WEST CORNWALL, Conn. -- People judge risk badly. We worry too much about minor hazards and are nonchalant about more serious ones. We're especially inept at judging chronic long-term risks -- such as climate change.
Insurance is a major part of how we deal with risk. Can it lead us to more viable ways to address climate issues? The picture is mixed.
When we manage risk by buying insurance, we endure the slow, small pain of insurance premiums in exchange for a big compensation should something ugly happen. The insurers profit from our lack of knowledge about risk. Buying insurance goes against the grain, but paying our premiums gives us more security against fires, earthquakes, business interruption and the numerous other events against which we can buy an insurance product.
Insurance as a guide
Insurers review policies annually and change terms if they see a change in the probabilities. When no major losses occur, the industry pats itself on the back for judging their risks correctly for that year. Insurers are happy and companies are profitable. If the risk landscape changes, they absorb the payouts and adjust the terms accordingly.
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The optimistic point of view is that insurance can play a major role in guiding businesses and individuals toward more climate-friendly decisions. In theory, insurers study the real probabilities of known hazards, figure out a viable premium that gives themselves a profit and the policyholders the agreed upon protection against the risk. When climate change raises the risks of flooding, business interruption and other insurance hazards, the premiums go up, which can lead their policyholders to change their behavior. Financing for a new factory can be prohibitive or even impossible to get if insurers won't cover it.
In practice, though, this theory is faulty for several reasons. Climate change poses special challenges to insurers, not merely because they are on the hook for weather risks such as hurricanes.
Three factors
First, to single out one kind of insurance, many factors combine in extreme weather events. A hurricane has many causes, and global warming might only be 2 percent part of the overall risk. If that part grows from 2 percent to 5 percent, it seems negligible, but, in fact, it's quite significant. As one insurance executive said, "Even a minor increase in a risk like that can mean billions of dollars in additional losses to insurers." If the winds are a few miles per hour stronger and the storm takes a path through a heavily insured area, insurers can be overwhelmed.
The same is true for other climate impacts. There always have been floods, extreme weather and times when the water cycle intensifies. But if climate change is turning up the dial, these familiar events may break out of their boundaries and become more frequent.
Second, insurers are people, too, and the cognitive blind spots that afflict individuals also affect the risk business. In practice, the insurance industry's grip on certain probabilities often relies on seat-of-the-pants methods that are subjective, and whose optimistic assumptions sometimes are rudely corrected by ugly surprises, especially when risks constantly are changing, as they are with climate change.
Third, insurance functions well when the risks of various hazards truly are independent of each other, and truly random. One trouble with climate change is that climate instability tends to make floods, windstorms, and other extreme weather more interrelated.
One force binding these factors together is land use, which, in the U.S. often is part of a highly entrenched political juggernaut promoting the worst possible policies, such as building heavily in floodplains, or on beaches prone to hurricane damage.
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Consider Florida, where the laws, business practices and general culture are geared to developing every square inch of land near water -- oceans, certainly, but also lakes, streams and wetlands. Even in the absence of climate change, this obviously is a dangerous policy. It's also popular. John Coomber, former CEO of Swiss Re, once grumbled that every American wants to live on the most vulnerable beaches they can find in Florida.
Governments occasionally try to buck the pro-development tide, but the political pressure against the antidevelopment forces is swift and merciless. Certainly no politician can withstand it. Rather than resisting, many property and casualty insurers have pulled away from vulnerable coastal property in Florida.
In response, Florida created its own public insurance pool. Result? Development continues and the state fund is actuarially unsound -- a major storm hitting a developed area would bankrupt the fund. A few more storms would bankrupt the state of Florida, which then would call on the federal government -- as the stand-in for taxpayers in all other states -- to bail it out.
These three factors mean the insurance industry is weaker than it appears when in matters of changing social and economic policies. The only way to change these entrenched policies would be for other social forces to align with the insurance point of view. That will require energetic political leadership and vigorous regulation. The market alone cannot save us.
Editor's Note: Thomas, of West Cornwall, Conn., is a a sustainability consultant. He is a member of the New York City Panel on Climate Change, EnviroComm and the Association of Green Technology Auditors. He is an activist member of the Conservation Commission. His blog is at http://carbon-based-ghg.blogspot.com .
