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Climate change and insurance: integrative principles and regulatory risks

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In medicine, an iatrogenic risk is a risk that arises from the medical treatment itself, such as side effects of surgery or drugs. The same phenomenon arises in the process of regulatory and legislative actions intended to facilitate mitigating and financing of catastrophic risks. Unanticipated regulatory or legislative fiats can have fundamental effects on insured risks. Moreover, economic disruptions in the much more densely interdependent global economy can also have systemic effects well beyond their direct locus of impact. These systemic risks are likely to become more evident in the catastrophe risk area in the years ahead, as the effects of climate change become more apparent. One can expect as a result increasing demands on regulators and parliamentarians who, in turn, are likely to look to the insurance and reinsurance industries for solutions. This paper describes the challenges likely to arise in this process, with a particular focus on catastrophe risks that may result from climate change (of course, weather-related events will continue to occur whether or not discernible climate change the culprit). These challenges include the magnitude of the hazards themselves, the complex interactions of mitigation with the Kyoto-driven carbon economy and the uncertainties associated with climate change itself. I review some principles that derive from the economics of insurance regulation and from the decision sciences. Some of these have been recently put forward as policy recommendations at the World Economic Forum and in the OECD Advisory Board on Financial Management of Large-scale Disasters. These recommendations on the role of insurance in mitigation and financing of catastrophe risks must be seen as part of a larger international debate on these issues. They are set against the background of increasing losses from catastrophes due to increased assets and population in vulnerable areas, the increased scale of weather-related events, possibly related to climate change, and increased interdependencies in the global economy. Given the magnitude of these risks, there is growing recognition on the importance of greater collaboration between the public and private sectors in identifying and quantifying risks from large-scale catastrophes and in the design of mitigation and residual risk financing mechanisms to cope with them. I argue here that it is essential that the insurance industry take a leadership role in developing principles and actions to address these risks.

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