A torrent of flood destruction

Economists Lawrence Hunter and George A. Pieler have an interesting piece on flooding in Forbes: The Organization for Economic Cooperation and Development (OECD), in collaboration with U.K.-based research institutions, says that potential damage from worldwide flooding in coastal areas will increase in value from $3 trillion today to $35 trillion by 2070. That sounds like a big increase, but how big is it, really, relative to expected growth in the global economy?

Using International Monetary Fund statistics, we estimate Gross World Product to be about $58.7 trillion in 2007 (measured in 2004 dollars). That means this year's flood damage will amount to slightly more than 5% of total world output. That is a relatively big number. It means a nickel of every dollar produced each year is washed away by flood waters. To reach $35 trillion by the year 2070, flood damage will have to increase on average by 4% a year during the next 63 years.

…Using these benchmarks implies that coastal flood damage will increase during the next 63 years about 21% a year faster than the world's economy has grown historically. If that is the case, and the world economy continues growing at its historical rate, by 2070 coastal flood damage will increase about one-and-a-half times as a share of world output, rising 43% from its current 5.1% of gross world product to 7.3%. (The OECD's estimate that $35 billion in flood damage will equal 9% of world output in 2070, or 76% greater than today, implies that global economic growth will slow to 3% a year.)

Even if global economic growth does not throttle back from its historical pace, a 43% increase in the annual destruction from flooding is a lot of destruction by anyone's standards.

How accurate are these projections? As Yogi Berra might say, "We won't know until we know," which means in the meantime insuring against flood risk--both for public infrastructure as well as private property--will be dicey. And if those numbers are anywhere near the mark, it means substantial and well-targeted increases in flood-insurance premiums will be required to match the insurers' revenue streams with expected claims payouts--or taxpayers will be put on the hook for much greater flood exposure.

The OECD findings are, of course, based largely on Climate Change Theory, which generates computer forecasts of more storm and flooding activity, allegedly due to greenhouse gas concentrations from, inter alia, burning fossil fuels. But these findings are also based on historical and projected patterns of growth and development in coastal areas--patterns driven by land use policy, economic incentives and the affection human beings have for being close to dolphins, sharks, water sports venues and hurricane-force winds.

As Insurance Journal reports, "The conclusions are of special interest to the insurance industry, as they provide real estimates of the possible consequences it faces from the effects of climate change." Well, yes. But coastal-area risk assessments have been rising anyway just because of those growth and development patterns. The climate change gloss in this new OECD report just dramatizes how hard-pressed insurers are to cope with modern risk assessment tools.

Whether or not climate change is upon us, insurers have to factor in OECD-type studies in making their own calculations, or face ridicule from regulators, politicians, and sometimes customers. Sorting out real risk from popular (and often misguided) theories becomes an almost futile task.

All the more reason, then, why the U.S. is behind the curve in maintaining a 19th-century regulatory structure for the insurance industry. Until insurers are freed up to innovate and compete globally, hypothetical risks like climate change will just ratchet up insurance costs and layer new rules on top of the already heavy stack of regulatory burdens.

Another big issue for the U.S. Treasury to factor into its "comprehensive review" of financial services regulation.

Dr. Lawrence A. Hunter and George A. Pieler are senior fellows with the Institute for Policy Innovation, a national non-profit economic think tank based in Dallas.