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The cost of natural catastrophes is rising into the billions. What role does climate change play?

According to insurance giant Swiss Re, 2011 will go down in industry history as one of the most expensive years on record, second only to 2005 when Hurricane Katrina ravaged the southern U.S.

It’s also the third year in a row that natural catastrophes caused at least $1 billion in damages. This is a 20-fold increase since the 1950s, says Glenn McGillivray, managing director of the Institute for Catastrophic Loss Reduction.

“We’re actually closer to a billion and a half” in 2011, McGillivray says. “We’re becoming bigger and more expensive targets.”

How did this happen? McGillivray says three factors have coalesced into a perfect storm of insured and uninsured losses that has already cost the industry US $350 billion in global economic losses in 2011.

Building highly concentrated urban centres, coupled with the poor condition of existing infrastructure, has driven up costs when disaster strikes, he says.

For example, according to a 2008 International Energy Agency estimate, Canada needs $240 billion to upgrade its electricity system by 2030. The Conference Board of Canada estimated in 2010 the amount at $294 billion. McGillivray counts the changing climate as another factor, though an exact causal relation is difficult to measure.

Reinsurers Swiss Re and Munich Re have both conducted global studies on climate change and natural catastrophes and their effects on the insurance industry. Munich Re suggests a “connection between the large number of weather extremes and climate change” in a 2010 press release. Swiss Re, on the other hand, has deemed the threat significant enough to coauthor the Economics of Climate Adaptation methodology, which charts out ways to access financing to address climate-related loss and damage.

“We’re engaging in dialogue with clients, governments and other stakeholders to further define how we and the insurance industry can play a productive role in delivering solutions to the challenges of climate change,” says David Bresch, Swiss Re’s head of sustainability and political risk management.

McGillivray says the insurance companies have started paying attention “because they are the ones picking up the tab for extreme weather.” No similar survey had taken place in Canada—until now.

University of Waterloo’s Blair Feltmate, an associate professor in the School of Environment, Enterprise and Development, has embarked on the first Canadian study to find out the role climate change is playing in increased payouts to the insurance industry.

The year-long project, with support from Intact Financial Corporation, is due out in February 2012 and will shed light on the course of action Canada must take in limiting the impacts of anthropogenic climate change.

“What is causing the increased cost?” Feltmate asks. “Is it because we have more basements that are finished today than we did 30 years ago? Is it because we have aging infrastructure? Is it because we are building more homes in low-lying areas subject to flooding?

“Or,” he says, “is it because of climate change? We have strong suspicions that it is.”

Fires have traditionally resulted in the biggest share of the insurance claims in Canada, but within the last decade they were usurped by water-related damages, a costlier upswing.

“Just about every city in Canada is being hit with water problems,” McGillivray says.

To reduce property damage there are steps only governments can take, such as offering tax rebates to incentivize the building of more robust homes, establishing resilient building codes, or mandating backwater valves, a simple fix that costs only $300 per unit.

This is not, however, an invitation for insurers to remain idle, McGillivray says. The industry can help mitigate further damage by offering incentives for homeowners to take preventive measures against basement flooding.

“If you disconnect your foundation drains and put in a backwater valve, then maybe you can get a reduction in the sewer backup portion of your premium,” he says. “Many companies are already increasing the sewer backup portion of the premium; putting caps on claims; and in extreme cases going as far as saying fix this issue or we can’t cover you at all.”

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Originally published in Advisor's Edge Report