Global warming insurance

One of the best ways to illustrate the growing societal consensus on global warming is the reaction of businesses. An alliance of conservation groups, car makers, utilities and industrial manufacturers is backing a system of cap and trade which would reduce allowable carbon emissions over several years, and create a market in efficiency and carbon reduction. The new owners of a utility in Texas scrapped plans for new coal plants and will replace those plans with low-emissions plants which will sequester carbon dioxide and extract energy from coal more efficiently. Other Texas utilities are able to sell wind power at lower cost than conventionally generated power.

The industry I'm watching most closely right now is insurance. Whether it's harsher storms destroying homes (a problem exacerbated by greater density of homes in areas that were risky to begin with), the threat of lower agricultural yields, melting permafrost destroying foundations or just the risks associated with rising oceans, there is a lot to insure against.

Not surprisingly, insurers are catching on. Tim Wagner of the National Association of Insurance Commissioners explains "Insurance is priced based on statistics and probability. What climate change has done is create ambiguity and uncertainty in the pricing scenario." Insurance companies can't just plan for the average number of claims, they have to be prepared for an unusual streak of bad luck, and that means that greater uncertainty means higher costs, even if average risk doesn't change.

Some insurers are ahead of the curve, but others are lagging. Last year, Allianz Group partnered with WWF to produce a report on risks to insurers from global warming, and Allianz is cautiously optimistic. Board member Clement Booth explained "if we can find a way to provide insurance in the face of major changes, from the first transatlantic voyages to global terrorism, then we can also find new ways to both incentivize emission reductions and provide coverage." Traveler's offers premium deductions for hybrid vehicles, and AIG. A subsidiary of Allianz is offering reduced rates to energy efficient commercial buildings that meet the LEED standards, and benefits for customers who upgrade to more energy efficient heating and cooling.

The WWF/Allianz report offers some helpful suggestions to policy-makers. The first is to move beyond uncertainty. "The U.S. insurance industry has emphasized, through its industry associations, that scientists disagree about the regional implications of climate change," and has yet to incorporate even extremely likely results of climate change, like melting polar ice and rising sea levels, into their catastrophic risk models. Insurance companies exist for precisely these sorts of situations, where outcomes are uncertain and probabilistic.

More concretely, they encourage insurers to work with regulators to allow increased rates for properties at greater risk from global warming. Many areas will be at greater risk of floods or fires in a hotter world, and some insurers are already abandoning parts of the marketplace because the risks are too great for the premiums they can charge.

Insurers are also advised to put their expertise at the disposal of planners and policy-makers. Insurance risk models can help city planners evaluate the risks and likely insurance costs resulting from zoning changes and different growth scenarios. Premium reductions for greenhouse gas mitigation which are currently voluntary programs may be worth mandating to reduce the collective action problem among insurers. Insurers could also work with urban planners to promote public transportation, which can cut emissions and reduce smog and traffic accidents.

There are limits to the involvement of insurers in reducing climate risks. Adjusting insurance rates can encourage people to quit smoking or install air bags because the person making the insurance decision is also deciding what course of action to follow. A smoker's individual action can radically improve his future health. An individual who decides to buy a hybrid car or a LEED certified house is only changing the risk of planetary climate change incrementally. Many areas in the US and globally that are at greatest risk from a hotter planet are not the areas that are contributing most of the greenhouse gasses. Insurers will have a hard time doing more than encouraging adaptation to a changed climate. Shifting the cost from the people facing the new risk to the ones causing it will require government action at the local, state, national and global levels.

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Judge Richard Posner has proposed similiar insurance, "disaster insurance". Whereas, the United States, or other countries, would take the discount rate of the estimated economic impacts of global warming and spend that money until...2107, in an attempt to rollback the potentially harmful effects.

Personally, I would support larger energy and carbon taxes. A cap-trade system has the same effect, yet, with carbon and gas taxes, it is easier to convince Congress to use those revenues to cut marginal tax rates on lower income earners, as the regressive nature of both systems is realized more readily.

The "capture theory" of regulation might play into the cap and trade style of regulation, as well. Whereas, political interest groups devote more resources to lobbying as their industry is further regulated, as they are forced to compete over allowances of carbon emissions. With carbon taxes, the administration is quick, efficient, and equipable. No new markets need to be set up.

If the entire international community fails to get behind the effort, as well, you might just see the shifting of the problem, rather than a solution. An example is embryonic stem cell research. With the restrictions imposed by President Bush, the practice was not stalled, but rather shifted to other countries where funds were readily available.