Floods, hurricanes, droughts - will climate change mean more wild weather ahead? That's a risk the insurance industry is taking very seriously, reports Peter Huck.

This month, as the US reeled from some very nasty weather - floods in Mississippi, drought in Texas, tornadoes in the Midwest - the New York Times got right down to brass tacks: given damage to property, crops and lost business, how much would insurers have to fork out? Ten billion dollars and counting seemed a safe bet.

"There's no question it's above average," says David Smith, a senior vice president with US company Eqecat, which uses modelling to advise the insurance industry on catastrophe risk management. "An average annual loss for severe convective storms - tornadoes, hail, thunderstorms and wind - is about US$6 billion. ($7.4 billion). We'll certainly end the year above that."

Indeed. Add in damage from February's monster blizzard, which shut down much of the Midwest; an "unseasonable" heatwave, dramatised by Arizona's largest wildfire; and, since June 1, a hurricane season the National Oceanic and Atmospheric Administration predicts will be "above-average", and payouts in the US may set records.

For an industry whose survival means managing risk, these are challenging times. Nations which are focused on their economic problems have barely begun to contemplate how they will deal with the scientists' scenario of a warming planet. Yet insurers must calculate their exposure as our assumptions - that homes will be safe, food will be secure and infrastructure will work - are tested by ever more common "Hundred Year" weather disasters, a change that reinsurer Swiss Re calls the "new normal".

Trying to get a handle on this new normal means taking climate science very seriously. And the news is not good. Last month the International Energy Agency said carbon dioxide (CO2) emissions rose by a record 31 billion tonnes last year, making it more likely that the temperature rise this century would exceed 2C, unleashing runaway global warming and apocalyptic changes, including famine.

The UN Intergovernmental Panel on Climate Change warns that atmospheric CO2 must not exceed 450 parts per million (ppm). The May total was 394ppm, rising around 2ppm each year. "I am very worried," Fatih Birol, the IEA's chief economist, told the Guardian. "This is the worst news on emissions. It is becoming extremely challenging to remain below 2 degrees. The prospect is getting bleaker."

The World Meteorological Organisation ranked last year, 2005 and 1998 as the warmest years ever recorded, confirming a "significant long-term warming trend".

Warm air holds more water. More evaporation generates more energy, intensifying storms, droughts and floods. Pumping more greenhouse gases into our atmosphere is likely to tweak events such as the La Nina phenomenon, linked to very dry weather in Western Europe, which follows an exceptionally chilly winter, the coldest in Britain for 300 years. The past year has seen weather extremes in Australia (floods), Russia (drought), Latin America (floods), China (drought, and now floods), and New Zealand (floods), to name a few.

"We are getting into very risky territory," says Christiana Figueres, executive secretary of the UN Framework Convention on Climate Change. The price of doing nothing, she says, could be US$1 trillion a year to mitigate the effects of climate change.

For those in the risk management business, simply denying climate change is not an option. Increasingly, the insurance industry is showing the way forward. It involves tough calls to protect the bottom line: dumping customers with properties on floodplains, or in hurricane-prone areas, while insuring "green" technologies that offer the best chance of slowing warming and protecting investments.

Despite "tremendous uncertainties" in scientific modelling of hurricanes and typhoons, Smith says there is a growing industry consensus that the warming climate is amplifying precipitation and floods. He believes some "very significant changes" lie down the road. Insurers face three big questions. How soon? How much? And how to respond?

The US benchmark for recent natural disasters is Hurricane Katrina, which devastated New Orleans and the Gulf Coast in 2005, costing US$45 billion, America's worst insurance hit. But localised slips, wildfires and floods are also costly.

Evan Mills, a staff scientist at the Lawrence Berkeley National Laboratory and IPCC member who writes about insurance, says weather-related losses, which account for about 90 per cent of all natural disasters, total US$80 billion a year worldwide, of which US$20 billion is insured.

Adjusted for inflation, international economic losses from weather-related events rose eight-fold, and insured losses 17-fold, between the 1960s and the 1990s. The IPCC believes those losses are understated, as in the US "small" events under $25 million in insured losses are excluded from the tally of natural disasters.

German reinsurer Munich Re, which publicly noted concern about climate change way back in 1973, has logged 28,000 events since 1950. The industry's biggest disaster database notes losses from weather-related catastrophes rose "by a factor of three" from 1980 to 2009, from some 133 events a year in the 1980s to over 350 a year today.

Figures compiled by the Insurance Council of New Zealand from 1968 to January 2011, excluding the 2010 Christchurch quake, show a similar trajectory: during the 1990s 36 natural disasters cost $214 million, rising in the noughties to 57 episodes costing some $630 million.

Recent natural disasters in Australasia alone, excluding Cyclone Yasi and the 2011 Christchurch quakes, cost the industry up to $15.8 billion according to a Munich Re March estimate.

"Aggregate losses from weather-related natural catastrophes since 1980 now total US$1600 billion, with insured losses increasing on average by 11 per cent each year," says Munich Re's media chief Nikola Kemper. And while she cautions that this rise is partly driven by higher property values and more people living in vulnerable floodplains and seashores, "it would seem that the growing number of weather-related catastrophes can only be explained by climate change".

Last month Munich Re announced a €948 million ($1.67 billion) loss for the first quarter of this year. "The earthquakes in Japan and the natural catastrophes in Australia and New Zealand have made this the most difficult start to a financial year we have experienced for a long time," said CFO Jorg Schneider.

The company hopes to absorb this blow and still make a profit, fuelling rumours that premiums will rise, and vulnerable areas, including Christchurch, may be uninsurable. This dire scenario is made worse by increased variability. Developing nations, says Mills are "significantly more vulnerable to climate change than are industrialised countries".

For a taste of what the insurance industry's changing attitudes can mean, take a look at the US. Of the 3 million American homes denied insurance between 2003 and 2007, only half found new coverage. Allstate, one of the major US insurers, said climate change prompted it to cancel or not renew policies in many Gulf Coast states.

The trend spread along America's hurricane-prone Southeastern seaboard. Florida's biggest private insurer, State Farm, stopped writing policies and quit Mississippi altogether. In 2008 Farmers Insurance stopped writing policies for North Carolina and refused to renew existing ones, forgoing US$55 million in annual premiums because of the risk of losses. Elsewhere, premiums increased by 42 per cent to 77 per cent in nine Southern states between 2001 and 2006.

In this country, the Insurance Council will not comment on whether hard-hit areas might be denied coverage, leaving that to individual insurers. But chief executive Chris Ryan says insurance is "a key solution" to climate change. Like insurers overseas, Ryan says the New Zealand industry believes it "should be at the very forefront of unbiased, pragmatic, fact-based dialogue", working with government and the private sector to help the economy and society cope with climate change.

In a climate-change world, consumers may face higher premiums or be denied coverage altogether. In Britain the Institution of Civil Engineers warned in 2008 that plans to build on floodplains had reached a "tipping point" as insurers would refuse coverage. And in 2009 an Australian study found 270,000 coastal homes in harm's way. The lesson was stark: unless government took steps to combat climate change, taxpayers would be stung for disasters as insurers withdrew from covering areas they considered too risky.

"Many of the risks posed by climate change will become uninsurable," predicts Mills.

Insurance survives by identifying risks in advance. But climate change is a new ballgame, both in scale and weather volatility. Insurers could also risk losses from liability suits brought against customers who are blamed for fuelling climate change - a fossil fuel company, for example.

In many ways insurance is a perfect example of the globalised, interconnected economy. Insurers take out insurance with re-insurers who, in turn, may buy their own re-insurance. It is these global connections that give the industry its clout and its giant resource pool. When the business takes a big hit from a natural disaster the costs are spread around.

Perversely, the cushioning effect of spreading risk means climate change may be underestimated. "The problem is convincing people there is a process happening," explains Gary Young, chief executive with the Insurance Brokers Association of New Zealand. "It may not seem significant now, but it is becoming more significant all the time."

And while Young is sanguine about the costs to the industry from disaster payouts - after all, payouts in one region can be balanced with profits elsewhere - a big question stalks reinsurers: what happens to the bottom line as climate change is fingered, albeit tentatively, in disasters?

While climate change is a growing background element in our weather, the big problem for insurers is factoring this volatile new normal into the cost of specific events. Was that flood caused by climate change directly, or was it caused by a La Nina event that was tweaked by climate change? How is climate change factored into a premium? This is likely to be contentious. Munich Re admits that despite "evidence indicating that the growing number of weather-related catastrophes most probably cannot be fully explained without climate change" more research is needed.

The company has partnered with the London School of Economics to glean "more detailed information on the link between climate change and the observed increase in losses due to weather extremes". Crucially, this link is accepted. So how will insurance fare in our climate-change world?

Commonsense is necessary, though it might not be palatable. It may be hard, even impossible, to buy insurance for a home or business located on a floodplain already battered by a weather-related disaster.

Similarly, it may be hard to insure a building threatened by tidal surges, which may intensify as sea levels rise due to climate change. That has huge implications for many low-lying coastal communities, including Auckland.

Then there is the impact on agriculture. Last year grain harvests took major hits from droughts in Russia and Australia, among other places. Floods in China have pushed vegetable prices up by 40 per cent. For farmers, extreme weather can wipe out crops, destroy equipment and pollute aquifers with salt water. How do you insure against such setbacks, especially if they happen frequently? Will insurers withdraw? Besides the likelihood of steep premium rises for farmers, there are downstream concerns for rural communities, exports and food prices.

Then there's the political fallout. Faced with steep premiums or denied coverage - and the swelling fallout, such as famine and refugee surges - will consumers demand governments address the underlying problem posed by climate change and adopt more sustainable consumption policies?

Meanwhile, industry leaders recognise that climate change has its upsides. A 2009 report, The Insurance Industry and Climate Change, from the Geneva Association, a major insurance bloc, suggests the industry consider exploiting sustainable investments.

Noting that insurance has driven past innovation, from automobile safety to building codes, Mills describes a gradual shift towards green technologies in his 2009 report, From Risk to Opportunity 2008: Insurer Responses to Climate Change. He cites 643 specific instances by 246 insurance entities in 29 countries. This can range from insuring sustainable businesses to investing in new technologies that reduce emissions.

Given the industry's eye for the bottom line, Mills says it favours action rather than inaction on climate change and, as a vital component in economic development and the financial markets, is a vital early warning component. To this end some insurers are beginning to invest in sustainable technologies and practices that allow them to profit by reducing risk.

Munich Re has responded with initiatives as varied as the grand Dii GmbH project, which would generate power in North Africa using solar and wind plants, then supply it to users in Europe, and by providing warranties for solar-power systems made by US firm SolFocus.

It's all very 21st century: support renewables and sound the alarm on climate change at the same time, while growing the clean tech economy. The industry is also exploring catastrophic loss insurance for developing nations, while AIG has lobbied for "market based solutions," such as a cap and trade mechanism to curb emissions.

Nonetheless, there is much that could be done, but isn't. On a grassroots level, home or business insurers could be rewarded with reduced premiums for "greening" buildings. This might involve simple steps such as insulation, or the adoption of alternative energy sources and other "clean" technology.

As insurers grasp the climate change nettle, governments might even follow suit. Otherwise, it will be taxpayers, not just the insurance industry, confronting the soaring cost of the new normal.