We learned this week that July 4th’s average global temperature of 62.92 degrees Fahrenheit was the world’s hottest day since at least 1979, when the US National Centers for Environmental Prediction began keeping records, and potentially the hottest. in about 125,000 years.
And yet, in a world where even ExxonMobil acknowledges the reality of climate change and promotes that it is “Playing a leading role in the transition to a lower emissions future”, it seems that insurance “consumer advocates” are the most adamant group in their refusal to face the inevitability of adapting to a warmer planet.
For the insurance industry itself, there is no question that the effects of climate change are already here and that, as the world’s richest and most insured nation, the economic impact (but not the human cost) has been felt most acutely in the United States. States According to the United Nations’ World Meteorological OrganizationUS catastrophes have accounted for $1.7 trillion of the $4.3 trillion in economic damage caused by extreme weather, climate, and water-related events worldwide between 1970 and 2021.
Broker Aon PLC finds the US accounted for 75% last year $132 billion of global insured losses from natural disasters, led by the $50 to $55 billion in insured losses from Hurricane Ian. swissrewho found similar estimates, also notes that the 2022 totals were 45% higher than the 10-year average of $91 billion in insured losses, continuing a three-decade trend of insured losses growing between 5% and 7% per year.
These trends have been clearly reflected in market prices, with Guy Carpenter recently reporting that mid-2023 reinsurance renewals for US-owned catastrophic accounts were the highest in 17 years. They have also been reflected in the declining availability of property insurance in certain catastrophe-prone markets, as seen in the ongoing collapse of the Florida Homeowners Market and high-profile decisions by state farm and allstate stop writing new coverage on California ravaged by wildfires.
And also, unsurprisingly, insurance regulators around the world are looking, like the International Association of Insurance Supervisors. put it earlier this year by announcing the launch of an 18-month consultation on the topic, “a globally consistent supervisory response to climate change within the insurance sector.”
For his part, in response to President Joe Biden’s proposal Executive Order on Weather-Related Financial Riskthe Federal Insurance Office of the US Department of the Treasury. published a report offers 20 policy recommendations to improve insurance regulators’ oversight of weather-related risks. These include the possibility of creating charges in risk-based capital (RBC) formulas for floods, convective storms and other weather-related risks; enhance the capabilities of NAIC’s Catastrophe Modeling Center to help regulators better assess insurers’ weather-related risks; and move towards a single “materiality” standard for weather-related risks to be used in insurers’ own risk and solvency assessment (ORSA) summary reports.
FIO also proposes various information gathering measures that, depending on their levels of cost or intrusiveness, are likely to generate some pushback in the industry. But overall, suggestions to improve the way prudential supervisors incorporate climate risks are reasonable and almost certainly necessary, one way or another.
But in response to the FIO report, the United Policyholders group issued a declaration with its own set of recommendations, almost all of which amount to finding ways to suppress, delay, or ignore the price signals that guide consumers on how and where to build as we adapt to a changing climate. As United Policyholders states:
We oppose allowing insurers to pass reinsurance costs on to policyholders. Reinsurance rates are not regulated and fluctuate frequently. We also oppose allowing insurers unlimited use of predictive CAT models to set rates. Unlike rating tools that are based on historical facts and real weather and claims events, CAT models are developed by for-profit companies to sell to for-profit insurers. They apply prospective algorithms to project future losses. Its advocates are persuasive, but they have a history of declining availability and affordability.
It would seem obvious that catastrophe models that project, as climate science itself does, that future losses will be worse than past losses will have to be reflected in more expensive and less available coverage for those properties most at risk of loss. It seems equally obvious that, given such trends, rates based solely on “historical facts and actual weather and claims” will be insufficient. Sticking your head in the sand to pretend these weren’t facts about the world is tantamount to denying climate change itself.
This position extends to several of the other United Policyholders proposals. The group proposes that California “develop a high-value public catastrophic tier facility” to provide reinsurance to the California Earthquake Authority and the California FAIR Plan, and that Congress “begin to draft a national model for catastrophic disaster insurance.” disasters to provide a basic amount of essential housing, building code updates, and temporary housing expense coverage.”
Obviously, the driving principle here seems to be a widespread mistrust of business itself, as seen in the shadow cast on cat models for being “developed by for-profit companies to sell to for-profit insurers.” But more fundamentally, the only reason to propose public insurance and reinsurance facilities is to allow them to charge less than private sector companies would. And it is certainly true that governments can offer insurance products that are not “for profit,” because they can trust taxpayers to make up the difference between the cost of coverage and the claims that will ultimately accrue. We need look no further than the National Flood Insurance Program, which remains tens of billions of dollars in debt to American taxpayers.
But is it a good idea? Providing coverage at rates below those actuarially justified is tantamount to subsidizing choices for living in danger, rather than allowing those price signals to encourage people to strengthen their homes or ultimately move to places with less exposure to the types of disasters caused by climate change. will inevitably make it more expensive. Instead, we have seen the reverse trend, with Americans move to places with greater exposure to catastrophic risks. As researchers at the University of Vermont put it:
We find that, controlling for socioeconomic and environmental factors, people have been moving toward areas with higher wildfire risk and toward metropolitan areas with relatively hot summers. As climate change progresses, we can expect to see higher summer temperatures and an increased risk of wildfires, which means that if these migration trends continue, more and more people will be in danger from heat and fire. We hope our findings contribute to increased awareness of these growing dangers, while providing empirical evidence to guide planners and policymakers as they strategize for climate resilience and hazard preparedness.
Of course, insurance and reinsurance price signals could play an appropriate role in countering or reversing these settlement patterns, but regulatory schemes like California’s Proposition 103 seek to suppress them. In fact, California embodies the preferences of United policyholders by denying insurers the ability to reflect reinsurance costs and limiting their ability to use prospective catastrophe models. That’s why, even after the state’s extreme wildfires in 2018 and 2019, and despite just behind hawaii in median home prices, Californians in 2020 paid a annual average of $1,285 in homeowners insurance premiums across all policy types, less than the national average of $1,319.
Such regulations not only interfere with pricing mechanisms that might otherwise facilitate climate adaptation in implementing states, but researchers Sangmin Oh, Ishita Sen, and Ana-Maria Tenekedjieva find that they generate counterproductive cross-subsidies across the country:
Using two different identification strategies and novel data on regulatory filings and rates at the ZIP code level, we found that insurers in more regulated states adjust rates less frequently and to a lesser extent after experiencing losses. Importantly, they overcome these rate-setting frictions by adjusting rates in less-regulated states, consistent with insurer cross-subsidies between states. In the long run, these behaviors lead to a decoupling of risk rates, which implies distortions in the distribution of risk between states.
Adaptation to climate change will be a difficult and harrowing process with no shortage of political pain points. Governments will undoubtedly have a role to play in helping citizens with mitigation, relocation, and potentially even subsidies to finance the overwhelming costs of insurance. But it does not serve policyholders or society in general to ignore the information provided by the insurance markets, let alone the climate science that drives current catastrophe models.