Economics of Global Warming - International Insurance

International Insurance

Traditional insurance works by transferring risk to those better able or more willing to bear risk, and also by the pooling of risk (Goldemberg et al., 1996, p. 25). Since the risks of climate change are, to some extent, correlated, this reduces the effectiveness of pooling. However, there is reason to believe that different regions will be affected differently by climate change. This suggests that pooling might be effective. Since developing countries appear to be potentially most at risk from the effects of climate change, developed countries could provide insurance against these risks.

Authors have pointed to several reasons why commercial insurance markets cannot adequately cover risks associated with climate change (Arrow et al., 1996, p. 72). For example, there is no international market where individuals or countries can insure themselves against losses from climate change or related climate change policies.

Financial markets for risk

There are several options for how insurance could be used in responding to climate change (Arrow et al., 1996, p. 72). One response could be to have binding agreements between countries. Countries suffering greater-than-average climate-related losses would be assisted by those suffering less-than-average losses. This would be a type of mutual insurance contract. Another approach would be to trade "risk securities" among countries. These securities would amount to betting on particular climate outcomes.

These two approaches would allow for a more efficient distribution of climate change risks. They would also allow for different beliefs over future climate outcomes. For example, it has been suggested that these markets might provide an objective test of the honesty of a particular country's beliefs over climate change. Countries that honestly believe that climate change presents little risk would be more prone to hold securities against these risks.