Climate change and insurance markets: let’s focus on real solutions, not finger-wagging

I don’t know why I’m writing about this when our democracy is on fire.  Maybe I need to focus on something cheery, like climate change.

The American Prospect has a couple of pieces up on insurance and climate change.  One identifies a genuine issue, the other misses the mark.

In this piece, Alexander Sammon asks why insurance companies aren’t taking steps to fight climate change, given that catastrophes like wildfires and hurricanes cost insurance companies money. 

The answer is simple.  Insurers pay out claims when their insureds suffer losses due to natural catastrophes, but they charge premiums that cover those loss payments and leave insurers with a profit.  In fact, more catastrophes will mean a bigger market for insurance and related products like catastrophe bonds.  Think about it – if there were no natural disasters at all, there would be no market for catastrophe insurance.  If anything, global warming will benefit insurers by expanding their market.

I am not claiming that insurance executives and investors are deliberately encouraging global warming for profit.  The most significant effects of climate change on insurance markets will occur far in the future, so today’s executives just don’t care much about them.  (Imagine you are an insurance company executive.  Today you can a) schmooze a prospective client, b) work on improving your current product, c) meet with your regulator to get a rate change approved, d) meet with your auditor to answer questions about your financial statements, e) deal with an IT problem that is causing some policies not to issue correctly, . . . or z) focus on climate change.  What would you do?)  And even if climate change will ultimately benefit (or harm) insurers as a group, each company would prefer to see some other company bear the costs of encouraging (or slowing) climate change.  It’s a standard free-rider problem. 

Sammon also suggests that insurers are facing risks from investing in fossil fuels.  Maybe, but a more plausible story is that insurance company investment committees have examined the risks involved and believe that fossil fuel companies are still worthwhile investments, in narrow economic terms.  They may be proved wrong, but the same is true for any investment.

None of this is intended to suggest that insurance company executives and investors are moral angels.  I was one, and I’m quite sure they aren’t.  They are just doing what market incentives tell them to do.  And that’s the point. Progressives should stop treating climate change like a morality play in which justice will prevail if only people can be persuaded or shamed into behaving better.  That is a recipe for endless, tiresome corporate greenwashing and blather about “sustainability”, and ultimately for failure.  We need the government to change the rules of the game to reduce the demand for fossil fuels by businesses and consumers.

The second article by Lee Harris focuses on government, specifically on the National Flood Insurance Program.  This is indeed a serious problem, and it is a problem caused not by markets, but by misguided government regulation of markets. 

In a free market for insurance, people who live in areas exposed to flood risk would have to pay more for insurance.  In some cases, they would have to pay a lot more for insurance, and they would refrain from building in flood-prone areas.  But the federal government offers heavily subsidized insurance that encourages people to build in flood-exposed areas. 

Everyone knows this should be ended, but as Harris notes, politicians resist raising premiums in flood-prone areas because this will hurt their constituents.

There is a similar problem at the state level with the market for homeowners insurance which protects against hurricane damage.  In many states, homeowners in areas exposed to hurricane risk are heavily subsidized by homeowners who live in safer, inland locations.  These subsidies are large, but they are far from transparent.  People building homes in fire-prone areas also receive subsidies.

The result of all these subsidies is that we are putting far more buildings in flood and hurricane and fire-exposed locations than we should.  This is costly today, and it will make our climate adaptation problems much more difficult.  Again, the problem here is not primarily the insurance industry, or markets, it is political interference with risk-based pricing.  And I suspect it’s mostly driven by voters, not by corporate lobbying.  (There is one potential market failure that Harris flags, the fact that pricing based on today’s catastrophe risks will not discourage people from building in areas that will become more vulnerable to catastrophes as the climate warms.)

We know what to do to fight climate change.  Finger-wagging at insurance companies is not on the list.  What is on the list is action by the federal government to decarbonize the economy, primarily by raising the cost of fossil fuels and using regulation and government purchases to encourage green electrification.  Figuring out how to get meaningful legislation through our dysfunctional political system is the problem we need to focus on.