The relationship between climate change and the insurance industry has been a favorite hobbyhorse of mine for over a decade, since I learned that Lloyd’s was closely studying the potential impact of climate change on insurance rates, profits, underwriting and the like. Good for the industry, I said then in my blog, for taking a proactive approach to a major threat to its business model. Beyond that, as I have written often, as goes insurance losses, insurance prices and the other economic disruptions caused by climate change, so too will go our collective economic, political and social willingness to respond to the crisis.

I wanted to briefly comment on this most recent article on the subject, from the Washington Post, concerning approval in California of increased homeowners’ premiums in exchange for continued or increased underwriting of risks in areas exposed to wildfire and other climate-based risks. It is interesting for at least two reasons that are worth noting. First, for some time now, the story – not just in California, but in other states, particularly Florida, as well – has been about insurers ceasing to write risks in a given state, given the losses due to climate related disasters. Now we are seeing the next and, for the market, hopeful step, which is the realigning of the financial models, including pricing, to allow for private insurance to step back into covering the risks. This is important because otherwise, only two realistic options exist, neither of them good: uninsured homes or state provided coverage.

Second, the story shows a state regulator and an insurer working together to align the increased costs of the exposure with the particular homeowners owning the at risk properties, rather than either the insurer abandoning the entire marketplace as a whole or transferring all of the costs of the risks to other insureds uniformly. While not entirely clear from the article, it appears that the rate increases are tied to the exposure of particular homes or areas, and a different article notes that the “rate hike also includes discounts for homeowners who take steps to reduce wildfire risks on their properties.” We know from the history of rebuilding in flood zones because of the availability of federal flood insurance that an absence of market discipline creates a moral hazard problem and reduces the incentive to act proactively to avoid future climate related losses. Allowing homeowners’ carriers to impose at least some market discipline with regard to the economic costs of climate change can only help drive sensible responses to climate change and sensible efforts to mitigate the harm from it, both economic and otherwise.

Now, that is not the end of the story, but it is close to it with regard to how much should be discussed in a single blog post. Allow me, though, to note that I am aware that allowing targeted premium increases directed to specific homeowners or small areas where property is particularly at risk is in tension with the underlying principle of insurance, which is to broadly share risks to reduce costs for all. I am also aware that it can result in large premium increases being imposed on some homeowners who cannot afford to carry it, because not all properties at increased risk of destruction from climate change are the beach houses of the rich. These are problems, however, with solutions or possible solutions, best discussed another day.

Enjoy Labor Day by the way!