Winter 2016

The Tragedy of the Horizon

In the first nine months of 2015 alone, wildfires in the western United States burned eight million acres of forest land, an area larger than Maryland. Pine bark beetles, once kept in check by frigid alpine winters, denuded mountainsides from Colorado up through British Columbia and the Yukon. California entered its fifth year of drought, forcing strict water rationing on residents and cutting off farmers’ access to surface water. Three thousand miles east, in the Gulf of Maine, codfish stocks were failing to recover despite severe catch limits, while lobsters disappeared from the rapidly warming ocean waters off Massachusetts, leading lobstermen to think about new lines of work.

In October, flooding in South Carolina killed nineteen people, washed out bridges, closed more than 300 highways, including interstates, and caused untold damage to property, with cleanup costs alone expected to top $1 billion. Not even the dead were unaffected, as cemeteries turned into a toxic soup of mud, embalming chemicals, and floating coffins. As former Vice President Albert Gore put it, “Every night on the television news is like a nature hike through the Book of Revelation.”

More of the same appears to be coming. Worldwide temperatures made 2015 the hottest year ever. The news shouldn’t have come as a surprise because the last fifteen years already included the thirteen hottest recorded. As we keep loading the atmosphere with carbon dioxide, nitrous oxide, methane, CFCs, and other greenhouse gases, temperatures will only continue rising, and storms and droughts will increase in number and intensity, according to climate scientists. “Hot areas are going to get hotter, and wet areas are going to get wetter,” says Patrick Parenteau of Vermont Law School, an expert in environmental law, who was speaking at a conference on climate change and insurance law held at Boston College Law School on November 5.

Convened a month before 150 world leaders gathered in Paris for the historic UN Climate Conference, BC Law’s event was a portentous occasion.

For one thing, the BC Law School conference brought together some of the best minds in the industry, who zeroed in on a climate-related question that hasn’t received much public notice but will likely affect every consumer, homeowner, and business on the planet: How can a 20th century insurance industry handle the 21st century’s natural catastrophes with their soaring costs and the political, economic, legal, and social rivalries they are likely to engender?

Traditionally, private insurers have paid certain claims for damage resulting from weather, but with violent weather increasingly common, private insurers could break under the strain of unprecedented claims.

For another, the conference advanced the Law School’s leadership in insurance law, policy, and scholarship, the result of the establishment several years ago of a Liberty Mutual professorship and funds to encourage scholarship in the field that envisioned BC Law as a key player in the insurance arena. Patricia McCoy, who became the inaugural Liberty Mutual Insurance Professor in 2014, was one of the conference organizers, along with environmental law professors Zygmunt Plater and David Wirth and staffers from the Boston College Environmental Affairs Law Review, which will publish the conference papers. (In January 2016, BC Law School co-sponsored, with the American College of Coverage and Extracontractual Counsel, another insurance conference, “The New Face of Insurance Litigation.”)

The November conference took on the “two major issues in the climate change area that haven’t received enough attention,” says McCoy. The first issue is how to pay for losses. Traditionally, of course, private insurers have paid certain types of weather-related claims, but with violent weather increasingly common, private insurers could break under the strain of unprecedented losses. Can someone else share their burden? Government is the chief, though not quite the only, candidate.

A second issue is whether insurers can get us to act more responsibly, especially in areas where government won’t regulate from fear of public backlash. “Whether it’s private insurers or federal insurance,” McCoy explains, “you have the same concern: property owners who don’t make an effort after a first loss to prevent the loss from recurring.” Paying for damage from successive storms to a dangerously sited property, she says, “is not a good use of social resources. There may be situations where we can engineer a solution to avoid losses. Or a property may need to revert to its natural state.”

McCoy could be thinking of a notorious seaside vacation house in Scituate, Massachusetts, that has suffered storm damage ten or more times, according to a Boston Globe article. The owner, described by the Globe as “a Florida widow,” has received just short of $1 million in insurance payouts and government grants in the past four decades. In this time, she’s expanded the property from a small cottage to a four-bedroom, three-and-one-half-bathroom house, dramatically increasing the value at risk.

Nor is this homeowner all that unusual. In Scituate alone, 150 houses have been designated “severe repetitive loss properties” by FEMA, with the owners of most having received insurance payouts at least four times.

Who Will Pay?

Because of its potential effect on their profits, insurers have probably been thinking about climate change for longer than any other business sector. According to Carl Hedde, director of risk accumulation at the Princeton, New Jersey-based reinsurer Munich Re America, “Munich started to realize that climate change was starting to impact their business model” as far back as 1970. The reinsurer was right to be concerned, too. Measured in constant dollars, property damage caused by violent weather has doubled every decade since the 1980s, which helps explain why Hedde’s office employs two meteorologists.

Despite this expertise—or, more likely, because of it—insurers long ago started dropping coverage for weather-related damages. “There’s an interesting question of the extent to which private insurers can profitably underwrite climate change risk,” McCoy explains. “Private insurance is premised on the assumption that bad things happen randomly and are not correlated. The problem is that climate change-related damages are correlated events.” When a sewer backs up, it might damage one house on a given block, for instance, and a loss on that scale is easy to cover. But when a violent storm hits, it can damage every house in a given region, meaning losses that strain the ability to cover.

In Scituate alone, 150 houses have been designated “severe repetitive loss properties” by FEMA, with the owners of most having received insurance payouts at least four times.

More than fifty years ago, having paid out epic claims that resulted from flooding of the Mississippi River, insurers began a headlong rush out of the residential flood insurance market. In 1968, private coverage was replaced by the heavily subsidized National Flood Insurance Program (NFIP), an arm of the federal government. But the story hardly ends there.

Since 1992, when Hurricane Andrew led to the insolvency of eleven insurers in Florida and Louisiana, more and more insurers have also refused to cover wind damage to coastal properties. Once again, government has stepped in, this time by forming state high-risk insurance entities such as North Carolina’s Coastal Wind Pool, a public-private partnership. Donald Hornstein, a board member of the wind pool and University of North Carolina professor, reports that the risk is borne by private insurers (who have to join the pool if they want to do business in the state), as well as reinsurers, taxpayers, and investors in so-called catastrophe bonds.

Michael Bennett, head of derivatives and structured finance at the World Bank, says the bank has carved out a role for itself as a promoter and, more recently, an issuer of “cat bonds,” which pay in the range of 10 percent interest with a 99 percent chance of recouping principal. Bonds tied to weather in World Bank member countries, many in the developing world, “are extremely attractive to capital markets because you can use [them] to diversify risk,” Bennett says. “Investors are already full up with Florida and North Carolina hurricane risk.”

A second new product, “parametric insurance,” pays the insured, usually a city or geographical region, based on a trigger event—a storm with a given wind speed, say—rather than a time-consuming damage assessment. The new insurance gets money to governments quickly and helps them put people back on their feet after an emergency, says Anastasia Telesetsky, a University of Idaho professor, who in her talk at the conference discussed a pilot program whereby the Chinese central government writes parametric insurance for the megacity of Shenzen.

Can Insurers Make Us Act More Responsibly?

Wind tunnel research by the Insurance Institute for Business and Home Safety, a nonprofit corporation funded by the insurance industry, compares the performance of two houses in a hurricane. A house built to code was literally blown to bits, while a house with $4,000 worth of metal strapping added to the frame survived the ersatz storm undamaged.

Clearly, it’s in insurers’ interest for homeowners to spend the $4,000. It’s likely in the homeowners’ interest, too, but how many of them will shell out the money? Insurers can lobby for stronger building codes, but it’s a slow and uncertain political process, and it doesn’t affect existing houses. They can also, through careful rewriting of policy language, act as regulators in place of government, getting us to do what we should have been doing in the first place.

Donald Hornstein points out that over the years, quasi-regulatory pressure from insurers has popularized measures like auto seat belts and safety testing of electrical appliances. In the area of climate change, insurers can regulate by incentivizing policyholders to adapt to it—or help reduce it. “Pay-as-you-drive” auto insurance policies offered by a number of companies, for instance, can reduce miles driven by up to 8 percent, according to an analysis in the journal Science, lowering both the number of claims and the drivers’ contribution to climate change.

Some private insurers also offer credits to owners of green buildings and drivers of low-emissions cars, based in part on the idea that these customers present less risk than average policyholders. Government insurers can also tweak their policies to encourage good behavior, says Chad Marzen of Florida State University, who has suggested revisions to federal crop insurance that would support the use of methods, such as growing cover crops, that reduce atmospheric carbon dioxide by storing carbon in the soil. “Only 2.5 percent of farmers now use cover crops,” says Marzen. “If you could get to 10 percent, that would have a huge impact.”

Insurers can, through careful rewriting of policy language, act as regulators in place of government, getting us to do what we should have been doing in the first place.

As to climate adaptation, Sean Hecht of UCLA, speaking to the conference by video link, described a recent attempt, supported by both libertarians and environmental groups, to discourage settlement in flood-prone locations by pricing flood insurance to actuarial risk, such that “buildings at a certain elevation would have dramatically high premiums”—too high for many people to pay. The change was embodied in a federal law, the 2012 Biggert-Waters Act, which provoked a big backlash and was largely undone by a subsequent law, the Homeowner Flood Insurance Affordability Act.

The NFIP has drawn wide criticism for creating moral hazard, by encouraging development in areas where people shouldn’t be living. (After a big flood “homeowners ask themselves, ‘Why rebuild here? Because if we do, we’ll get bailed out again,’ ” says Christopher Serkin, associate dean at Vanderbilt Law School.) According to Hecht, government has a range of options for reducing moral hazard now that Biggert-Waters has been rolled back: Buy out the riskiest properties in flood-prone areas; price premiums to risk but offer means-based subsidies, or discounts to homeowners who take measures to protect their houses from floods, such as raising them on stilts, with the adaptations financed by low-interest loans; drop the NFIP and let homeowners seek coverage in the private market, where, if it were even available, it would be far too costly for many.

Edward Richards, of Louisiana State University, in what he calls “a thought experiment,” has proposed a variation on the last of these ideas: replacing the NFIP with a product whose premiums rise substantially each year, as with life insurance policies. “You’d have a schedule of premiums that’s a multiple of sea level rise,” he says. Eventually insurance costs would reach a point where it would pay to move to higher ground, especially if the new insurance were coupled with a government buyout program for vulnerable coastal properties. And so much the better if the buyout price were to drop year by year.

Richards notes that private flood insurance still exists—for business properties, which don’t qualify for the NFIP. After Hurricane Katrina, he reports, skyrocketing insurance premiums started driving businesses out of New Orleans, hollowing out the city’s economy. As Richards has written, “Despite the city’s rebirth myth, jobs data show a continuing shift to low-wage service jobs during the Katrina recovery.… The city’s economy will continue to decline…as it awaits the next catastrophic storm.… At the very least, New Orleans should have had its footprint reduced significantly after Katrina. But social justice concerns kept this off the table. The poor have been carefully put back into the highest risk areas in the city.”

New Orleans, like other low-lying regions, faces a grim choice, he says: either an orderly evacuation or mass flight from a future storm that may be even more violent than Katrina. “Property rights evolved in a steady state world,” Richard says. “Until we internalize that land is going away, we’re not going to make any policy progress.”

In addition to serving as an unacknowledged regulator, insurance can also create the conditions for needed government regulation, says Vanderbilt’s Serkin. They can do it, Serkin argues, by stiffening the spine of local government.

An article by Serkin examines the effects of municipal insurance policies that fail, as virtually all of them do, to cover liability for “regulatory takings”—that is, reducing the value of a property by enacting regulations that restrict its use. The lack of coverage, Serkin contends, makes governments of smaller towns and cities, which already shy away from risk, very hesitant to regulate developers, no matter how inappropriate the proposed development—in planning, economic, and environmental terms. In Serkin’s view, big cities, and not small ones, are making innovative land use policy, partly because larger cities are more likely to self-insure and not have to worry about gaps in their insurance coverage. Serkin expressed the hope that his article might alert private insurers to the need of smaller towns and cities to be insured against regulatory takings lawsuits, and that a few insurers might even jump into the market, thus seizing “a real opportunity” while strengthening the hand of local government. Failing that, he says, government should once again step in, with states providing coverage to municipalities as “a kind of subsidy for local land use and environmental regulations.”

For all their ideas, predictions, and solutions, the experts convened at BC Law acknowledged that there is one huge obstacle to action. Panel commentator Cynthia McHale, director of the insurance program at Ceres, a nonprofit advocating sustainability leadership on behalf of institutional investors, lamented what’s been called “the tragedy of the horizon”—the widespread human tendency to think short term, ignoring problems such as climate change whose worst harms will be suffered by future generations.

“We have a way to deal with intergenerational cost,” suggested Serkin,” and that’s debt.” Why, he asked, aren’t we incurring debt right now to invest in the infrastructure needed to reduce and adapt to climate change?

“The same reason we don’t invest in roads and bridges,” Edward Richards shot back.

“So it’s politics, not policy.”

“Right. That’s how we got in this trouble in the first place.”


David Reich is the author of a novel, The Antiracism Trainings. His personal essay on violent crime in Mexico appears in the December 2015 issue of the literary journal Gargoyle.

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