Assessing the costs of climate change is a critical part of developing proportionate national and international policy responses to manage climate risks. Insurance relies on detailed assessment of weather and its costs in order to price risks and provide a viable risk transfer mechanism. Insurance acts as a useful messenger of the financial costs of extreme weather, both today and in the future.

This study examines these costs under high and low climate change scenarios, enabling a global assessment of impacts and the choices available to reduce them.
Scientific consensus suggests that climate change could increase both global temperatures and the amount of energy available in the climate system. As a consequence, the weather could become more volatile. Previous studies that place the cost of climate change at between 2 – 4% of global GDP by the end of the century take limited account of the costs of possible changes in extreme weather, even though extreme weather today costs $10 – 40 bn each year.
This study is one of the first to use insurance catastrophe models to examine the potential impacts of climate change on extreme storms. It focuses on one of the most costly aspects of today’s weather –hurricanes, typhoons, and windstorms, because of their potential to cause substantial damage to property and infrastructure.

Climate change could significantly increase the costs of storm damage

Recent scientific evidence suggests that warmer temperatures could increase the severity of storms, but may not change the number of major storms forming. If carbon dioxide concentrations double relative to current levels (likely by the 2080s under high emissions scenarios), windspeeds of Atlantic hurricanes affecting the US and typhoons affecting Japan could increase by around 6% compared to present.

This could be the difference between a category 4 and category 5 storm (the most severe). For Europeanwindstorms, the science is more equivocal, but some evidence suggests that the number of the most severe storms could increase by up to 20%. There may be an impact on less intense storms, but these are not considered here, because quantitative information about the changes is still limited.
Under these climate change scenarios, total average annual damages from these three major storm types could increase by up to $10.5 bn above a baseline of $16.5 bn today, representing a 65% increase.

Around 60% of the increase in total damages ($6 bn) would be insured if insurance coverage does not change.
These costs would not be spread evenly over time, but would occur in a series of extreme storms. In some years there might be no storms, in others a few moderate storms, and in rare cases a very severe storm.
Extreme losses that only occur once in 100 years to 250 years could be affected by this doubling of carbon dioxide concentrations as follows:
• Insured wind-related losses from extreme US hurricanes could increase by $41- 62 bn above present day losses of $60 – 85 bn, representing a 70 – 75% increase, which is equivalent to an additional two to three Hurricane Andrews in a single season (2004 prices).
• Insured wind-related losses from extreme Japanese typhoons could increase by $10 – 14 bn (¥1100 –1500 bn) above present-day losses of $15 – 20 bn (¥1600 – 2200 bn), representing a 67 – 70% increase, which is more than twice the cost of the 2004 typhoon season, the costliest in the last 100 years.

1. For the purpose of this report the doubling of CO2 refers to a 2.2 times increase. The emissions scenarios were developed by the Intergovernmental Panel on Climate Change (IPCC). No one scenario is more likely than another.
2. For ease of comparison, all financial costs in this report are given in US $ (2004 prices), with local currency equivalents included where appropriate.
3. Losses with such return periods have a 0.4 – 1 % chance of occurring each year in each of these regions. As seen in 2004, different regions could experience exceptional weather in the same year.
FINANCIAL RISKS OF CLIMATE CHANGE •

Insured wind-related losses from extreme European storms could increase by $2 – 2.5 bn
(€1.6 – 2 bn) on top of present-day losses of $30 – 35 bn (€24 – 28 bn), representing a 5% increase.
This increase excludes any flood costs. The additional wind-related costs are equivalent to the 1999 windstorm Martin, one of the most costly windstorms on record.
These costs underestimate the full potential impacts of climate change on future storm losses because:
• Changes in only certain aspects of storms were modelled. The costs of flooding associated with extreme storm damages through intense precipitation and storm-surges were not explicitly modelled despite evidence to suggest these will increase with climate change.

Climate change could also change the frequency of tropical cyclones, or the intensity of less intense European windstorms, both of which could have significant effects on losses, but where the science is still limited.
• The impacts of socio-economic developments, which could substantially increase society’s exposure to extreme storms, were not considered. Population sizes are growing and concentrating in urban areas, along with overall wealth, infrastructure and assets at risk.

The costs of Hurricane Andrew, for example, would have been double in 2002 compared to 1992, due to increased coastal development and rising asset values. Of course, in some cases, socio-economic factors could reduce vulnerability, e.g. improved housing standards, but current trends of increasing exposures are likely to predominate in the future.
Climate change could significantly increase the costs of flooding, particularly
in Europe, but the impacts need to be quantified better.
Worldwide floods are currently the second costliest weather-related catastrophes after windstorms. In Europe, present-day annual average losses from flooding are greater than wind-related losses ($8 – 10 bn vs. $3 bn). In developing countries, particularly South East Asia, damages from flooding typically exceed those from wind damage.
Climate change will increase flood risk on the coast through rising sea-levels and storm-surge heights, inland through increases in seasonal rainfall, and in urban areas through increases in rainfall intensity (flash-floods).
In the UK, climate change could increase the annual costs of flooding by almost 15-fold by the 2080s under the high emissions scenario, leading to potential total losses from river, coastal and urban flooding of more than $40 bn (£22 bn). If climate change increased extreme European flood losses by a similar magnitude, annual costs could increase by a further $120 – 150 bn (€100 – 120 bn). However, more research is needed to quantify these costs more accurately.

Climate change impacts on other sectors of the economy could have further
implications for financial markets.
As well as causing damage to property, climate change could affect many other parts of the economy with direct links to the insurance industry. For the weather-sensitive sectors of health and agriculture, the overall effects of climate change are likely to be significant but mixed (some positive, some negative). But recent events have shown how harmful the impacts of extreme weather could be.
• Health and heatwaves. The European heatwave in 2003 resulted in huge increases in hospital admissions and over 22,000 premature deaths. Changes in the weather have already doubled the chance of a very hot European summer like 2003, and by the 2040s, more than half of all European summers are projected to be warmer than that of 2003.
• Agriculture and forestry. In January 2005 Sweden was hit by windstorm Gudrun, causing the country’s largest ever insured loss. Half of the costs comprised damage to commercial forestry, affecting over 46,000 hectares (equivalent of 10 years’ worth of fellings). Total forestry losses for the storm are currently estimated at $2.5 bn (€2 bn), of which $0.25 bn (€0.2 bn) was insured.
Increased losses from extreme storms and floods could raise the cost of financial
capital, and increase the volatility of insurance markets, if not properly anticipated
Insurers need access to capital to smooth losses from infrequent, very severe weather. Under a high emissions scenario, where carbon dioxide concentrations double by the 2080s, insurers’ capital requirements could increase by over 90% for US hurricanes, around 80% for Japanese typhoons, and at least 5% for European windstorms (excluding flood damage and the impact of climate change on less intense storms). In total, an additional $78 bn could be needed to cover the gap between extreme and average losses resulting from changes in the most extreme storms in the US, Japan, and Europe.

Capital requirements within European markets are likely to increase further as a result
of increases in costs of flooding.
These greater demands for capital could increase costs of capital for the insurance industry. Credit ratings could be affected, with agencies taking into account the increasing number of extreme storms and potential losses. The cost of capital could rise in a finite capital market; investors will demand higher rates of return for placing greater amounts of capital at risk, particularly if property insurance is seen as riskier than the alternatives.
If climate change increases both average losses and insurers’ capital requirements, risk premiums could increase. Under the high emissions scenario, and ignoring socio-economic effects, an increase in the aggregate risk premium of 80% might occur for both US hurricane and Japanese typhoon insurance markets by the 2080s.

The possible wind-related increase in the aggregate risk premium for European
storm would be smaller at 15%, but likely to be higher if flood-related damages and possible impacts on less severe storms were included.

Many climate change costs could be avoided by taking action today
Many of these additional costs due to climate change could be reduced by taking action to manage the risks. Action to stabilise concentrations of carbon dioxide could reduce the potential impact of climate change on costs of extreme weather.
• Limiting carbon emissions (the low emissions scenario) would avoid 80% of the projected additional annual cost of tropical cyclones by the 2080s. Insured costs from extreme events (1-in-100 and 1-in-250 year losses) would also be reduced by 80%, saving $35 – 50 bn, roughly equivalent to avoiding two Hurricane Andrews in one season (in 2004 prices).
• The effect of this would be to reduce insurers’ projected additional capital requirements for extreme storms by more than $60 bn by the 2080s, offering a saving of more than 80%.
• Flood risk across Northern Europe might only increase 2 – 4 fold compared with 10 – 20 fold under the high emissions scenario, offering potential annual savings of $120 bn (€100 bn) each year by the 2080s.
Action to reduce society’s vulnerability to the inevitable impacts of climate change through adaptation would bring further benefits. Socio-economic factors have been a strong driver of changes in the costs of extreme weather in recent decades. Managing these effects could play a significant role in reducing society’s exposure to weather in the future.
The financial benefits of adaptation were not modelled in this study, but considerable cost savings could be achieved.
Strong and properly enforced building codes have been shown to prevent and reduce losses from windstorms. If all properties in south Florida were built to meet the strongest local building code requirements, damages from a repeat of Hurricane Andrew would fall by nearly 45%. If design codes for buildings in the South East of the UK were upgraded by at least 10%, increases in climate-induced damage costs from windstorms could be reduced substantially.
Global damages from a 0.5 metre rise in sea-level have been estimated as $24 – 42 bn per year.
Adaptation – in the form of coastal defences – could bring these costs down to $8 – 10 bn per year.
In the UK, taking account of climate change in flood management policies, including controlling development in floodplains and increasing investment in flood defences, could limit the rising costs of flood damage to a possible four-fold increase (to $9.7 bn or £5.3 bn) rather than 10 – 20 fold by the 2080s.
Policy appraisals of options for tackling climate change should take account of
extreme events. For society to make informed choices about possible responses to climate change, it needs to understand fully the consequences of failing to act, as well as the costs and benefits of acting.

Analysis of different policy responses to climate change rarely includes consideration of the financial consequences of very extreme weather events, and the possible knock-on effects through capital markets. Policy-makers should incorporate the potential direct and indirect impacts of climate change on extreme weather in their cost-benefit analyses, given the scale of the possible risks.

The insurance industry can play an important role in communicating climate risks through its detailed assessment of extreme weather risks. But insurance only provides a risk transfer function, and cannot reduce the absolute risk from climate change. The costs of climate change will fall on the wider economy in some form – either through the premiums of those with insurance, through taxes where the government is insurer of last resort, or by the individual where no insurance is in place.

Ultimately governments have a responsibility to manage the risks of climate change for society in the long-term.
More information is needed on the financial impacts of climate change and extreme weather
This study is only the first step towards a more systematic assessment of the impacts of climate change on the costs of extreme weather and their financial implications. Future work should build on the framework set out in this study and:
• Develop more sophisticated analyses of the impacts of climate change on flood risk at a regional level.
• Refine our understanding of the impacts of climate change on European windstorms, where the frequency of less severe storms could also increase.
• Establish integrated models that couple outputs from climate change models with insurance industry catastrophe models.
• Examine how socio-economic factors could exacerbate or alleviate the effects of climate change on costs of extreme weather.