Climate change is putting more people and property in harm’s way—and also exposing hard limits to the protection that property insurance can offer. Far too many people don’t have insurance against damage caused by flooding, wildfires, and intensifying storms, either because they are not aware of the risk they face, or because they cannot afford insurance. More people need insurance, but increasingly the climate crisis is making many places too risky to insure at reasonable rates. As the summer Danger Season gets underway, here are some thoughts about insurance in a warming world. I will unpack more as the season progresses.
Insurance is a vital tool, but it is not a panacea
When major disasters strike, the toll on people, homes, and infrastructure can be immense. Having access to insurance can be a huge help for communities struggling to recover and get back on their feet. Even ahead of disasters, insurance rates can help signal the level of risk in a particular place (all else equal, higher rates would signal greater exposure to risk), so people can make more informed decisions based on their risk tolerance. And insurance programs can also create incentives, through discounts on insurance rates, for taking precautionary actions—such as investments in floodproofing or fireproofing—to lower one’s risks.
In the U.S., most homeowner flood insurance is purchased through the taxpayer-backed National Flood Insurance Program administered by the Federal Emergency Management Agency (FEMA), although in the last decade the private flood insurance market has also been growing. Wildfire insurance is delivered mainly through private homeowner’s insurance. Many states also offer an option for insurance of last resort, so-called ‘FAIR’ plans, an insurance pool program with bare-bones insurance available at a lower cost for homeowners who may not be able to purchase insurance on the open market otherwise. Reinsurance and innovative approaches like catastrophe bonds and parametric insurance can also help expand the reach of insurance and the ability to be quickly responsive to extreme events.
Of course, this is how things should work theoretically. But there are longstanding gaps and failures in the insurance market—including the fact that many low-income and fixed-income homeowners struggle to pay for insurance and are often forced to go without; that subsidizing insurance without adequate risk disclosure can create perverse incentives that actually increase exposure to risk; and that split incentives between federal and state actors can also create challenges.
The increasingly untenable risks of climate change in many places have been highlighted by the recent news that State Farm and All State have stopped offering new homeowner’s insurance policies in the California market primarily due to growing costs of wildfires, and by the news of skyrocketing costs of flood insurance in Louisiana. Similarly, Hurricane Ian has exposed the precariousness of the Florida insurance market. Our nation’s history of racist and discriminatory housing policy—including mortgage redlining—as well as the current crisis of the lack of affordable, safe housing also result in the fact that some of the places most exposed to climate risks are also where low-income communities and communities of color live.
Globally, the situation is even more dire as most people in the Global South on the frontlines of climate change—such as the millions of people affected by the devastating floods in Pakistan last year—simply do not have any access to insurance.
Insurance is the ‘canary in the coal mine’ for climate change
The risks of climate change have long been recognized by the reinsurance industry—including SwissRe and Munich Re—but U.S.-based insurance companies have been slower to acknowledge them publicly until now. State Farm, which is the largest provider of homeowners insurance in California, attributed its decision to stop offering new policies in California to “historic increases in construction costs outpacing inflation, rapidly growing catastrophe exposure, and a challenging reinsurance market.” Even for major global reinsurers, the rising spate of extreme events worldwide is severely testing their profitability. A recent report from Moody’s notes that reinsurers are reacting by raising rates for primary insurers and even exiting markets. Florida and California stand out as among the most exposed insurance markets.
There are important specifics to keep in mind when examining public versus private insurance—including access, equity, affordability, taxpayer exposure, and options for investing in science-informed rate-setting—but all types of insurance are suffering from a similar challenge when it comes to climate change. Heated public debates on this topic fail to acknowledge that, with the fundamental underlying physical risks growing worse because of human-caused climate change, simply shifting from one form of insurance to another will not help address the root of the problem.
The conundrum we face is that, clearly, more people need insurance because the areas exposed to risks are growing rapidly, but at the same time insurance is also becoming more expensive and harder to get. Climate change is fueling hotter, drier conditions in the Western U.S. and, coupled with a history of poor forest and fire management and growing development in wildfire-prone areas, this is contributing to catastrophic fire seasons. The warming climate is also contributing to increased flooding in many places, through the increased risk of heavy rainfall events, intensifying storms, and sea level rise. These risks are worsened by the continued increase in development in flood zones. Local zoning laws that are out of step with climate risks, the desire for increasing development as a way to reap property taxes to fund local amenities, and continued subsidization of real estate markets in risky areas all contribute to the challenge too.
Insurance administrators, both public and private, have been relying on outdated models, driven by past data, in predicting risks and setting rates. With climate change, the past is no longer a good predictor for the future. Newer updated models that take climate projections into account are coming into use and more are being developed. NOAA and the NSF recently announced a new research center to help meet insurance industry data needs. FEMA, too, has implemented a new initiative called Risk Rating 2.0, using private sector data and tools, which it says would help it “deliver rates that are actuarily sound, equitable, easier to understand and better reflect a property’s flood risk.” However, the large resulting rate hikes have brought huge protests, and FEMA is now being sued by 10 states and dozens of municipalities.
The latest science shows a systematic increase in many types of climate risks, and these risks can coexist and compound in the same place. Instead of risk being random, with a distribution of the risk profile that is spread out, risks are increasingly shifting toward the high end, and skewing the distribution. That makes it harder to apply older actuarial tables to help calculate and spread the risk across a population or geography, and sustain a well-functioning insurance market. Growing climate-driven risks are also serving to make insurance much more expensive and putting it out of reach for many people.
For true climate resilience, science and equity must go hand-in-hand
Going forward, using the latest science to assess and project risks is critical to help protect people and property. Mid-to-long term projections can help people make choices about where to live, how much insurance coverage they need, and if/when to think about moving to a safer place. We also need seasonal and real-time maps and alerts, which are crucial to help get ready for Danger Season with protective measures and emergency plans that can also help lower insured losses. Insurance is one tool in the toolbox, where we can aim to incorporate science and help improve outcomes. But the time horizons most insurers consider are usually no more than 2-5 years out, so it certainly has its limits.
A more long-standing challenge that is equally important to address: insurance does not necessarily serve those who need it most. Low- and fixed-income families may not be able to afford insurance—or to invest in the protective measures it would take to lower their insurance rates—and they have the fewest resources to recover from disasters. Adding well-targeted affordability provisions to the NFIP, for example, is critical, especially as Risk Rating 2.0 causes rates to rise rapidly in some places. The National Academies of Sciences (NAS) has developed recommendations for this, FEMA has put forward an affordability framework and a package of legislative proposals for NFIP reauthorization that include affordability provisions, and Congress must now act to legislate them.
Of course, better risk modeling will only serve to highlight that, whether insurance markets reflect it or not, climate change is dangerously altering physical risks to people and property. So, we also need rapidly scaled-up and equitable investments in climate resilience, not just disaster recovery, that go well beyond what insurance can deliver. And we’ve got to do all we can to sharply cut heat-trapping emissions to limit runaway risks from climate change.
As the 2023 hurricane and wildfire seasons get underway, it’s important for people to check on their insurance coverage and look at the latest flood and wildfire risk maps for where they live. (Remember that fire-denuded landscapes are prone to mudslides and flooding.) And please also raise your voice to call on policymakers to support affordable, accessible, science-informed insurance as part of a broader suite of equitable climate resilience investments.