Extreme climate events meet the financial sector and what science and policy do you get?

This briefing conveys the need for critical examination and understanding of the financialization of risk before proposing improvements to science-policy connections around extreme climate events.

Lewis (2007) describes how risks from extreme climate events get packaged into catastrophe bonds that spread the risk from the individual customer to the insurance company to the re-insurance company to the global financial sector. It is said that only global capital markets can absorb the shock of a rare “Big One.”

Insurance and finance corporations want to make money—pricing the bonds well requires well-informed science, as evident in the employment of scientists by the cat bond firms (mentioned in Lewis 2007). These corporations also don’t want to crash, which means that buying and selling the bonds involves decisions in light of assets, exposure, and psychology under uncertainty. How this financialization of risk shapes policy making is an issue for further inquiry, as is whether and how it directs what science gets done.  (The intersection of the financial sector and research has certainly shaped biotechnology; see Fortun 2008.)

Such inquiry might consider questions such as the following:

  1. Has the proposition that “only global capital markets can absorb the shock of a rare ‘Big One’” been rethought since the meltdown of 2007-8?
  2. Is the reason for cat bonds really about the “Big One” or is it mostly a new way to make money from re-insurance, where most events covered are not catastrophic?
  3. What new vulnerabilities arise given, say, inaccurate rating of bonds, predatory purchases during storms, unequal information, etc.
  4. Is the use of cat bonds by government authorities associated with a reduced funding (past and ongoing) for infrastructure, prevention, mitigation, relief?
  5. What is to ensure that risks are covered, that players are not assuming that the government will step in if insurance is inadequate? What is the track record?
  6. What models (e.g., from game theory [Zhou 2013] or agent-based modeling) illuminate the dynamics of financialization, especially in relation to Qs 2-5? E.g., are there identifiable policy and regulatory environments in which cat bonds do not undermine funding (Q4)?
  7. How does the rise of cat bonds intersect with Klein’s (2007) thesis that corporations use disasters to extract, with democratic oversight, changes in policies favorable to them?
  8. What substance is there to the proposition that cat bonds are based on real, quantifiable risks, while other bonds are subject to subjective economic forecasting?
  9. What new science and new policy has arisen with the impetus of cat bonds?

Phillips (2014) provides an accessible review of the rise of cat bonds and addresses some of the preceding questions. (See also commentaries attached at the end.) Thought-provoking observations of Phillips include:

It is likely that the most vulnerable are least likely to be insured, or be able to pay an extortionate premium to be covered. Much like how private health insurers in the US refuse to insure those at high risk of cancer, the investors in catbonds are less likely to be able to provide coverage for those least developed countries most at risk of climate chaos, such as Bangladesh. Indeed, there are certain to be “uninsurable” regions, just as there are millions of Americans without health coverage. Rather than modelling climate insurance on a Scandinavian or Canadian socialised system, ensuring that everyone is equally covered, the catbond market replicates the broken healthcare system of the USA with its storied injustices. Here, due to increased premiums paid to already wealthy northern investors by southern governments least able to pay, there is a transfer of wealth not from north to south, but from south to north – a situation Swedish scholars have described as “particularly odious”.

“The [cat bond] model replaces ability and responsibility as a basis for distributive justice with a kind of vulnerable pays principle, according to which resources flow into the insurance pool in proportion to one’s risk,” they continue. “This is a far cry from the substantial redistribution from wealthy polluters to the worst off that the standard principles of climate justice recommend.”

[I]nsurance regulators are asking whether the complexity built into this securitization of insurance products can restrict investors’ capacity to monitor their risk exposure.

Steps ahead: Phillips (pers. comm.) has not pursued these issues further. My initial inquiries into the dynamics of financialization lead me to the provisional picture that work on game theory and agent-based modeling is quite new and underdeveloped (http://bit.ly/1p4u8ev) and not yet pursued by critics of neo-classical economics. Leads welcome: peter.taylor@umb.edu .

References

Fortun, M. (2008) Promising Genomics. Berkeley, CA: University of California Press, http://www.ucpress.edu/book.php?isbn=9780520247512

Klein, N. (2007). The Shock Doctrine: The Rise of Disaster Capitalism. New York: Metropolitan Books.

Lewis, M. (2007) “In Nature’s Casino” New York Times Magazine (26 Aug), http://www.nytimes.com/2007/08/26/magazine/26neworleans-t.html (viewed 24 Feb. 2016)

Phillips, L. (2014) “Cat bonds: Cashing in on catastrophe.” http://roadtoparis.info/2014/11/18/cat-bonds-cashing-catastrophe/ (viewed 24 Feb. 2016)

Zhou, F. (2013). Application of Agent Based Modeling to Insurance Cycles. (Unpublished Doctoral thesis, City University London)

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