TEN
The business and finance community got what it wanted on climate change in the 1990s—no action whatsoever. This was the result of a many-pronged effort, ranging from influencing the structure of the initiatives to combat climate change, torquing the agendas of international conferences, putting pressure on politicians, and fueling the nascent efforts of what was to become the climate change denier movement.
These “successes” began early in the decade when energy was dropped as a separate section in the Rio Earth Summit of 1992. In 1990, a group had been formed at the recommendation of the UN General Assembly to prepare a report on renewables as part of a proposed chapter on energy in Agenda 21, the road forward that was to be agreed upon at the Rio Conference. Thomas Johansson chaired the group, and the report was delivered to the relevant preparatory committees. Then nothing happened. The commission took note of the report, but mysteriously—it was never explained to Johansson—energy disappeared from the agenda. The conveners decided that they didn’t need a separate section on energy solutions at a conference whose primary focus was climate change and development. This was akin to convening a conference on pandemics and not mentioning COVID-19. To this day, Johansson is convinced that the fossil fuel industry lay behind this omission, abetted by the oil-producing nations and a vast network of backroom influences. Johansson notes that it took another twenty years for a Rio Conference successor to explicitly include renewable energy as a sustainable development goal.
Other factors also slowed the movement toward renewables. In the United States, major capital projects such as a power plant typically have a life span of roughly thirty years. In the early 1990s, a large number of coal-fired plants were coming to the end of their useful life. This meant that whatever technology replaced them would be with us for another thirty years. In effect, the utilities would be making a choice about the sources of electricity for the next generation. They didn’t choose renewables. Any impetus to shift to renewables was short-circuited because natural gas was plentiful and thus prices were quite low in the early part of the decade. Moreover, combined-cycle plants (power plants that use both furnace heat and waste heat to generate electricity) were getting much more efficient. This precipitated a massive shift to gas-fired power plants, committing many utilities to fossil fuels until the third decade of the new millennium.
This was just bad luck. Other setbacks were planned hits. The dense, hedged wording of the Executive Summaries produced by the IPCC, the beatdown Clinton suffered on the BTU tax, and the snubbing of energy at the Rio Conference all bore the fingerprints of industry pushback. At the beginning of the decade, those who wanted action on climate faced a virtual united front. Pillars of the business establishment such as the U.S. Chamber of Commerce and the National Association of Manufacturers joined with traditional adversaries such as the unions, including the United Auto Workers, the AFL-CIO, and the United Mine Workers, to oppose the UN-sponsored treaty process on climate change.
Economics could have helped but didn’t. Environmental economics enjoyed a renaissance during the 1990s, as many creative minds tried to think of ways to price environmental services and the cost of pollution and otherwise bring economics into harmony with ecology. It was enormously important work.
Few governments listened. Business listened, or at least their PR departments did. British Petroleum, the oil major, announced that BP stood for “Beyond Petroleum,” and, for a few years, the company became the darling of environmentalists. Even as it was advertising its green credentials, however, the company was supporting fossil fuel industry efforts to weaken regulation of offshore drilling, successful efforts that led to the Deepwater Horizon oil spill of 2010, the largest in U.S. history. Efforts to block regulatory strengthening of the Minerals Management Service, the agency responsible for regulating offshore platforms, began when reforms were announced in 1991, and the delaying tactics were so successful that the reforms weren’t finalized until nearly twenty years later when the spill took place.
Economists did try to tackle the future costs of climate change. The hope was that by bringing the alleged rigor of economics to calculating the future costs of various scenarios for global warming, policymakers could make informed decisions about costs and benefits of future actions. Based on the models developed by mainstream economists in the 1990s, the informed decision would have been to do nothing, a message that was taken up with a vengeance by the business community.
Richard Tol, a British environmental economist, published a study in 2018 entitled The Economic Impacts of Climate Change. In it, he looked at twenty-seven estimates of future costs of various degrees of warming that had been published since the 1980s. Each estimate gave a number for the average reduction in a person’s income for a given temperature change by 2100. Perhaps the most prolific and influential modeler was William Nordhaus of Yale, a respected economist whose efforts to price the cost of climate change dated back to the 1970s. For an anticipated 3 degrees Celsius of warming, his best estimate, published in 1991, was a 1 percent loss of income. In 1994, he published two estimates with most likely being a 1.3 percent loss in one and a 3.6 percent loss in the other. In 1996, he and a colleague published an estimate of a 1.4 percent loss for a 2.5 degree Celsius increase in global temperatures.
One reason for such modest estimates was that Nordhaus assumed that because most of the U.S. economy happened indoors—87 percent was the figure he arrived at in 1994—it was immune to the impacts of climate change. It’s mind-boggling that a serious scientist would have made that assumption. The huge petroleum and chemical facilities in Houston and New Orleans probably did not feel immune after Hurricanes Katrina and Harvey, and the myriad indoor businesses of the U.S. West might dispute their immunity to the impact of the wildfires of 2020.
If economists ignored second-order impacts, climate scientists did not. Nordhaus requested estimates for potential economic damage from a number of prominent climate scientists. Their estimates came in twenty to thirty times higher than those of the mainstream economists.
Nordhaus’s estimates for the hit to the U.S. economy were even more modest. In his 1993 paper “Rolling the ‘DICE’: An Optimal Transition Path for Controlling Greenhouse Gases,” he wrote, “A growing body of evidence has pointed to the likelihood that greenhouse warming will have only modest economic impacts in industrial countries, while progress to cut GHG emissions will impose substantial costs.” How modest? Nordhaus estimated that a 3 degrees Celsius warming would cost the U.S. economy a minuscule one-quarter percent of national income. He admitted the possibility of unmeasured or unquantifiable variables he might be missing, but in his view, they might only bring the cost up to about 1 percent of national income. To put this in perspective, last year Moody’s Analytics estimated that the global economic toll of 2 degrees Celsius warming was $69 trillion. A recent study undertaken by Oxfam and Swiss Re estimated that the costs to the global economy of a 2.6 degrees Celsius rise by 2050 would be 13.9 percent of GDP each year (relative to a world without warming), an estimate that is three times the damage inflicted by COVID at the height of the epidemic. The damage from 3 degrees warming is likely incalculable, as ecosystems would fail and civil order disintegrate in many places.
The do-nothing crowd took Nordhaus’s estimates and ran with them. In 1997, for instance, the late William Niskanen, then chairman of the ultraconservative Cato Institute, seized on Nordhaus’s figures to argue before Congress that it was premature to take action on climate change because “the costs of doing nothing appear to be quite small.”
These estimates from the 1990s become even more absurd when put in the context of the rapidly advancing science. Four years after climate scientist James Hansen told Congress that global warming was already happening, Nordhaus suggested that the “thermal inertia of the oceans” meant climate change would have a “lag of several decades behind [greenhouse gas] concentrations.” When I asked Thomas Johansson how Nordhaus could talk about a lag of several decades before the impact of global warming became evident when record hot years were already accumulating, he replied, dryly, “Only an economist can do that.” Partly for his efforts in the economic modeling of climate change, in 2018 Nordhaus was awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, commonly referred to as the Nobel Prize in Economics.
There was one very large sector of the economy that did not buy these benign estimates of future risk: the property and casualty insurance sector, particularly the reinsurers who insure against catastrophic losses. Because they live or die by accurately pricing risk, the expectation was that these companies would be hypervigilant in surveying for risks just beyond the horizon—such as climate change—and that they would be active in lobbying Congress for action, just as they had been for lighting standards, seat belts, and construction standards in storm zones.
It didn’t happen, and therein lies a mystery. A $2 trillion industry, the insurers certainly had the heft to get a hearing. And, in fact, the reinsurance industry took an early and deep look at the risks associated with climate change. Giants such as Swiss Re and Munich Re sponsored conferences and reports on how global warming might inflict economic damage. I was sufficiently impressed with the apparent commitment of the insurance industry to lead climate action that I wrote an article for Time in 1994 about the positive role that insurers might play in focusing policymakers on the financial risks of climate change.
It wasn’t that reinsurers weren’t aware of the risk. In that article I interviewed Frank Nutter, then and now president of the Reinsurance Association of America. “It is clear,” he remarked, “that global warming could bankrupt the industry.”
Insurers also had the perfect set of tools to force people to confront the issue. If the reinsurers began to raise premiums or cancel policies for homes and businesses at heightened risk for sea level rise, more frequent and intense storms, and wildfires, it would bring home the message that climate change was a pocketbook issue. Insurers did pull out of some markets in the 1990s, but underwriting continued apace in many other at-risk areas. Nor did insurers put pressure on Congress to act as they had in the case of seat belts. Worse, the big reinsurers continued to underwrite policies for coal-fired plants (without such insurance, most plants could not get financing), which meant that even as they were estimating the negative economic impacts of climate change, they were enabling further emissions from the worst greenhouse gas offenders.
It would be more than twenty years before reinsurers began in earnest to take the actions that I and others expected in the 1990s. The delay resulted from several factors, some of which might have been anticipated, others not. The case study of how the insurance industry has responded to climate change is disheartening and also a cautionary tale because it shows how perverse incentives can thwart action even in an industry exquisitely tuned to risk.
I made three mistakes in 1994. The first was forgetting that insurers have to sell insurance. I underestimated the degree to which incentives at the retail end of the property and casualty insurance business differed from those at the other end—the part that dealt with catastrophic risk. The second was to underestimate the industry’s genius for coming up with ways to spread, shift, and otherwise defang risks. The third was to underestimate the degree to which embedded perverse incentives up and down the chain made it imperative for all to continue to compete for business even as the risks of climate change became more obvious.
By the early 1990s, the insurance industry “knew” some basic, scary aspects of climate change. They knew that it was likely that there would be an increase in frequency and intensity of extreme weather events and that this reduced the utility of using past patterns and data for predicting future losses. The industry also knew that they could not use straight-line projections to predict future losses; that the interaction of an increased number of extreme events with social, economic, and political factors made such predictions nonlinear in the sense that the secondary reactions to events would carry with them unmeasurable and unpredictable costs as well.
Given that, in the early 1990s, it was natural to expect that property and casualty lobbyists would try to influence politicians to take actions that might head off or mitigate the threat, as the industry did with seat belts, smoking, and electrical standards. That did not happen, at least not with anywhere near the vigor that the industry applied to the other problems.
It would also be natural to expect that insurers would begin to pull back or reprice policies in areas most at risk for extreme weather. That happened a bit, but for complicated reasons, not nearly to the degree one might expect.
In sum, where the industry in the past had been proactive with risks that might affect its bottom line, with regard to climate change it has been reactive. The reason has to do with the structure of the industry. Thus, an industry that should have acted as an early-warning signal of climate danger, and also, through its pricing, might have forced action by pricing the threat, failed to deliver either the early warning or the pricing signals that might have made a difference in the 1990s.
Let’s begin with a brief tour into the plumbing of the insurance industry. When a homeowner buys an insurance policy, the agent who sells the policy gets a commission. The company that underwrites the policy will backstop the losses up to a certain point, and other companies will join in to pick up the next tranche of losses. Most of the last tranche of losses, those that come from true catastrophes, will be picked up by the reinsurance industry.
The agent who sells the policy doesn’t really care about catastrophic risks. So long as the company the agent works for is willing to back the policy, the price presumably accounts for the risk, and until catastrophe actually strikes, the agent’s loss ratio (the proportion of policies written that involve claims) will be good and he or she can participate in profit sharing.
Chris Walker, who now promotes environmentally sustainable investment, used to be a managing director in Swiss Re’s sustainable business unit, where he was in charge of Greenhouse Gas Risk Solutions. Swiss Re is a giant in the reinsurance industry, and from that perch Walker had a synoptic view of the force field of competing incentives that swirled around the pricing of climate change risk in underwriting insurance policies. He agrees that the incentives at the retail level were tightly focused on selling policies. This meant keeping prices competitive with other insurers. Because the rewards of writing policies were immediate, and the costs of realized risks lagged, this meant risk was habitually underpriced.
In 2008, the world got an expensive lesson in what happens when perverse incentives lead the sales end of an industry to underprice risk. That financial meltdown provides a foretaste of what might happen in the insurance industry in coming years.
As noted in the introduction, one of the triggers of the 2008 crisis was the earlier parabolic rise of home prices as the explosive growth of a new type of bond incentivized lenders to write mortgages regardless of whether a household had the wherewithal to keep up payments. The bankers got fees for writing mortgages but didn’t worry about repayment, because they quickly sold the mortgages to other bankers who would use the mortgages as the collateral for billion-dollar securities. Those buying the mortgages had a false sense of security because data going back to World War II showed that home prices rose only on an annual basis.
Insurance brokers are similarly incentivized to continue to write policies until a catastrophic event happens. Chris Walker says that typically there is a year lag between the event and when losses appear. Consequently, even though insurance risk analysts knew that climate change increased the odds for western fires, until serious outbreaks of such fires occurred in the 2010s, the incentives for the agents at the retail level were to continue to write policies in the fire zones.
Competition for business also explains a reluctance for reinsurance companies to tighten standards. Ordinarily, when a new risk surfaces, the reinsurers will first ask about the insured party’s possible exposure to the risk and what they are doing about it. If the risk is broad enough and expected to continue—e.g., sea level rise and increased storm frequency and intensity—the reinsurers will pull back from underwriting specific policies or add exclusions for certain kinds of risks.
At all levels, from retail to reinsurance, insurers have an ace in the hole. Most policies have to be renewed yearly, which gives an insurer some comfort. Instead of having to consider a vastly increased likelihood that a major hurricane or wildfire will hit a specific area at some point in the future, they can limit their worry to whether a catastrophe will hit a certain property in the next year. A house that has a 100 percent chance of being flooded in the next hundred years has only a 1 percent chance of being inundated in the next year. And if because of climate change such floods become twice as likely, that risk doubles—but it is still only 2 percent.
Still, reinsurers are not always eager to absorb a doubling of risk. This is where industry ingenuity came into play. Ironically, it was a major hurricane that led to an innovation that enabled the insurance industry to continue underwriting policies in areas at risk for climate change.
The hurricane was Hurricane Andrew, which hit just south of Miami as a category 5 hurricane in August 1992. During its short, thirteen-day life, the monster storm wrecked 125,000 homes in Dade County alone. The destruction led to the insolvency of eleven insurance companies, and it could have been worse, since it was a relatively compact storm and hit shore a few miles south of a major city. Estimates of the damage of a direct hit to Miami today range from about $50 billion to more than double that number.
After that debacle, reinsurers began balking at fully backstopping risk, and sixty-three insurers either left the state or curtailed new business. A mathematician named Eberhard Müller at the German reinsurer Hannover Re began thinking about possible solutions and came up with the idea of a security, which became known as CAT bonds, that allowed outside investors to get paid generous interest rates to take part of the risk. It was a brilliant idea from a number of perspectives. It allowed reinsurers to offload some of their risk so that they could continue to underwrite lucrative policies in at-risk areas. It also gave reinsurers access to the vastly larger financial resources of the world’s markets. For investors—usually hedge funds and institutional investors—it offered tempting returns that were uncorrelated to other markets (in the sense that the risks of these bonds had nothing to do with market movements or the economy), allowing them to diversify their portfolios.
An obvious question was, why would any investor assume a risk that very smart reinsurers wanted to unload? The answer has to do with the aforementioned limited time exposure of the risk. Even if climate change dramatically raises the probabilities of catastrophic events, the odds of a particular catastrophic event at a particular place within the time frame of a few years don’t really rise that much. A CAT bond might insure the risk of a category 5 hurricane hitting a specific area like Miami in the next two or three years. Another reason is the recent global financial context of ultralow interest rates. In a world awash with negative interest rates, the bonds offer institutions and hedge funds fat returns.
In terms of climate change, the invention of CAT bonds allowed insurers to put off facing the issue. As Chris Walker noted, “Just as was the case with mortgage securitizations in 2007, your underwriting criteria don’t have to be that strict if you’re going to be offloading that risk.”
Walker’s job was to incorporate the increasingly scary findings on climate change into underwriting. He says he never got traction except in some cases involving climate liability for directors and officers (called D&O insurance). For example, he noted that if a given company was 1 percent of global emissions and knew for thirty years that climate change was a real threat, that company might be found to have 1 percent of the liability. Walker said that they did manage to get some climate liability exclusions written into some D&O policies. He fully expects that some suits will be forthcoming. “Look what happened with tobacco,” he says. “It took one case to break through and then the floodgates opened.”
As it turned out, reinsurers had several ways of kicking the ball down the road rather than integrating climate risk into their insurance pricing. Apart from CAT bonds and limiting policies to one year, they could also pull out of areas deemed too risky. That’s what happened in Florida after Hurricane Andrew. Even as the risks grew for coastal areas, those same areas enjoyed a building boom as affluent and aging Americans sought out the sun coasts, the closer to the water the better. Insurers sought to raise rates, but state regulators wouldn’t let them. A number of big insurers responded with a collective shrug and said sayonara.
In the following decade, the Republican-led government of Florida chose to protect its coastal citizens from having to pay the true price of living in the crosshairs of wind risk by hurricanes by socializing that risk. This in turn had the effect of camouflaging the risk and encouraging people to move into harm’s way. Current statistics are that 5 million people have moved to the Florida coast since Andrew.
Hurricane wind risk is but one threat global warming carries with it. Another is flood risk from sea level rise and storm surges. Here too insurers routinely exclude flood and storm surge damage from policies. Again, if that risk was properly priced, buyers might think twice about purchasing homes in harm’s way and thereby become aware that global warming could cost them money. But there’s profit to be made by burying that thought, and so that risk has been socialized at the federal level through FEMA’s National Flood Insurance Program. Here too the government underprices risk. In fact, flood insurance policies not only fail to reflect risks priced on recent history, they are based on maps that don’t reflect the realities of sea level rise (in 2019, the Trump administration tried to stop FEMA from updating their maps). In this case, it’s the entire nation that subsidizes those who choose to live in harm’s way.
Thus, a combination of perverse incentives, the efforts of reinsurers and states, and the unintended consequences of federal programs all served to dampen a price signal that might have caused people to take notice of the threat of global warming. Had insurers done in the 1990s what many thought they would do, it would have mooted the Panglossian economic forecasts of Nordhaus. It would have let the public know that global warming was not just some hypothesis about a far-off danger but a pocketbook issue. The reality that this threat carried costs in the present would have undercut the disinformation campaign of the fossil fuel industry.
Underwriting might sound like an arcane corner of the financial world, but the consequences of the failure of the insurance industry to price the risk of climate change were global. Millions of people facing rising insurance costs in coastal areas, or areas at risk for wildfires, would have made adjustments in their choices about where to live and likely also made climate change a political issue. The insurers might have opted out of underwriting coal-fired power plants much earlier than they did. Investors might have put more money into alternative energy and governments created more incentives for the shift to renewables. Perhaps there would have been more of a sense of urgency at the Kyoto talks later in the decade.
There was one very positive innovation in business and finance in the 1990s with regard to climate change, although it only had real impact starting in the 2000s. This was the adoption of so-called feed-in tariffs, first by Germany, then other European countries, and then, starting in the 2000s, by China, India, and other big emerging economies. As of this writing, the United States is the only major economy not to have adopted feed-in tariffs as a way of spurring investment in renewables.
Here’s how they work. The tariffs, as they are presently configured, provide a guaranteed return to investors over a period, usually twenty years. This structure takes much of the risk out of financing wind, solar, and other renewable energy projects. Unfortunately, it took a decade of tinkering to find a structure (now the cost of generation plus a reasonable rate of return) that mitigates the uncertainties and unpredictability of fluctuating electricity costs. The new model has proven wildly successful. These successes underscore the crucial role that finance has played in the global warming era.
But in the 1990s, moneyed interests were a distinct negative, although they don’t bear all the blame for the world’s inaction. The IPCC, the natural reticence of scientists to go beyond the data, the emergence of a well-funded disinformation campaign, lack of charismatic political leadership—all deflated any sense of urgency that might have been felt about the issue.
It could have been otherwise; the world was not fated to fail to address the threat of global warming. Instead of a lost decade in terms of taking action, the 1990s could have been the decade during which the developed world began the shift that is underway now, and it could have been the decade during which emerging nations powered their development with leapfrogging technologies. Had this happened, we might have entered the new millennium with true momentum behind a shift away from fossil fuels.
Instead, the new millennium began with the reality of climate change already upon us, with the scientific community fully aware of the imminence and degree of the problem but with the public still barely taking notice, and with the financial community still living in a world where the biggest perceived issue was the imagined threat to profits that might come from action to head off global warming.
The failure of the United States and the global community to address the problem has larger implications than putting us on a ruinous path toward climate change—though that one consequence is plenty bad in itself. Climate change posed a test: Could the world’s biggest economies change course to avert a global catastrophe? They couldn’t.
Those same countries passed this test in the 1980s when nations came together (mostly) to defuse the threat of CFCs to the ozone layer. In that case, however, the major special interest, DuPont, had an incentive to support global action. In the case of climate change, by contrast, a wide spectrum of special interests were driven by financial incentives to continue business as usual. If the dominant moneyed interests see global action as endangering short-term profits, they will thwart collective action, even if it increases the likelihood of long-term disaster. There couldn’t be a better example of an economy designed to drive off a cliff, and we’ve seen it borne out time and again since the 1990s—in the tech crash of 2000, the Great Financial Crisis of 2008, and, just recently, in the U.S. reaction to COVID-19.