American International Group (AIG)is the first major US insurer to establish a policy on climate change, though many European re-insurers, including Swiss Re (RUKN.VX)and Munich Re , have been addressing it for years.  Like any prudent company in any industry, AIG says that it is addressing the impact of climate change across all of its businesses, and looking for new, typically market based opportunities, including tradable carbon credits, consulting services and various financial products.  AIG says it may invest in forests, renewable energy resources and greenhouse gas mitigating technologies, and green real estate. 

AIG may be first mover in the US (Johnny come lately vis-a-vis Europeans), but it’s a safe bet that every similarly structured insurance company will have a similar statement sooner rather than later.  Climate change provides revenue growth opportunities: it will also increase the cost of claims.  Climate change related insurance will not be as predictable as auto insurance: it is not a conservative equation.  But it is a good time to be a climate-savvy actuary.

What is more interesting about AIG's new policy (and thus eventually other insurance companies) is its effective embrace of key parts of the Kyoto Protocol including: 

• Clean Development Mechanism (CDM).  This mechanism enables industrialized nations (like most of Europe, Japan and Canada) to offset their own greenhouse gas emissions by investing in emission-reducing projects in developing nations (China, India, most of Africa).  The idea is that the same level of GHG reductions can be achieved at a much lower cost (effectively enabling the world community to pick the lowest hanging fruit).  The main criticism is that CDM takes place in countries not obligated to lower emissions and thus makes distortions more likely.

• Joint implementation (JI).  This mechanism enables industrialized nations investing in emission reducing projects in other industrialized nations (as opposed to developing nations).  JI is mainly to address the heavy emission issues of industrialized Eastern Europe and the former Soviet Union.  Unlike the CDM, JI is in countries obligated to reduce emissions and thus will be more closely monitored.  Success is measured in emission reduction unit (ERU) credits, with one ERU equal to one ton of CO2 equivalent.

• EU Emission Trading Scheme.  This is the world’s largest multi-national GHG trading scheme.  Each country has a National Allocation Plan (NAP) specifying emission caps on GHGs for individual power plants and other large point sources. These NAP caps will tighten over time. To be under the cap, each country has to either:

1. Reduce emissions to be within that allowance, or
2. Purchase credits from others with excess allowances.  It is an effective tax for inefficient sources, and an additional revenue stream for efficient ones.  

AIG’s statement makes sense, but other than being first mover, there doesn’t seem to be any sustainable competitive magic based on this issue alone.  The intrigue is how they are buying into key parts of Kyoto, which may provide early clues to Kyoto II (the original Kyoto protocol is scheduled to expire in 2012 and policy makers are beginning to noodle the nature of any subsequent protocol).