Insure or Invest in Green Technologies to Protect Against Adverse Weather Events

Abstract

This paper analyses investments in green technologies when insurance is also an option. Green technologies are defined to have the power to increase productivity and decrease volatility of future revenues. The insurance options involve the scale and coverage either in a yield insurance or in an index insurance. The stochastic process is a combination of insurable stationary short-run process and non-stationary long run process. The optimal decision rules are solved numerically by stochastic dynamic programming. The results suggest that the index insurance maintains market based incentives to invest in green technologies whereas a yield insurance substantially decreases investments, as expected. An actuarially fair yield insurance decreases investments at high productivity firms. By contrast if the insurance premiums are supported to the extent that the net loading becomes negative, firms with the lowest productivity have strong incentives to collect the benefits of the subsidized insurance rather than invest in higher productivity and lower risks. The yield insurance is the most attractive for low productivity firms while the index insurance is the most attractive for high productivity firms. Nevertheless, the demand for actuarially fair index insurance is reduced also amongst the high productivity firms, when the correlation between the yield and the index falls below 50%.