As if it wasn’t hard enough trying to displace the internal combustion engine as the motive force of the automobile, then this happens.  First the plug-in hybrid Chevy Volt’s battery starts catching fire.  Then battery-maker Ener1 files for bankruptcy protection.  Last Thursday, the electric vehicle arena acknowledged more bad news.  Fisker Automotive, maker of the electric sport coupe Karma and promisor of the Nina, issued a press release following a set of disquieting reports from various outlets.  The sour news:  “As a prudent business measure, project Nina has been temporarily put on hold until financing, either from the DOE or elsewhere, can be secured.”

Fisker is the high end of electric vehicles.  Its “plug-in extended range” Karma sedan seats four and retails between $96,000 and $109,000.  It can do 0-60 in 7.9 seconds in full electric (Stealth) mode (the plug-in part).  But turn on its gasoline engine, which turns its electric generator, and you’re down to 5.9 seconds (Sport Mode) (the extended range part).  Motor Trend calls it “a sweetheart to hustle.”

Nina is (was?) the more consumer-friendly version of a Fisker. It is to be (according to reports) a compact or midsize sedan, priced in the $40,000 range (after the $7,500 federal tax credit).  It is to be built in a refurbished GM plant in Delaware, which Fisker bought out of GM’s bankruptcy in 2009.  Predicted production levels were 100,000 vehicles per year.  That goal is currently not realizable.

Fisker has raised a lot of money.  Besides over $850 million in private financing, in 2009 “Fisker Automotive closed a $529 million loan arrangement under the Department of Energy’s Advanced Technology Vehicles Manufacturing Loan Program for the development and production of two lines of plug-in hybrid electric vehicles. The project is expected to create about 2,000  jobs in Wilmington, Delaware.”   Times change.  In May, after providing $193 million to Fisker, DOE stopped lending because various milestones in Karma sales and production had been missed.  Or as Fisker put it in its recent press release:  “In May 2011 Fisker Automotive opted to stop taking reimbursements from the DOE while the company entered negotiations to implement more realistic and achievable milestones.”

Fisker's financial difficulties are not being kept secret.  The tip of the proverbial litigation iceberg made its appearance earlier this month in the form of a lawsuit filed in California Superior Court: Wray v. Fisker Automotive Holdings et al. (Complaint attached below.)  In the suit Mr. Wray, an investor in Fisker and various Fisker investment entities, claims he was deceived into buying Fisker securities because he was unaware that a subsequent "pay to play" offering could require him to increase his investment or lose the beneficial position he had procured by virtue of his earlier contributions.

Mr. Wray put over $200,000 into Fisker. In return he received preferred stock with various benefits such as "conversion price discounts", "anti-dilution protection", and "liquidation preferences." While risks of investing were disclosed, nowhere, it is alleged,

did the offering memoranda inform Daniel Wray, or any other investor, that if he did not participate in future forced financing of Fisker, as Fisker and Advanced Equities [the broker/dealer] dictated, he would suffer a significant dilution of all of his earlier investments; conversion of the convertible preferred stock to common stock loss of all the rights, preferences and privileges that his ownership of preferred stock conferred, including liquidation preference, anti-dilution protection and initial public offering discounts/special conversion rights. Complaint ¶ 26.

But on January 18, 2012 the broker/dealer wrote Mr. Wray (and presumably others) seeking money: "Due to Fisker's urgent need for equity capital, the Financing now contains a "pay to play" provision that requires all holders [of certain securities] to purchase Series D-1 Preferred Stock in an amount equal to at least 40% of such holder's aggregate dollar amount invested ...".  Id. ¶ 28.  Mr. Wray had slightly over $200,000 invested, and was now on the hook for another $83,922.32. In his complaint, Mr. Wray alleges breach of fiduciary duty, fraud, negligent misrepresentation, and various violations of the California Corporations and Business & Professions Codes, among other things.

The greencarreports blog did a little investigating and is not overly sanguine about Mr. Wray’s chances on the merits.  We look at it from a different perspective.  We are not privy to Mr. Wray's thinking but his suit may be an astute way to buy time before committing to the next $80,000. If the DOE funding hurdles are cleared, or private sources come through, then the investment, particularly for one in preferred status, may be particularly fruitful. And if the big money is not forthcoming, then throwing good money after bad might be avoided.  In that case, Mr. Wray might not find himself alone on the tip of the iceberg any longer either.

20120207 Complaint, Wray v. Fisker Automotive Holdings, Inc..pdf (707.64 kb)

We blogged last May and again in December about the tidal wave of litigation set loose by Our Children's Trust (OCT), an Oregon environmental group that had orchestrated the filing of  a dozen suits asserting the defendant States and the United States had an obligation under the public trust doctrine to restrain carbon dioxide emissions, as well as regulatory petitions in about 40 jurisdictions.  One can find OCT on Facebook, Flickr, YouTube and Vimeo. It prepares "backgrounders" for the press (attached). It has even coined its own acronym, ATL (atmospheric trust litigation) for its legal assault.  OCT is media savvy. It has still not established that it is litigation savvy. 

The petitions have not fared well.  OCT's website is not up-to-date but petitions have been denied in at least 27 jurisdictions (Arkansas, Connecticut, Florida, Georgia. Hawaii, Idaho, Illinois, Iowa, Louisiana, Maine, Maryland, Michigan, Missouri, Nevada, New Hampshire, North Dakota, Ohio, Oklahoma, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, and Wyoming and Washington, DC).   The denials have  prompted two more lawsuits (appeals) in Iowa and Texas. 

On the litigation side, motions to dismiss have been the defendants' responses of choice.  The lawsuit against Montana filed in the Montana Supreme Court was dismissed almost immediately.  Montana has a rule permitting an original action before the Montana Supreme Court where there are no factual issues and the matter is urgent. The court rejected that position:  "This Court is ill equipped to resolve the factual assertions presented by Petitioners. We further conclude that Petitioners have not established urgency or emergency factors that would preclude litigation in a trial court followed by the normal appeal process."  Accordingly, the petition for original jurisdiction was denied.

Fast forward to today, the tidal wave is starting to break.  New Mexico and Oregon had oral argument on their motions in January. Decisions have not been issued.  In the Oregon suit it was reported that, after argument, the judge remained undecided about whether to dismiss the case.  This month there are hearings in Alaska, Arizona and Washington.   

And last Monday the first merits decision was handed down.  In Aronow v. Minnesota the Minnesota District Court dismissed the case with prejudice.

Plaintiff's complaint (attached) lays out the threats posed by climate change in great detail.  It then explains the public trust doctrine, including legal authority for extending it to the atmosphere.  "The Public Trust Doctrine is a foundational aspect of sovereignty; it holds government responsible, as perpetual trustee, for the protection and preservation of resources necessary for the common welfare of all citizens, those living and those yet to be born. ... The atmosphere, because of the climate stability it makes possible, is a necessary resource protected by the public trust."  The doctrine is, according to the complaint, partially codified in the Minnesota Environmental Rights Act (MERA) (Minn. Stat. §§ 116B.01 - 13). 

Plaintiff coffered two theories as the basis for relief:  one under the public trust doctrine and the other under MERA.  He sought a declaration that the atmosphere was protected by the public trust doctrine and that the defendants were in violation of the doctrine.  He also sought a declaration that defendants had violated MERA (without identifying what part of MERA was violated).  Last, plaintiff asked the court to "Compel Defendants to take the necessary steps to reduce the State's carbon dioxide output by at least 6% per year, from 2013 to 2050, in order to help stabilize and eventually reduce the amount of carbon dioxide in the atmosphere."

The defendants, Minnesota, the governor and the Minnesota Pollution Control Agency, filed a motion to dismiss.  They succeeded.   In dismissing the claims, the court set down its opinion (attached) in three parts:  1. can the governor be sued (no); 2. does the public trust doctrine apply to the atmosphere (no); and 3) are there viable causes of action under MERA (no).

As to the governor, he had no legislative authority or funding "to  implement the policies sought by plaintiff." Accordingly, he was not a proper party to the suit.

As to the public trust doctrine, this ruling is arguably the most important part of the decision.  A ruling in OCT's favor would provide it ammunition in the imminent battles in other jurisdictions.  A ruling against it would supplement the arsenals of the defendants in those other cases.  Further, the court's decision was the first merits decision on the central tenet of OCT's raft of cases:  the public trust doctrine applies to the atmosphere.  The court's analysis is brief so we provide it in full: 

Minnesota Courts have recognized the Public Trust Doctrine only as it applies to navigable waters. "Navigability and nonnavigability [sic] mark the distinction between public and private waters. The state, in its sovereign capacity, as trustee for the people, holds all navigable waters and the lands under them for public use." Nelson v DeLong, 7 N.W.2d 342, 346 (Minn. 1942) (emphasis added). The Nelson court ultimately held that a private citizen's riparian rights are subordinate to the State's needs as it manages the navigable waters that are held in the public trust. See also Pratt v. State, Dep't of Natural Resources, 309 N.W.2d 767, 771 (Minn. 1981).  In Larson v Sando, 508 N.W.2d 782 (Minn. Ct. App. 1993), rev. denied (Jan. 21, 1994), the court declined to extend the public trust doctrine beyond the state's management of waterways, partly because the cases cited by the parties applied only to waterways. Id. at 787 (declining to extend the doctrine to land). Similarly, this Court cannot locate, nor did counsel for either party supply, a Minnesota case supporting broadening the Public Trust Doctrine to include the atmosphere. This Court has no authority to recognize an entirely new common law cause of action through plaintiff's proposed extension of the Public Trust Doctrine. 

That is it.  There is no analysis of whether the public trust doctrine should or should not apply to the atmosphere.  Instead, the court simply ruled it has not been done before in Minnesota and it will not be done by this district court here.

Last, are the MERA claims.  The court went out of its way to consider a variety of ways that a MERA suit might be justified. We want to focus on the simplest: the statutory requirements. Under § 116B.03 a resident of Minnesota could bring suit in the name of the State "for the protection of the air ... from pollution impairment or destruction." A problem was that plaintiffs had not complied with the statutory requirements of giving notice, which was "fatal." Another problem was that plaintiff was required to sue on behalf of the State, which he did not.  A final problem was that the required "pollution, impairment or destruction" was defined by statute, and the statutory requirement, according to the court, was not met.  We have trouble with this conclusion, however.  To be sure the statutory definition required "conduct by any person which violates, or is likely to violate, any environmental quality standard, limitation, rule, order, license, stipulation agreement, or permit," but it also alternatively permitted a claimant to challenge "conduct which materially adversely affects or is likely to materially adversely affect the environment."  Minn. Stat. §  116B.02(5).  Plaintiff expansively alleged how carbon dioxide emissions lead to climate change which is causing numerous deleterious effects on humans and the environment.  And he alleged how Minnesota's state government's conduct (inaction) was materially adversely affecting the environment.  These allegations just don't seem to square with the court's conclusion that "the Complaint does not allege anything falling within the definition of 'pollution, impairment or destruction.'"  We wonder why the court ventured into this area when it had established the procedural bars.

Alternatively, under Minn. Stat. § 116B.10 a Minnesota resident could "maintain a civil action .... for declaratory or equitable relief against the state ...where the nature of the action is a challenge to an environmental quality standard, limitation, rule, order, license, stipulation, agreement or permit promulgated or issued by the state ... for which the applicable statutory appeal period has lapsed."  Plaintiff's fundamental problem was that his complaint failed to "refer to or challenge a single environmental quality standard, limitation, [etc.]"  In other words, by its terms plaintiff's claim did not meet the statutory requirements.

OCT is 0-27 in the regulatory arena.  It is now 0-2 in litigation.  Notwithstanding, we cannot see the future here.  Regulatory agencies cannot move into new areas without legislative authority.  We will not be surprised if OCT is 0-40 in the not too distant future.  But in the courts it may be a different story.   Montana's dismissal simply set the stage for re-filing in the trial court.  In Minnesota the court did not reject the concept of applying the public trust doctrine to the atmosphere; it simply was unwilling to plow new ground.   And the Oregon trial court is reportedly on the fence.  We still await thoughtful jurisprudence on whether the public trust doctrine applies to the atmosphere.  We note, however, that we expect a long wait for this to settle down; whatever happens in the immediate future, there are certain to be appeals.

20120130 Order of Dismissal, Aronow v. Minnesota (Our Children's Trust).pdf (960.57 kb)

Aronow v. Minnesota Complaint (Our Children's Trust).pdf (247.79 kb)

Our Children's Trust, National Backgrounder (ATL) 12-1-191.pdf (316.65 kb)

Notwithstanding that millions tune in to the long-running reality TV show America's Next Top Model, the real modeling action is not in Hollywood.  Instead, it is on computer mainframes churning out annual simulations of 100,000 years or more of catastrophes such as hurricanes, earthquakes and terrorist attacks. Such analysis drew the attention of the Maryland Court of Appeals in its seminal opinion last Wednesday in People's Insurance Counsel Division v. Allstate Insurance Co. (attached), which affirmed the appropriateness of modeling in an insurer's decision to issue, or not, homeowners' insurance policies.

The facts in Allstate were relatively simple. In 2006 Allstate determined that it would no longer write homeowners' policies on Maryland properties within one mile of the Atlantic Ocean. It subsequently extended that decision to completely exclude from new policies five Maryland counties, and portions of an additional six counties (all identified by zip code). It relied on a model developed by Applied Insurance Research, Inc. (AIR), which showed that the hurricane losses Allstate would suffer in the identified zip code areas were too high. Dutifully Allstate filed the appropriate papers with the Maryland Insurance Administration. The Administration found nothing exceptional about the application. The People's Insurance Counsel Division (PICD) (a part of the Office of the Attorney General) did, however, and requested a hearing.  It lost before the Commissioner of Insurance, then before the Circuit Court and again before the Court of Special Appeals (see our post).  

PICD then appealed to Maryland's highest court and argued before the Court of Appeals that Allstate had failed to meet its burden of showing that its decision was not "arbitrary, capricious or unfairly discriminatory."  See Md. Ins. Code § 27-501(a)(1).   Following from that, PICD further argued that the designation of areas by zip code did not have an objective basis and therefore was arbitrary and unreasonable. See Md. Ins. Code § 19-107(a).  Allstate's proofs consisted primarily of computer modeling evidence, which the Commissioner found sufficient.

Much of the opinion is directed to the parsing of Maryland's Insurance Code and its legislative history to determine whether § 27-501 even applied (the Court of Special Appeals had found it did not, and the Court of Appeals reversed that portion of the decision). We leave it to the insurance blogosphere to address that further.

What is of interest to this readership is how modeling came into the decision and where modeling stands as a result.

In the proceeding Allstate offered a model that simulates hurricanes from genesis to decay and the damages that would be suffered.  Basically, AIR modelers "developed mathematical functions that describe the interaction between buildings and their contents and the local intensity to which they are exposed." PICD at 7.  Allstate established with expert evidence that catastrophe risk is not diversified ("adding additional catastrophe risk does not reduce overall risk because of pooling but actually increases the overall risk") and that historical loss data is incomplete and outdated "making it difficult to estimate losses."  PICD at 7.  Accordingly, "it has become standard practice for insurance companies to use catastrophe models to anticipate the likelihood and severity of potential future catastrophes before they occur." PICD at 5-6.

The advantages of modeling are substantial; 

(1) It was able to capture the effects on catastrophic loss distribution of changes over time in population patterns, building codes, amounts insured, and construction costs;
(2) It provides a complete picture of the probable distribution of losses rather than just estimates of probable maximum losses;
(3) Because simulation models can be tested more easily than other approaches, it leads to greater stability in estimating expected annual losses;
(4) It provides a means to determine the impact of new scientific information; and
(5) It provides a framework for performing sensitivity analyses and “what if” studies. PICD at 6

As the Court noted, "By using computer models, they can get 100,000 years of simulated loss experience, which is good not just for State-wide pricing but also for loss characteristics related to hurricanes down to the ZIP Code level." PICD at 7. 

PICD retained an actuary to rebut Allstate's proofs; he testified with respect to "actuarial science." He was hampered, perhaps fatally, when the Commissioner refused to allow him "to express any opinion with respect to the model that formed the basis of Allstate's amended filing." PICD at 11. We were not there but the Court of Appeals paints a picture of a non-committal expert. He offered that the decision to not write new policies was unreasonable "'because there is no showing that it is reasonable.'" And he "declined to choose" the method Allstate should have chosen to reduce its risk.  PICD at 11.

In a post-hearing submission PICD argued that "Allstate was required to produce valid statistical data demonstrating the probability of a hurricane sufficiently strong to cause catastrophic damage actually making landfall in Maryland and that it failed to do so."  PICD at 23.  The statistical standard was based on dicta in an earlier Court of Special Appeals decision, Crumlish v Ins. Comm'r, 520 A.2d 738 (1987), which the Commisioner and the Court distinguished.  First, Crumlish's requirement for statistical evidence was not a universal requirement. PICD at 25. More significant was the "catchall" exception added to § 27-501 which established a "standard approved by the Commissioner that is based on factors that adversely affect the losses or expenses of the insurer under its approved rating plan and for which statistical validation is unavailable or is unduly burdensome." PICD at 25.

"That is what the Commissioner did in this case."  PICD at 25.  In other words, the Commissioner found Allstate's evidence met its burden of demonstrating that its use of modeling as the basis to stop writing policies in certain areas was reasonably related to its business and economic purposes and was not discriminatory. 

The dissent would have adopted the Crumlish dicta and required Allstate to offer statistical evidence concerning the landfall of destructive hurricanes in Maryland. PICD, dissent at 5.  Such an assessment was either to be based on the historical record (an impossibility as no hurricane had ever made landfall in Maryland) or "climate science" (which one would think would include modeling).  PICD, dissent at 9, 10.  According to the dissent, all Allstate provided was a computation of the "relative risk" of a hurricane landfall in Maryland as once in 25,000 years based on the worst 5% of hurricanes that made landfall in North Carolina, Virginia, and Delaware.  Allstate justified its decision based on hypothetical hurricanes, i.e., a model.  PICD, dissent at 7.

The Court properly rejected this distinction.  The use of probabilistic catastrophe risk modeling came of age following the destruction caused by Hurricane Andrew in South Florida in 1992. As stated by modeler RMS in its 2008 A Guide to Catastrophe Modeling (p6):  "It became clear that a probabilistic approach to loss analysis was the most appropriate way to manage catastrophe risk. Hurricane Andrew illustrated that the actuarial approach to managing catastrophe risk was insufficient; a more sophisticated modeling approach was needed."  Another modeling firm, EQECat, put it this way:  "The main concern for all users is the uncertainties in the models. Some time ago, the only way to estimate a probable loss was to trust few statistical studies of past losses from some historical events and or on the experience of the underwriter. The uncertainty in these models was quite large as confirmed once a new event [such as Hurricane Andrew] took place. The main problem is that there is not enough historical data, and the standard actuarial techniques of loss estimation are inappropriate for catastrophe losses." 

One of the purposes of catastrophe modeling is to assist the user (often an insurer) in avoiding the alliteratively named "risk of ruin."  If all the industry is using a tool that can minimize the risk of run, it would ill-behoove a court to take away that tool.  In Allstate the Maryland Court of Appeals agreed. 

Nevertheless, if one is looking for guidance on how modeling will be received in the courts, there is one significant question left unresolved by this decision:  how will competing models be treated?  PCID's expert seems to have been completely out of his league. Whatever his actuarial credentials, if the issue is modeling then a modeling expert is needed. And at the very least the AIR model was subject to challenge. In a review published just this month, Assessing US Hurricane Risk: Do the Models Make Sense?, AIR takes on its competition, RMS, and states:  "with this latest round of updates, we [modelers] find ourselves more divergent in our views of risk than ever." (p5)  As one example of this divergence, "Catastrophe modeling companies have vastly different views on what influence sea surface temperatures (SSTs) in the Atlantic Ocean have on U.S. hurricane landfall risk." (p12).  If AIR is correct, perhaps application of the RMS model would have altered the list of excluded zip codes. More fundamentally, does the uncertainty established by competing models (and that is inherent in modeling) impose an unavoidable and unacceptable arbitrariness in application?  That is for another day.  For the moment, modeling companies and those who use them likely will proceed full speed ahead.

Post scriptum - Climate change seems to have been a subject not to be discussed.  As noted by the dissent, if Allstate was worried about the science of climate change, it didn't bring it up.  Nevertheless, the dissent did bring it up and asserted that meteorological change occasioned by climate change could be a legitimate basis for Allstate's decision.  The modeling firms think otherwise. Eqecat's CEO Bill Keogh has stated because of the uncertainty associated with climate change's effect on hurricanes, " it has no role in catastrophe risk modeling."

Peoples Insurance Counsel Division v Allstate Insurance Company.pdf (78.07 kb)

NOAA reported that 2011 was one for the record books:  12 weather and climate-related disasters each causing over $1 billion in damage.  One might expect (or hope) that a national climate change policy would be coming into place to prevent repeating or setting a new record.  One would be disappointed.  U.S. climate policy is "uncertain," to quote Michael Morris, CEO of American Electric Power, "dysfunctional" is the word applied by Resources for the Future, "hamstrung" is how the chief UN climate change negotiator and Executive Secretary of the UNFCCC, Christiana Figueres, calls it.  

We don't disagree with these viewpoints; they are accurate.  But if a response to climate change is the goal, it is worse than these commenters are acknowledging because not only has Congress shown that it is incapable of getting anything done, other avenues are not delivering either.  As the year expires we thought it might be helpful to sift through the year's detritus and assess  the status of attempts to reduce carbon dioxide emissions, distinct from overt attempts like passing laws and adopting regulations.

1. Tax emissions - Some will remember our blog on the federal lawsuit brought by Mirant Corp. against Montgomery County challenging the County's tax on carbon emissions which fell only on Mirant. The County challenged the federal court's jurisdiction and won before the federal district court. In June, however, the Fourth Circuit reversed.  With that Montgomery County folded its tent and abandoned its carbon tax.

2. Favor renewable energy - The inexorable scrutiny of the markets has proved the undoing of several former high-flying renewable energy ventures. Most well-known is the debacle with Solyndra LLC, whose well-publicized collapse generated scrutiny by the FBI and Congress. Others that have failed with less limelight in 2011 include numerous solar companies (Solar Millennium, Stirling Energy Systems, Evergreen Solar, Spectrawatt), as well as ventures in wind (Skycon), energy storage (Beacon Power), and biofulels (Range Fuels).

3. Impose liability for emissions of carbon dioxide - The results here are mixed.  Everyone points to American Electric Power v Connecticut for the principle that for greenhouse gas liability claims the federal common law of nuisance has been displaced by federal regulation. They could equally point to Connecticut v AEP before the Second Circuit for the principle that the political question doctrine does not bar these types of claims or to the Fifth Circuit panel in Comer v Murphy Oil USA that held similarly.  However, even if the cases are permitted to move forward, they face daunting problems in proof of causation.

4. Force state action to regulate carbon dioxide - We blogged last May and just this month about the tidal wave of litigation unleashed by Our Children's Trust, an Oregon environmental group that had orchestrated a dozen suits asserting the defendant States had an obligation under the public trust doctrine to restrain carbon dioxide emissions, as well as regulatory petitions in about 40 jurisdictions. 

Time has not been good to OCT. First, its petitions have been denied by at least 23 agencies (Arkansas, Connecticut, Georgia. Hawaii, Idaho, Illinois, Iowa, Louisiana, Maine, Maryland, Michigan, Nevada, New Hampshire, North Dakota, Ohio, Oklahoma, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, and Wyoming).  Where OCT filed lawsuits, three states (Arkansas, Minnesota and New Mexico) responded with motions to dismiss.  The lawsuit against Montana was dismissed. In the federal lawsuit, the plaintiffs lost a motion to transfer.

5. Reach regional agreements - With great fanfare the Regional Greenhouse Gas Initiative was launched in 2005. Despite a recent study that claims significant economic benefit to the states in RGGI, its future success is unclear. New Jersey pulled out, New Hampshire tried to leave but the governor vetoed the bill. In New York, there is a court challenge. 

6. Voluntarily trade carbon dioxide emissions credits - The only carbon exchange in North America came to an end in 2010 when the Chicago Climate Exchange closed its doors.  A shadow of its former self, the CCX now registers verified emission reductions based on a comprehensive set of established protocols.

7. Develop carbon capture and storage - The most prominent project in the US came to a halt in July when American Electric Power concluded not to build a full-scale CCS plant at its Mountaineer, West Virginia plant. As noted above, AEP explained its decision as based on the uncertainty of US climate policy.  The lack of direction in American climate change response hurts business. AEP walked away from a $300 million Department of Energy match.  It didn't help that the Virginia consumer advocate, in successfully arguing against including CCS costs in the rate base, asserted:  “Any potential benefit is speculative and outweighed by the enormous cost of the pilot project.”

Some may think no policy is the best policy.  We think otherwise.  Climate change is happening.  There will be a response.  All will benefit if that response is choreographed over time, rather than rushed into when political consensus ultimately concludes that something must be done NOW.  Maybe in 2012?  Happy New Year. 

Durban, South Africa.  Home to the Shark Tank (where Kwazulu-Natal's rugby team, the Sharks, plays), extensive beaches and South Africa's busiest port.  But not home to a new treaty to address climate change.  COP-17 gets underway on Monday and the delegates haven't even met yet; some might think we are being somewhat premature.  We think not.  There is an election here next year.  Europe is mired in a sovereign debt crisis.  China and India will not derail their economic growth just to appease the industrialized West. 

Notwithstanding that there will not be any legally binding agreement, the discussions in Durban are of some moment.  Before we get to that, let's make sure we are all on the same page.  COP-17 is the annual "Conference of the Parties", the yearly meeting of the United Nations Framework Convention on Climate Change. In diplomat-ese, it is also 7th Session of the Conference of the Parties serving as the Meeting of the Parties (CMP7) to the Kyoto Protocol. The ultimate objective of the Framework Convention is “to stabilise greenhouse gas concentrations at a level that will prevent dangerous human interference with the climate system”.  Nearly all nations (including the United States) are members.

There are three primary subjects that will be considered in Durban:

1.  Kyoto Protocol - This treaty entered into force in 2005 and established a regime to address greenhouse gas emissions around the world.  There were two tiers:  developed nations and developing nations.  The standards for the first group were stricter than those for the second.  While most nations signed on to the treaty, the United States (and Andorra, Afghanistan and South Sudan) did not.  The United States' primary criticism is that the Protocol did not appropriately take into account the massive greenhouse gas contributions that are now coming from developing nations like China and India.  Now Kyoto is set to expire.  COP-17 is to set up the next stage.  However, the United States, Russia and Japan have stated that they will not sign on for a second stage.  The consensus of observers is that Kyoto will not be extended.

2.  Green Climate Fund - At COP-15 (Copenhagen in 2009), developed nations promised to provide by 2020 $100 billion per year or more to help developing nations address climate change.  As noted by the Overseas Development Institute in the United Kingdom, how to do this is not simple, even apart from finding the funds.  The payors (wealthy nations) favor funds to reduce emissions and running funds through the World Bank (where large donors have more control). The payees (poorer nations) have a much more pragmatic approach.  They favor direct access to funds and more adaptation than mitigation.  To quote Greenpeace Africa:  “The argument is that the developed countries, especially the United States and Western Europe, built their economies on dirty energy – principally coal. So they’re chiefly responsible for the greenhouse gases, such as carbon dioxide, that are causing climate change. Yet the worst of the climate change impacts are being felt in least developed countries. So there is definitely a strong argument for the developed countries to greatly help poorer countries to switch to renewable energies.”  In October the UN Transitional Committee submitted a draft instrument on the structure of the Fund.  News reports state that the United States does not support the draft.

3.  REDD+ - Reducing emissions from deforestation and forest degradation is an additional path to addressing greenhouse gas emissions, separate and apart from combustion sources.  Forest degradation is responsible for up to 20% of global greenhouse gas emissions.  The UN organized a program in 2008 to address this problem.  "Reducing Emissions from Deforestation and Forest Degradation (REDD) is an effort to create a financial value for the carbon stored in forests, offering incentives for developing countries to reduce emissions from forested lands and invest in low-carbon paths to sustainable development.“REDD+” goes beyond deforestation and forest degradation, and includes the role of conservation, sustainable management of forests and enhancement of forest carbon stocks."  Some have claimed that REDD is "the fastest-moving portion of the whole climate negotiations."   Some environmental groups want a portion of the Green Climate Fund earmarked for REDD.

So why does this have any significance for businesspeople in the United States?  We start from the premise that climate change is occurring. No dispute about that. There will be significant changes as a result. No dispute about that either. And humans, as is their nature, will respond to the change in their habitat.  Likewise, no dispute.  In the jargon, there will be adaptation - armoring the shore against rising sea levels, further restrictions on water usage for drought areas, more hurricane-proof building codes, enhanced floodplain analysis - and there will be mitigation - efforts at reducing the emissions of greenhouse gases.  For better or worse, the COP meetings set the rules of the mitigation game, and influence responses to adaptation.  Although the Kyoto Protocol was not adopted in the United States, it led to the establishment of a billion dollar trading system in Europe on carbon credits.  It influenced RGGI and the Western Climate Initiative here.  We have written about how the European system is set to impact American air carriers at the first of the year.  Down the road, we believe the nations of the world, including the United States, will come together to address climate change.  The frameworks that are in place - built by the COP meetings - will inevitably be important in cementing and implementing the mutuality of purpose.

We wrote yesterday to introduce Ceres’ report on the disclosure of climate risks by insurers and considered its first Recommendation to Regulators concerning mandatory and public disclosures.  We address today the second recommendation in Climate Risk Disclosures by Insurers:  Evaluating Insurer Responses to the NAIC Climate Disclosure Survey.    Ceres’ second recommendation is to "[c]reate shared resources around the implications of climate trends on enterprise risk management."  Id. at 51.  In other words, more research should be made available concerning investment risks and opportunities, correlated risks, loss modeling, the potential for loss of health and life, and customer resilience (ability to resist extreme events).  Id. 

Taking modeling by way of example, Ceres discusses modeling thoroughly in Part 2 and the discussion is thought-provoking.  Several insurers are conducting climate change modeling internally.  For the rest, they rely on third-party vendors, which invokes much criticism from Ceres.  "The majority of insurers that report using catastrophe models describe them in terms that suggest their company does not have a clear understanding of how the models can or cannot be used to anticipate changing risk.  Most of the industry relies on third-party catastrophe risk models that only marginally integrate changing extreme weather."  Id. at 6.  "[I]nsurers relying entirely on third-party models may be severely unequipped to adjust pricing to incorporate emerging climate risks." Id. at 31.  "Insurers' disclosures suggest that the majority of insurers may be setting pricing based on flawed assumptions of how the industry's loss models incorporate changing climate trends."  Id. at 32.

Ceres lauds those companies that can do it in-house.  But specialization and economies of scale are fundamental drivers of the market.  Were every insurer to bring modeling inside, undoubtedly there would be some new insights not presently uncovered.  But there would also be insurers who got the models grievously wrong and, in most cases, the resources spent on modeling would be more cost-effectively spent on other items necessary to delivering products or services.

To be sure, reliance on EQECAT, AIR Worldwide and RMS as the sources for all climate change modeling has its flaws.  One need only think back a few years to where another triumvirate dispensing financial ratings (allegedly) misled sophisticated investors around the globe.  But in a world of constrained resources, or even an unconstrained one, third-party modelers are necessary and beneficial. 

Further, a disadvantage to society from in-house modeling is that the insights developed from proprietary work may remain just that:  proprietary.  Ceres acknowledges "it is ... possible that asymmetrical information can be used by individual companies to secure a competitive edge against their peers."  Id. at 38.  Indeed, "larger insurers more readily recognize the inherent limitations of current catastrophe models in light of changing climate than do their smaller competitors or clients.  These players have a clear competitive advantage in deploying resources to build the latest climate science into their pricing models."  Id. at 37.  Third-party vendors, on the other hand, spread their best products across many insurers, in effect sharing their best research (but only to those willing to pay for it). 

We wrote yesterday of the need to recognize that intellectual capital is a business asset and criticizing a goal of making climate change disclosures public available.  We think those comments apply likewise to the sharing of resources.

Nevertheless, Ceres does great work in raising the bar for third-party vendors.  By pointing out to insurer-users that they may not be getting what they really need from the modeling firms, we expect the modelers will have to go out and address Ceres’ criticisms.  For example, insurers are exposed if (as Ceres asserts) "few insured perils are modeled by insurers, leaving the possibility for climate-affected perils to be underpriced."  Id. at 35.  More specifically, "recent years have demonstrated that climate change may be driving up aggregated losses from smaller events, including perils such as floods, snowstorms and hailstorms, in ways that erode insurer profitability."  Id.

Tomorrow we conclude our review with a look at Ceres’ third recommendation as well as sharing some concerns about research.

Ceres released last week the first analysis of the insurer climate change disclosures submitted to state regulators pursuant to the National Association of Insurance Commissioners rule.  The report is eye-opening.  The authors have combed through the disclosures of 88 insurance companies and offer thoughtful insights on, for example, investment practices, management structure and modeling.  Those seeking to advance their bottom line will find nuggets of information directly related to competitive advantage.  In this post, we outline the report and discuss its first recommendation regarding mandatory and public disclosures.  In subsequent posts we will address Ceres’ second and third recommendations.

The report’s title is dry and daunting:  Climate Risk Disclosures by Insurers:  Evaluating Insurer Responses to the NAIC Climate Disclosure Survey.   Fortunately, it does not live up to the ominous desiccation foretold by the title.  We know from the get-go where this is going:  "This report documents this powerful industry's sluggish and uneven response to the ever-increasing ripples from global climate change, which could undermine both its own financial viability and the stability of the larger global economy."  Id. at 3.

For those to whom Ceres and NAIC are unfamiliar, the former is a non-governmental organization composed of a coalition of investors, environmental organizations and other public interest groups, whose mission is to “integrat[e] sustainability into day-to-day business practices for the health of the planet and its people.”  The latter is the National Association of Insurance Commissioners, which in 2009 approved mandatory requirements for climate change disclosures for insurance companies, because "[a]s regulators, we are concerned about how climate change will impact the financial health of the insurance sector and the availability and affordability of insurance for consumers.  This disclosure standard will give regulators the information we need to better understand these risks."    NAIC later revised its requirements to make disclosure voluntary.

Ceres's work is based on the 2010 disclosures of 88 US insurers filed in six states (mandatory:  New York, California, Pennsylvania; voluntary:  New Jersey, Oregon, Washington).  The report is set up in three parts.  Part 1 describes climate change risk and the need for disclosure.  "The changing climate will profoundly alter insurers' business landscape, affecting the industry's ability to price physical perils, creating potentially vast new liabilities and threatening the performance of insurers' vast investment portfolios." Climate Risk Disclosures at 9. 

Part 2 is the meaty analysis of the report and addresses the following topics:

Risk Perception and Management Structure
Risk Exposure and Management
Financial Effects
Loss Modeling
Investments
Emissions Management
External Engagement

Its goal is to set out “risk perceptions and management practices for handling climate change across the American insurance industry.”  Id. at 17.  While often couched in possibilities, the analysis raises numerous interesting issues.

Part 3 is the Recommendations to Regulators.  There are three and we focus there.  First, Ceres recommends “implement[ing] mandatory disclosure annually, and mak[ing] survey responses publicly available."  Id. at 50.  We take no position on whether NAIC should require climate change disclosures and would be interested to read NAIC’s own evaluation of the disclosures and how they advance the goals of insurance regulators.  As for public disclosure, while we are perhaps more interested than most in these types of things, we are acutely sensitive to the issue of competitive advantage.  There will be winners and losers in the insurance industry as a result of climate change.  The winners will be those who, among other things, recognize correlated risks first, have more accurate models, and innovate better.  Requiring companies to give away their proprietary information may lead them not to generate it in the first place.

And items leading to competitive advantage are all over the NAIC submissions.

Harleysville Insurance Company reports that “over time the Company has witnessed the traditional tornado alley expand causing increased losses further east and toward the southeastern states." Id. at 24.

"[A] handful of insurers discuss the ways their approach to establishing reserves, reinsurance coverage or capital market transfers have been adapted to reflect changing risk statistics or future scenarios where historic statistics do not illuminate future risk."  Id. at 32.

Allianz is “developing products and services geared to address climate change, ... leveraging climate change research, and contributing to related public policy development."  Id. at 19.

There are a lot of things that make a business succeed.  Intellectual capital is one of them.  Just as we would not expect businesses to give out greenbacks to passersby, why should their green ideas be treated differently? 

Tomorrow we will look at Ceres’ second recommendation concerning shared resources.

My train this morning usually continues to New York. Today it terminated in Philadelphia, a victim of the deluge delivered by Hurricane Irene. Amtrak explained:

Most Northeast Regional service will operate south of Philadelphia, but no Acela Express, Northeast Regional or other Amtrak trains can operate north of Philadelphia to New York.

As of early this Monday evening, about a half-mile of Amtrak right-of-way remained submerged near Trenton, N.J. As the water levels recede, Amtrak engineering forces will make repairs to the track and signal control infrastructure. Updates will continue to be provided and an estimate for restoration of full service south of New York is not yet available.

Many attribute the recent spate of natural disasters (heat waves, droughts and wildfires in Texas, tornadoes in Missouri and Alabama, Hurricane Irene) to the effects of climate change. We reserve judgment. Climate change is about trends, not individual events.

One trend we are watching closely is the status of flood plains. We dug up the Flood Insurance Rate Map for the Trenton train station. The Amtrak right of way mentioned above is in the 100 year flood plain. We weren't able to determine how many times it had flooded recently, but the mayor of nearby Lambertville noted that they have been flooded out 5 times in the last ten years.   The flood at the train station was a record, nearly seven feet above flood stage.  Id. And  a study out of the University of New Hampshire  reports New Hampshire has experienced 4 100-year floods in the last four years.  Some may discern a trend.

Fortunately, we are not the only ones watching. FEMA is in the process of preparing a report on climate change impacts on the National Flood Insurance Program. Preliminary information indicates that some Special Flood Hazard Areas (the 100-year flood plain) will double in size and that by the next century the nation's flood plain will be 40%-45% larger.  Look for The Impact of Climate Change on the National Flood Insurance Program to be out this fall.

FEMA currently does not directly address climate change in the NFIP, because its practice is to make its assessment based on the historical record.  But that does not mean communities and businesses cannot.  For example, a community may request that the applicable Flood Insurance Rate Map address future conditions.  44 CFR 64.3(a)(1).  Where business continuity planning is standard practice (and we hope that is everywhere) vulnerability assessments need to ask not only where is the flood plain, but where is it likely to be.  Many have been off to a slow start on climate change planning.  But, as with trains, late is better than never.

View of Trenton Amtrak right of way (c) Times of Trenton

Half a degree doesn't sound like much. And it isn't, if you are talking about a baccalaureate. But in a world of climate change, a half a degree increase in Baltimore's average temperature combined with average temperature increases in all the lower 48 states is confirmation of what the scientists are telling us:  the planet is warming.  Thus, the National Weather Service's release on Monday of revised 30-year average temperatures gives some satisfaction, or at least Schadenfreude, to those trying to lead (or push) their organizations into proactively managing climate change.

Or does it?  Here is how this news was reported in Tampa, Florida 

"Some of the changes emerge from tossing out statistical peaks and valleys from the 1970s, the weather service says. A shift in instrument locations could explain more change.

And the continued development around Tampa International Airport and Tampa in general could account for some of the warmer nights that helped push average temperatures higher for April through August.

A slight shift in equipment location at Tampa International Airport could also influence the low morning readings, the weather service says.

Or, the overall reason also could be changes in global climate, but that’s impossible to determine from readings at one location, the weather service says."

So if this is all statistics, what is one to do?  You could instead get your weather news from Montgomery, Alabama, which reported on the same news:

Updated theories of global warming and climate change predict a pattern of increasing temperatures. The theories are based on an increased amount of carbon dioxide in the atmos­phere leading to high tempera­tures.

The shift in temperatures is more likely associated with the Pacific Decadal Oscillation, said Dr. Roy Spencer, a princi­pal research scientist at the University of Alabama in Huntsville. Spencer also has served as a senior scientist for climate studies at NASA's Mar­shall Space Flight Center in Huntsville.

So which is it?  Statistics, decadal oscillation or climate change?  The statistics answer is easy to discern.  For Tampa, scientists cannot say that its temperature specifically is driven by climate change.  But when the whole country is changing, that is a different story.  Montgomery is a little more difficult.  I tracked down Dr. Spencer's webpage  and learned that he believes, "Climate change — it happens, with or without our help."  His research is into whether the climate change we are observing is natural or man-made.  He agrees that the climate is changing.

This seemingly disparate information contains a valuable lesson.  Where there is no controversy or skepticism, it is easy to make choices of what to do.  Where controversy surfaces, however, to move forward, one needs to understand precisely what is controverted.  And often, of course, that will have to be done by degrees as understanding matures.

We hope you don't come to this blog for stock tips but it doesn't take John Bogle to know that the debt ceiling impasse and the budget furor do not bode well for renewable energy stocks.  Citing the debt crises and oversupply, here is how one report put it:  "One of the biggest losers on the day was the PowerShares WilderHill Clean Energy Portfolio (PBW) which slumped by 1.4% to open up the week." 

So where else is the national obsession on the nation's debt going to take a bite out of responses to climate change.  We tracked down a few subjects.

Carbon Dioxide Regulation - Efforts by House Republicans to defund USEPA's steps to regulate carbon dioxide resulted most recently in H.R. 2584, the proposed Department of the Interior, Environment, and Related Agencies Appropriations Act of 2012.  Section 453 provides, among other things, that "None of the funds made available under this Act shall be used--(1) to prepare, propose, promulgate, finalize, implement, or enforce any regulation pursuant to section 202 of the Clean Air Act (42 U.S.C. 7521) regarding the regulation of any greenhouse gas emissions from new motor vehicles or new motor vehicle engines that are maufactured after model year 2016 to address climate change; ..."  
This is not a new tactic.  It is probably fair to say that what is in the works now at EPA is not what will be the final word.

Tax Credits - Under § 1603 of the American Recovery and Reinvestment Tax Act renewable energy project developers may take cash payments in lieu of the investment tax credits.  The Treasury reports over 7000 projects funded to the tune of $6.4 billion, resulting in total investment of $21.6 billion.  Although the credits do not expire until October 2012, some think they are under the gun right now. 

Ethanol - The most subsidized part of the renewable energy mix, ethanol producers and corn farmers received a stern message on June 16 when Senator Dianne Feinstein obtained a symbolic vote (73-27) in favor of ending ethanol subsidies on July 1.  The White House promised a veto and the proposal has not gone anywhere in the House.

Energy Efficiency - Congress can't figure out the debt ceiling mess but remains expert at creative bill naming.  H.R. 2417, the Better Use of Light Bulbs (BULB) Act, passed overwhelmingly, but didn't take effect because of the procedural rule adopted to permit a vote, which required a supermajority.  The bill would have repealed certain provisions of the Energy Independence and Security Act of 2007 that prescribed energy efficiency standards for incandescent lamps (among other things).

We are sure there are others.  Notwithstanding that the Energy Independence and Security Act of 2007 passed both houses of Congress by wide margins, the winds of change are now blowing hard and furiously.  Where all these programs will be when the furor over the debt ceiling subsides is unknown, but no one can dispute that the climate has changed.