Can insurance as we know it survive climate change?

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Graphic: Increasing insurance (un)natural disaster events, Source: Gallagher Re

Let’s hope so. Shrinking coverage and rising temperatures are a risky combination.

By Mark Harris

A Financial Storm Is Brewing

1. A growing protection gap. Adding up losses from Nat Cats and subtracting the amount that was insured gives your “protection gap.” This intuitive interactive tool from re-insurer Swiss Re illustrates the problem. A country with a small protection gap, like the UK at 21%, is well able to recover from climate disasters as individuals and businesses have funds to rebuild and reorganize. But in India and China, with protection gaps of over 90%, those affected by disasters can have their wealth completely wiped out. The really worrying news is that protection gaps globally have widened by 20% over the last five years, according to Swiss Re.2. The knowledge paradox. “Knowledge is a blessing and a curse to insurance,” writes University of London professor Paula Jarzabkowski in this surprisingly readable paper on disaster insurance. Insurers need to understand the true nature of risks before calculating premiums, but advances in climate science and weather modelling means they can now pinpoint the most dangerous places to live with some precision. “Insurers used to cross-subsidize people at highest risk out of ignorance because they didn’t know any better,” one insurer said. That’s no longer the case, so the people who most need climate insurance are finding their premiums sky-rocketing. Homeowners in hurricane-prone Florida pay an average of over $11,000 for home insurance—triple that of less vulnerable states. In the US, about 13% of homes have no insurance at all, and up to 40% in parts of Florida.

2. “Nat Cats” sound fuzzy and adorable. They’re not. Hurricanes, wildfires, flooding, extreme heat, and other natural catastrophes are now so common that the insurance industry has given them a cutesy nickname. In the year to September, the world experienced at least 51 separate Nat Cats that each caused a billion dollars or more in losses—nearly twice as many as a decade ago. Most of the damage came from storms, and that total doesn’t even include October’s Hurricane Milton blitz. “The fingerprints of climate change continue to become more evident on individual events,” wrote insurance consultancy Gallagher.

The basic premise of insurance is that the premiums of the many pay for the losses of the few. But what happens when the few become the many, and losses reach for the sky?

In one scenario, vulnerable parts of the world become completely uninsurable, and economic and/or natural forces dismantle communities. Adaptation happens, but it’s painful. In another, insurance is just too big and too useful to fail—it reinvents itself as a positive force in our struggle to thrive on a warming planet.
3. When the going gets tough, insurers go away. Even if you can afford the premium, coverage for some risks can be impossible to find. In this informative op-ed at The Conversation, business professor Andrew Hoffman from the University of Michigan lays out the challenge: “Seven of the top 12 insurance carriers have either cut existing homeowners policies or stopped selling new ones in the wildfire-prone California homeowner market, and an equal number have pulled back from the Florida market due to the increasing cost of hurricanes.” That has led to the emergence of “insurance deserts,” where commercial insurance is not available at any price.

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Insurance Is Too Big To Fail: Time To Get Creative

1. A quasi-public market. Many developed nations have an insurer of last resort. In the US, so-called FAIR plans in some states offer limited insurance for catastrophic events at high premiums, backed by the local government. In geologically-active New Zealand, all homeowners pay a natural hazards levy that covers the first $175,000 (US) of damages from earthquakes, storms or flooding, keeping top-up private insurance affordable. These protection gap entities can “make a positive, large, and indeed crucial difference in recovery from disaster,” says Professor Jarzabkowski. But they can also be controversial. California recently changed its rules so that extreme fire or storm losses would leave the rest of the state’s home-owners on the hook to bailout its FAIR plan.

2. The resilience discount. By 2010, most insurance companies had stopped writing policies along the hurricane-whipped Alabama coast. Then the state established a program to lure them back. Licensing fees on insurance agents paid for a program to windproof homes, and the state forced insurers to offer discounted premiums to anyone who participated. Although insurers initially disliked the measure, they eventually embraced it, according to a report in US News. Alabama now has 80% of the nation’s fortified homes, and similar efforts are underway in Minnesota, South Carolina, Connecticut and Kentucky.

3. Parametric possibilities. Insurance traditionally covers your actual losses. But as anyone who’s ever claimed for a leaking pipe or a crumpled fender knows, the loss adjustment process can be onerous and glacially slow. Multiply that by a Class 5 hurricane or fire-storm hitting a city and you can imagine how long each claim might take. Parametric insurance is a recent innovation that instead automatically pays out when certain conditions are met. You can buy parametric tornado insurance that will pay out if your home is on a National Weather Service tornado track, or earthquake insurance that delivers if the ground shakes at a certain speed. On a wider scale, farmers can buy parametric insurance when the weather is too hot, cold, wet, or dry, or if crop yields in an area drop by a certain amount.

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What To Keep An Eye On

 

1. Disaster payouts. As Nat Cats continue to surge, don’t expect disaster response agencies to replace insurance. In the US, FEMA has purchased over 40,000 flood-prone properties in the last three decades, but rising waters will threaten millions more homes by 2050, according to climate modelers at the First Street Foundation. That could test the nation’s will to bail out climate-denying condo owners on Florida’s beach fronts.

2. Attaching strings to aid. After Gatineau, Quebec experienced two “100-year” floods within three years, the provincial government required home-owners who received financial aid to either leave the flood zone or, if they chose to rebuild, give up any claim to future payouts, reports the Washington Post. The concept of “managed retreat” of coastal communities is now considered a credible solution to sea level rise, according to insurer Zurich.

3. Insuring against dodgy offsets. It’s no secret that some voluntary carbon offset programs fail to deliver, whether from fraud, mismanagement, or simply a forestry project burning down. Buyers can now buy insurance that will pay out if an offset program doesn’t live up to its promise, perhaps allowing them to purchase better credits elsewhere. Whether these policies will work is still up in the air, reports Insurance Journal, but some experts feel it could bring stability and credibility to an industry that’s had a tough few years.
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