The Tampa Tribune
by Brian Thomas
June 20, 2011
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 — like 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 a little more security against fires, earthquakes, business interruption and the numerous other events against which we can buy an insurance product.
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 many weather risks such as hurricanes.
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 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 climate change is turning up the dial, these familiar events may break out of their boundaries and become more frequent, more intense or changed in unexpected ways.
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 overoptimistic assumptions are sometimes rudely corrected by ugly surprises, especially when risks are constantly changing, as they are with climate change.
Third, insurance functions well when the risks of various hazards are truly 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 all these factors together more tightly is land use. 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, wetlands. Even in the absence of climate change, this is an obviously dangerous policy. 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 few more storms would bankrupt the state, which would then call on the federal government — as the stand-in for taxpayers in all other states — to bail them out.
These three factors mean the insurance industry is weaker than it appears 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.
Brian Thomas is a sustainability consultant with a focus on communications. He is currently a member of the New York City Panel on Climate Change.
