Environmental externalities are unscrupulous and malicious because those generating them seldom have to pay the full costs of the damage they cause. It is transferred elsewhere, whether to a neighbor, or, as is increasingly the case, the entire globe.
Perhaps one of the cruelest examples of the capaciousness of externalities is that fifty of the Least Developed Countries (LDCs) are likely to be the first to suffer from the consequences of climate change, yet they contribute less than one percent of the world carbon dioxide emissions. Consider the impact a flood surge would have in Bangladesh. Droughts in Africa would devastate its agricultural. And low-lying islands in the Pacific could be inundated. Climate models predict all these, and their impact in human and economic terms will be ruinous.
Yet, most of these externalities are generated by the private sector in industrial countries, which choose to be oblivious to the impact on others, and complacent on how climate change will affect their own business, which they believe will be remote and incidental.
Not to be denied, nature is ready to extract its revenge, and levy the private sector with externalities that few companies are aware of, let alone taking into account in their strategic planning.
On reason for this complacency is that in the commercial world, nature’s externalities are covered by insurance. No modern business would risk operating without insurance. Climate change, however, presents unprecedented risks that the insurance industry may not be able or willing to cover. In areas that are particularly vulnerable, some Insurance companies have already started to withdraw or steeply increase their premiums. As natural disasters caused by climate change increase in frequency and intensity, insurance will become unaffordable.
The Allianz Group Insurance Companies stated that it has experienced a “fifteenfold increase in weather-related insurance claims over the last 30 years.”
Swiss Re announced recently that “economic losses from natural catastrophes and man-made disasters will likely reach at least USD 140 billion in 2012”.
Munich Re, the world’s largest reinsurance company, published “Severe weather in North America,” which showed that during the past 30 years of weather-related disasters there was a clear rising trend for both extreme weather events and the costs of recovery.
There was no better example of nature’s revenge than Hurricane Sandy. Breaking records in terms of wind span, it hit land in a densely populated area on the East Coast of the U.S. The storm surge caused widespread flooding and damage. Not only was it a human tragedy, but also property damage is likely to cost $50 billion. The direct costs to the insurance industry are lower, in the order of between $10 and $20 billion.
The insurance industry faces another challenge. To stay commercially viable, actuaries need to be able to accurately calculate risks. In the past, they have calculated these risks by using historical data. For climate change, such data are seldom available, and so insurers will need to rely more on climate projections and models. Although these predictors are getting more reliable, they are nowhere as accurate as required. To play it safe, actuaries are likely to use conservative estimates of climate impact, meaning insurance costs will be based on the upper boundary of potential losses. That’s more bad news for business.
What would happen if insurance premiums increased 50 percent? 100 percent? 200 percent? Companies would have the impossible choice of deciding whether to continue to accept increases in their overheads or operate without insurance (euphemistically referred to as “self-insuring). For most, either solution would not be sustainable.
It may be time for the private sector to revise their comfortable assumption that climate change is someone else’s problem. In fact, now is the time to realize that Nature’s revenge is very much their problem.