Perhaps like many of the readers of this blog, I am a climate agnostic. Given the politicization of environmental issues and the unfounded scares of the last few few decades (see Paul Sabin’s book and my review of it at the Library of Law and Liberty), I am not sure that disastrous climatic changes are occurring nor that human activity is responsible or to which extent. I haven’t looked at the climate models that serve as a basis for the dire warnings. As much as I am willing to defer to a consensus among people who know things that I don’t, I also realize how forecasting models are uncertain, whether in economics or in a chaotic field such as climate science (remember that it is a meteorologist, Edward Lorenz, who discovered chaos theory). And even if climate change were to cause serious problems to a portion of mankind, these costs would be at least partly compensated by weather benefits for another portion.
More important, we should forget that individual liberty is the most endangered species in the world and should not be sacrificed to the “visible fist” of the environmentalist state, to borrow an expression that Murray Rothbard opposed to the invisible hand of the market. In standard (and narrower) economic terms, reducing the forecasted temperature rise by reducing carbon emissions may cost more than the climate change itself, or reduce the cost by only a small proportion. Our co-blogger David Henderson recently discussed this point in relation to the work of recent Nobel Prize winner William Nordhaus and of Texas Tech’s economist Robert Murphy (see “A Nobel Economics Prize for the Long Run,” Wall Street Journal, October 8, 2016).
If climate change were an imminent danger, one would expect the corporations for which money is at stake to take notice. Apparently, they are now taking notice, which seems to contradict part of my climate agnosticism. In 2016, an unprecedented forest fire in the oil-sands region of Alberta (a Canadian province) roared over an area larger than Delaware, burned down a large part of the town of Fort McMurray forcing its evacuation (see picture), and caused $3 billion in damages. The Wall Street Journal explains how this natural catastrophe is leading the insurance industry to reevaluate the risks of climate change: “Climate Change Is Forcing the Insurance Industry to Recalculate,” runs the title of the story. Speaking about one of the insurance companies hit by the damage, Avila PLC, the Journal writes:
Aviva studied the incident and concluded the wildfire was an example of how the earth’s gradually warming temperature is changing the behavior of natural catastrophes. Aviva increased premiums in Canada as a result.
The effects of the planet’s slow heating are diffuse. Predictions of the fallout are imprecise, and the drivers are debated. But faced with the prospect of a warming planet, the world of business and finance is starting to put a price on climate change.
Instead of whining (which is a more prevalent behavior among environmentalists and at the highest levels of the state), insurance companies are trying to find a way to price the risk and sell coverage:
“It takes a lot of premium, a lot of margin, to account for this increased uncertainty, and I’m not sure we’re doing a good job of reflecting this and charging appropriately for it,” said Marc Grandisson, chief executive of insurer Arch Capital Group Ltd., at an industry conference …
“What we call the protection gap is still huge,” says Edouard Schmid, group chief underwriting officer at Swiss Re. “We of course want to offer solutions around risks, including climate risks.”
As insurance companies are incited to correctly price the risk of climate change, their customers will be incited to take steps to reduce their insurance costs by taking efficient actions of their own–moving installations threatened by possible rising sea level, for example. Such private solutions are certainly preferable to coercive state intervention. We can expect markets to calculate costs more efficiently than politicians and bureaucrats.
READER COMMENTS
Thaomas
Oct 16 2018 at 8:32am
I would ask why, even for an honest CC skeptic, the small certain cost of a carbon tax (whose revenue effect could be offset with reduction in other distortionary taxes such as taxes on corporate income or the wage tax) and the changes in the patterns of production, consumption and technological change that it would induce, is not worth the reduction in the large environmental risks (even those these will be mitigated for individual victims by proper pricing of insurance? The question stands, especially since if in 25 or 50 years or whenever investigation and development of climate models the scientific consensus has shifted to reveal that CC is not occurring or that something other than reducing CO2 accumulation in the atmosphere is the cause, the tax could be withdrawn.
Kevin Dick
Oct 16 2018 at 1:59pm
@Thomas. If you have a carbon tax that is too high, you cause harm just as surely as if it’s too low, including killing poor people in exactly the same statistical way.
Most economically literate skeptics, myself included, agree that a carbon tax is the solution to whatever negative externalities exist from carbon emissions.
However, alarmists typically don’t behave as if _they_ believe this:
– They do not stipulate that the tax would replace most other anti GW measures
– They focus on mandates and bans
– They focus on threshold limits to warming
– They focus on 100% renewable goals
– They do not do an honest job of accounting for the benefits of warming
– They do not do an honest job of estimating the probabilities of catastrophic scenarios
So we have kind of a hard game theory problem here. If skeptics support a carbon tax that they know, in practice, will be in _addition_ to existing measures and will be set too high, then that support does more harm than good.
Thaomas
Oct 16 2018 at 4:29pm
But we already have policies that cost more per Kg of CO2 emitted than any conceivable carbon tax. (the Tesla subsidies, percent mandates!) And opposition to carbon taxation, particularly when it is allowed to be confused with denial of the harm from CO2 accumulation, can only empower the “alarmists” when one of these days some disaster hits and THEN everybody decides to “do something” about it. How much chance will we have to enact a carbon tax that replaces other more distorting taxes like the corporate income tax, the wage tax, and “green” subsidies, THEN?
Alan Goldhammer
Oct 16 2018 at 8:38am
The US military takes climate change seriously and is already experiencing flooding issues at the large Norfolk/Hampton Roads naval installation.
I wonder what the adjusted property casualty premiums are in some of the coastal areas that have been subjected to hurricane damage over the past decade. I vaguely remember a recent story on earthquake insurance in CA and that many homeowners are forsaking coverage because of the high cost. In the absence of such coverage, are they banking on a bail out by the US government if there is catastrophic damage from an earthquake?
Philo
Oct 16 2018 at 9:06am
Good question! The insurance market may provide us with a flawed estimate of the real risk because it is distorted by people’s expectations of government bail-outs in cases of disaster.
Jon Murphy
Oct 16 2018 at 9:55am
I may be wrong (and someone correct me if I am), but I believe flood insurance is somewhat subsidized right now.
Thaomas
Oct 16 2018 at 10:26am
It is heavily subsidized AND more so because it is based on data that do not take account of climate change. Politicians who deny that costs of climate change are real can hardly be expected to allow correct pricing of flood insurance.
Mark Z
Oct 16 2018 at 11:18am
I would simplify that: Politicians … can hardly be expected to allow correct pricing of flood insurance.
Pierre Lemieux
Oct 20 2018 at 10:39am
Well said, Mark Z! (Many of the other comments are interesting too.)
dede
Oct 17 2018 at 11:56pm
“The US military takes climate change seriously”
Sure : are they paying the costs of their decisions or benefiting from increased spending?
Thaomas
Oct 16 2018 at 10:22am
While it is incontrovertibly correct that correct prices for the risks created by climate change (if the scientific evidence for the change in risk is accepted) * can induce changes in behavior — new construction and rebuilding in areas less prone to storm damage, sea-level rise and wildfires — that reduce the harm caused by climate change, these prices do not reduce the costs to zero. A tax on net emissions of CO2 into the atmosphere would be calibrated against these already minimized costs.
Continued opposition to carbon taxes by people who understand why they would be the lowest cost way of dealing the accumulation of CO2 in the atmosphere runs the risk of much more costly policies, possibly policies whose costs exceed the harms of climate change itself.
* Skepticism among the public about the reality of climate change makes it more difficult politically to correctly price the risks.
Rob Weir
Oct 16 2018 at 10:48am
Insurance is highly regulated, with most (all?) states having a board that must review and approve rate changes. So, I wonder whether insurance companies really perceive an increased risk from climate change? Or whether they see an opportunity to raise rates by appealing to a politically favored fear?
Jon Murphy
Oct 16 2018 at 11:07am
Either way, it would have the effect of forcing individuals to re-evaluate their plans
Dan
Oct 16 2018 at 11:04am
“As insurance companies are incited to correctly price the risk of climate change, their customers will be incited to take steps to reduce their insurance costs by taking efficient actions of their own–moving installations threatened by possible rising sea level, for example. Such private solutions are certainly preferable to coercive state intervention. We can expect markets to calculate costs more efficiently than politicians and bureaucrats.”
This is not correct. There are externalities. Costs of and benefits of climate change are not fully internalized. Increase in insurance prices will not lead to a more efficient outcome. On the contrary, increase in insurance will lead to an even greater mis-allocation of capital by unequally distributing costs.
Jon Murphy
Oct 16 2018 at 11:08am
Increasing costs of insurance would be one way to internalize the costs.
Dan
Oct 16 2018 at 12:17pm
No, unless the insurance specifically targets firms/individuals causing climate change.
Jon Murphy
Oct 16 2018 at 3:25pm
Oh! I see what you’re saying now. Let me think on this
Mark Z
Oct 16 2018 at 11:22am
Why would the unequal distribution of costs lead to a less efficient outcome? You may argue that the existence of externalities precludes higher insurance prices from leading to a fully efficient outcome, but I don’t see the argument that it wouldn’t at least lead to a more efficient outcome.
Dan
Oct 16 2018 at 1:34pm
Because the firms/individuals who benefit from emitting the most CO2s are not necessarily the same firms/individuals who suffer the most from climate change
In the absence of an increase in insurance because of climate change, there will either be a decline in the provision of insurance for everyone or an increase in premiums for everyone. If insurance is targeted away from the average, then it would lead an inefficient outcome. An example would be a coal energy producer reaping private benefits from CO2 emissions, and this leading to coastal farmers relocating as a result of higher flood insurance.
I should have said likely to lead to a less efficient outcome, since if the insurance is targeted away from average towards those responsible for CO2 emissions (unlikely) than it could produce a more efficient outcome.
Thaomas
Oct 16 2018 at 4:42pm
Insurance companies that are free to set rates according to the expected costs of certain climate change related risks — storms, sea level change, wild fires will induce people to change their behavior in ways that reduce the damage from climate change. But this is desirable what ever the cause of the changes in risks. Insurance can do nothing to change the fact that the emitter of CO2 does not internalize the cost (somewhat mitigated by market induced behavior change) of CO2 accumulation.
Dan
Oct 16 2018 at 10:19pm
No, insurance does not “induce people to change their behavior in ways that reduce the damage from climate change”. If anything, it will do the exact opposite
Thaomas
Oct 18 2018 at 7:32am
Admittedly we do not have an estimate of the relevant elasticities, but presumably if the cost of fire insurance in fire-prone areas fully covers the expected losses, and these expected losses rise as a result of climate change, then people will be less prone to building in those areas (“change their behavior”).
Thaomas
Oct 18 2018 at 7:38am
Correct pricing of insurance will, by inducing behavioral change, reduce the harm from climate change, but is does not reduce the harm to zero, Hence a negative externality remains at the level of the emitter of CO2 (and methane).
nobody.really
Oct 19 2018 at 5:03pm
Please–you’re showing disrespect to Lemieux’s religion.
Anyone with a passing acquaintance with externalities and market failures knows that the set of facts described gives us no basis for assuming that private remedies would be more efficient than public ones. But Lemieux isn’t arguing on the basis of facts, or even theory. He’s arguing on the basis of faith.
Pierre Lemieux
Oct 20 2018 at 11:04am
I suggest that Dan’s point is incomplete and that Jon was more right than he thought–at least if you believe in the Coase theorem. The idea is that the polluted is as much responsible for the pollution as the polluter: if people did not swim in the river, the paper mill would not cause pollution. (The same argument was made in Buchanan and Stubblebine’s 1962 article “Externality.”) Perhaps Dan meant that the distribution effect should not be ignored, but this has no bearing on efficiency except in a deep welfare-economics sense where changes in income are so large than people move on the utility-possibility frontier.
Charley Hooper
Oct 16 2018 at 11:54am
Americans are building houses in disaster-prone areas, whether due to flooding, wind, or fire. If insurance companies are properly planning for future disasters, they will be planning for additional costs, even if the true incidence of some types of these disasters is actually declining.
To discuss the true climate effect on insurance, we need to separate the economic effect.
Ted
Oct 16 2018 at 4:11pm
Pierre,
You write that whining is more prevalent among environmentalists. From what data do you draw this conclusion?
(I consider myself an environmentalist who doesn’t whine and who votes for carbon pricing at every opportunity. But I know I shouldn’t generalize from my n=1 data point, so I am curious what data you are working from.)
Thank you in advance for your reply.
Pierre Lemieux
Oct 20 2018 at 11:27am
Thanks for your comment, Ted. My evidence is mainly anecdotal observation from environmentalist declarations as reported in the press. But note that this is consistent with the Simon-Ehrlich bet and the history of environmentalism since the 1960s: see my review of Paul Sabin’s book at http://www.lawliberty.org/book-review/running-out-of-everything/.
Brian J Gladish
Oct 19 2018 at 2:03pm
Insurance is the right way to go! Being by the seashore or in flood zones, non-governmental insurance (meaning “priced to generate a profit” as opposed to “priced to promote risky behavior”) will provide an incentive for people and firms to relocate. If the threat increases, premiums will also increase and accelerate the change, while they will decrease if the threat is found to be less-than-expected. This solution is market-based, and the only legislation required is to repeal the government-subsidized flood insurance program.
Mark Bahner
Oct 19 2018 at 9:30pm
Insurance companies are indeed incited to correctly price the risk of climate change internally, but they are also incited to exaggerate what those risks are when communicating with their customers (the general public). That’s how the insurance companies make money…they convince their customers that there is more danger than there really is.
At least that’s my personal experience, based on a guy who actually came to my dorm room in college, and tried to sell me (a single guy, in perfect health, a maybe $1500 of student loan debt) a $300,000 life insurance policy.
Pierre Lemieux
Oct 20 2018 at 11:35am
Mark: This is not true: “That’s how the insurance companies make money…they convince their customers that there is more danger than there really is.” They use the law of large number and, if the market is free and competitive, they price the risk exactly (including a normal return of capital for themselves).
On the personal anecdote, you are in perfect health today, but you might not be tomorrow–when your life insurance premium might be very close to the promise payment at death. If one is risk-neutral or risk-adverse, buying life insurance when one is young is the way to go. The only caveat: make sure you get an idea of what is the rate of interest/return implicit in a life insurance contract and what will be the rates at which you may later borrow on your policy.
Mark Bahner
Oct 20 2018 at 9:19pm
I don’t know about you, but my goal in investing is to maximize my return…not to get a “normal return of capital.” I think you’re being tremendously naive if you think that there isn’t every incentive for an insurance company to convince customers that the risks of whatever they’re insuring against are greater than risks really are.
Regarding my personal anecdote: this was approximately 40 years ago, so my memory is understandably hazy…but I’m pretty sure it was a term life insurance policy.
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