Natural disasters have cost the United States more than $ 600 billion in the past five years. With climate change, these costs are expected to continue to rise. In the future, the management and distribution of these harms will become increasingly important. Insurance is a tool to do it. Unfortunately, the insurance system is also threatened by climate change.
By modifying the underlying risk profile of certain insurance products, climate change threatens the economic model of insurers. At the same time, insurers also face risks as investors, as the assets of insurers may be overvalued due to unassigned weather risk. Improved data, research and resilience planning can contribute to a stronger and more equitable insurance system, while improved financial disclosure requirements can limit investment risk. As recently as last month, the New York State Department of Financial Services made great strides in addressing these issues by issuing guidance on how insurers are expected to incorporate climate risk assessment into their policies. operations and their investments. Further measures are needed.
Insurance works by pooling risks within a population. Essentially, policyholders pay in a pot. When an insured suffers a loss, he deducts the value of the pot. Because only a small number of policyholders are likely to suffer an insured loss during a given period, the money of the lucky policyholders covers the claims of the unlucky ones.
However, this system breaks down when a large part of the population suffers damage at the same time, as is the case with many climate-related events. Consider a forest fire, which can affect an entire region. In response, insurers can either raise premiums beyond what most Americans can afford or pull out of a high-risk market altogether, leaving gaps in coverage and reducing affordability (a trend alarming common to homeowners in California wildfire prone areas).
Underwriters and policyholders alike need better access to climate data in order to make informed decisions about climate risk. However, when private insurance is not cost effective, policymakers should consider how public insurance programs can play a role, with a view to designing such programs to distribute risk equitably. Along with this research, policymakers should consider how resilience measures can reduce damage from disasters, limiting overall risk in the first place. Federal Resilience Grants have been found to save the public $ 6 for every $ 1 spent.
However, underwriting risk is only one piece of the puzzle. Insurers are also large institutional investors, holding about $ 7.5 trillion (roughly one-third of U.S. gross domestic product) in cash and invested assets. As investors, insurers face and create climate risks by making investment decisions without fully considering the undervalued financial risks created by climate change.
For example, rising sea levels could mean coastal homes are worth less than they appear, and letting go of reliance on fossil fuels could indicate long-term oil assets of little value. . Just as mortgages were overvalued in 2008, experts fear that investors will ignore climate risk and, as a result, overvalue our economy’s assets, creating a climate bubble. This climate bubble means that insurance companies, their policyholders and their investors may find themselves on a much less stable financial footing than they realize.
Policymakers should take steps to uncover the risks hidden in insurers’ portfolios. Requiring insurers to identify and disclose climate risk in their portfolios is a necessary step. Disclosure would create a basis from which policymakers could consider how climate risk threatens the solvency of insurers and, from there, regulate the risk. This is important not only for insurers and policymakers, but for all Americans who rely on a well-functioning financial system.
Change is coming. On the investment side, a recent BlackRock survey found that 95% of insurers expect climate change to affect the way they build their investment portfolios. Regulators are also taking action, as evidenced by recent New York guidelines, by expecting insurers to analyze their weather risk as both underwriters and investors and report this risk to stakeholders.
These efforts are encouraging, but more urgently needed.
These solutions must be integrated in all 50 states. While insurance is regulated by the state, the Federal Insurance Office, created by the Dodd-Frank Act on Wall Street Reform and Consumer Protection, is responsible for overseeing the insurance industry and may play a role. essential role in giving States the tools they need to do the job. . By working with a coalition of advocacy groups, we have encouraged the agency to use its unique position to define and socialize best practices in this area, providing the insurance industry, policyholders and state regulators with better data. climate change, as well as to develop research on resilience efforts and the role of public insurance in risk allocation.
Climate risk can only be redistributed up to a certain point; Ultimately, the best tools in the fight against climate change are the decarbonization of the economy and investment in climate resilience measures. But, as climate risks escalate and the climate bubble expands, there is a need to align incentives in the insurance industry to avoid widespread defaults that would leave policyholders unprotected. When insurers are absent from the market, policymakers must also consider who bears the risk in society and how that burden can be shared. Other states should follow New York and take concrete action to protect consumers and investors.
Bridget Pals is a lawyer at the Institute for Policy Integrity at the New York University School of Law.
Michael Panfil is Senior Counsel and Director of Climate Risk Management Strategies at the Environmental Defense Fund