Climate change involves systemic risk, so it’s not possible to insure against, or diversify away the risk.
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Over the years I have sometimes heard investors talk of insuring their portfolios against climate change risks. A group of students once came up with an ingenious project for funding the costs of climate change mitigation and adaptation by selling options to those parts of the world that might benefit from climate change. But mostly these ideas are unworkable because climate change is making most of the world worse off – there are few, if any, winners.
It’s increasingly obvious that extreme weather is become more common. Weather is what we get in the short term, and is highly variable; climate is the long term average. But you would have to be both an optimist and to ignore the increasingly persuasive attribution analysis, to think that the extreme heat, drought and floods that we observe in north America, India, China and Europe are somehow within the bounds of normal weather.
What we used to call global warming has a deceptive simplicity: you heat up a saucepan of water and it gets hotter. The reason why climate change is more accurate is that the greenhouse effect of added CO2 and methane in the atmosphere is equivalent to adding a lot more energy to a complex global system that involves air, oceans and land. The results are complicated: more water in some places (floods in Pakistan) and less in others (droughts causing hydroelectric power shortfalls in China, leading to more coal burning); and hugely varying increases in temperature across the globe and within continents, which are poorly captured by the slow but relentless rise in average temperatures.
Insurance, like portfolio diversification, depends on events being imperfectly correlated. Take fire insurance. If the probability of your house burning down is uncorrelated with that of the average house burning down (1), across a sufficiently big population, then an insurance company can charge everyone a premium that profitably covers the cases where a fire actually happens.
Similarly a portfolio of assets can be diversified to the extent that only systematic risks remain. We usually think of these as macroeconomic risks, which can be diversified to some extent across nations, but even then there are common causes (such as the actions of the US Federal Reserve).
But climate change makes the whole world worse off, so it’s a systematic risk. It is conceivable that some particular areas may benefit from higher temperatures, but it’s hard to be sure. Some people had thought that Russia, with so much of its land in high latitudes, might be better off with higher average temperatures (while losing its core export revenues, as oil and gas are phased out). But a book published in 2022, Klimat: Russia in the Age of Climate Change casts doubt on that benign outcome, with melting permafrost being just one potential offsetting threat. (2)
The US, the biggest historic emitter, and China, the largest current emitter of greenhouse gases, are both suffering from climate change. Bloomberg Green, a free and very useful daily newsletter (you can subscribe here), yesterday reported that:
From January to June, the US has been hit with 12 extreme weather disasters bringing at least $1 billion in damages, according to the National Centers for Environmental Information. A quick recap of some of this year’s worst include the California floods from January to March, Texas hail storms in May and multiple bursts of severe thunderstorms and tornados across the central US this past spring.
Meanwhile the excellent China Project (whose Chief Marketing Officer is a Cambridge MBA graduate) reports yesterday:
A landslide left two people dead and two others missing in a village in Gansu Province on July 10, the latest victims of a deluge of rainfall and floods that have sparked a number of landslides all over the country.
Other regions have been sweltering in record-breaking heat. At least two people died due to heatwaves in Hebei Province on July 7, while Beijing logged a record-breaking temperature of 41.1°C (106°F) for that month on June 22 — its second-highest temperature since modern records began.
The extreme weather events have spurred Chinese authorities to launch emergency response measures and issue a string of warnings to local officials and the public, in an effort to protect people and property, crops, and the country’s power grids.
I was lucky that my recent trip to China was to Shanghai and Shenzhen, not to Beijing, which reported record temperatures for June.
The China Project Daily Dispatch also mentions that Huawei has launched an AI-enabled weather forecasting service. (In case you’re sceptical, a paper on the service, called Pangu Weather, has appeared in the journal Nature.) You can subscribe to the China Project, which includes the Daily Dispatch newsletter, the excellent Sinica podcast and a lot of other stuff (it’s not free, but well worth it) here.
So, you can’t diversify away from climate change and can’t insure against it. The rational thing to do is therefore to take action to prevent it. This is something that can surely the US and China can agree on.
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(1) It may well be correlated with the risk of your next door neighbour’s house burning down, hence the need for a large population to achieve diversification.
(2) You can read a sobering review in New York Review of Books.
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