[Disclaimer: this post could be a little depressing.]

I think climate change is a fascinating subject. I know, I know–it may seem morbid to be fascinated by something that promises to be (and perhaps already is) such a destructive force. But what intrigues me is not the potential devastation, but humankind’s response to this challenge–and on a more specific level, the insurance industry’s response.

Insurance is all about managing risk. You are managing risk when you buy a policy, and insurers are doing the same when they issue one. If the latter party thinks something (or someone) is risky, they charge more–partly because they need to have enough cash on hand when when 16-year-old Johnny totals the family station wagon or when a hurricane comes trundling down Hurricane Alley.

If you believe the science of climate change, it looks like we’re in for a bumpy ride - one that’s fraught with risks, both known and unknown.

The insurance industry is particularly adept at managing that first kind of risk. They know that from looking at their records that Johnny is probably going to roll stops signs more often than his 75-year-old grandmother. They know that homes built in the Gulf Coast are more likely to be flattened than ones in built in Connecticut.

While insurers are good at poring over the historical record, they’re not quite as good at looking into the crystal ball, which is where we all need to be looking in order to prepare for the effects of climate change. Sure, we have the geologic record, which can tell us about previous warming periods, but that’s pretty difficult to draw practical conclusions from. Besides, human-caused warming is new territory.

Recently, Allianz, an international insurance and investment services provider, and the World Wildlife Fund (WWF) published a paper entitled: “Climate Change and Insurance: An Agenda for Action in the United States.” According to the report:

For U.S. insurers, past events continue to form the basis for catastrophic risk modeling and weather-event planning, despite the fact that the science indicates that the future for many years to come is going to be significantly different from the past as a result of anthropogenic climate change.

The folly of the current approach is pretty clear: it’s like driving a car by looking in the rearview mirror. If the road is perfectly straight and wide–and the risks known and accounted for–driving in this way is in fact possible. But what if you don’t know the road and it’s windy and narrow?

O.k., it’s a clunky analogy, but you get the point: insurers need to look to the future as well as the past when they decide how much risk to take on.

As the report notes, re-insurers are already doing this. (Re-insurers are the insurers of the insurance companies.) The result, perhaps not surprisingly, is that they are charging insurance companies more.

Here’s the rub: When the federal government and/or insurance companies underestimate the amount of risk they take on–or when state legislatures mandate artificially low premiums that don’t reflect the real amount of risk–we all lose. Because eventually there will be a correction, and premiums will rise accordingly. The problem is that by that time we’ve already settled into our condos on the waterfront and are used to paying artificially low premiums.

The Allianz-WWF report says the National Flood Program (NFIP) is a case in point. The NFIP charges artificially low premiums–something that keeps homeowners happy but is not a sustainable policy. According to the report, the artificially low premium sends the wrong message to homeowners, essentially saying that there is little risk in building in a flood prone area.

“The program also makes payments to consumers who have failed to pay premiums, and to homeowners who continue to build, over and over again in high risk areas,” the report notes. “Some 120,000 properties have received multiple payments from NFIP, costing U.S. taxpayers about $7.75 billon. 26,000 of those have received four or more payments.”

The NFIP is $21 billion in debt. What does that mean? If the past is any indication, a correction is somewhere around the corner.

Read the entire Allianz-WWF report here.