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Informing an Effective Response to Climate Change CHAPTER THREE Decision Frameworks for Effective Responses to Climate Change The earth’s climate system is moving outside the range within which it has fluctuated in recorded human history. As a result, decision makers will need to go beyond conventional approaches and develop new ways to think about preparing for and adapting to change. This chapter reviews frameworks that decision makers might use to address the unique combination of complexities that climate change presents. We use the term frameworks to describe the underlying set of ideas and principles that provide the overall basis for decision making. There is an old joke about the person who was surprised to learn that he already knew how to speak in prose. Similarly, most people already use a variety of decision frameworks in their personal and professional lives. For instance, a pilot might use a checklist to ensure the aircraft is ready for takeoff. A firm might use a hurdle rate (a minimum required rate of return) to help determine what new products it will invest. A court of law provides jurors with a strict framework for the information they can use and the questions they must answer. Most people have an ethical code of conduct, often derived from religious sources, that helps them determine what actions to take and which to avoid. People make decisions based on an assessment of risk in their everyday lives when deciding what level of insurance to purchase, whether to take steps to improve their health, or where to invest their savings. In most cases, however, people do not spend much effort considering what decision framework to use in a particular situation, because habit, custom, law, and external framings (see Chapter 1, “Barriers to Effective Decision Making,” for further discussion in relation to the climate problem) may dictate their choice and response. At present, however, the appropriate framework for climate related decisions remains an open question. As discussed in the preceding chapters, climate change presents a host of novel challenges that may require many organizations to change their standard operating procedures in order to consider new types of information and to incorporate that information into their decisions in new ways. Such choices help define a decision framework.
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Informing an Effective Response to Climate Change Our panel finds that an iterative risk management framework, suitably modified to address some of the novel characteristics of the climate challenge, represents the best available decision framework for climate related decisions. This finding mirrors that of the Intergovernmental Panel on Climate Change (IPCC) Fourth Assessment Report (IPCC, 2007b), which states: “Responding to climate change involves an iterative risk management process that includes both adaptation and mitigation, and takes into account climate change damages, co-benefits, sustainability, equity and attitudes to risk.” An iterative risk management perspective uses a suite of tools to approach problems. It does not look at a single set of judgments at one point in time. Rather, the approach provides a basic conceptual structure to make choices that reduce risk, despite uncertain knowledge of the future. An iterative risk management approach also actively updates and refines strategies about complex issues as new information emerges. This kind of decision making is similar to moves in a backgammon or chess game, where pieces are repositioned and risk is reassessed in reaction to the roll of dice or a response from an opponent. In this same way, iterative risk management can be defined as an ongoing process in which the potential but uncertain consequences of climate change and climate policy are identified, assessed, prioritized, managed, and reevaluated in response to experience, monitoring, and new information. The advantage of an iterative risk management approach is that it includes a strategy for responding to climate related risks as conditions change and we learn more about them. Some scholars use the term adaptive risk management to describe the process of learning from experience and adjusting management in response to new information, with policies sometimes designed as experiments. With either terminology, the panel recognizes that in practice decision makers will employ a variety of frameworks in decision making. They will merge results from multiple sources in refining their intuition and arrive at an informed decision. Overall, iterative risk management is an advisable strategy for climate change decision making because it uses a broad set of concepts and many other frameworks and tools, such as cost-minimization, cost-benefit, and integrated assessment, within its rubric. Iterative (or adaptive) risk management has been adopted as an overarching approach to the climate change problem by groups that include the United Nations Development Programme (UNDP, 2002), the World Bank (2006), the Australian Greenhouse Office (AGO, 2006), and the U.K. Climate Impacts Programme. A risk management approach is also increasingly adopted, however imperfectly,1 by the private sector, including insurance, agriculture, and in the management of greenhouse gas 1 Many commentators attribute the 2008 meltdown of the U.S. and global financial systems to improper risk management.
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Informing an Effective Response to Climate Change emissions by major corporations. In the following sections, the main elements of iterative risk management identified by the panel are discussed in detail. Some of the more important qualities of iterative risk management appear in the real life case studies, which illustrate the ways this framework is used and can address different areas of climate change decision making. The next chapter discusses some of the specific methods and tools available to implement the decision frameworks discussed here. WHY RESPONDING TO CLIMATE CHANGE NEEDS A DECISION FRAMEWORK For many years, federal government efforts related to climate change have employed a decision framework that uses scientific research to address questions such as whether Earth’s climate is changing, in what ways it is changing, and whether the changes are attributable to human activity. Efforts to understand these questions are appropriately addressed within an analytical framework in which new surprising phenomena are not confirmed until observations have been demonstrated with high statistical confidence (typically 95 percent). The findings are then reviewed by scientists to check their accuracy, evaluate the validity of inferences, and rule out alternative explanations of the reported observations. The phenomenon of climate changes in the observational record have been investigated within this framework for decades and, as described extensively in other America’s Climate Choices (ACC) reports, has lead to a preponderance of evidence that human actions are changing the Earth’s climate. However, responding to climate change now requires a decision-making framework that addresses an expanded set of questions. For instance, a decision framework might help policy makers consider how much greenhouse gas emissions might be reduced, and by whom, or help them consider how the design of a new bridge might take into account the potential for future climate change. To address such questions, a decision framework must help illuminate tradeoffs among often competing values and objectives. It must also provide a means for considering appropriate actions in the face of uncertainty. Inevitably, decision makers need to act in the face of uncertainties, which is a ubiquitous characteristic of our knowledge of the world around us. An appropriate framework can help avoid paralysis in the decision making process and help suggest where prudent action is appropriate and where it is not (see Boxes 3.1 and 3.2). Decision frameworks can provide a variety of benefits. In some cases they can support a particular approach for a formal process by comparing alternative decision options. Decision frameworks can also provide decision makers with methods and rules of thumb that can help them determine alternatives. For instance, a large body of quantitative analysis of greenhouse gas reduction policies by the integrated assessment
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Informing an Effective Response to Climate Change BOX 3.1 An Example of Rick Management Approach at the City Level: Case Studies from New York City and Chicago New York City (NYC) In December 2006, the NYC Mayor’s Office announced PlaNYC, a comprehensive sustainability plan for the city. As part of this effort, the NYC Panel on Climate Change (NYCPCC) was created consisting of leading climate change and impact scientists, academics, and private sector practitioners, such as legal, insurance and risk management experts. Their role has been to respond to city level decision makers’ demand for actionable climate science and climate change impacts assessment information. In February 2009, NYCPCC released a “Climate Risk Information (CRI)” report which called upon these various experts to identify the risks to and quantify the impacts from climate change on NYC infrastructure. “The CRI is designed to help New York City decision makers better understand climate science and the potential consequences for city infrastructure. The CRI contains information on key climate hazards for New York City and the surrounding region, likelihoods of the occurrence of the hazards, and a list of initial implications for the city’s critical infrastructure” (NYCPCC, 2009). Working alongside the Climate Change Adaptation Task Force, NYCPCC has been successful in advancing useable science and implementing adaptation strategies across NYC. Several lessons have been learned since NYCPCC’s inception that can inform other local-level governments in crafting an effective climate action plan (NYCPCC, 2009): Climate change, impacts, and adaptation strategies should be regularly monitored and re-assessed as part of any climate change adaptation strategy. Iterative risk management is also presented in Adapting to the Impacts of Climate Change (NRC, 2010a). Adaptation plans should be assessed regularly to determine whether they are meeting their intended objectives and to discern any unforeseen consequences. For example, by monitoring trends in population, the economy, policy, operations, management and material costs, future adaptation strategies can be iteratively tailored to ensure they remain consistent with broader citywide objectives. Chicago The Chicago Climate Action Plan (CCAP) was formed in November 2006 by the Mayor’s Office in response to the recognition that climate change is occurring and can have substantial and costly impacts on the city of Chicago. In contrast to the NYC model, Chicago first requested a Climate Impacts Report conducted by expert scientists. This report fed scientific information to an Economic Impact Analysis of Climate Change carried out by a risk assessment firm that applied costs to these potential impacts. This process ultimately allowed Chicago to prioritize its mitigation and adaptation efforts.
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Informing an Effective Response to Climate Change Mindful that creating a plan as complex as CCAP is challenging to large urban areas, much less smaller ones with fewer resources, a Lessons Learned report was developed (Parzen, 2009). A variety of useful tools, checklists, and guidelines for ensuring the creation of an effective climate action plan are provided in this report. The authors are cognizant, however, of the fact that their findings were specifically tailored for the city of Chicago and will likely require modifications to best inform decision making in other localities. Here, we provide a few examples from the Lessons Learned report that illustrate the demand for information from city-level decision makers, as well as how to provide it to them. Key Lessons Learned from creating the Chicago Climate Action Plan (Parzen, 2009) Mitigation and Adaptation Belong in the Same Plan (see figure below) Strong Support from the Mayor and Mayor’s Office Paves the Way Support from Government, Civic, and Business Leaders Fuels Action Dedicated City Staff is Essential for Program Success A Strategic Nonprofit Partner Can Help Keep the Process Moving Solid Research Helps Leaders Choose Credible 2020 and 2050 Goals and Actions Dedicated Funds Are Needed to Support Research and Planning and, Later, Implementation A Task Force of Local Leaders Adds Enormous Value and Legitimacy City Commissioners and Sister Agencies Need Their Own Process to Provide Input Frequent Climate Summits Keep Stakeholders Informed of Progress and Provide a Way to Get Input A Research Advisory Committee Adds Knowledge and Credibility Start on Implementation Early in the Process Have an Aligned Communications Strategy Build on Existing Initiatives Successful Climate Action Depends Upon Long-Term Public-Private Partnerships The Way to Ensure Success is to Track Progress and Continually Reassess A schematic illustrating how carefully crafted mitigation and adaptation strategies can provide synergistic, or “winwin” outcomes. An example would be keeping rainwater on site to help reduce flooding (i.e., an adaptation action), and the need for pumping water which saves energy (i.e., a mitigation action). SOURCE: City of Chicago, 2008.
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Informing an Effective Response to Climate Change To address the city’s growing concerns over managing the risks from climate change on the city’s infrastructure and livelihood, CCAP implemented a risk management framework for developing, implementing, and managing a climate action plan. The Chicago climate action plan checklist can prove valuable to other cities and states trying to craft their own climate action plan and risk management framework. Chicago Checklist for Climate Action Planning, Part of a Risk Management Framework (Parzen, 2009) Create a staff and organizational structure to carry out work and manage funds. Find a nonprofit partner. Engage a group of funding partners. Create a climate planning task force. Create a research advisory committee and research plan. Perform or gather research on climate change impacts on the region and priorities for adaptation. Analyze baseline greenhouse gas emissions. Create a process for engaging municipal departments and sister agencies. Create a process for engaging local civic and nonprofit leaders. Assess and summarize existing city initiatives, resources, and capacities. Inventory best practices from other cities. Collect ideas for emissions reduction and adaptation from the task force, departments, and civic and nonprofit leaders. Analyze emissions reductions options, including size of potential reductions, cost-effectiveness, feasibility, and other benefits. Vet and prioritize climate mitigation and adaptation options with all stakeholders. Choose overall goals for emissions reduction and actions to achieve them. Develop implementation plans, structures, and partnerships for the highest priority actions (and a timeline for the rest). Establish performance monitoring tools. Develop and implement an ongoing communications strategy. Launch a climate action plan. Continue ongoing planning, monitoring, and reassessment. modeling community, often conducted in a cost-effectiveness decision framework, emphasizes the importance of the following general rules: Reduce emissions where it is cheapest to do so (for example, by allowing for trade in emission rights, the Clean Development Mechanism, or emissions offsets);
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Informing an Effective Response to Climate Change Allow banking and borrowing of emissions rights through intertemporal trade; Focus on the full suite of greenhouse gases; Develop a portfolio to allow poorer countries to develop using less carbon intensive technologies; and Plan for learning and midcourse corrections. Finally, a decision framework, particularly one that has been well developed and widely used, can provide general insights and concepts that can help guide decision makers’ intuition. For instance, decision makers have been using a cost-benefit framework at least since the time Benjamin Franklin suggested weighting choices by writing down lists of pros and cons. The vast body of formal cost-benefit studies generated in recent years makes the basic principles behind this framework even more accessible and useful to decision makers. OTHER WAYS OF MAKING DECISIONS A wide variety of decision frameworks have guided decisions about how to respond to climate change (Table 3.1). Some have proven more helpful than others. As a result, a set of criteria has been useful in choosing among such frameworks. Generally, an effective decision framework for climate related decisions should: Help to relate actions to consequences in a way that decision makers can compare the extent to which alternative actions achieve various objectives and goals; Provide a way to address uncertainty, in particular the deep uncertainties that often characterize many climate related decisions; Provide a way to handle multiple, often competing objectives; and Provide a process and results seen as legitimate by stakeholders to the decision. These criteria suggest that iterative risk management, suitably modified as discussed in the section “Fundamental Elements of a Risk Management Framework,” provides the best available framework. Precautionary Frameworks The precautionary principle takes many forms, but the key concept is that decision makers take steps to prevent future harms and identify key vulnerabilities (Schneider et al., 2007) even, and especially, when the causal chain between action and outcome
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Informing an Effective Response to Climate Change BOX 3.2 Responding to Hazards, Adapting to Climate Change Variation: An Example from Tulsa, Oklahoma Many disaster loss reduction programs (e.g., those concerned with land use management and building codes) are already well established, and they constitute an important line of defense against both near and longer-term adverse climate trends. For example, some communities have developed aggressive flood loss reduction initiatives in the face of climate-induced extreme events. The city of Tulsa, Oklahoma, is one such community. Located on the Arkansas River, Tulsa has a long history of flood disasters, including major floods in 1923, 1970, 1974, and 1976, as well as an especially deadly and damaging flood in 1984. The city’s flood losses have increased over time, in part because the city relied on levees and dams for flood protection and allowed intensive development in the floodplain. In the mid-1970s, Tulsa began implementing a series of measures to reduce flood losses, including acquiring land in the floodplain, passing a moratorium on building in the floodplain, developing comprehensive floodplain and stormwater management programs, and establishing a flood early alert and warning system. Over the next two decades, these measures were strengthened and hundreds of buildings were relocated (see Haddow et al., 2008; Meo et al., 2004; Patton, 1994). Due to the city’s flood hazard management efforts, flood insurance rates for Tulsa residents are significantly lower than those in other flood-prone communities around the country. Tulsa’s actions arose through a combination of drivers. Repeated flooding made the hazard difficult to ignore and led to the formation of citizen groups that pressured local government to act. The involvement of a member of Congress helped gain additional support. The passage of the Water Resources Development Act, which was championed by the same Congress member, provided a stimulus for further action. The 1984 flood (see figure below) occurred only 19 days after the election of a new mayor, who subsequently organized a flood hazard mitigation team for the city. The mayor was assisted in these efforts by other committed local officials, including a city attorney, and by engineering consultants. Later, federal funds provided support for coordinated local disaster loss reduction activities, and local businesses stepped in to continue those efforts when federal support ended (Meo et al., 2004). The Tulsa case shows how institutional arrangements, programs, and collaborative networks designed to protect communities from specific hazards can also reduce their vulnerability to climate change.
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Informing an Effective Response to Climate Change Tulsa flood of 1984. SOURCE: Tulsa World (1984).
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Informing an Effective Response to Climate Change TABLE 3.1 Some Commonly Used Frameworks to Make Decisions about Climate Change Framework Example Principles Muddling through Ad hoc decisions Scientific evidence Scientific observation and analysis using statistical confidence Economic Least cost (or maximum value) Precaution Avoid harm Political Responds to voters, special interests, political beliefs Risk Iterative approaches learn from experience and respond to new information to reduce, control, or manage negative outcomes is unclear and the likelihood of these outcomes is uncertain. Many decision makers use precaution in practice. For instance, in advising patients, doctors may ignore estimated probabilities and act as if a specific medical risk will in fact become reality (Van Asselt and Vos, 2006). The United Nations Framework Convention on Climate Change also contains precautionary language in stating its goal of preventing dangerous interference with the climate system. The precaution concept sets a threshold of acceptability in some observable parameter, and then prohibits any policy action that might cause that parameter to exceed the given threshold. The threshold may be zero, as in the doctor example above, or some other value, such as the target levels often proposed for dangerous climate interference (see Box 3.7). Precautionary approaches have become especially important to the business community when it comes to environmental impacts because of the potential for litigation, and because of regulatory requirements for certain pollutants. The precautionary approach, however, does not always address several of the criteria for an effective decision framework. Precaution provides no way to balance among competing goals (Sunstein, 2005). For instance, one group might use precaution to argue for rapid emission reductions to reduce the risk of adverse impacts from climate change while another group might use precaution to argue against any limits on emissions to reduce the risk of adverse impacts on the economy. Precaution also offers no systematic way to consider uncertainty, such as the confidence scientists have that rising above the 2°C temperature threshold is truly dangerous (Lempert and Collins, 2007).
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Informing an Effective Response to Climate Change Muddling Through and Political Frameworks Decisions are often made in less systematic and structured ways. Extensive research on the role of heuristics, or commonsense problem solving techniques, in judgment under conditions of uncertainty reveals numerous “cognitive shortcuts” that influence decision making. For example, decision makers may focus only on the short-term consequences of their decisions; be influenced by recent dramatic but atypical occurrences; or fail to take into account high consequence, presumed low, but actually unknown, probability risks (Gilovich and Griffin, 2002; Gowda and Fox, 2002; Kahneman et al., 1982). The careful analysis and deliberation that are required for effective decision making may be ignored. Organizations and decision makers may also opt to follow trends, responding to pressure to jump onto the latest bandwagon, rather than thinking through the consequences of their decisions (Abrahamson, 2009; Collins, 2000; Jacobson et al., 2005; Kaissi and Begun, 2008). And while there may be advantages to “muddling through” a decision strategy (Fortun and Bernstein, 1998; Lindblom,1959), the common tendency toward sequential ad hoc decision making contains many pitfalls. Given the novel challenges and opportunities posed by many climate related decisions, and the often long time lags between actions and consequences, such ad hoc decision making could be a particularly poor means to address the criteria for an effective decision framework. In particular, it often fails to provide a systematic way to connect decision makers’ actions to their potential consequences. Economic Decision Frameworks The use of economic analysis to support decision making about climate change has a long tradition (Cline, 1992; Nordhaus, 1977) but gained considerable attention with the publication of the Stern Review and subsequent debate about the findings that the benefits of early action on climate change considerably outweigh the costs (Stern, 2007). An economic decision framework focuses on the costs and benefits of alternative actions. Economic frameworks are often supported by common tools or methods such as cost-benefit analysis, risk analysis, and integrated assessment models. Stern used economic analysis to compare the costs of reducing emissions with the damages associated with inaction. Economic decision frameworks have the advantage of providing a systematic structure for understanding the consequences of alternative decisions, in particular in complicated human systems when some actions may have surprising or counterintuitive consequences. In practice, however, economic analyses are often criticized for oversimplifying important aspects of climate related decisions, for example, by ignoring (or poorly representing) non-market values such as life or
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Informing an Effective Response to Climate Change BOX 3.6 Climate Response in the Insurance Industry: The Case of Swiss Re Swiss Re, a global reinsurer, derives 49 percent of premiums from its North American operations. Reinsurers create value by analyzing risks and providing coverage for those they judge to be insurable (Swiss Re, 2004). As a vital link in the risk chain, a reinsurer needs to be aware of how these risks may ultimately end up on its balance sheet. Climate change is a central concern because it undermines a fundamental assumption upon which (re)insurance is based: that the Earth’s systems, though somewhat unpredictable in the short term, are stable in the long-term. Thus, if insurers fear their risk estimates are increasingly imprecise, it may undermine their ability to properly price their products. Swiss Re has employed climatologists to work with its catastrophic business unit since the late 1980s and has interacted extensively with the climate science community. In 1994, it produced its first publication on climate change, Global Warming, Elements of Risk (Swiss Re, 1994), which was ground breaking because (1) it came from a financial services company and (2) it argued that the repercussions from climate change “could be enormous, with threats posed not only to citizens and enterprises, but also to whole cities and branches of the economy, even entire states and social systems.” Swiss Re’s risk management strategy includes the following elements: Advance knowledge and understanding of climate risks and, where relevant, integrate them into risk management and underwriting frameworks. As insurance companies define the parameters of climate change risk, they will potentially be able to partner with government to provide incentives to change behaviors. global reinsurers—Swiss Re and Munich Re—have been the most active on the issue by incorporating climate science into their models of natural catastrophes (see Box 3.6). Figure 3.3 illustrates computer-based catastrophe models being used by many private insurers. The increase in insured losses is a result of more people moving into harms way, higher property values, and to changes in the frequency of events. Government Insurance Programs The goals of major federal insurance programs differ from those of private insurers. Whereas private insurers seek to maintain their financial sustainability, the statutes governing the National Flood Insurance Program (NFIP) and the Federal Crop Insurance Program (FCIP) promote affordable coverage and broad participation by individuals at risk. The failure to apply a risk management model and to consider the implications of climate change may limit the effectiveness of these programs. Federal programs are not required to limit catastrophic risk strictly within the programs’ ability
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Informing an Effective Response to Climate Change Develop products and services to both mitigate and adapt to climate risk. An example is Swiss Re’s collaboration with the World Bank for a demonstration aid project that pays Malawi farmers up to $5 million, based on an index, if they suffer from a drought related shortfall in maize production (A report of the Economics of Climate Adaptation Working Group (2009). Raise awareness about climate change with clients, employees and the public and advocate a worldwide policy framework for climate change. Swiss Re sponsored the study Climate Change Futures: Health, Ecological and Economic Dimensions (Center for Health and the Global Environment, 2006), which explains the links between climate change and human health in 2005,a and A Report of the Economics of Shaping Climate Resilient Development: A Framework for Decision Makingb in 2009 (Economics of Climate Adaptation Working Group, 2009). Transparent annual emissions reporting to tackle the company’s carbon footprint. In October 2003, Swiss Re was the major company in the financial services industry to announce that it would reduce or offset its greenhouse gas emissions with a goal of becoming carbon neutral in 2013. a In partnership with the UNDP and the Center for Human Heath and the Global Environment at the Harvard Medical School. b In partnership with ClimateWorks Foundation, Global Environment Facility, European Commission, McKinsey & Company, The Rockefeller Foundation, and Standard Chartered Bank. to pay claims on an annual basis. One implication of this risk management approach is that there is little incentive to develop information on the potential risk of climate change. The government does not have the incentive to figure out what its losses will be. For example, if the insurance programs were to raise rates in areas that are at higher risk for the impacts of climate change, then this may in turn suppress development in those areas and be politically difficult to implement. However, escalating exposures to catastrophic weather events are already leaving the federal government at increased financial risk. According to a 2007 Government Accountability Office (GAO) study, taxpayer exposure has increased 26 fold to $44 billion since 1980 under the FCIP and quadrupled under the NFIP to nearly $1 trillion in 2005. The GAO (2007) report found that: Many major private insurers are incorporating some near-term elements of climate change into their risk management practices. One consequence is that, as these insurers seek to limit their own catastrophic risk exposure, they are transferring some of it to policyholders and to the public sector… Federal
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Informing an Effective Response to Climate Change FIGURE 3.3 The historical loss-based model and the catastrophe model are two computer-based models being used by many private insurers. SOURCE: GAO (2007). insurance programs, on the other hand, have done little to develop the kind of information needed to understand the programs’ long-term exposure to climate change… Consequently, neither program has had reason to develop information on their long-term exposure to the fiscal risks associated with climate change. This can come at high cost, and as costs increase there may be other, more effective policies, such as land use regulation, that can reduce vulnerability to risk. It is difficult, however, for policy makers to withdraw insurance support that helps particular interest groups or regions. In a changing climate, government insurers will need to analyze the implications for future insurance rates and identify prevention measures that may be taken to reduce climate exacerbated risks, such as floods, to prevent the average claimant from being a repeat claimant. Finance Sector: Risk Awareness and Management As noted in Chapter 2, the finance sector is using a risk management approach to include information about climate change in its investment strategies. To be included in financial statements, climate change risks must be quantified and given a transparent financial valuation. Financial reporting systems are the means by which investors, creditors, and others obtain the credible, transparent, and comparable financial information to make investment and credit decisions. A key element in the current financial crisis is inadequate and inconsistent regulation of financial markets, and particularly the insufficient availability of accurate information on risk exposure. Unfortunately, current U.S. accounting rules, disclosure requirements, and rating agencies do not
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Informing an Effective Response to Climate Change adequately factor in climate change into usable financial information (Doran and Zimmerman, 2009). Financial accounting offers a range of decision frameworks, methods, and tools for both emission reduction and adaptation strategies (KPMG, 2009). While major accounting firms have established climate change oriented advisory services, the accounting guidance for reporting contingent liabilities from potential climate exposure and for emissions reductions for U.S. companies is unclear. As a result, companies use different approaches from one another and sometimes even for different business units (IETA and PWC, 2007). Accounting frameworks are required for all types of emission reduction efforts. In 2008, the U.S. Financial Accounting Standards Board (FASB), whose mission is to improve accounting standards to assist decisions by the public, insurers, and other stakeholders, announced it was considering proposed rules for handling undisclosed potential liabilities. Climate and carbon exposure could fall under these proposed rules, but, as of April 2009, FASB had not reached any conclusions on the accounting questions related to measurement of tradable offsets in cap-and-trade emissions trading schemes. The International Accounting Standards Board is also considering accounting for assets and liabilities in emissions trading. Further integration of U.S. reporting systems into international accounting standards for carbon is required to enable multinational corporations to harmonize their accounting and to account for potential offsets from other jurisdictions, such as the Clean Development Mechanism. The Securities and Exchange Commission (SEC) provides key information for climate related decision support. Investors, banks, customers, risk managers, and regulators are increasingly seeing climate change as a threat and thus requesting disclosure of climate related risks directly from companies (Mills, 2009).5 Since 2004, a number of leading institutional investors coordinated by CERES6 have called on the SEC to eliminate any doubt that publicly traded companies should be disclosing the financial risks of global warming in securities filings, and they recently petitioned the SEC to require that material climate risks be disclosed under existing law (Young et al., 2009). In 2008, 5 For instance, investors have been filing shareholder resolutions requesting climate risk exposure for a number of years. Such resolutions hit an all-time record of 57 in 2008, as well as an all-time high of 25 percent of shareholders voting for the resolutions. 6 CERES is a national coalition of investors, environmental groups, and other public interest organizations working with companies to address sustainability challenges such as global climate change. CERES directs the Investor Network on Climate Risk, a group of more than 80 institutional investors from the United States and Europe managing approximately $7 trillion in assets.
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Informing an Effective Response to Climate Change two of the largest emitters of greenhouse gases in the United States agreed in settlements with the New York Attorney General’s Office to provide investors with detailed information on the financial risks posed by climate change. The settlements are the first binding agreements between government and private industry regarding climate change disclosure10-Ks (Kerschner, 2009). A Form 10-K is required to describe all issues material to a company. According to a survey of SEC filings (Fishel, 2006), nearly 100 percent of the electric utility sector and 80 percent of companies in the oil industry discuss climate change in their 10-K forms. In contrast, only 15 percent of U.S. insurers even mention climate change, leading investors to file a number of shareholder resolutions requesting disclosure of potential climate change exposure. Insurers are not heavy emitters of carbon; their financial exposure is mainly on the impact climate change will have on the property, flood, weather, crop, forestry, and business interruption policies they issue. In March 2009, the National Association of Insurance Commissioners (NAIC) adopted a mandatory requirement that insurance companies with annual premiums of $500 million disclose each year starting in May 2010 the financial risks they face from climate change and the actions the companies are taking to respond to those risks, including steps taken to engage and educate policy makers and policy holders. Independent ratings agencies are well established instruments for enhancing the transparency and efficiency of financial markets. Mainstream Rating agencies, such as Standard & Poor’s 500 (S&P 500), have a global low-carbon index to meet growing investor demands for environmentally focused indices. However, climate exposure ratings have not been factored into municipal or corporate bond ratings or in evaluation of Real Estate Investment Trusts in any substantial form. Determining the long-term viability of bonds or investment real estate is vital for the financial stability of the economy. In 2008, the world’s first independent carbon credit ratings service was launched, which provides credit ratings for carbon offset assets in both the international Kyoto mechanisms (the Clean Development Mechanism and Joint Implementation) and voluntary offset markets. Each asset studied is given a rating based on an analysis of the underlying project, leading to an assessment of the likelihood of it delivering its stated emissions reductions in the stated time period. In January 2010 the SEC decided to provide public companies with guidance on disclosure relating to climate change. The guidance suggests that climate change triggers disclosure in relation to the potential direct and indirect impact of climate change legislation, regulation and international accords, and to the potential physical impacts of climate change (SEC, 2010). If a company relies on fossil fuel based energy, legislation on greenhouse gases could affect future positions and should be disclosed.
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Informing an Effective Response to Climate Change If a company owns property or uses inputs which could be vulnerable to changes in climate, this is a relevant disclosure. The panel judges that this initial guidance on climate change risk disclosure requirement from the SEC will facilitate transparency and comparison of corporate exposure and provide information relevant to policy choices. THE UTILITY OF ADAPTIVE GOVERNANCE IN DECISION MAKING ABOUT CLIMATE CHANGE Adaptive management addresses uncertainty about the environment and human systems by consistently testing, monitoring, and revising policy assumptions and has strong links to iterative approaches to risk management. Adaptive governance extends these practical, problem-solving frameworks to policy institutions themselves (Box 3.7). Thus, adaptive governance can be a useful tool for Congress and state legislatures. The concept of adaptive governance is a foundation of American politics. The nation’s federal system provides 50 state laboratories for policy and institutional experimentation. For example, recent state-level efforts to implement cap-and-trade systems, and long-standing programs for energy efficiency, provide valuable experience that Congress can draw upon in fashioning a federal program for limiting emissions of greenhouse gases. Frequent elections and a commitment to unfettered public debate provide ample opportunities for assessing what policies and institutions are working and then changing those that are not. In practice, however, significant challenges face Congress and state legislatures in implementing adaptive governance for climate related decisions. By their nature, institutions are meant to cement particular policies and practices into place and to resist alteration. In addition, public officials address constituency needs and may not serve in office for long periods of time. Such stability is essential to the operation of markets, interactions among individuals, and other activities that form the basis of social life. In this vein, many U.S. firms are now advocating for federal regulation of greenhouse gas emissions. A key motivation is to obtain the “policy certainty” (USCAP, 2009) they need to more effectively plan their own long-term investments in technology, products, and infrastructure. But this need for certainty conflicts with the need for continuing learning and innovation. For example, most paths to a zero carbon economy will require significant regulatory innovation. The United States and other nations may create carbon markets and associated rules, regulations, verification processes, and related service industries. Nations may link these markets globally. The trade system may become involved, for example, through carbon tariffs, along with development agencies, public and private financial institutions, and other agencies. Implementing such policies will take decades and involve significant learning at every step to determine what
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Informing an Effective Response to Climate Change BOX 3.7 Targets Can Help Communicate Policy Goals and Motivate Appropriate Actions Adaptive governance often involves the use of targets to frame near and long-term policy goals, and targets are being used extensively in efforts to mitigate and respond to climate change. For instance, in 2009, the G-8 endorsed a target for not allowing the global mean surface temperature to rise more than 2°C above pre-industrial levels (G8 Fact Sheet on Climate Change). The United Nations Framework Convention on Climate Change calls for stabilization atmospheric levels of greenhouse gas concentrations at a level such as 450 ppm. States such as California have pledged to cap greenhouse gas emissions at 1990 levels by 2020 and 80 percent below 1990 levels by 2050 (Assembly Bill 32: California Global Warming Solutions Act of 2006; Caponi et al., 2008). Bills before the U.S. Congress employ similar emission reduction targets. Numerous scientific studies have explored the range of impacts that might be expected from various temperature, concentration, and emissions targets. However, there are also important questions regarding the ability of alternative types of targets to help communicate the goals of policy and to help motivate appropriate actions to achieve those goals. Such questions represent an important issue in any study of the best means to inform effective climate related decisions and actions. A number of modeling studies have examined the ability of different types of targets to provide appropriate feedback that can guide the evolution of an adaptive decision strategy for limiting greenhouse gas emissions. Given the large uncertainties in climate sensitivity, it is generally understood that a target that focuses on temperature suggests a very wide range of potential emission reduction paths and thus provides weak feedback for an adaptive strategy. Dowlatabadi and colleagues have shown that adaptive decision strategies that rely on temperature, as opposed to concentration targets, can prove unstable over time in the sense that the evolving science can first suggest increasing then decreasing then increasing again the necessary emission reduction rates. The advantage of temperature targets is that they may be more closely linked to actual impacts from climate change than targets based on emission reductions or atmospheric concentrations of greenhouse gases. Concentration and emission targets have the advantage of being more closely policies work and which do not, what technologies and practices are cost effective, and what society tends to regard as dangerous levels of climate change. While many actions need to be made in the near-term, efforts will be require sustained commitments many decades into the future. Lazarus (2009) notes the difficulty of setting the proper balance between policies sufficiently rigid to endure for the decades needed to stabilize atmospheric concentrations of greenhouse gases and sufficiently flexible to learn. He writes: The legislation [regulating U.S. emissions of greenhouse gases] must be sufficiently steadfast to resist, over the longer term, the constant barrage of pressures launched by economically and political powerful interests seeking
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Informing an Effective Response to Climate Change linked to human actions, that is, specific policies designed to reduce emissions. However, some have criticized some long-term emissions and concentration targets as appearing disconnected in most people’s minds from any necessity to take near-term actions. For instance, given the long lifetime of energy producing and using infrastructure, it may take significant actions over the next few decades, starting now, to meet an 80 percent emissions reduction goal by 2050. However, this fact may not be readily apparent to most people. In response to this potential problem and to emphasize equity issues between developed and developing countries, some have proposed using targets based on cumulative emissions (Allen et al., 2009). To our knowledge, there is little research that explores any differences in the ability of such targets to help people understand the climate change challenge and to motivate appropriate actions. Finally, there is some debate as to strengths and weaknesses of using any targets at all to motivate appropriate action. Lempert et al. (2009) describes the tension between stretch and legitimacy building goals. The former are intended to motivate people to achieve some difficult-to-obtain objective. Those setting the goals would be disappointed if the goals were often achieved, since that would be a sign that the bar was not set high enough. The latter are designed to demonstrate the competence of the goal setting organization. Thus, those setting the goals will endeavor to ensure that goals are set and responsibility assigned to reduce the chance of being blamed for missing the goals. Since limiting climate change will likely require stretch goals, but many political organizations will pursue legitimacy seeking goals, the use of targets as a primary means of communicating and implementing climate policy may suffer a serious tension between risking failure by promising more than can be delivered or failing to exploit potential opportunities by promising too little. Policy makers might reduce this tension by focusing more on creating strong incentives for emissions reductions, and building constituency, rather than particular targets to be reached. A recent NRC study, Climate Stabilization Targets: Emissions, Concentrations, and Impacts over Decades to Millennia (2010c), evaluates the implications of different atmospheric concentration target levels and describes the types and scales of impacts likely associated with different ranges, including discussion of the associated uncertainties, time scale of impacts, and potential serious or irreversible impacts. to delay and relax the law’s proscriptions for their own short-term gain. But it would be no less of a mistake for the law to be wholly inflexible and not subject to revision. Precisely because the effectiveness of any climate change law depends on its success over the long-term, the law must admit the possibility of significant legislative or regulatory change in light of new information and changing circumstances. Additional constraints result from the division of responsibility among different agencies, legislative committees, and branches of the Federal government and among different levels of federal, state, and local governments. Lazarus (2009) calls climate change law “no less than environmental law’s worst nightmare,” arguing that “[b]y fragmenting lawmaking authority and relying on short-term election cycles, we make
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Informing an Effective Response to Climate Change it almost impossible to form the political coalitions necessary to address long-term issues.” In particular, those most at risk from climate change, including future generations and those living in today’s developing countries, are much less well-represented by today’s elected officials than those who will pay any near-term costs. In addition, opponents of climate change policy and legislation, including those who will benefit from both non-action and from climate change itself, possess significant economic and political power; and the success of any U.S. emission reductions will ultimately depend on reductions in large developing nations like India and China. Addressing these challenges requires leadership, use-oriented science, networks that facilitate information flow across diverse agencies and organizations and across levels of governance, and institutional arrangements that are able to operate at different scales (Olsson et al., 2006). The panel describes in Appendix B that there are lessons to be learned from past experiences on responding to complex problems that face our nation such as ozone depletion, clean air, small pox, and the transcontinental railroad. Adaptive governance structures have emerged to deal with sector-specific climate related problems such as ecosystem, coastal, and water management (Scholz and Stitfel, 2005). New York, Los Angeles, Chicago, and many other communities have developed climate change mitigation and adaptation strategies that involve a mix of governmental and private sector entities (NRC, 2009a, 2010d,a). In other policy areas, Congress and state legislatures have successfully reformed institutions that remain both flexible and enduring over time. For example, the U.S. Social Security program and the 1965 Voting Rights Act (P.L. No. 89-100) have endured because each empowered groups with a strong interest in maintaining the program. Nurturing constituencies with an interest in addressing climate change may help enable effective adaptive governance in this area as well (Patashnik, 2003). Examples of constituencies that stand to benefit from a low-carbon economy include developers and vendors of low-carbon energy systems and investors in long-lived permits under a cap-and-trade system. Constituencies that could be mobilized to support climate change adaptation include the insurance and reinsurance industries, which stand to gain from programs that reduce losses from extreme events; health care professionals, particularly those concerned with the health of already at-risk populations; as well as social movements concerned with environmental quality, natural resource conservation, and ecosystem maintenance and restoration. Wiener (2009) argues that a key difference between a policy based on carbon taxes and one based on cap-and-trade is that the latter creates assets that can be used to provide incentives to nations that might otherwise be reluctant to join an international climate protection regime.
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Informing an Effective Response to Climate Change CONCLUSIONS AND RECOMMENDATIONS A variety of frameworks can be used for making decisions about climate change ranging from ad hoc response to politics and events to those based in only economics or science. Based on previous NRC reports, the research literature, and on the recent practices of both public and private actors, we have identified iterative risk management as a key element in the decision making process for making sound policy related to climate change because of the opportunities it offers for considering uncertainty and adjusting decisions to experience and new information. For government, as well as organizations such as environmental conservation groups, we find that adaptive governance also provides a useful approach to managing climate change risks, because it allows a revision of policies in response to evolving conditions, new information, and lessons learned. Climate related decisions confront a number of especially difficult challenges that include the expectation of surprise, the frequent need for long-term decision making, and the potential demands of crisis response. Addressing such challenges requires augmenting the basic iterative risk management framework, incorporating the objectives of multiple actors, using robustness criteria to help manage the deep uncertainties facing many climate related decisions, and embedding the framework in a broader process of institutional learning and adaptive governance. We find that the assumptions of a number of current decision frameworks may need to be revised given the risks of climate change. For example, the GAO (2007) has already noted that federal insurance programs such as Federal Crop Insurance and National Flood Insurance should take account of the long-term fiscal implications of climate change. The viability and costs of these programs will be seriously affected by climate change as well as policies and programs to manage and adapt to climate impacts and should be reviewed and revised in response to climate science and shifts in policies. Conservation activities by both governments and NGOs must also include climate change and climate policies in their decision frameworks, especially those for adaptation, in order to protect investments and respond to evolving climate risks. Businesses will need to address climate risks in their overall corporate decision strategies. Because most actors must respond to stakeholders, incorporating their views and feedback into decision making processes about climate can also be a useful component of decision frameworks. Our review of evolving frameworks for risk management in the financial sector suggests that many firms still do not take account of climate risks and that the lack of uniform accounting, disclosure, ratings, and reporting requirements is creating confu-
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Informing an Effective Response to Climate Change sion. We find that the proposals that the SEC (Securities and Exchange Commission) develop a clear financial disclosure requirement for climate change risks are likely to facilitate transparency and comparison of corporate exposure. Recommendation 3: Decision makers in both public and private sectors should implement an iterative risk management strategy to manage climate decisions and to identify potential climate damages, co-benefits, considerations of equity, societal attitudes to climate risk, and the availability of potential response options. Decisions and policies should be revised in light of new information, experience, and stakeholder input, and use the best available information and assessment base to underpin the risk management framework. There are important areas in which iterative risk management is already being used to manage climate risks. For example, the Federal government uses the Federal Crop Insurance Corporation (FCIC) and National Flood Insurance Program (NFIP) to share and reduce the risks of current weather variability for farmers and homeowners. However, the insurance programs do not take into account climate change, its impact on likely losses, and the fiscal implications. In the private sector, some firms already report on their management of environmental impacts to government and shareholders, but reporting can be inconsistent, and many firms still do not take into account climate risks (e.g., responsibility for emissions, policy uncertainty, and climate impacts) in their planning and disclosure. Recommendation 4: The federal government should review and revise federal risk insurance programs (such as FCIC and NFIP) to take into account the long-term fiscal and coverage implications of climate change. The panel endorses the steps that have already been taken to by federal financial and insurance regulators, such as the SEC, to facilitate the transparency and coordination of financial disclosure requirements for climate change risks.