Managing risk through the insurance industry
The climate collapse that is on gong today will cause costs far greater than the total value of the global economy. These costs will come about through large scale deaths due to heat exhaustion, famine, mass migration, war and the destruction of critical infrastructure at sea level such as ports, agricultural land and nuclear power plants.
To mitigate against these costs, funding must be made available for a climate restoration programme that is sustainable, which will not be at the whims of politics and which also constrains fossil fuel consumption.
The insurance industry is most incentivised to enable this.
The insurance industry is already experiencing exponential growth in their liabilities to climate change losses. At the same time, the returns they are making on investments are stagnating as the global economy has struggled to grow since the banking crisis in a foretaste of the future economic conditions that climate change will bring. Exponentially rising costs and falling income have only one outcome; collapse.
Delaying the inevitable - the extent of today's approach
The insurance industry’s response to this is to increase premiums, but this is not managing risk, it is merely delaying the inevitable. The inevitable results are that premiums become prohibitively expensive and assets become uninsurable. With an increasing number of uninsurable assets, economic activity slows down, thus less money is available in the economy to pay the increasing insurance premiums. The result is an economic death spiral and collapse.
This is not some far-fetched future. It is happening today. Large swathes of once high value houses in the Carolinas and Florida are already uninsurable and worthless in the face of rising sea levels, see here. This is merely the start of the chaos to come and if left, it will quickly grow to such a magnitude that a climate restoration programme will be impossible. So a dialogue that will ensure a stable and sustainable approach to funding the risk management of climate change must start now.
Starting a dialogue
Some attempt to do this was made with the Bank of England’s PRA report on “The impact of climate change on the UK insurance sector,” the purpose of which was to set financial market policy in the face of climate change.
However, it is deficient in its analysis in a number areas; most critically it is premised on the temperature rises being held at 2 deg C through the INDCs of the COP21 agreement and that the economic dislocation this would cause will primarily be limited to stranded assets in the fossil fuel industry. This runs counter to the accepted view of the inadequacy of the INDCs which puts the planet on track to at least a 3.60C temperature increase, which the UK government acknowledges. A temperature rise of this magnitude brings with it an existential threat to civilisation and most other higher life forms on the planet.
More critically the Bank of England’s report goes on to say, “the [high carbon] energy sector accounts for around 4% of total UK premiums.” While this is UK specific, it will be largely analogous for other developed economies.
This is an extraordinary statement.
Climate change is the biggest single future liability facing the insurance industry, yet the companies that are at the forefront of causing this pay nothing on their premiums to cover the risk they cause. As well as going against all the principles of risk management that the insurance industry is based on, it also goes against common justice where the house holders are ultimately expected to the pay for the risk that others cause them.
A climate change third party premium on fossil fuel companies
Thus we propose that a third party insurance premium be added to the insurance contracts of the fossil fuel companies with the intent of raising the funds for a climate restoration progamme. To do this is nothing new as it is analogous to the third party insurance premiums that drivers pay on car insurance to cover the risk they cause to other road users. In the same way that this prices young drivers out of high performance cars, then pricing in the future climate change insurance liabilities onto the insurance premiums of the fossil fuel companies will disincentivise extraction of fossil fuels and help drive the transition to a low carbon economy.
Once the costs of the climate restoration programme are established, the additional third party insurance premiums can be set by actuaries in the normal way that they would price any risk.
There is a legal obligation to do this. Under the new Solvency II regulations, insurers must be sufficiently capitalised to withstand the losses of a 1 in 200 year event over a one-year time horizon. However, with climate change on its current track to wipe out civilisation well before 200 years, this can only be achieved with a successful climate restoration strategy. Thus without supporting a climate restoration programme the insurance industry is automatically in violation of its governing regulations as well the risk management principles set out within it.
The other illegal act of the insurance companies is their failure to disclose the risk on their long term policies such as life endowments and pensions where the risk of climate change puts the the entire capital invested at serious risk should there be no successful climate intervention programme. Thus, if they want to continue selling long term policies, they must proactively support a climate restoration programme.
This approach is self-policing as any company that attempts to not pay the climate change insurance policy will not get insurance. Without this they will not be able to operate or raise funds from their shareholders or the markets. By the integrated nature of the insurance industry where insurance companies are multinationals and risk is amortised by selling it across borders through the re-insurance industry, then it becomes virtually impossible for a single country to take a unilateral approach of not playing by the rules by not requiring its indigenous industries to take out such policies.
Comparison with Alternatives
In effect this becomes a market based approach that steps in where the governments have been unable to act due to the increasing competitive pressures on them. The failure to implement carbon taxes and agree legally binding cuts in CO2 emissions has demonstrated the limited ability of governments to act in collective interest, rather than self-interest.
If carbon taxes where to be the mechanism for funding a climate restoration programme, then the conflict between protection of national self-interest and collective interest will turn the myriad of negotiating points into stumbling blocks; for example, should the most polluting nations be the ones that contribute the most to the programme such as the USA and China, or should the fossil fuel producing countries contribute the most, such as Saudi Arabia, Russia and Australia. For all practical purposes the chance of any sort of agreement, given the fragile state that the global political system has already fallen into, is most likely to be near to zero.
By contrast the insurance industry has direct incentives to overcome all these issues.