Global financial structure and climate change

Little of the literature from economists on climate change has focused on how accelerating climate change will affect economic structure, and the consequences which follow. Here we analyze the medium- to long-term implications of global warming for global financial structure. Stern (2007) suggests that greenhouse gas emissions generated by human activities could lead to global temperature increases of between 1 and 5°C by 2050. This will result in a large increase in global risk of extreme weather events, changing crop yields, sea level rise, and adverse health effects. Part of this risk, while uncertain, is non-diversifiable; but the other part, while diversifiable, is difficult for conventional insurance arrangements to accommodate. No established pattern of location or feature specific risks exists that are comparable to annual mortality tables for life cover. Insurance arrangements regulated on a national basis pose further possible problems. The response, we suggest, will be global financial market innovation primarily in the area of insurance, but also in diversification of asset holdings. Pressures will also build for a very large increase in government provided insurance. We suggest in this paper that, even with modest climate changes of 1 to 2°C, global insurance markets will expand dramatically. Under more extreme climate change scenarios, the entire global financial structure will undergo major change, with a refocusing of major financial activity away from intermediation between borrowers and lenders and the facilitation of the accumulation of assets, towards a focus on insurance arrangements and the diversification of risks associated with climate change. This will likely involve new contingent instruments, new issuers and financial institutions, and extensive government involvement.