Should We "Go Green"?
August 2007
To benefit society and the environment ethically,
or to benefit both policyholders and their stockholders financially, should
property-liability insurers join the current global trend to "go green"? If
so, how can we be certain that becoming "green" will not someday put our insureds
and us in the financial "red"?
by George
L. Head, Ph.D.*
Let us focus on standard commercial property-liability policies, setting
aside environmental pollution as a sometimes separately covered peril. This
means that environmental pollution liability is not an issue here. Instead,
a key issue is whether encouraging policyholders to change their products, procedures,
and materials to ones that better protect the environment will generate benefits
for policyholders and for insurers that will exceed the costs of making these
changes.
We need to examine whether insurers' granting lower premiums or discounts
to their commercial insureds who adopt environmentally friendly practices will
reduce these policyholders' overall costs, increase insurers' underwriting profits,
and brighten the insurance industry's still-tarnished public image. We need
to consider whether this is the time, and whether environmental responsibility
is the issue, for our industry to move forward.
Green Means "Go"
It's easy to want to go green. Reducing toxins and promoting cleaner, less
hazardous manufacturing techniques throughout our environments improves the
public's health, including that of the employees, the customers, and those who
live and work in our neighborhoods. This alone will obviously reduce the health
hazards and injury losses an insured faces when handling, storing, or using
toxic, caustic materials or breathing in toxic fumes. Therefore, insureds will
face fewer health or injury hazards for which they can be sued reducing liability
claims.
In short, encouraging insureds to protect the environment also protects insurers'
underwriting results for bodily injury, not to mention the property damage claims
prevented when spills of hazardous materials are eliminated by switching to
earth-friendly substances.
The easiest way insurers can encourage insureds to go green is by offering
them premium discounts. These discounts, while still less than the increase
in underwriting profits, should be sufficient to motivate insureds to practice
greater environmental responsibility. Therefore, these discounts should reward
steps that have true environmental benefits, be it in product choice or in the
manufacturing process. To illustrate, some insurers are now offering up to 10
percent discounts on their premiums for automobile insureds who choose hybrid
cars.
Because going green is such a currently popular trend, it is important that
the public recognize that insurers are in tune with their concerns. By addressing
the issue of environmental responsibility, insurers demonstrate to their policyholders
that they can and will respond to the changing demands of our times. Showing
that they are responsive to change, insurers hopefully will earn public and
regulatory support well into the future.
Red Means "No Go"
Despite the positives of promoting a cleaner environment and its all-around
good effects on our policyholders and the general public, insurers need to keep
a realistic perspective on the scope of environmental change. Is there really
anything insurers can do, or encourage their policyholders to do, that will
have a meaningful impact on climate change or worldwide pollution? To protect
their underwriting profits, insurers must not act too hastily.
For example, insurers should not grant premium discounts that unthinkingly
encourage insureds to adopt untested new technologies that do not actually generate
long-term environmental improvements and therefore do not reduce actual insured
losses or—worst of all—actually create new bodily injury or property damage
losses. Furthermore, we should not tempt policyholders with premium discounts
that encourage them to incur large upfront costs they cannot reasonably expect
to recover, especially if insurers find in a year or two that they must cancel
their once enticing discounts because something newer, cheaper, and more efficient
emerges. To illustrate, ethanol—a fuel once heralded by environmentalists—now
has become controversial due to its rising manufacturing costs and the impact
it has had on commodity prices, making even the average American's breakfast
more expensive.
Being responsive to the public is a fine quality for insurers to have. Policyholders
depend on insurers to guide them in practicing responsible risk management,
implementing practices that in the long run will benefit both them as individual
entities and society as a whole. Our industry's reputation depends on time-tested
actuarial principles, not on social fads or political "fashions." Let us not
act in haste.
No Time To Be Yellow
"Going green"—done not with "yellow" cowardice but with correct caution—seems
to me to be the way for insurers to go. Following the ethical principle of "doing
the greatest good for the greatest number," first introduced by Jeremy Bentham
and other Utilitarians in the Eighteenth century, and currently followed by
today's financial corporate executives, I suggest that insurers consider a seven-step
process in deciding whether to grant premium discounts. These discounts would
be given to insureds who take carefully defined, environmentally responsible
actions that generate net global consequences whose expected present value is
positive.
The seven steps for estimating the expected present value of the probable
net global consequence (or EPVNGC) for each alternative course of policyholder
action are:
-
Separating consequences into three groups—those which affect (a) an insurer's
stockholders, (b) an insurer's policyholders, and (c) members of the public.
-
For each consequence for each affected group, assigning a positive (plus)
value to those consequences which generate a benefit for that group, and
a negative (minus) value to those consequences which generate a cost for
that group.
-
Estimating an average dollar value for each benefit/cost for each member
of each affected group.
-
Estimating the number of people in each affected group.
-
For each consequence for each group, estimating the probability of that
consequence actually occurring.
-
Discounting each cost or benefit by an appropriate factor for the time
value of money (such as the federal funds discount rate) for the time interval
between when an insured incurs the expenses of taking an environmentally
friendly action and when the insured begins receiving the premium discounts
and perhaps other financial benefits of that action. (For many such actions,
this time interval is essentially zero, making such discounting unnecessary.)
-
Giving the benefits positive values and the costs negative values as
determined in step 2, multiply for each consequence the value in step 3
by the number of people in step 4, multiply again by the probability in
step 5, and, if necessary, discount by the value factor in step 6 to arrive
at an expected present value of the probable net global consequence (EPVNGC)
for each alternative.
Basing their decisions on calculations such as these, insurers should consider
giving premium discounts for those policyholder actions that offer significant
positive EPVNGC values. It is important that the policyholder actions that earn
premium discounts be specified in detail and that policyholders truly take these
actions to qualify for these discounts. Moreover, these calculations should
guide, not replace, insurers' actuarial and senior management judgment.
This decision process for choosing which, if any, policyholder actions merit
premium discounts for "going green" is complex. More importantly, however, it
is a decision process that insurers should follow if they wish to be environmentally
and ethically responsible to the insureds, stockholders, and society they strive
to protect and serve.
*Lisabeth A.
Groller contributed significantly to the substance
of this commentary.
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