Don’t let the title of the Schwarcz paper dull your curiosity! Long and technical, with the sedating word ‘insurance.’ Well, if you survived such charmless (but perfectly informative) invitation, you are up for a treat. You will learn how a minor but creative tweak in a legal rule governing contracts would yield a major breakthrough in climate preparedness.
The contracts are homeowners insurance policies. The question is whether they can create incentives for construction and upkeep of homes resilient to climate disasters such as hurricanes, floods, and wildfires. Obviously, the stakes are colossal. Public law ought to be at the center of this urgent regulatory enterprise, but politics stand in the way. It turns out—surprisingly—that private law could do much of the work, and Schwarcz discovered an important guiding path.
There are sure ways to build homes and neighborhoods to reduce harms from natural disasters. Roofs could be fortified against wind. Elevations and drainage could reduce flood harms. Spacing could mitigate the spread of wildfires. Some of the most effective measures are public goods, requiring collective investments at the infrastructure level. Floodplains control, wetland preservation, forest management, as well as communal coordination via zoning restrictions and smart building standards—these actions yield indivisible and non-excludable benefits to all members of the community.
I used to think that private homeowners insurance contracts could create proper incentives by granting premium discounts for homes that invest in robust roofs, effective drainage, or vegetation removal. In many lines of insurance—auto insurance comes to mind—there’s evidence that contractual incentives work to reduce accidents. But not in property insurance, and Schwarcz explains why. For one, unlike safe driving which is a private action, property protection requires concerted-communal effort that individual contracts are powerless to influence. Besides, most climate mitigation investments yield long-term benefits which the annual horizons of homeowners policies fail to internalize, rendering any discounts offered by insurers insufficient. And, alas, climate-related perils—like flood damage in waterfront areas—are so expensive to insure or prevent that people can afford neither.
Proposals have been put forward to address the rapidly rising and increasingly uninsured climate harms, focusing on capital investment mandates, relocation, federal insurance and reinsurance subsidies, zoning reforms, pollution liability, and much more. The dreadful performance of the centerpiece insurance “affordability” program—the National Flood Insurance Plan—has not-quite-chilled these energetic proposals. They all missed a most promising (and certainly most original) solution—Schwarcz’ collective insurance path.
The idea is splendidly simple: let private insurers sell homeowners policies as group plans. In the same way that employers negotiate health insurance plans for their employees, geographic communities would negotiate disaster coverage plans with insurers, inviting residents to opt in. Insurers would set premiums to reflect community-shared rating features and further adjust within each zone the individual premiums to match each home’s idiosyncratic risk profile. Communities that invest in collective risk mitigation would be rewarded with premium discounts which, over the long term, would more than pay for these investments. In other words, because of these discounts, communities would be propelled to make the infrastructure adaptations. Moreover, the bounded rationality of individual households—unable to appreciate which mitigation costs are justified and affordable—would be overcome by the collective expertise of their representatives. And no freerider problem: whether they join the plans or not, households bear their respective cost through taxes the community levies to fund the investments.
You may wonder (as I did), why is such collective insurance not being presently offered? Primarily, because state law prohibits insurers from issuing group policies unless people share an insurable interest, effectively limiting such policies to common property. This antiquated prohibition originated from the interests of insurance agents, who feared losing business if group administrators were to become the distributors of individual policies. There is surely enough political muscle these days to repeal that rule.
The prohibition against group homeowners plans also descended from an anti-discrimination hunch—what if geographic rate variation would disfavor weaker demographic neighborhoods, a type of insurance redlining? The reality of homeowners insurance is exactly reversed. Locations most vulnerable to floods and fire—on oceanfront or in forests—are disproportionately affluent. Presently, due to rate regulations and public plans of last resort, these areas are subsidized either by taxpayers or by less affluent homeowners, artificially inflating the insurance costs of poorer areas. Schwarcz’ group plans would put an end to this senselessness. Affluent high-risk localities would carry their own insurance weight, and instead of using their political muscle to secure regressive public subsidies, they’ll be guided by insurance plan administrator to better protect against disasters or, perish the thought, relocate.
