programs
indicate the federal government has grown markedly more exposed to
weather-related losses. Figure 4 illustrates the growth of both program's
exposure from 1980 to 2005. For NFIP, the program's total coverage
increased fourfold in constant dollars during this time from about $207
billion to $875 billion in 2005 due to increasing property values and a
doubling of the number of policies from 1.9 million to more than 4.6
million. The FCIC has effectively increased its exposure base 26-fold
during this period. In particular, the program has significantly expanded
the scope of crops covered and increased participation. The main
implication of the exposure growth for both the programs is that the
magnitude of potential claims, in absolute terms, is much greater today
than in the past.

Figure 4: Total Coverage of NFIP and FCIC, 1980-2005

Dollars in billionsDollars in millions1,000 60,000

        900 50,000

800 700

        40,000 600

500

30,000

        400 20,000

300 200

        10,000 100

0

0

1980 1981 1982 19831985 1984 1986 1987 1988 1989 1990 1992 1991 19931994
1995 1996 1998 1997 2000 1999 2002 2001 20032004 2005

        Years

NFIP (left axis)

FCIC (right axis) Source: GAO analysis of NFIP and FCIC data.

Neither program has assessed the implications of a potential increase in
the frequency or severity of weather-related events on program operations,
although both programs have occasionally attempted to estimate their
aggregate losses from potential catastrophic events. For example, FCIC
officials stated that they had modeled past events, such as the 1993
Midwest Floods, using current participation levels to inform negotiations
with private crop insurers over reinsurance terms. However, NFIP and FCIC
officials explained that these efforts were informal exercises, and were
not performed on a regular basis. Furthermore, according to NFIP and FCIC
officials, both programs' estimates of weather-related risk rely heavily
on historical weather patterns. As one NFIP official explained, the flood
insurance program is designed to assess and insure against current-- not
future--risks. Over time, agency officials stated, this process has
allowed their programs to operate as intended. However, unlike private
sector insurers, neither program has conducted an analysis of the
potential impacts of an increase in the frequency or severity of
weather-related events on continued program operations in the long-term.

Information on Federal Agencies' Long-Term Exposure to Catastrophic Risk
Could Better Inform Congressional Decision-Making

While comprehensive information on federal insurers' long-term exposure to
catastrophic risk associated with climate change may not inform the NFIP's
or FCIC's day-to-day operations, it could nonetheless provide valuable
information for the Congress and other policy-makers who need to
understand and prepare for fiscal challenges that extend well beyond the
two programs' near-term operational horizons. We have highlighted the need
for this kind of strategic information in recent reports that have
expressed concern about the looming fiscal imbalances facing the nation.
In particular, we observed that, "Our policy process will be challenged to
act with more foresight to take early action on problems that may not
constitute an urgent crisis but pose important long-term threats to the
nation's fiscal, economic, security, and societal future." ^[200]11 The
prospect of increasing program liabilities, coupled with expected
increases in frequency and severity of weather events associated with
climate change, would appear to fit into this category.

Agency officials identified several challenges that could complicate their
efforts to assess these impacts at the program level. Both NFIP and FCIC
officials stated there was insufficient scientific information on
projected impacts at the regional and local level to accurately assess
their impact on the flood and crop insurance programs. However, members of
the insurance industry have analyzed and identified the potential risks
climatic change poses to their business, despite similar challenges.
Moreover, as previously discussed, both the IPCC and CCSP are expected to
release significant assessments of the likely effect of increasing
temperatures on weather events in coming months.

The experience of many private insurers, who must proactively respond to
longer-term changes in weather-related risk to remain solvent, suggests
the kind of information that needs to be developed to make sound strategic
decisions. Specifically, to help ensure their future viability, a growing
number of private insurers are actively incorporating the potential for
climate change into their strategic level analyses. In particular, some
private insurers have run a variety of simulation exercises to determine
the potential business impact of an increase in the frequency and severity
of weather events. For example, one insurer simulated the impact of
multiple large weather events occurring simultaneously. We believe a
similar analysis could provide Congress with valuable information about
the potential scale of losses facing the NFIP and FCIC in coming  decades,
particularly in light of the programs' expansion over the past 25 years.

^11 GAO,  21st  Century  Challenges:  Reexamining  the  Base  of  the  Federal
Government [201], GAO-  [202]05-325SP (Washington,  D.C.: February  2005),
77.

Concluding Observations

We believe that the FCIC and NFIP are uniquely positioned to provide
strategic information on the potential impacts of climate change on their
programs--information that would be of value to key decision makers
charged with a long-term focus on the nation's fiscal health. Most
notably, in exercising its oversight responsibilities, the Congress could
use such information to examine whether the current structure and
incentives of the federal insurance programs adequately address the
challenges posed by potential increases in the frequency and severity of
catastrophic weather events. While the precise content of these analyses
can be debated, the activities of many private insurers already suggest a
number of strong possibilities that may be applicable to assessing the
potential implications of climate change on the federal insurance
programs.

Accordingly, our report being released today recommends that the Secretary
of Agriculture and the Secretary of Homeland Security direct the
Administrator of the Risk Management Agency and the Under Secretary of
Homeland Security for Emergency Preparedness to analyze the potential
long-term implications of climate change for the FCIC and the NFIP,
respectively, and report their findings to the Congress. This analysis
should use forthcoming assessments from the Climate Change Science Program
and the Intergovernmental Panel on Climate Change to establish sound
estimates of expected future conditions. Both agencies expressed agreement
with this recommendation.

Mr. Chairman, this concludes my prepared statement. I would be happy to
respond to any questions that you or other Members of the Committee may
have.

Key Contact and Staff Acknowledgments

For further information about this testimony, please contact me, John
Stephenson, at 202-512-3841 or [email protected]. Contact points for our
Offices of Congressional Relations and Public Affairs may be found on the
last page of this statement. Contributors to this testimony include Steve
Elstein, Assistant Director; Chase Huntley; Alison O'Neill; and Lisa Van
Arsdale.

      (360827)

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References

Visible links
 190. http://www.gao.gov/cgi-bin/getrpt?GAO-07-285
 197. http://www.gao.gov/cgi-bin/getrpt?GAO-07-285
 201. http://www.gao.gov/cgi-bin/getrpt?GAO-05-325sp
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