Can Insurance Save Us From Climate Change?

First, many factors combine in extreme weather events. A hurricane has many causes, and global warming might only be two percent part of the overall risk. If that part grows from two percent to five 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 have always 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, more intense or change 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 over-optimistic assumptions are sometimes rudely corrected by ugly surprises, especially when risks are constantly changing, as they are with climate change.

Like all of us, insurers want certainty, even when they know that certainty cannot be attained. At a 2007 conference about hurricane science for an insurance audience, the world's top climatologists discussed various topics in modeling and hurricanes. The head of underwriting at a major North American insurer snorted at the hedged, qualified way the scientists stated their conclusions. The underwriter then complained, "Why don't the scientists give us numbers we can use! These probabilities are too nebulous for us to write business with them!" His impatience is widely shared, but the answer is no greater certainties are currently available.

Third, insurance functions well when the risks of various hazards are truly independent of each other. 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, which in the U.S. is often part of a highly entrenched political juggernaut promoting the worst possible policies, such as building heavily in flood plains or on beaches very prone to hurricane damage.

Consider Florida, where the laws, business practices and general culture are geared to developing every square inch of land near water—not just oceans, but also lakes, streams wetlands. Even in the absence of climate change, this is an obviously dangerous policy. It's also very 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 anti-development forces is swift and merciless. Certainly no politician can withstand it. Rather than resisting, many property and casualty insurers simply have pulled away from vulnerable coastal property in Florida.

In response, Florida created its own public-insurance pool. The result? Development continues, and the state fund is actuarially unsound: A major storm hitting a developed area would bankrupt the fund in short order. A few more storms would bankrupt the state of Florida, which would then call on the Federal government—as the stand-in for taxpayers in all other states—to bail it out.

These three factors mean that 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.