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Risk AlertRisk Alert

Climate Change

A report for clients and colleagues of Marsh on risk-related topics

Volume V, Issue 2April 2006

Climate Change: Business Risks

and Solutions


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Contents

Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Climate Change Science . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Climate Change and Natural Disasters . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Climate Risks and Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Regulatory Risks and Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Shareholder Risks and Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Litigation Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Reputational Risks and Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Competitiveness Risks and Opportunities . . . . . . . . . . . . . . . . . . . . . . 13

Developing Climate Risk Management Strategies . . . . . . . . . . . 14

Corporate Preparedness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Insurance Coverage Issues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Overall Insurance Industry Impacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Environmental Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Property Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Directors and Officers Liability Insurance . . . . . . . . . . . . . . . . . . . . . . . 22

Weather Risk Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Renewable Energy Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Carbon Trading. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Carbon-Trading Strategy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

Web Sites of Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

Abbreviations and Acronyms in This Issue . . . . . . . . . . . . . . . . . . 32

Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Marsh publishes Risk Alert to keep its clients and colleagues informed on criticalissues related to risk. For additional copies, please contact [email protected] report is also available for download at http://www.marsh.com.

Author: Tom Walsh Editor: Meike Olin, CPCU, CIC

Production Manager: Christine Reilly Publisher: Timothy Mahoney


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Volume V, Issue 2, April 2006 | 1

Climate Change at Davos

When world business and govern-ment leaders gathered for the WorldEconomic Forum in Davos,Switzerland, in January 2006, climatechange was high on the list of riskissues they discussed.

One of the cornerstone reports onrisk released at the forum looked atemerging global risks, the linksbetween them, and their likely effecton different markets and industries.

Global Risks 2006produced by the

World Economic Forum in collabora-tion with MMC (Marsh's parentcompany), Merrill Lynch and SwissReconcluded that climate change isone of a set of emerging risks thatare moving to the centre of thepolicy debate and may offer thegreatest challenges for global riskmitigation in the future.

The report identified three core areaswhere such risks can be addressedand risk mitigation improved:

1. Enhance the quality of informationon risk and improve its flowamong stakeholders.

2. Reassess risk priorities and reallo-cate resources and incentives to act.

3. Strengthen the capacity andresilience of all levels of business,political, and administrative institu-tions.

Of climate change, the report said:Consensus on the nature of thisrisk and its consequences for globalsociety and for the global economyhas not yet been reached, though agrowing body of scientific evidencepoints to the seriousness of thelong-term challenge.

Copies of Global Risk 2006can beobtained by visitinghttp://www.mow.com.

Introduction

Climate changeoften referred to as global warmingis one ofthe most significant emerging risks facing the world today, pre-senting tremendous challenges to the environment, to the worldeconomy, and to individual businesses. It is also one of the mostdifficult risks to mitigate.

Climate change is a clear example of a risk where long-termplanning is essential to mitigate some potentially irreversibleeffects.This is a complex global issue at the intersection ofscience, risk, and public policy. Although some debate continuesabout the extent to which human activityspecifically, theemission of greenhouse gases (GHGs) into the atmosphereislinked to climate change, very few experts now question whetherthe climate is indeed changing.

The business risks from climate change include:

the strong threat of increasingly volatile weather conditions,rising sea levels, and new health impacts;

resulting impacts on insurance markets, business resources,personnel, and corporate preparedness;

increasing legal and regulatory pressures; and

mounting public and shareholder activism.

Climate risk also presents new opportunities for businesses, suchas participation in the emerging carbon-trading markets; use anddevelopment of new, cleaner energy resources; reputationalboosts; and more. For example:

General Electric Co. has undertaken an initiative it callsEcomagination, with plans to double its revenues from greenproductsincluding wind turbines and coal gasificationtechnologyby 2010.

DuPont has committed to reducing its GHG emissions by 65percent in 2010 compared to its 1990 levels.

Bank of America has outlined a set of actions aimed at reduc-ing GHG emissions in both its operations and its investmentopportunities.

This report provides background on the science behind climatechange, discusses the business risks and opportunities associated


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with climate change, addresses development of risk management

strategies, outlines relevant insurance coverage issues, and looksat the risks involved with the rapidly developing renewable andalternative energy.

Climate Change Science

Climate change has been a contentious issue for more than twodecades. Underlying climate change is the greenhouse effect, thebasic premise of which is simple: Greenhouse gases in the upperatmosphere let in short-wave radiation from the sun. But theyabsorb the long-wave heat radiation that comes back from theEarths surface, re-radiating it and keeping the planets overalltemperature livable. As the concentration of these gases increases,so do the warming effects.

Part of our understanding of this effect comes from climatology,the study of long-term weather patterns and conditions. Usingtree rings, seabed sediments, and ice cores bored from glaciers,climatologists piece together a record of the general weather con-ditions going back tens of thousands and even hundreds of thou-sands of years. Although the underlying science encompasses

many fields and can be exceedingly complex, there is broadagreement that the Earths surfaceincluding the surface air andthe subsurface oceanhas recently entered another period ofwarming attributed to a buildup of carbon dioxide (CO2) andother GHGs.

Since temperature records using reliable instruments were firstkept in the 1860s, the warmest 10 years have all occurred since1990. Indeed, NASA recently announced that 2005 was thewarmest year ever recorded. Much of the remaining debate aboutclimate change occurs over why the Earth is warming: specifically,

over how much, if any, of the warming is related to human activi-tiesprimarily the burning of fossil fuels, industrial activity, anddeforestation.The predominant GHGand the one receiving themost attentionis CO2.

2 | Risk Alert

Physical Effects ofClimate Change

The following are among the possi-ble physical effects that could resultfrom climate change:

Sea level rise: Melting of the polaricecaps and a resulting rise in the sealevel could be one of the most seri-ous consequences of climate change.The potential for damage is enor-mous, especially as coastal areasbecome more developed. Companiescould be affected not only throughdirect loss of facilities and real estate,

but also through potential impactson their workers, many of whomcould be forced to move if seawatersrise significantly. Not only mightsome areas be submerged, but areasnot previously at risk to storm surgecould become so.

Hurricanes and typhoons:Hurricane Katrina focused worldattention on the damage a massivehurricane causes when it strikes apopulated area. As with a rising sealevel, coastal areas could expect tobear the brunt of the damage from

increased storm activity; althoughtropical-storm damage from floodsand wind can extend hundreds ofmiles inland. Asian countries depend-ent on monsoon season could bedamaged by any change in the tim-ing and intensity of storms.

Drought: Some areas of the worldmay become more prone to drought;already-dry areas may find the deli-cate balance they now live under tilt-ed to one of desertification. Amongthe potential losses are destroyedcrops, loss or reduction of water

resources, damage to ecosystems,and forced migration of people.

Wildfires: Along with increaseddrought conditions comes the possi-bility of an increase in wildfires, bothin forests and grasslands. Wildfirescould threaten business facilities;

(continued on page 3)


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U.S. Greenhouse Gas Emissions by Gas, 2004

Source: U.S. Energy Information Administration

In recent years, many respected groups have weighed in to sayclimate change is occurring, including:

the United Nations International Panel on Climate Change(IPCC), comprising 2,500 leading experts;

the joint National Academies of Sciences from 11 countriesincluding the United States;

the G8, which issued a joint communiqu at the G8 GleneaglesSummit in 2005 calling climate change a serious and long-termchallenge; and

six former leaders of the U.S. Environmental Protection Agency(EPA)five Republicans and one Democrat.

The reality is that governments, international bodies, shareholders,media, and members of the public are askingand in some casesrequiringcompanies to take climate risk seriously.They are doing

so through treaties, regulations, resolutions, and public debate.

Climate Change and Natural Disasters

One of the alarming unknowns about climate change is how itwill affect natural disasters (see sidebar on page 2).

Two weeks before Hurricane Katrina hit the Gulf Coast of theUnited States and caused unprecedented damage, a professor

Physical Effects ofClimate Change

(continued from page 2)

tourism centers; timber, grazing, andagricultural land; wildlife habitat;private homes; and more.

Heat waves: The European heatwave of 2003widely cited as beingrelated to climate changecausedthe deaths of an estimated 22,000people. Demand for air conditioningduring periods of extreme heat couldlead to massive power outages.

HFCs, PFCs, and S155.9 (2.2%)

F6

Energy-relatedCarbon Dioxide5868.0(82.4%)

Nitrous Oxide353.7 (5.0%)

Methane639.5 (9.0%)

Other Carbon Dioxide105.0 (1.5%)


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4 | Risk Alert

from the Massachusetts Institute of Technology wrote that he

had compiled statistical evidence that climate change affectshurricanes.Writing in the journal Nature, a respected and peer-reviewed publication, Professor Kerry Emanuellong known forhis neutrality in the global warming debatesaid the heating ofthe oceans was causing storms in the Atlantic to be moreintense. Katrinafollowed swiftly by Rita and Wilmahelpedmake the 2005 Atlantic hurricane season not only the most activeon record in the number of storms, but also the most economi-cally damaging. These three storms produced an estimated 2.8million insurance claims and $49.2 billion in insured damages,according to the Insurance Information Institute.

Health risks: Climate change also poses a threat through poten-tial impacts on the spread of diseases. A recent study by HarvardMedical School, for example, concluded that rising temperaturesand extreme weather affect the breeding and spread of diseasevectors such as mosquitoes that carry malaria and ticks thatcarry Lyme disease. Rising temperatures may also increase thegrowth of ragweed pollen and cause a rise in the incidence ofasthma, according to the 2005 study. Air pollution could alsoworsen in some areas, with a related rise in respiratory illnesses.The economic consequences in terms of cost to company and

government health plans could be significant.

Top Ten Most Costly Hurricanes of All Time

(in billions)

Source: ISO/PCS; Insurance Information Institute

4 | Risk Alert

$3.5 $3.8

$38.1

$4.8 $5.0$6.6

$21.2

$8.4$7.8$7.3

Georges(1998)

Jeanne(2004)

Frances(2004)

Rita(2005)

Hugo(1989)

Ivan(2004)

Charley(2004)

Wilma(2005)

Andrew(1992)

Katrina(2005)

Climate change also

poses a threat through

potential impacts on

the spread of diseases.


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Glaciers: Canaries in theCoal Mine

For more than 50 years, the world-wide retreat of glaciers has been citedas evidence that the climate is gettingwarmer.

A recent study by NASAs JetPropulsion Laboratory and theUniversity of Kansas found that therate of ice loss from Greenlanddoubled between 1996 and 2005 asglaciers atop Greenlands ice sheetflowed faster into the ocean.

Using data gathered by satelliteover the past decade, researchersconcluded that the changes toGreenlands glaciers in the past 10years are widespread, large andsustained over time. They are progres-sively affecting the entire ice sheetand increasing its contribution toglobal sea level rise(http://www.jpl.nasa.gov).

Greenlands massive ice sheetup totwo miles thick in spotscontainsone-tenth of the worlds freshwaterreserves and can be expected to be asignificant contributor to sea-levelrise. Scientists have estimated that ifthe entire Greenland ice sheet wereto melt, sea levels would rise by 20feet worldwide.


Natural disaster catastrophe modeling: Catastrophe models for

weather events estimate losses based on a large number ofevents and their associated probabilities. A key factor is the esti-mated frequency of events of varying severity. Relevant data alsoinclude the insured values at stake in areas subject to damage.Models are important risk management tools as they can helpcompanies:

understand and assess their exposures to natural hazards;

analyze infrastructure damage;

obtain advice on risk-reduction measures; and

identify the need for upgrades to buildings.But because models are based in large part on what has hap-pened in the past, some people fear they are not prepared to cap-ture potential changes caused by the relatively rapid warming ofthe climate in recent years. Worried that the risk of loss may bebeing underestimated, the U.S. National Association of InsuranceCommissioners has asked insurers to begin considering theimpact of climate change on their models.

A 2004 study by the Association of British Insurers (ABI), FinancialRisks of Climate Change (available at http://www.abi.org.uk),

modeled the potential impacts of climate change on extremestormshurricanes, typhoons, and windstormsin the UnitedStates, Japan, and Europe.The following are among the conclu-sions from the ABI study:

Climate change could increase insured losses from hurricanesin the United States, typhoons in Japan, and windstorms inEurope by two-thirds to an annual average total of $27 billion(in 2004 U.S. dollars) by the 2080s.

Climate change could increase losses from the most extremestorms (those expected to happen once every 100 to 250 years)

to a range of $100 billion to $150 billion in the United States,$25 billion to $34 billion in Japan, and $32 billion to $38 billionin Europe.

Climate change could increase the annual cost of floodinglosses in Europe by $120 billion to $150 billion by the 2080s.

Coastal development: Under any model and in any discussion ofpreparing for potential climate change impacts, a major factor to


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consider is the ever-increasing development of coastal areas. As

the shores are built up, not only does the number of potentialinsureds increase, but the insured value of property subject tostorms also increases.The ABI study, for example, said that ifHurricane Andrew had hit southern Florida in 2004 instead of in1992, insured losses would have doubled due to increased coastaldevelopment and asset values.

Climate Risks and Opportunities

Climate risk cuts across almost every industry in every corner ofthe worldenergy producers and consumers; transportationproviders and those reliant on it; forestry, agriculture, and foodproducers; construction; chemicals, pharmaceuticals, and the lifesciences; real estate; communications and technology; tourismand hospitality; the retail industry; and more. The number ofcompanies publicly addressing the risks and opportunities posedby climate change has increased dramatically over the pastseveral years.

Most have put aside the debate over the extent to which humanactivity has contributed to climate change and are focused,

instead, on climate risk as a business reality for which they mustplan. In a survey completed by 354 of the Financial Times Global500 companies, more than 90 percent cited climate change asposing commercial risks and/or opportunities (see sidebar onpage 14).

Regulatory Risks and Opportunities

Regulatory risks are particularly pronounced in Europe, where theEuropean Union Emissions Trading System has been operationalfor more than one year, with over 6,000 companies facing manda-

tory emissions-reduction targets and stringent noncompliancepenalties. In the United States, a growing number of companiesand legislators believe it is likely that some form of emissionsrestriction at the federal level will soon be put in place.

International obligations: The major international regulations onclimate change fall under the Kyoto Protocol of the UnitedNations Framework Convention on Climate Change. The KyotoProtocol went into force in early 2005 (see sidebar on page 6),

6 | Risk Alert

The Kyoto Protocol

The Kyoto Protocol is an internationaltreaty, adopted in 1997, intended toreduce greenhouse gas emissions. Ittook effect on February 16, 2005,when Russia signed the treaty. TheUnited States has not signed ontoKyoto. President Bush has insteadcalled for other means of reducingemissions, relying heavily on volun-tary measures.

The Protocol sets legally binding lim-its for the industrialized nations thathave signed it on their emissions ofcarbon dioxide (CO

2), methane,

nitrous oxide, hydrofluorocarbons,perfluorocarbons, and sulfur hexa-fluoride. The Protocols stated goalis to reduce the overall emissionsof greenhouse gases by at least 5percent below 1990 levels by 2012,when the Protocols first commit-ment period ends.

Developing countriesincluding Indiaand Chinaare exempt from the reg-ulations. The commitment level underthe Protocol varies from country tocountry. Cuts of 8 percent from 1990levels are expected from mostEuropean Union countries,Switzerland, and most Central andEast European countries; and 6 per-cent from Canada, Hungary, Japan,and Poland.

The United States was called on tomake a reduction of 7 percent, but, asnoted above, withdrew its supportas did Australiaand did not sign theProtocol. New Zealand, Russia, andUkraine are called on to stabilize theiremissions, while Norway is allowed anincrease of up to 1 percent andIceland up to 10 percent.

The Protocol offers three mechanisms

for countries to meet their targets,apart from outright reductions inemissions.

Joint Implementation (JI): Thisallows for countries to earn emissionscredits if they help develop climate-friendly projects in other industrial-ized nations.



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more than 15 years after the first calls for a global treaty on cli-

mate change.The Protocol targets emissions in 35 industrializedcountries; only the United States and Australia among industrial-ized countries have not ratified it. But even U.S. companies areaffected by the Protocol if they have operations in countries thatare party to it.

The first round of commitments under the Protocol expires at theend of 2012. Planning for the next round of commitments beganin earnest in December 2005 at a meeting in Montreal.

Regulatory confusion: Companies, particularly those based in theUnited States, may find themselves mired in a multitude of

potentially conflicting regulations. In the absence of U.S. govern-ment participation in the Kyoto Protocol, some U.S. cities, states,and regions have taken their own actions on climate changeissues. If states and other entities adopt a variety of regulatoryregimes, companies may find themselves forced to operate underdifferent rules in the different states in which they operate.Thismay make it difficult to adapt standards throughout a companyand expose the company to unforeseen events that will affect itslong-term planning on such strategic decisions as capital outlays.

The following are a few of the federal, state, and local initiatives

currently taking place in the United States: Efforts are under way at the federal level to limit GHG emis-

sions. Some businesses with international obligations are look-ing for a sense of consistency across their operations and clearguidance as to what will be expected of them. For those thatparticipate in carbon-trading programs, there is also a desire tosee the programs increase in size.

One of the first efforts to limit GHG emissions to be put inplace in the United States is the Regional Greenhouse GasInitiative, an agreement signed by the governors of seven

Northeastern states (see sidebar on page 8). Under theprogram, the states will establish a total amount of emissionsto be allowedthe emissions capby power plants in theregion.

At the state level, California recently adopted regulationsaimed at reducing CO2 emissions from automobiles. In doingso, the state cited a desire to limit the impact such emissionshave on the climate. Since then, 10 other states have said they

The Kyoto Protocol


Clean Development Mechanism

(CDM): This allows countries to earncredits for establishing or assisting cli-mate-friendly projects in developingnations.

Emissions Trading (ET): This allowscountries to buy and sell emissionscredits (generally accomplished inone-ton units). It allows companies/countries that produce fewer emis-sions than the Protocol sets as a capto sell credits to companies/countries

that do not expect to meet their caps.

Both CDM and JI mechanisms repre-sent a significant growth area formeeting Kyoto targets and for newinvestment opportunities.

More information about the KyotoProtocol can be found athttp://www.unfccc.int.


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will follow Californias lead. The auto industry has sued to pre-

vent the rules from going into effect, arguing that the changesthat would be required to meet the regulations would dramati-cally increase the price of automobiles.

At the local level, the mayors of more than 200 cities in 38states have signed the nonbinding U.S. Mayors ClimateProtection Agreement.The mayors are urging Congress to passfederal legislation to reduce GHG emissions, working to get theirstate legislatures to reduce GHG emissions, and pledging tomeet or better Kyoto Protocol targets in their own communities.Despite being nonbinding, businesses could find themselvesin a public-relations quandary if they do not work with localofficials.

Other environmental regulations: There is a possibility thatenvironmental laws not specifically aimed at climate changecould nevertheless come into play. For example, some lawsuitsin the United States have been brought under the NationalEnvironmental Policy Act.The plaintiffs in those cases havealleged that defendants failed to consider climate changewhen detailing the impacts their projects would have on theenvironment.

Regulations and opportunities: Consideration of the range ofpotential scenarios is especially critical for companies under-taking or planning for major capital outlays that could beaffected by climate-related regulations. Companies that makean informed effort to reduce emissions nowafter carefulanalysis of their unique situationscould find themselves in abetter position to meet regulations that may eventually be putin place. Careful analysis is essential, as a company thatreduces its emissions now may find itself in a difficult situa-tion later. For example, if a company reduces its emissions by20 percent voluntarily now, what happens if a government

mandate were to appear in five years saying it must reduceemissions by 20 percent? Will the voluntary reduction begrandfathered in? Or will the company be required at thattime to reduce its emission by another 20 percent?

Some companies that anticipate regulation of GHGs may findthemselves in a position to sell services or emissions credits tocompanies that need to reduce their emissions.

8 | Risk Alert

United States: RegionalGreenhouse Gas Initiative

On December 20, 2005, the governorsof seven states in the NortheasternUnited States signed an agreement toimplement a mandatory program tolimit GHG emissions from powerplants in their states.

The Regional Greenhouse GasInitiative (RGGI) is the first mandatoryGHG cap-and-trade program in theUnited States. The seven statesConnecticut, Delaware, Maine, NewHampshire, New Jersey, New York,

and Vermontexpect to have theirindividual programs up and runningby January 1, 2009.

Under the cap-and-trade program,the states will establish a totalamount of emissions to be allowedthe emissions capby power plantsin the region covered by the agree-ment. The total amount will be splitamong the states, which will furtherdivide the emissions allocation amongpower plants located in their states.

For each ton of emissions, a powerplant will be issued one allowance,setting up the trade portion of the

program. Power plants that do nothave enough allowances to covertheir projected emissions can eitherfind a way to reduce their emissionsor buy allowances from others.

As with the international KyotoProtocol, the RGGI will allow compa-nies to meet some of their obligationsthrough offsets such as planting treeson land not currently forested orimproving energy efficiency.

The RGGI set a goal of reducing CO2emissions by 2018 to a level 10percent below 1990 levels, toapproximately 121 million tons peryear. Failure to comply with theprogram would subject a companyto enforcement by state environ-mental authorities.


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Shareholder Risks and Opportunities

Increasingly, shareholders and investment managers are askingcompanies about their policies on climate change. As with mostissues, such questions carry with them potential risks and poten-tial rewards. One of the first questions facing those overseeinginvestment accounts is: Is there a fiduciary responsibility toaddress climate risk?When examining the issue from theperspective of public and private pension trustees in the UnitedKingdom, Mercer Investment Consulting, a Marsh sister com-pany, answered with a definitive yes.

The materiality of climate changeclearly shows that climatechange risk could have the potential to impact a Funds invest-ments over the long term. In addition, we suspect climate changerisk is neither fully known nor understood and that it is not yetproperly managed by the various groups involved in the ongoingmanagement of pension scheme assets (A climate for change,Mercer Investment Consulting, the Carbon Trust, and theInstitutional Investors Group on Climate Change, August 2005,available at http://www.mercerIC.com/climateforchange ).

A company that ignores questions from shareholders about itsclimate change policies may run afoul of its own bylaws. If such

questions are answered haphazardlyor if the company has noanswers to giveinvestors may wonder if the corporation isfiscally responsible and may ultimately decrease their invest-ments. Finally, a company that unnecessarily runs afoul ofimportant shareholder groups may find the issue dragged intothe media spotlight, potentially damaging its reputation.

On the opportunity side, a company may find that answering itsshareholders questions helps to uncover important strategic andoperational issues related to climate change. Companies alreadyaddressing such issues may find their reputations boosted by

making such efforts and strategy public.Typically, shareholdersare asking that the companies in which they invest disclose threetypes of information:

1. What policies and procedures does the company have in placeto evaluate the financial consequences of climate changeissues?

A company that ignores

questions from

shareholders about

its climate change

policies may run afoulof its own bylaws.


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World Cities Commit toEmissions Reductions

The International Council for LocalEnvironmental Initiatives is an associa-tion of worldwide governments thathave made a commitment to sustain-able development. Under its Cities forClimate Protection (CCP) program, itenlists municipalities to adopt andimplement measures to reduce green-house gas emissions. Among the citiestaking part in the program are:

Cape Town, South Africa: Thesouthernmost metropolitan area in

Africa, Cape Town has committed to agoal of reducing GHG emissions by 10percent by 2010, in part through thedevelopment of renewable energysources and efficiency measures. Forexample, some government buildingshave recently been retrofitted forelectricity efficiency. Another goal isto switch 80 percent of energysources to natural gas and renewablesources by 2050.

Heidelberg, Germany: The southernGerman city has reduced CO2 emis-sions from government buildings by

30 percent. Other efforts includerequiring developers to guaranteehigh levels of energy efficiency innew buildings. Economic growth hasmade it difficult, however, for the cityto meet its goal of reducing overallGHG emissions by 20 percent from1987 levels.

Hyderabad, India: The fifth largestcity in India Is one of 17 in Indiataking part in the CCP program.Projects aimed at reducing overallGHG emissions include the develop-ment of more energy-efficient street

lighting and water-pumping stations,improved traffic flow, and increaseduse of solar water-heating systems.

London, England: In June 2005,Londons mayor established theLondon Climate Change Agency tolook at the CO2 dimensions of energy,


2. What action is the company taking to maximize shareholder

value in light of current and anticipated climate changeregulations?

3. How many tons of GHGs does the company currently emitincluding emissions from the end use of a productand whatsteps is it taking to reduce emissions?

A recent survey by Mercer Investment Consulting of 183 U.S.-based institutional investorspension funds, endowments, andthe likeabout their perceptions of various environmental,social, and corporate governance (ESG) issues found:

44 percent of those surveyed believed climate change wasvery important or somewhat important from an economicrisk/return standpoint; and

an additional 14 percent said climate change will be importantin five years.

The survey found (available at http://www.mercerIC.com/usrisurvey)that other environmental issues ranked higher as a concern thanclimate change, a possible indicator that climate change willcontinue to grow in importance over time if its potential environ-mental impacts come to bear.The survey found:

77 percent of respondents ranked sustainability as veryimportant or somewhat important; and

74 percent ranked environmental management as veryimportant or somewhat important.

In a related survey, Mercer Investment Consulting asked 157investment managers from around the worldmanaging anaggregate of more than $20 trilliontheir views on the relevanceof ESG issues to investment performance.That survey, too, foundthat climate change and other environmental issues are rising in

terms of perceived importance to investment decisions. Amongall respondents, climate change:

ranked 9th out of 11 ESG topics in terms of current relevance tomainstream investment analysis; and

ranked 4th out of the 11 in terms of its likely relevance in fiveyears time.

10 | Risk Alert


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World Cities Commit toEmissions Reductions


waste, water, and transportation. Oneof the goals is to reduce the munici-palitys CO2 emissions 20 percentbelow 1990 levels by 2010 and 60percent by 2050. The city also begancharging automobile drivers a fee toenter certain zones in London at peakhours in an effort to reduce conges-tion and emissions.

Melbourne, Australia: Australias

second-largest city reduced GHG emis-sions by 15 percent between 1996and 2003 and hopes to reduce netemissions to zero by 2010. Anothergoal is for 50 percent of the powerused by the municipality to comefrom renewable sources.

Mexico City, Mexico: The MexicoCity metropolitan region produces anestimated 20 percent of the countrysgreenhouse gas emissions. Under aninitiative it calls Proaire, the city iscombining efforts to improve airquality and reduce GHG emissions.

Among the goals are to replace80,000 of the citys taxis with lower-emissions vehicles, improve domesticwater and energy efficiency, andparticipate in international emissions-trading markets.


As in the investor survey, broader environmental issues were per-

ceived as becoming increasingly important factors in investmentdecisions.

Litigation Risks

With a growing perception among the public, governmentofficials, and businesses that climate change causes damage,the likelihood increases that lawsuits may be filed againstthose believed to contribute to the buildup of GHGs. Companiescould find themselves embroiled in courtroom battles on anumber of fronts.

Regulatory agencies: As government agencies and world bodiesput regulations in place limiting emissions, enforcement actioncan be expected against companies found not to be in compli-ance. Such companies may then face significant costs from finesor from fighting against the regulationsor against allegations ofhaving violated themin court.

Shareholders: Lawsuits from shareholders could center onwhether a company suffered financially due to a lack of planningfor climate risks by directors. For example, its conceivable that apower company may choose to do nothing to limit emissions,

and then the federal government could pass legislation requiringCO2 limits. Companies that had not prepared for the possibilitycould find themselves at a disadvantage to competitors that didprepare.

Mass torts: In a world increasingly following the U.S. trend offiling class-action-style lawsuits, climate change could become amore popular cause of action. Already, a handful of lawsuits havebeen filed or contemplated.

Residents of several island chainsincluding Tuvalu and theMaldiveshave said they may attempt to file lawsuits against

companies and/or governments they blame for contributing toclimate change.The islanders fear that their homelands will beswallowed by the sea should ocean levels rise.

Energy and resource companies in Australia have been threat-ened with class-action lawsuits stemming from climate changeissues.


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12 | Risk Alert

At least one lawsuit filed in the wake of Hurricane Katrina

seeks class-action status based on allegations that the exten-sive damages were caused in part by climate change. The law-suit contends that the emissions from numerous companiescaused Katrina to become exceptionally strong.

In September 2005, a federal judge in New York dismissed twolawsuits that had been filed against five power companies.Thelawsuitsfiled by eight states, New York City, and several envi-ronmental groupsalleged that CO2 emissions from the com-panies coal-burning power plants damaged the health, safety,and financial well-being of citizens.The judge in the case citednational and international debate about climate change andsaid the issue was a political one, not a matter for the courts.The plaintiffs have appealed.

A challenge to the U.S. governments decision not to treat CO2as a pollutant under the Clean Air Act is now pending consid-eration by the U.S. Supreme Court. Adding to the confusion, atleast one state has adopted the government finding as a matterof state law.

One of the issues in any potential lawsuit based on a claim ofclimate change is the legal issue of standing. Experts say that

having the proper standing to be allowed by a court to file a suitcould pose a high hurdle, but one that could be cleared. In animportant case in California, a federal district judge found thatplaintiff environmental groups had sufficiently demonstratedconcrete harm, causation, and redressability to challenge theOverseas Private Investment Corporation (OPIC) and the Export-Import Bank over their failure to conduct an environmentalassessment of the climate impacts of project lending guaranteesfor projects that would increase GHG emissions in developingcountries.

Another vexing issue will be the assessment of blame and, thus,damages. It would likely be exceedingly difficult to apportionblame for CO2 emissionsonly one of the GHGs, albeit the mostprevalentamong all of the possible emitters. However, one needonly look at asbestos lawsuits to find cases in which the deeppockets are tapped.

Emissions Offsets and theCarbon-Neutral Pledge

From rock stars musical tours toentire corporate operations, there is agrowing movement to offset theoverall emission of CO2 through othermeans. The offsets can involve a vari-ety of activities, from planting newtrees to improving energy efficiency.

Projects that tie up CO2 in carbonsinks or that lead to cleaner energycreate emissions credits for compa-nies. These credits can be used tooffset some of their CO2 emissions,

or they can be sold to other compa-nies that cannot meet their emis-sions-reduction targets.

Among the methods companies canuse to generate offsets are:

energy-efficiency gains throughprojects that conserve andimprove energy use;

use of renewable energy sourcessuch as solar, sea, wind, or biomass;

switching fuel sources from car-bon-intensive sources such as coalto less-intense sources such as gasor renewable energy;

capturing and combusting GHGemissions from landfills and con-verting them to energy (waste-to-energy projects); and

undertaking forestry projectsand/or soil and land conservationprojects that lock up CO2 in anatural process known as seques-tration.

The idea behind a pledge to becarbon-neutral is that if a companycan figure out how much CO

2it

causes to be emitted into the atmos-phere, it can offset that amountthrough activities that tie up anequivalent amount of CO2. Forexample, trees and other plants, ina process known as sequestration,remove CO2 from the atmosphere



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Reputational Risks and Opportunities

Although most consumers do not currently consider climatechange to be a front-burner issue, it is likely to become a main-stream consumer concern by 2010, according to Brand Value at RiskFrom Climate Change, a study conducted by the Carbon Trust withLippincott Mercer, a Marsh sister company. In part, climate changewill gain visibility among consumers in the coming years throughthe impacts of media reports on severe weather, increased regula-tions, political debate, and an increase in products marketed asclimate-friendly.

As climate change gains awareness among consumers, compa-

nies may find themselves at a disadvantage if competitors man-age to take the lead in promoting a positive image for their brandon the issue. Although reputation damage from climate changeissues is difficult to quantify, experts at Lippincott say companiesin some sectors could expect to lose market share if they are seento be behind competitors in addressing climate risks.

A number of companies from a range of industries are already pro-moting themselves as environmentally friendly and, specifically,climate change-friendly. Those successful at convincing consumersof their efforts to mitigate climate risk stand to gain market share

at the expense of those companies seen as lagging in commitment,according to Lippincott. One way in which companies are promot-ing their climate awareness is through carbon-neutral pledges, inwhich they commit to running their businesses in a manner thatproduces no net GHG emissions (see sidebar on page 12).

Competitiveness Risks and Opportunities

A company that manages the above risksphysical, regulatory,shareholder, litigation, and reputationalmore effectively thanothers in its industry may gain a competitive advantage. Forexample, if a manufacturing firm undertakes a comprehensive

effort to reduce its energy consumption, it may significantlyreduce energy costs, discover ways to streamline its processes,exceed shareholder expectations, and project a positive environ-mental image.

Many companies are now aggressively developing new productsas part of environmentally friendly strategies. Sales of hybridautomobiles, for example, are robust, especially as consumers

Emissions Offsets and theCarbon-Neutral Pledge


through photosynthesis and store itin their trunks, roots, branches, andleaves.

Recently, a rock super group madeits world tour carbon-neutral byplanting a sufficient number oftrees to act as sinks to store anamount of carbon equivalent to theamount the events would produce.Several major financial institutions

have pledged to become carbon-neutral through a variety of offsets.

Such efforts likely bring at least asmall reputation boost amongconsumers concerned with climatechange. However, it should benoted that some skeptics arequestioning whether carbon-neutralefforts are all theyre cracked up tobe. They say it could be a way forcompaniesand individualstocontinue wasting energy on thepremise they will offset the usage.

Others say that tree planting maybe relied on too heavily as an offsetand that there is not enough avail-able land to be planted to trulyoffset carbon emissions over thelong term. Some also point to scien-tific questions about how much CO2trees actually remove from the airand how long it remains tied up.

Some insurers have worked with con-sumer-products companies to entirelytransfer to the insurer the burden ofa voluntary offset of the carbon emis-sions impact products. For example,

a company in Australia installed car-bon-neutral gas pumps at gas sta-tions. The cost to the consumer was afew cents more per gallon, but thecompany said it would use the extrarevenue to offset the GHG emissionsassociated with the gasoline fromthose pumps. The company paid aninsurer to locate and manage carbonoffsets on their behalf.


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14 | Risk Alert

deal with extreme fluctuations in gasoline prices in recent years.

Demand for wind energy has propelled a growing market in windturbines and related power-generation equipment. Architects andengineers are focusing on energy efficiency in new buildingdesignsuch as Londons signature, 41-story office and shoppingcomplex, 30 St. Mary Axe, and a new 51-story skyscraper at OneBryant Place in New York City. Power producers are exploring coalgasification, a technology that produces power from coal withdramatically lower emissions. Insurers are working to understandclimate risks and develop new products to mitigate them.

Conversely, a company that ignores climate risk may find itselfburdened with higher energy costs, stuck with outmodedtechnology, mired in shareholder litigation, and panned asenvironmentally unfriendly.

Developing Climate RiskManagement Strategies

Some potential impacts of climate change may not be felt for anumber of years, such as a rise in sea levels; increased precipita-tion in some areas, drought in others; and so on. Other impacts,

however, are already being felt, such as increasing regulatoryrequirements and pressure from shareholders. Companies needto develop a strategy to better understand and prepare for cli-mate risk challenges.

For those that have already started down this path, its importantto continually assess their strategies to see where gaps or inade-quacies may exist. For example, in a recent pilot survey of Marshclients with exposure to the European Union Emissions TradingDirective, 80 percent of respondents said risk management andinsurance strategies need to be better integrated with climaterisk strategies.

Climate change is simply another lens through which to viewrisk. But it is helpful to keep in mind some of its unique charac-teristics, including:

the long-term horizon of potential impacts;

uncertainty over what, exactly, the effects will be;

The Carbon DisclosureProject

In February 2006, the nonprofitCarbon Disclosure Project (CDP) sentits fourth request for information tomajor businesses around the worldasking how those companies incorpo-rate climate change risk into theirplanning. The letter was signed by211 institutional investors represent-ing assets of more than $31 trillion.

The European-based CDP is oneexample of the increasing demand

from international shareholders forcompanies to disclose their currentand future policies regarding climatechange. The project also shows thegrowing willingness of companies toshare that information.

The 2005 surveysigned by 155 insti-tutional investors representing $21trillion in assetswas answered by 71percent of the Financial Times Global500 (FT500) companies (includingMMC, Marshs parent company), upfrom 59 percent in 2004 and 47 per-cent in 2003.

Results from the 2005 surveyincluded:

more than 90 percent of the 354responding companies saying cli-mate change posed a commercialrisk and/or opportunity for theircompanies;

86 percent saying they have allo-cated management responsibilityfor climate change;

80 percent disclosing emissionsdata;

63 percent saying they are takingsteps to assess their climate risk andto reduce their greenhouse gasemissions;

51 percent saying they havealready implemented emissions-reduction programs; and



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the worldwide impact, but one that may well vary depending

on geography and industry;

an evolving and conflicting regulatory regime on the interna-tional level and in individual countries; and

potential macro impacts that could significantly alter entireregions and industries and shift the ways companies do busi-ness and the locations from which they operate.

Assess: The first step in developing a climate risk strategy is toassess where your business stands.A logical starting point is toform a climate risk management team, possibly including board

oversight, to begin assessing the risks throughout the organiza-tion. The team should become versed in macro-level climate risks,then drill down to see how those could relate to the company, itssuppliers, and its customers. One useful tool is to create a riskmapa comprehensive inventory ranking climate risks byfrequency and severity. Another early action should be to developa baseline assessment of GHG emissions from operations, elec-tricity use, and products. Its important not to overlook potentialstrategic planning opportunities during the assessment phase.

Act: After conducting a thorough initial assessment, companies

should consider adopting and enacting company-wide goals andpolicieswhen applicableto reduce climate risk exposures.Depending on the nature and extent of the risks identified,actions could include:

instituting corporate-preparedness plans in light of climate riskand benefits;

reducing GHG emissions through an assessment of internalreduction opportunities versus externally available approachessuch as carbon trading;

creating offsetssuch as energy-efficiency projectsfor someportion of the firms GHG emissions;

increasing the use of alternative energy sources; and

identifying new products, processes, and/or services to bring tomarket aimed at reducing GHG emissions or mitigating globalweather concerns.

The Carbon DisclosureProject


13 percent saying they havereduced their emissions since theprevious year.

Results from the 2006 survey will bereleased later this year.

Source: http://www.cdproject.net


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16 | Risk Alert

Disclose: Especially in the light of continued and increasing

pressure from shareholder groups, members of the public, andregulatory agencies, companies should take the time to develop adialog with stakeholders around the issue. When feasible, climaterisk initiatives should be made public.

Corporate Preparedness

Overall, the same basic concepts apply to corporate preparednessand business-continuity management (BCM) for climate risk asfor other risks. Its important to keep in mind that corporatepreparedness should not be treated as an add-on to a companys

operations. It should be part and parcel of the integrated plan-ning that goes into establishing a business process in the firstplace. In other words, management needs always to have onhand a plan for what to do should something begin to go wrong.Operations managers and other executives with risk manage-ment responsibilities should consider the following when assess-ing corporate preparedness for climate risk:

Understand the potential means by which climate risk coulddirectly and indirectly affect their operations, resources, repu-tations, and financial fitness.

Review existing corporate-preparedness plans, procedures, andpolicies, including BCM, risk management controls, human-resource policies, communications capabilities, public image,critical suppliers and vendors, and potential sales impacts. Allexisting plans should be reviewed, updated, and tested basedon the threat posed by climate risk. For example, companiesshould ask themselves: What currently unanticipated physicalriskssuch as increased likelihood of wildfire, intense storms,and so onmight climate change bring? Will the plan work inthe event of a Category 5 storm? How might climate changeaffect our long-term sales of certain product lines? How will

new emissions regulations impact our operations?

Assess what additional risks climate change presents to thesupply chain.Will regulations affect the ability of any suppliersincluding energy suppliersto provide materials or services?Could it raise the price they charge?

Test operations-continuity plans regularly. If a companybelieves that some effect of climate risksuch as a prolonged

Overall, the same basic

concepts apply to

corporate preparedness

and business-continuity

management (BCM)for climate risk as for

other risks.


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drought or increased floodingcould affect operations, it

should consider running rehearsals using scenarios to test theplans effectiveness.

Try to ensure that senior managers have the skills to manageany such event before it becomes a crisis.

So what happens if climate change does indeed cause anincrease in the frequency and severity of major storms, lead tomore droughts, increase the number and severity of wildfires,cause certain diseases to become more prevalent, and precipitateother problems? One of the primary goals of corporate prepared-ness is to establish your company as one of the first to renew

operations in the wake of a catastrophe.

Consider hurricanes. If they increase in severity or number,many of the basic BCM concerns remain the same. Evacuationplans need to be developed and tested. Material for boardingup and securing facilities needs to be on hand. Plans need to bein place to restart the business as soon as possible once thedanger has passed. Employee and family assistance plans needto be considered.

Climate change will also have an impact on other levels of plan-

ning. A company faced with repeated battering from storm afterstormor with water shortages, a rise in sea level, and/or otherdifficultiesmay need to consider relocating, which triggers newissues. A company that has built its facilities to withstand aCategory 3 hurricane may need to consider strengthening towithstand a Category 4 or Category 5.

Companies located farther inland may, likewise, be forced torethink their normal operations and emergency-response planswhen faced with more frequent or severe storms. For example,what if a business depends on certain ports being open in orderto ship products or receive supplies? Will an increase in hurri-

cane or typhoon activity cause those ports to be out of operationmore frequently or for longer periods of time? If so, does thecompanys plan provide for alternative means of shipping? Orshould a two- or three-week supply of needed components bestockpiled during hurricane season?

What if a change in climate leads to changes in electricityproduction and use? If demand for cooling drives up electricity


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18 | Risk Alert

prices or causes supply shortages in a region during increasingly

warm summers, what will the impact be on a companys abilityto maintain production or profitability?

What about changes in marketplaces themselves? What will itmean for a sweater manufacturer if it has been supplying north-ern Europe with sweaters based on people needing them sixmonths per year, but they start needing them only four monthsper year? Can the business still be profitable?

The above are just some of the types of scenarios companiesneed to evaluate when managing climate risk.The way in whichcompanies respond to the new operational and strategic risks

and opportunities of climate change will have far-reachingimpacts on corporate profitability and shareholder value.

Insurance Coverage Issues

Because businesses that sustain losses often look to insurancefor potential relief, there may be a question as to whether cover-age is available for damage related to climate change.

There is no current policy that provides explicit coverage for the

risk of climate change. However, there are policies that coverthe types of damage that might be associated with it, such asflood, wind, freezing, heat, earth movement, or collapse. Thefollowing is a broad overview of potential issues that may arisein several common coverage areas.

Overall Insurance Industry Impacts

Evan Mills, a researcher at the U.S. Department of EnergysLawrence Berkeley National Laboratory, recently wrote: Virtuallyall segments of the [insurance] industry have a degree of vulnera-bility to the likely impacts of climate change, including thosecovering damages to property (structures, automobiles, marinevessels, aircraft); crops and livestock; pollution-related liabilities;business interruptions, supply-chain disruptions, or loss of utilityservice; equipment breakdown arising from extreme temperatureevents; data loss from power surges or outages; and a spectrumof life and health consequences (Insurance in a Climate ofChange, Science, August 12, 2005).

Insurance Availabilityfor Renewable EnergyProjects

Limited data on the commercial oper-ating history of renewable energyprojects poses a significant challengeto insurers looking to develop prod-ucts and insure projects in that area.In fact, many insurers believe thatimprovements in actuarial data andin technical risk information couldhelp drive new product developmentin the renewable energy sector.

These are some of the conclusions

from a study conducted by MarshsRenewable Energy Team in Londonfor the United Nations EnvironmentProgram. The surveys purpose was tocollect baseline information on theavailability of insurance for renew-able energy projects.

The majority of insurers and reinsur-ers participating in the survey saidthat a combination of brokers, insur-ers, project developers, and financiersare best placed to drive productdevelopment.

Among the key observations in thereport: In theory, sufficient capacityis available to meet the insurancerequirements of the renewable ener-gy industry. However, in reality, thereare a number of factors which restricthow much capacity any one under-writer is prepared to commit to anyone project.

Those factors include:

availability of underwriting infor-mation, including risk-assessmentand loss-prevention measures;

technical expertise and ability to

price risk in an economic and sus-tainable manner;

low insured values associated withsmall-scale projects; and

ease of access to developing coun-try projects and insurance markets.

For a copy of the report, send ane-mail to [email protected].


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According to the IPCCs Climate Change 2001: Recent history has

shown that weather-related losses can stress insurance compa-nies to the point of bankruptcies, elevated consumer prices,withdrawal of insurance coverage, and elevated demand forpublicly funded compensation and relief. Increased uncertaintyregarding the frequency, intensity, and/or spatial distribution ofweather-related losses will increase the vulnerability of the insur-ance and government sectors and complicate adaptation efforts.

Faced with this, the insurance industry can be expected to reactby attempting to develop specific climate-related products, man-aging the exposure created by its current products, and working

to mitigate the damages. Examples of changes in products mightinclude:

increasing premiums for coverages applicable to weather-relat-ed events and catastrophes;

increasing the use of exclusions applicable to losses associatedwith climate change; and

increasing deductibles for weather-related losses.

Examples of risk-mitigation activities might include:

working to change building codes to make construction morelikely to withstand damage;

encouraging insureds to maintain strong loss-control policiessuch as emergency-preparedness and business-continuityplans; and

developing new insurance products that will allow for risktransfer.

With insurers becoming increasingly aware of climate risks andopportunities, companies have an opportunity to work with theirbrokers and insurance markets to craft products to address their

specific needs and those of their industries. Challenging issuessuch as carbon capture and storagemay be eased if insurerscan become comfortable with underwriting the engineeringapproaches and understanding the risks.

With insurers becoming

increasingly aware of

climate risks and

opportunities, companies

have an opportunity towork with their brokers

and insurance markets

to craft products to

address their specific

needs 3and those of

their industries.


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20 | Risk Alert

Environmental Insurance

Because climate change is arguably, at its roots, an environmentalissue, companies may conclude that their environmental liabilitypolicies should respond to these losses. However, at present, itappears unlikely insurers would accept these arguments.

There are a range of potential arguments insurers could beexpected to make in response to such claims. Environmental lia-bility or pollution policies typically provide coverage for damagearising from pollution.This is often further restricted to certaintypes of pollution, such as indoor-air quality, pollution at a partic-ular site, and/or a particular pollutant involved in an industrialprocess.The term pollution is often broadly defined, but is asoften restricted by policy language or case law to mean industrialchemicals or substances classified as pollutants by governmentalentities and environmental laws. Many policies also contain thefurther restriction that coverage applies only to expensesincurred in response to a government order issued under author-ity of a relevant environmental statute, an argument that may bepertinent in states that have not adopted regulatory programs forgreenhouse gases.

Insurers are also likely to argue that the policies apply only

where it can be shown that the particular insureds actionscaused a particular and measurable harm.The scientific debateas to the causes of global climate change may present one setof issues; the nonspecific nature of the effects associated withclimate change presents another. Given these concerns, it doesnot appear likely that insurers would simply agree that existingenvironmental liability policies provide coverage for the broadarray of damages potentially associated with climate change.

This is not to say that claims can never be presented under thesepolicies. Given the flexibility of modern pleading and of concepts

such as nuisance, it may be possible to argue that certain kinds ofclaims could trigger coverage. Indeed, litigation now developingaround the concept of plaintiffs standing to assert claims fordamages from climate-related impacts contains the seeds forsome of these arguments. However, these potential exceptionshelp to show the fact-specific nature of the coverage and theneed to carefully consider both the nature of the coverage andthe facts of the particular loss and claim. Another possible


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22 | Risk Alert

Do the facilities meet building codes? Following Hurricane

Andrew in 1992, investigators discovered that much of the roofdamage to buildings resulted from failures to follow existingbuilding codes.

What about the local infrastructure? Are there numerous waysto get customers, employees, and supplies into and out of thebusiness? Or is there, for example, only one road across a low-lying peninsula?

How well could the business withstand a power outage?

Are there key suppliers or customers in catastrophe-proneareas where a loss to such entities could result in a loss ofbusiness? Have other suppliers been considered as backups?

Are all emergency-preparedness and BCM plans up-to-date?Have they been exercised in the past six months?

These questions should not be new to planning for your propertyinsurance needs. But they need to be cast in a new light, one thatspotlights the potential for more damaging weather patterns.They should also inform other aspects of your decision making.For example, if you are planning an expansion, should you dou-ble the size of an existing facility, or would it be better to build a

second plant more out of harms way that would provide somebackup should the original be forced to close for some time?

Finally, it is important to communicate with your broker and/orinsurer. Your broker should know if you make upgrades to yourbuilding, purchase specialized equipment, or make otherimprovements to allow your business to better withstand orrecover from a storm. Such preparations can play a role when aninsurer determines pricing for your policy and the deductible forweather-related events. One of the immediate insurance impactsstemming from Hurricane Katrina has been an increasesome-times substantialin deductibles for windstorms.

Directors and Officers Liability Insurance

The increased oversight of climate risks from regulators,investorsincluding institutional investors in both the public andprivate sectorsand other public-interest groups has implica-tions for directors and officers (D&O) liability insurance. In 2005,shareholders filed climate change resolutions with 30 companies

Climate ChangeGovernance Steps

The Coalition of EnvironmentallyResponsible Economies (CERES)identified 14 actions that major oilcompanies are taking in response toclimate change:

assigning a directors committee forenvironmental affairs;

conducting a board-level review ofclimate change strategies;

having the chief environmentalofficer report directly to the CEO or

to an executive committee;

making attainment of greenhousegas emissions targets an explicitfactor in employee compensation;

issuing a clear statement from theCEO about the companys climatechange strategy;

including a statement on climatechange risks and opportunities insecurities filings;

issuing a sustainability report;

calculating emissions savings and

offsets from projects; inventorying emissions and report-

ing results to shareholders;

establishing an emissions baselineto gauge trends;

making projections of futureemissions and setting targets tomanage and control them;

hiring a third-party auditor tocertify emissions data;

participating in an external GHGemissions-trading program; and

purchasing or developing renew-able energy sources.

Source: Corporate Governance and Climate

Change: Making the Connection (CERES,

June 2003).


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during proxy season, seeking greater disclosure of climate risks.

Recognizing climate risk as an issue and addressing it in somefashion is becoming an important consideration for companymanagers and boards of directors. The most significant concernscenter on how a company recognizes, analyzes, and disclosesenvironmental and/or climate risk. Disclosureor the failure todiscloseis central to much D&O litigation.

The Securities and Exchange Commission (SEC) has not finalizedrules regarding disclosure specifically on climate change-relatedrisks. However, the SEC does requireunder Item 101 ofRegulation S-Ka disclosure with respect to the effects of com-plying with federal and/or state provisions on the discharge of

materials into the environment. Item 303 of Regulation S-K callsfor additional disclosure around future trends likely to affectprofitability. And its interesting to note that the U.S. GovernmentAccountability Office has issued a report calling for the SEC toimprove and track the transparency of environmental disclosures.

Added to that is the fact that institutional investors are activelydeveloping a private code of conduct for climate risk reporting.Some institutional investors, financial analysts, and rating agen-cies have issued comparative assessments of how well compa-nies across certain industry sectors are positioned to address cli-

mate risk. Insurers are starting to take notice of all this activity,and a few have developed general questions to better assess therisk. There may soon be an increased level of underwriting activityaround climate risks. At the moment, insurers questions arefocusing on areas such as the following:

Management accountability/responsibility: Does a companyallocate responsibility for the management of climate-relatedrisks? If so, how does it do so?

Corporate governance: Is there a committee of independentboard members addressing the issues?

Emissions management and reporting: What progress, if any,has a company made in quantifying, disclosing, and/or report-ing its emissions profile?

Regulatory anticipation: How well has a company planned forfuture regulatory scenarios?

Disclosure requirements and investor petitions can target anyindustry. Oil, gas, transportation, and other manufacturers receive

Recognizing climate risk

as an issue and

addressing it in some

fashion is becoming an

important considerationfor company managers

and boards of directors.


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24 | Risk Alert

most of the attention around climate change. Because there has

already been public-nuisance litigation against the power and oiland gas industries, insurers are starting to pay greater attentionto the possibility of future litigation. But it is important to notethat all industriesnot just oil and gasare in some senseaffected by these developments. There are beverage companies,for example, concerned about climate changes potential impacton water supplies and availability. And the loan portfolios of cer-tain banks are directed toward high-risk sectors with exposure toboth the regulatory and weather risks of climate change.Theinsurance industry itself has received attention from investorgroups concerned about the overall impact climate risk has on

the industrys total portfolio.Risk managers and other executives involved with an organiza-tions D&O exposures need to:

be prepared to discuss climate risk issues with D&O insurers;

work closely with brokers and other advisors to clearly identifyareas of concern and relevant mitigation techniques;

be proactive and work closely with brokers and insurers toaddress any specific language issues to try to ensure thatcoverage is as broad as possible; and

keep an eye on regulatory developments.

Weather Risk Management

There are risk-transfer mechanisms outside of traditional insur-ance products that can be used for risks associated with climatechange.Weather derivatives are financial instruments used bycompanies to offset financial risk and uncertainty caused byvolatility in such phenomena as temperature, rain, snow, or wind.A ski resort, for example, may be able to use a weather derivativeto smooth the financial risk from the potential for below-average

snowfall. Also, power-price protection for utilities provides ameans for hedging costly demands for peak power.

If climate change increases the uncertainty that already sur-rounds extreme weather, it can be expected that interest in suchproducts will increase. Already, the use of weather risk manage-ment has increased substantially in recent years, according to theWeather Risk Management Association (WRMA). For the periodfrom April 2004 to April 2005, the face value of all weather risk

Weather derivatives

are financial

instruments used by

companies to offset

financial risk anduncertainty caused

by volatility in such

phenomena as

temperature, rain,

snow, or wind.


27/36


management instruments increased to $8.4 billion from $4.6

billion in the year prior, according to WRMA. The biggest users ofsuch instruments were in the energy sector, followed by agricul-ture, retail, construction, transportation, and miscellaneousothers, according to the survey.

Renewable Energy RisksDemand for and investment in renewable and alternative energysources is on the rise, driven in part by societys changing percep-tion of climate risk (see sidebar on page 25). Renewable energysourcessuch as wind, solar, wave, tidal and so oncan be inter-mittent, but are inexhaustible.

In addition to climate change, there are a number of political,social, technological, legal, and environmental drivers behind thegrowing demand for renewable energy sources, not the least ofwhich is concern over the future instability of oil prices and thesecurity of the energy supply. Other factors include the following:

The Kyoto Protocol, the European Union Emissions TradingSystem (EU ETS), and other current and pending regulatoryframeworks are driving companies to reduce their GHG emis-sions.

Legislative support schemes in place in various countriesinclude mechanisms such as tariffs, quota obligations, tradablegreen certificates, investment subsidies, fiscal incentives, andtendering systems. For example, the Australian governmentintroduced the Mandatory Renewable Energy Target, whichcalls for reducing GHG emissions through the use of renewableenergy by 6.5 million tons per year by 2020. And in the UnitedStates, a number of states require energy companies to deliverspecific percentages of their power through renewable sources.

Wind power: Wind power is far and away the leader in therenewable energy market. In 2004, wind energy accounted for 91percent of the so-called green power markets in the UnitedStates; U.S. wind-power generation is growing at an estimatedannual rate of 31 percent. In Europewhich since 1999 hasaccounted for 70 percent of the worlds wind powergenerationgrew by 18 percent in 2005 to over 40,000 megawatts (MW).Amegawatt is equal to a million watts, enough energy to serveapproximately 600 homes over a year.

Renewable EnergyInvestments Heat Up

Spurred in part by concerns about thechanging regulatory environmentrelated to climate change, renewableand alternative energy products andservices are hot investment propertiesamong venture capitalists.

Venture capital funding of renewableand alternative energy projects hasincreased dramatically in the lastdecade. In 1995, venture capitalistsinvested about $2.95 million in thesector; that jumped to $181 million in

2005, according to The Wall StreetJournal (Alternative Fuels AttractingVenture Capital, February 6, 2006).

Part of the investment surge comesfrom large pension funds that havebegun to figure climate change intoinvestment strategies. For example,the two largest pension funds in theUnited States have committed a totalof $450 million in private-equityinvestments toward the developmentof environmental technology.

The push for renewable energyinvestments also received a high-

profile boost when President Bushsaid, in his 2006 State of the Unionaddress, that the United States isaddicted to oil and needs todevelop new, nonpetroleum energysources.

Among the main renewable andalternative energy sources attractingattention are wind, solar, biomass,fuel cell, coal gasification, ocean,small-scale hydro, and geothermal.

Use of Renewable Energy Sources

in United States2004

Source Megawatts Percent*Wind 2,046 91.6%

Biomass 135.6 6.1%

Geothermal 35.5 1.6%

Small hydro 8.5 0.4%

Solar 8.1 0.4%

* Percent of U.S. renewable energy

Source: Marsh Environmental Practice


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26 | Risk Alert

European Leaders: Top Ten Wind Power Markets 2005

Source: The European Wind Energy Association

Power companies can use wind power to reduce GHG emissionswhile still meeting customers demands. Likewise, customerswith emissions-reduction goals may find that purchasing wind

power provides an attractive offset. Obviously, the availability ofwind at the turbine site is crucial to a projects success. And yet,relying on a steady wind to blow could be risky. In the context ofclimate change, wind power serves as a good example of how aweather derivative can help a company mitigate some risks.

A wind-power derivative transfers the risk of below-averageenergy production to a third party. The first step in structuringsuch a derivative is to know how much wind is likely at the siteinvolved. This relies on data from the wind-availability study,which would have been performed by an independent sourceduring project planning.The wind data are then combined withpower-production curves for the projects wind turbines, pro-viding an estimate of the amount of wind power that can beexpected to be produced in a normal year.

The derivatives triggerthe point at which payments will bemade to the derivatives purchaseris entirely based on the levelof power produced. For example, a derivative could be structuredso that payment kicks in if low winds in a given period lead to a

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Argentine ProjectHighlights Interest inKyoto Mechanism

In September 2005, the governmentof Argentina announced the creationof the Argentine Carbon Fund. Thegovernment described it as the firstfund in a developing country tofinance projects to reduce green-house gas emissions in line withKyoto Protocols Clean DevelopmentMechanism (CDM)

The CDM provision of Kyoto allowscompanies to earn credits for estab-lishing or assisting climate-friendlyprojects in developing nations.Projects must be approved through arigorous vetting system. The creditsare tradable and can be used to off-set emissions in developed countries.

Argentina said it believes the newfund will help develop projects thatwill reduce CO2 emissions in thecountry by about 30 million tons peryear and bring in about $250 millionin revenue to the country.

The fund will help private and public

entities locate, develop, and financeCDM projects. Other countriesincluding Brazil and Mexicohavesaid they may develop similar funds,and many have already helped indi-vidual CDM projects get under way.

The projects vary widely in theirscope, financing, and other details. InChina, for example, several CDMprojects are under way; with the solerevenue flow expected to be carboncreditslandfills, animal waste/methane projects, and more. Otherprojects will generate credits in addi-

tion to their normal outputsteelproduction, chemical production, andsuch.

As of March 2006, 142 CDM projectshad been officially registered withthe United Nations body that over-sees them, 10 of which had beenapproved for credits to be issued.



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Argentine ProjectHighlights Interest inKyoto Mechanism


The projects are expected to result inmore than 270 million tons worthof emissions credits by the timeKyotos first commitment period endsin 2012. At the same time, nearly500 other projects representing 530million tons of credits were awaitingcertification.


10 percent reduction in the projected amount of power. However,

if the wind is such that more power is produced, the party back-ing the derivative will receivedepending on the exact structureof the dealan additional payment based on the extra revenuethe energy-generating company receives.There are a number ofways to structure a wind derivative, but the bottom line is toreduce financial volatility.

Other wind-risk considerations: The winds uncertainty is butone of the risk management considerations in developing a windproject. Many of the other risks are more traditional and can bemanaged through other insurance and risk management vehi-

cles. Among the other risks in a wind project are the following: Technology: Wind-turbine technology continues to develop

rapidlyturbines capable of producing 5 MWs of electricity arenow being tested.The scope and security of the warrantiesoffered by wind-turbine manufacturers and the ability to wrapthese warranties by insurancemaking sure there are no gapsbetween the warranties and the insurance coverageare criti-cal to the effective management of this risk.

Lightning damage: Protection against lightning has improvedsignificantly, but wind turbinesoften twice as tall as the

Statue of Libertyremain at risk from strikes. Construction-site access: Land-based wind farms are most

often built in remote areas, requiring many miles of road overoften-difficult terrain. Ocean-based sites are generally severalmiles offshore, but in relatively shallow areas requiring special-ized equipment.

Start-up delays: Numerous eventsfrom damage to equip-ment in transit to installation damagecan delay the expectedstart of a project and, thus, the flow of revenue.

Business interruption: A significant risk currently affecting

the wind industry is the ability to access replacement turbinesfollowing a physical loss or a breakdown.The current highdemand for turbines means it can take a long time to replaceinoperable machines.

Natural catastrophes: Earthquakes, wildfires, high seas, andother perils may damage turbines or related equipment.


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28 | Risk Alert

Offshore wind farm risks: Installing and operating a wind farm

offshore is inherently riskier than doing so onshore.Yet off-shore projects with potential production of more than 30,000MW have been announced in North America and Europe.

Carbon Trading

The Kyoto Protocol and related developments have spurred thecreation of major markets in CO2 emissions allowances andcredits. Projects to provide credits under the Clean DevelopmentMechanism (CDM) and the Joint Implementation (JI) establishedunder the Kyoto Protocol represent one class of traded commodity(see sidebar on page 28).

The European Union Emissions Trading Scheme (EU ETS) is theworlds largest emissions-trading program. Under the program,which became operational in January 2005, participating installa-tions are issued allowancesthe right to emit a ton of CO2that,in total, add up to an overall cap. National Allocation Plans (NAPs)are in place, and member states are now developing Phase 2NAPs for the 2008-2012 period. Companies that emit less thantheir allowances can sell the excess allowances to firms that facehigher costs to reduce their emissions. These transactions involve

buying and selling emissions allowances. More than 12,000 indi-vidual facilities are involved in the system, from sectors includingenergy, iron and steel production, minerals, and pulp and paper;and there is a possibility that the aviation and chemical indus-tries will soon be added.

One of the biggest surprises in the first year of emissions tradingin the EU ETS was the sharp rise in the price of CO2 allowances.When the system started operation in early 2005, CO2 allowancestraded at about 8 per ton; by the end of the year, the price hadincreased to almost 30 per ton.The reasons for the price

increase are complex, as noted by analyses prepared by NERAEconomic Consulting, a Marsh sister company that has assistedthe European Commission with regard to the EU ETS and assist-ed the United Kingdom in the development of their Phase 1 NAP.NERA also has evaluated the effects of the EU ETS on electricityprices, another major issue that has arisen as the program hasbeen implemented.

Carbon-Trading Risks

The market for carbon credits underthe Kyoto Protocols CDM and JImechanisms provides additionalopportunities and risks for companiesthat attempt to develop carbon cred-its under these programs. As emis-sions-trading markets grow andmature, a number of risks related tothe EU ETS and the CDM/JI projectscan be expected to arise, including:

carbon-regulatory risks, such asthose associated with host-countryand international policies govern-

ing emissions-reduction projectssuch as project approval, validation,and verification;

host-country investment and politi-cal risks that could alter climatechange policies and obligations,such as host-country instability,expropriation of credits, contractfrustration, credit confiscation, andmore;

technology-performance risks asso-ciated with operational aspects ofthe project activity;

carbon-financing risks, including aninability to secure financing basedon projected carbon-revenuestreams;

carbon-performance risk associatedwith variability in the generation,permanence, and ownership ofemissions reductions;

counterparty credit risks, includingthe failure to deliver credits as con-tracted;

resource supply risks, such as possi-ble fluctuations in fuel and weath-

er issues;

volumetric-related weather risksthat adversely affect earnings;

noncompliance risks, such as finesand other sanctions resulting frommissed targets;



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In a presentation at the Montreal international climate change

negotiations, NERA noted that the development of the EU ETSrepresented an enormous accomplishment for the EuropeanCommunity as a cost-effective CO2 reduction program to meet itsKyoto obligations. NERA noted that the EU ETS also provides therest of the world with a model for a continent-wide emissions-trading platform.

In the United States, the voluntary Chicago Climate Exchange(CCX) began operating in September 2003 and is now the worldssecond-largest carbon-emissions trading market. Its membersinclude utilities, multinational corporations, cities, the state of

New Mexico, agricultural organizations, and liquidity providers.The parent company of CCX recently formed the New YorkClimate Exchange and the Northeast Climate Exchange to developfinancial instruments relevant to the newly created RegionalGreenhouse Gas Initiative (see sidebar on page 8).

Carbon-Trading Strategy

Consider a simple example to illustrate the opportunities andrisks from carbon trading under the EU ETS. Imagine that bothEnergy Co. ABC and Power Co. XYZ are power producers withinthe European Union, each with an annual allocation of 20 million

metric tons of CO2 for the 2005-2007 period. Energy Co. ABCslong-term plan has been to move aggressively into energy pro-duction from alternative sources and otherwise reduce CO2 emis-sions at costs it anticipates to be less than the market price ofallowances. Based upon these changes to its operations, itexpects to emit only 15 million metric tons of CO2 in 2007.

Power Co. XYZ, on the other hand, concludes that alternativeenergy sources would be more expensive than purchasingallowancesalthough it is watching the development of coal-gasification and other low-CO2 technology. The company expects

to emit 25 million metric tons of CO2 in 2007. Under the EU ETS,Energy Co. ABC can sell its expected 5 million tons of excessemissions allowances, generating additional income; Power Co.XYZ can buy 5 million tons of allowance, avoiding high-costcontrols or penalties.The combined emissions of the two compa-nies would be equal to their combined allocation of 40 milliontons, with the two firms sharing in the cost savings from trading.

Carbon-Trading Risks


price and liquidity risks, such asvolatility in energy and carbonprices;

legal liabilities, such as those stem-ming from

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