Thursday, February 12, 2009

Solutions to anthropogenic global warming: insurance providers II

I received criticism concerning one of my points in the previous article. The argument boils down to that:
How are carbon-conscious insurance providers going to get enough funds to pay for additional damages caused by climate change if they offer cheap rates to anyone driving a hybrid? It's an unsustainable business model. Only government, with its monopoly on force, can effectively curb high carbon outputs by taxing the hell out of it or outright banning it!
The objection is valid. There's a contradiction between needing more money to pay for higher damages and lowering rates at the same time. This creates another bad incentive, an enticement to avoid any customers within the mid- to high-risk regions such as areas close to the sea, a river or a potentially expanding desert. If we limit ourselves to the level of single insurance companies, the dilemma can hardly be resolved.

However, insurance companies also enter agreements with reinsurers. Reinsurers make sure damages on a really big scale that ordinary insurance companies cannot pay will be paid. Most details are similar to a deal between an insurance company and a customer: the higher your risk group, the higher your rate. Let's assume you're running a reinsurance company for medical services (quite unlikely, but still). You're insuring two insurers: the "Healthy Athletes' Pooling Group" and the "Obese Smokers' Insurance Corporation". You'll charge an extra fee for the latter company for picking its customers from a high-risk group.

The problem with carbon-based insurance calculation is that your carbon footprint does not necessarily increase your personal damage risk. Just because you fly your private jet for fun doesn't mean your house will be hit by a meteor, but maybe you increase risks for someone living on the coast or near a river. Why wouldn't insurance companies simply charge higher rates for those who live in a high-risk region, you ask? Well, if only symptoms and not root causes of a problem are being addressed, it's bound to get worse. If insurance companies decide to dump all those who live near a coast to let their homes be swallowed by the sea, then suddenly you'll have a new high-risk group in the former heartland due to a shift in sea levels. You could try to make living in a high-risk region unattractive by charging insane rates, but that'll only shrink your overall customer base. If climate change is real, nobody will be able to run from it. Far-sighted businessmen will recognize this fact and invest accordingly.

So, if insurance companies refuse to implement any kind of carbon footprint in their premium calculations because the effects of climate change are unlikely to affect their customers, reinsurers will remind them of their duties. Reinsurers have huge incentives to minimize risks due to their global obligations. Insurance companies which primarily insure carbon bigfoots will then have to pay higher premiums to their reinsurer, thus creating an incentive to join the carbon-conscious calculation style. Low-output insurers will have lower premiums, thereby being able to both cut rates and still have enough funds to compensate for any new damages thanks to reinsurers backing them. When everyone has become a low-output case, then, according to AGW theory, we should see a decline in additional climate-based damages so that lower rates for everyone appear sustainable.

But what if insurance companies simply refuse to do business with reinsurers that demand carbon-based premium calculations? Two things should be considered:

1) Even in low-risk regions, accidents occur. That's why you want to have a reinsurer. Insurance companies that refuse to deal with reinsurers due to a reluctance towards carbon-conscious premium calculations will lower their credibility since they follow a reckless risk-pooling policy and face bankruptcy in case of any major events. In short, they're walking on a tight rope.

2) What happens if you own a notoriously polluting factory that poisons the village next to it and decide to hide in your mansion on a hill to avoid the rage of the villagefolk? Right, at some point in time, they'll ring your doorbell with forks and torches in their hands. Those who try to hide from their climate responsibility will be faced with a similar scenario. Public ostracism and discrimination against those insurers which try to opt out will ensue. At some point, it may become profitable to give up the isolationism.

Finally, it should be said that insurance companies are by no means the only way to combat harmful climate change. They're an interesting economic aspect of the struggle against this common enemy within a free society, but not the sole cornerstone of all endeavors to prevent bad environmental changes. Thus, even if there's risks involved in the insurance approach, it doesn't need to be perfect since it can be complemented by other actions of free men in a free society.

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