The Moral Hazards of Resilience: What Are We Insuring?
“The insurance industry has to be central to how we manage adaptation.”
That statement, heard at a workshop with philanthropies and climate change NGOs during New York Climate Week, was repeated by perhaps four or five other people during the same workshop, followed by echoes in other sessions such as the Resilience Hub.
One of the positive developments in adaptation and resilience is that we aren’t just talking about isolated one-off projects anymore. Our sense of the relevant scales has expanded and grown — we see more systems, more kinds of institutions. Change a program, and we influence hundreds of projects.
And we can manage more complex impacts as well. Fifteen years ago, I used to worry about farmers and forest management agencies, freshwater dolphins and cities. Now many of us are looking at sectors very far removed from what we used to think of as the front line of climate impacts.
Perhaps most recent set of institutions are the larger financial and economic system, from central banks to credit rating agencies. A lot of us have come to understand that climate risk — and enabling resilience — are relevant to the flow of investment and capital and the rules we used to manage economic priorities.
Insurance was certainly the first finance sector to think hard about climate change. Insurance (and reinsurance) provides a safeguard mechanism — compensating for loss, sharing risk. That’s true for public entities like Spain’s drought insurance program for farmers as well as the US flood insurance program. It’s also true where I live for fire risks: my family pays a premium to a company to manage our exposure to forest fires.
But the mechanisms to determine compensation, premiums, and how risks are identified by insurance companies are all being subjected to ongoing stress tests by climate change, which of course is a moving target. (Insurance is also important as a giant pool of money that is widely invested — a relevant issue for resilience, but one we can politely ignore for now.)
Insurance companies are really risk evaluation institutions. Looking back to some of the early insurers centuries ago like Lloyds of London, they prepare a risk profile for an asset. They have moved far from the elaborate hand-written tables prepared for ships in the eighteenth century scoring the quality of captain, integrity of the hull, and dangers from storms and pirates. But the principles of seeing and evaluating risk are not that different today.
Climate change and a reordering geopolitical landscape add a lot of complexity to that calculus. To my south, many commercial insurers are leaving the prosperous but increasingly flammable state of California, worried that they cannot sustain their business by continuing to insure communities from proliferating fire risks. Only a few companies and public insurance bodies have been left behind.
One of the insurance representatives I met in New York said something with profound implications: we are making decisions now that, like it or not, look like public policy. Where we insure, how we price, and how we evaluate risk profoundly alter economic and financial relationships. Is that what you want us to do?
Perhaps most interestingly, they are making decisions about how to pay for damage. If they replace a home or business in a newly flood-prone area, are they recreating the risk, inadvertently placing people back in harm’s way? Profitability may not be a good lens for setting public priorities. And the public itself may not want to pay for some kinds of damages.
Twice I heard this question raised. And twice I heard financial professional grimly state two words in reply: Moral hazard.
If we compensate farms for their losses from a drought but they keep making the same decisions without recognizing that drought may be a recurrent, even worsening issue, then we have incurred moral hazard. If we rebuild a sinking city damaged by a typhoon, we have incurred moral hazard.
Companies see this. And companies are pulling back to protect themselves. In that void, we need collective decisions about resilience. Perhaps we compensate the drought-stricken farmer, but pay her an additional sum to create an aquifer recharge zone. Or we begin preparing the way for the inundated city to move farther inland — certainly a process that will take decades. But one we can manage with planning.
We are asking too much of companies — and too little of policymakers. They are incurring a different type of moral hazard: that of inaction.
John Matthews
Corvallis, Oregon, USA
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