It's uncertain whether president-elect Donald Trump will follow through with his campaign promise to back out of the Paris Agreement on climate change. But The Global Covenant of Mayors for Climate and Energy, co-chaired by Mike Bloomberg, the former mayor of New York City, and Maroš Šefčovič, the vice president of the European Commission, has make its commitment clear. Municipalities around the world have pledged to reduce their carbon footprints and make their cities more resilient to climate change.

The mayoral pledge highlights the important role that cities and towns continue to play in mitigating the impact of severe weather, whether or not caused by climate change and whether or not climate change is man-made. Incompetent government planning and execution, however, could hurt people, reduce property values, and trigger business interruptions in unforeseeable ways. A misplaced or poorly designed seawall, for example, might reduce flooding in one area, but divert water to an even more populated area.

Part 1 of this series discussed how municipal liability insurance, that specifically prices the risk of government ineptitude, might incentivise municipalities to take greater care to adopt the best strategies to minimise severe weather losses.

Government immunity

Firstly, the lack of a private insurance market isn't itself the issue. Rather, the problem is that in most cases, the government simply isn't liable for its actions in the first place. Government immunity protects the government from liability unless it specifically waives the protection.

Removing or modifying the shield exposes the government to legal risk. But this threat might not by itself incentivise the government to take greater care when designing and implementing its disaster mitigation plans if it knows that it can rely on taxpayers for an open-ended bailout. While it's true that tax dollars fund the payment of municipal insurance premiums, the hope is that the threat of premium increases or cancellation of coverage provides enough of an incentive for the government to get its act together so that it can avoid begging the taxpayers for even more money.

The Federal Tort Claims Act already allows private citizens to sue the US government if a federal employee is negligent when acting within the scope of his employment. There are a variety of similar state and local laws. These laws, however, typically include a broad "discretionary function" exception which preserves the shield whenever the government exercises its judgment when conducting its activities, even if its judgment turns out in hindsight to be wrong. And other laws like the US Flood Control Act have been broadly interpreted to absolve the government from flood-related liability.

The result is that homeowners and taxpayers are left holding the bag. Some commentators have responded by calling for legislation that specifically creates climate change-related government tort liability. But rather than try to enact sweeping reform, which is a political non-starter, the better solution is to make any such law agnostic as to climate change and its causes – in other words, narrowly tailored to address the direct consequences of severe weather events. Long-tail losses arising from "man-made" climate change are for insurance purposes speculative, which makes the risk difficult to price.

Regulatory takings claims

Another interesting question is how the insurance market will adapt to climate-related takings litigation. These claims assert 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.

The concept of inverse condemnation long predates the public debate over climate change – plaintiffs burdened by overly restrictive land use regulations have a rich history of suing the government for compensation. Insurers therefore don't like to insure the government for regulatory takings. According to scholarship by Christopher Serkin, a law professor at Vanderbilt University, "municipal insurance policies inevitably contain a curious exclusion of coverage for regulatory takings claims… Many courts have interpreted this exclusion broadly, applying it to all land-use litigation." Professor Serkin asserts that the exclusion has a huge impact on inverse condemnation litigation strategy, and argues that state insurance regulators should find ways to cover regulatory takings claims.

Jump starting the market

What else can we do to catalyse the development of a private insurance market? Scholarship by David Dana, a law professor at Northwestern University, offers some clues. Taxpayer-backed government policies also distort the incentives for municipalities to protect their own property from severe weather. He proposes to jump start the private market for municipal property insurance by modifying federal aid programs to "require the municipalities to obtain private insurance against climate-change-related damage to public property and infrastructure."

Time to act

Despite these uncertainties, municipal insurers, including municipal risk pools in which many smaller cities and towns participate instead of purchasing commercial insurance, cannot afford to take a "wait and see" approach. They have plenty of reasons right now to proactively consider the size and nature of their exposure more carefully. John Rappaport, a law professor at the University of Chicago who makes a similar argument regarding municipal liability for wrongful criminal convictions, likens the current market to how insurers adapted to terrorism risk after 9/11.

"Many insurers before 9/11 didn’t realize they were covering terrorism risks, but they were – because they hadn’t excluded those risks from their broadly worded general liability policies. After 9/11, terrorism risks became far more salient, and insurers started excluding them from coverage under their general policies. Over time, insurers figured out how to price and write coverage for this newly salient risk, and they started offering to cover it again, often separately from, or as a rider to, the general lines of coverage."

Municipalities sued by flood victims will surely argue that broadly-worded general municipal liability policies cover their claims if the policies do not specifically exclude those claims. And while insurers have thus far successfully excluded takings claims, they should consider how reducing their exposure in one area might inadvertently undermine the integrity of the market and increase their overall long-term exposure. The time is right for municipal insurers to focus on how to price these unique and emerging risks.

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.