Bailout

Still looking for a climate-change strategy

By Felix Salmon

Initial reaction to my Climate Desk bleg has been pretty interesting. I’m looking for companies which are taking a serious strategic look at managing the risks of climate change, and so far I haven’t really found any. The on-topic responses I have received have generally fallen into two categories: “look at the reinsurers”, and “look at us, we’re doing a great job reducing our carbon emissions”.

The carbon-emissions story is basically about positioning a company for present and future emissions regulation, as well as doing one’s part to try to prevent the worst excesses of climate change itself. But it doesn’t really help in terms of positioning a company for whatever effects of climate change do come.

As for the reinsurers, they are certainly looking a lot at climate change, especially insofar as they’re involved in catastrophe reinsurance: hurricanes, in particular, are associated with a rise in sea-surface temperatures. So as the global climate gets warmer, it makes sense for hurricane reinsurance premia to rise. I haven’t yet talked to any reinsurers directly, or even read their reports — if anybody has some useful links for me, I’d be eternally grateful. But outside of hurricanes, it seems that the effects of climate change on reinsurance rates are pretty small in areas like crop or life reinsurance.

More generally, pricing tail risks is what reinsurers do — it’s pretty much the core part of their job. When they look at the possible effects of climate change, they’re not making a strategic decision about the long-term future and structure of their business: they’re just pricing pretty short-term insurance contracts, like they’ve always done, using as much information as they have to guide them.

It’s important to remember, here, that reinsurance contracts are generally only a year or two in length — in that respect, reinsurers don’t really care all that much, when they’re pricing policies today, about what the global climate is going to look like in 30 years’ time. As and when climate change happens, reinsurers can react to it: if there are areas of the UK with lots of flood-insurance policies and sea levels start rising, for instance, there will be more than enough time for reinsurers to react by jacking up flood reinsurance rates or simply refusing to offer that product at all.

One other group of people has a long-term time horizon and is very alert to tail risks, and that’s institutional investors. To that end, a large group of buy-side firms, along with Mercer and the World Bank, has launched a climate change strategic asset allocation study designed “to identify potential new investment opportunities and possible future risks related to climate change”.

That’s a very good and worthy idea. But it does seem to me that risk management, when it comes to climate change, is best done at the corporate level, rather than at the shareholder level. If a big agricultural company risks running out of water, for instance, then it might make sense to be wary of its stock, or to worry about tail risks there. But it would make much more sense for the company itself to put in place a strategy for making sure that it will continue to be able to produce large amounts of food, even in the event that the environment in general, and local water access in particular, starts to deteriorate. That’s the kind of thing I’m really looking for, and that’s the kind of thing that so far I haven’t really found.

Full post as published by Macroprudential on March 11, 2010 (boomark / email).