Sustainability

Can municipal liability insurance foster climate change-related sustainability?

October 28, 2016

Global

October 28, 2016

Global
Lawrence Hsieh

Author

Lawrence Hsieh is author of the Corporate Transactions Handbook. He works for Thomson Reuters, but the views expressed here are his own. Lawrence is a graduate of the University of Chicago Law School and holds a degree in mechanical engineering from Cornell University

This is the first part of a two-article series on municipal liability and climate change.

While politicians at the highest levels of government debate the science of climate change, officials in city halls around the world make the zoning, building code, land use, and flood plain management decisions that either mitigate or exacerbate the impact of severe weather, no matter what the cause. Local government decisions have an immediate impact on public safety, property values, and business continuity. Their decisions also impact long-term migration patterns – whether more people and critical infrastructure move closer to or farther away from flood-prone areas. These consequences create significant legal exposure for municipalities.

Municipalities should look at private industry to determine how to best mitigate their liability. Private companies typically purchase liability insurance as a sensible part of their risk management strategies. The commercial market for the corresponding municipal (or public sector) insurance, however, is comparatively less developed. Broadly-worded municipal liability policies that do not specifically exclude such risks might cover, albeit unwittingly, faulty government planning or execution of disaster mitigation plans.

This is the first part of a two-article series that addresses the question of whether municipal liability insurance that specifically prices such risks, might effectively incentivise municipalities to adopt the best strategies to minimize severe weather losses.

Rising municipal liability risk

Litigation thus far hasn't seriously tested any theory that holds governments liable for the to adapt to climate change. That makes sense because current science cannot link global warming (regardless of cause) to specific storms. But restive homeowners desperate for relief are beginning to question the government over poor planning and execution of sea wall, drainage, and other disaster mitigation projects. According to Ralph De Mesquita, principal risk analyst at Zurich Insurance in London, "depending on the damage caused, [local U.K. government] currently are generally not liable for flooding but there are specific circumstances in which liability could potentially arise particularly under the law of nuisance".

The biggest roadblock for U.S. plaintiffs is to negligence liability for a variety of official activities. Therefore, plaintiffs are increasingly turning to legal theories rooted in to try to overcome the obstacle. One argument proffered is that inundation of private property caused by lax or faulty government risk management amounts to inverse condemnation, which is the unlawful government confiscation or "taking" of the impacted property. Another theory asserts that any government plan or action that benefits one group of property owners at the expense of another violates the impacted property owners' equal protection rights under the 14th Amendment of the US Constitution. This might include, for example, a plan or action that benefits a commercial area by diverting (even unintentionally) water to a residential area.

Need for municipal liability insurance

Given the legal exposure, the market for municipal liability insurance to cover these claims seems poised for growth. There are strong arguments to support a robust market for private insurance.  Some of these can be extrapolated from recent scholarship relating to another controversial area of municipal governance. by John Rappaport, a law professor at the University of Chicago, suggests that municipal liability insurance can foster better community relations by offering market incentives to regulate the use of force.

First, municipal liability insurance is not interested in the cause of global warming, which might help politicians focus on the symptoms, even if they cannot agree on the cause. Proper risk-pricing helps to foster government behaviours that help to minimize potential losses before disaster strikes.

The current system works the opposite way as the government relies on taxpayer-funded disaster and reconstruction relief to clean up and rebuild after a calamity strikes. This isn't sustainable because it encourages municipalities to drain taxpayer-funded relief, and fund any shortfall by reallocating tax dollars that were earmarked for other essential services. They can also increase property taxes, invoking desperate need, but taking no responsibility for exacerbating the problem in the first place.

Furthermore, insurers that take on this risk have the same incentive as law enforcement liability insurers to audit risky municipal behaviours, which may benefit the entire insurance sector. This is because many insurers invest their premiums in real estate. Falling property values due to inundation plus large disaster pay-outs and sudden upticks in disaster-related mortality could jeopardize insurer solvency across all lines of coverage, and threaten the reinsurers and capital markets investors who traffic in insurance risk.

There are, however, a number of challenges to the development of a robust private market for climate change-related municipal insurance, and these will be addressed in the second article in this series.

discusses some of the challenges that impede the development of a competitive private market for climate change-related municipal insurance.

The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of The Economist Intelligence Unit Limited (EIU) or any other member of The Economist Group. The Economist Group (including the EIU) cannot accept any responsibility or liability for reliance by any person on this article or any of the information, opinions or conclusions set out in the article.

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