Government Policies are Discouraging Adaptation to Climate Change

"Unless these perverse risk-shifting incentives are replaced with measures that strongly promote precautionary adaptation before disasters strike, climate change damages are likely to make the Wall Street meltdown seem like a minor blip."

By Robert Repetto on June 8, 2016

"Unless these perverse risk-shifting incentives are replaced with measures that strongly promote precautionary adaptation before disasters strike, climate change damages are likely to make the Wall Street meltdown seem like a minor blip."

The 2008 financial crisis struck mainly because financial firms and institutions could shift the risks they created onto others, mostly taxpayers and homeowners, while keeping short-run profits for themselves. This led them to engage in reckless practices. Government programs dealing with climate change risks are now creating similar perverse incentives, raising the likelihood that future natural disasters will bring enormous losses.

We know that global warming is creating more extreme weather in the United States: intense storms and hurricanes, flooding, hailstorms and tornados; and in other regions, more frequent droughts, heat waves and fires. Munich Re, the world largest reinsurer, found that the frequency of large natural disasters has more than doubled in the last 50 years. We don't know when or where the next disasters will strike. Though the federal government preaches adaptation and risk reduction, many of its policies lead businesses, households and local governments to become even more vulnerable. Consequently, population and property values continue to concentrate in high-risk locations.

For example, in the 2014 Farm Bill, Congress enacted a highly subsidized crop insurance program that discourages farmers from acting to avoid future climate change damages by shifting most of the costs of future crop losses onto taxpayers. The main beneficiaries are the largest 20 per cent of farms, which get 80 per cent of the insurance subsidies. These sophisticated agribusinesses have the knowledge and resources to adapt to global warming but now have little incentive to do so.

The largest subsidies are linked to insurance policies that provide the most comprehensive coverage. Consequently, most farmers choose "Cadillac" policies that insure against yield and revenue losses in bad crop years and also against revenue losses when farm prices fall in bumper crop years. Such coverage promotes moral hazard, encouraging farmers to extend their planting onto more vulnerable acreage or to continue with riskier farm practices.

Taxpayers lose twice: once, by footing the bill for the subsidies, and again, by paying the higher food prices that crop losses will impose. The Congressional Budget Office projects that taxpayers pay more than USD 8 billion per year in subsidies and program costs, in addition to the losses from climate change. This program is not only counterproductive and costly to taxpayers, it's also unnecessary. Farmers can already hedge in well-established forward markets against price fluctuations. Private crop insurance against yield reductions would emerge but cannot compete against a government insurance program that charges farmers only 40 to 50 per cent of actuarially fair premiums.

The National Flood Insurance Program (NFIP) creates the same flawed incentives. In 2008 FEMA, which administers the program, was instructed to study increasing flood risks and adjust premiums to reduce the program's USD 20 billion deficit. Its study found that insured losses would increase significantly over coming decades, partly because of increasing shoreline development but mainly because of climate change. In response, in 2012 it raised insurance premiums substantially to risk-adjusted levels, but Congress, responding to complaints from affected homeowners, developers and local governments, delayed or eliminated those increases.

Subsidizing flood insurance discourages property owners from making changes that would reduce losses from future floods. Some state insurance regulators have compounded the problem by constraining private insurance rates below levels reflecting current risks and then filling the coverage gap with subsidized public insurance systems. Setting aside the dubious proposition that waterfront property owners cannot afford insurance, a better approach would be to bring premium rates up to the levels justified by increasing climate risks and then provide means-tested vouchers for genuinely low-income households to use to buy insurance.

These distorted incentives are exacerbated by the government's approach to disaster relief. Just as banks took on excessive risk before the financial meltdown in the expectation that, in a crisis, the government would bail them out, households and communities exposed to climate damages are also tolerating excessive risk, expecting government to bail them out—literally. For example, a large percentage of households supposedly required to have flood insurance policies have let them lapse, partly because disaster relief grants to individual property owners are a form of free insurance.

When a natural disaster strikes, the president typically declares a disaster and provides funds for relief and rebuilding, usually now through a special Congressional appropriation. Since 1950 the average number of declarations per decade has tripled and the federal share of the cost has risen dramatically: from 5 per cent for Hurricane Diane in 1955 to 80 per cent for Hurricane Sandy in 2012. Most relief goes to disaster-prone states and weakens the incentives of state and local governments to require unpopular but effective zoning and land-use changes.

Although the Disaster Mitigation Act of 1980 established a national program for pre-disaster mitigation and provided additional funding to states that develop approved mitigation plans, the vast majority of federal assistance is still provided only after a disaster occurs. Pre-disaster funding for mitigation, preparedness and planning is limited, and after 9/11, when FEMA was put into the Department of Homeland Security, funding available for local preparedness shifted toward terrorism.

Even though hazard zoning, building elevation, land purchase and setbacks have high benefit-cost ratios, they are given little attention or funding. Stronger carrots and sticks are needed to induce state and local governments to adopt them because developers, homeowners and local government don't want to limit new construction or rebuilding in hazardous areas. They prefer beach replenishment, levees and seawalls, which are much less effective in the long term but are politically attractive. The federal share of disaster relief should be lower for those communities that have not implemented mitigation plans involving high benefit-cost measures.

It's the same story with forest fires, which have been increasing in frequency and extent as the country warms and the West dries out. Ten per cent of all land in the lower 48 states and a third of all houses are already on the forest fringe or “wildland-urban interface”—and construction is increasing in these threatened areas. The Forest Service forecasts a 40 per cent increase in the number of Wildlife Urban Interface homes by 2030. Local governments welcome second home and vacation developments and are a strong constituency for federal fire protection, though not for imposing zoning restrictions or upgraded building standards and other straight-forward protective measures that can reduce risks.

The cost of firefighting, now more than USD 1 billion dollars annually, has increased dramatically. The Forest Service spends most of its regular budget plus special budgetary supplements putting out fires, especially large fires, and those efforts are concentrated on preventing losses to life and property. Much less attention or funding goes to fuel reduction or other loss prevention programs. Consequently, hazardous development on the forest fringes continues to increase despite the certainty that risks will increase as the winter snowmelt comes earlier and the hot dry summer season lengthens. One study estimated that a further one degree Celsius temperature increase would triple the annual area burned. To contain future losses, the federal government should require state and local governments to pick up a larger share of fire suppression costs if they have not adopted risk reduction measures and should shift more of the Forest Service budget towards prevention.

Other examples of perverse risk-shifting policies are easy to find. The Bureau of Land Management, which manages 400 million acres, grossly underprices grazing rights leased to private ranchers, leading them to overgraze and mismanage a deteriorating landscape that will be even more stressed as climate changes. Similarly, the Bureau of Reclamation underprices federal irrigation water to irrigators fortunate enough to get some, discouraging farmers from adopting water-saving crops and irrigation methods. State governments in the West and Midwest have allowed irrigators to draw down aquifers, depleting an asset that will be crucial in future drought conditions.

One recent study estimated that overcoming decades of natural disasters is expected to cost the government and taxpayers a shocking USD 7 trillion dollars. Private property owners and their insurers would lose trillions of dollars more. Unless these perverse risk-shifting incentives are replaced with measures that strongly promote precautionary adaptation before disasters strike, climate change damages are likely to make the Wall Street meltdown seem like a minor blip.

This article was originally posted on the Energy Future Coalition website on June 6, 2016, and is reprinted here with permission.