Climate ‘poses systemic financial risks’

And the increasing sophistication of cars, with semiconductors and sensors all over them, is making repairs more complex and so more costly. But extreme weather also plays its part – damage and accidents become more likely as the weather gets worse.

Bailout

Put all this together and what you get is another squeeze on living standards through the familiar combination of climate change, and profit-maximising. There have been calls in Parliament for an investigation by the Financial Conduct Authority into insurance price rises, although the FCA, somewhat typically, at present says there is nothing to see.

But the lurking danger behind all this is the way the insurance industry ties into the wider financial system. 

To operate profitably, insurance companies depend on having many different households or cars – or whoever that they insure. As long as the chances of them having various accidents and misfortunes don’t match with each other – so not everybody claims all at once – the company can take in fees, make some payouts and turn a profit. But if everyone tries to claim all at once, the company goes bankrupt.

This is what happened to the largest insurer on the planet back in 2008 – the American International Group, AIG, which had been offering insurance against the complex financial packages of US household mortgages that major banks and financial institutions had been making and trading. 

When these packages, the notorious collateralised debt obligations, started to fail en masse, AIG ended up with a $99bn bill in total. It was only saved from bankruptcy and failure with a massive loan from the Federal Reserve Bank of New York – a bailout. The problem is that all these claims arrived at the same time, in the middle of a financial crisis. This is what’s called a systemic risk. 

Systems

What’s critical about climate change, from the financial system’s point of view, is that it makes it more and more likely that many disasters will arrive all at the same time – you get more and often bigger extreme weather events so at any point in time you, as the insurer, are likely to face more claims. It’s a guarantee of rising systemic risk in the financial system, with insurance companies the worst affected. 

We more or less know what the likely outcome is here, and it’s the same it was in 2008 – a bailout from government. This is already happening, with governments like Britain’s effectively working to prop up the household insurance market by offering insurance to those households who couldn’t get it otherwise. This leaves the private insurance companies free to offer insurance only to the profitable, that is, less risky, prospects. 

And that, in turn, will mean more government borrowing, more government debt, more demands for austerity. 

The first step solution is likely to be simply squeezing out the private profit-making element of insurance – let the lower risk households subsidise higher risk, strip out the additional costs of the profit, and in principle everyone can benefit.

Further down the line we need more comprehensive forms of insurance against all kinds of risk, like a universal basic income, as the new campaign for a farmers’ basic income is demanding. And further still we need redesigns of our towns and cities and the systems we rely on to make them far more robust to extreme weather shocks.

This Author

Dr James Meadway is an economist and former political advisor. This article is a transcript of an episode of James Meadway’s podcast, Macrodose.

 

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