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Could climate risk insurance be the answer to the massive economic loss of climate catastrophes?


Winds from a hurricane splashes a wave on a coast and several palm trees are being blown.
Image credit: Wix

2022 was a year of climate disaster. Of the top ten costliest extreme weather events, each amounted to at least $3 billion in damage on top of the insurmountable human loss and environmental damage.


The most expensive of these disasters was Hurricane Ian. Late last September, its 150-mile-per-hour winds ravaged Cuba, Florida, and other parts of the Caribbean, South America, and the Southeast United States. The total economic toll was more than $100 billion.


Last year’s second costliest natural disaster was the floods that submerged Pakistan in June, displacing 7 million people and resulting in more than $30 billion in damages.


Only $5.6 billion was covered by insurance.


Back in the states, Hurricane Ian pushed Florida’s unstable home insurance market closer to collapse. The storm was one of the largest insured loss events in U.S. history, piling on the $120 billion in insured losses hurricanes and floods caused in 2022.


In the wake of Ian, Floridians saw massive price hikes on top of already higher-than-average premiums and struggled with insurance claims payouts. Insurers saw billions lost to the storm only for the deadly winds to push them out of The Sunshine State.


Climate change is intensifying disasters globally, but in the United States specifically, global warming is expected to lead to the accumulation of particularly harsh hurricanes and storms, already seen in Hurricane Ian, Hurricane Fiona, and the deadly storms currently deluging California.


Aside from direct losses, research shows that tropical storms can substantially reduce the economic growth of affected countries for more than a decade.


As researchers of a recent study at the Potsdam Institute for Climate Impact Research (PIK) show, the economic loss of climate change is rising with temperatures. Thus, to mitigate the loss, the researchers posit that climate risk insurance could effectively pay this bill.


Between 1980 and 2014, hurricanes cost the U.S. more than $400 billion in direct economic losses, peaking in 2005 when the $150 billion Hurricane Katrina made its landfall. Published in the journal Science Advances, the PIK study examines the effectiveness of climate risk insurance in the U.S. in mitigating high costs like that of Katrina, Ian, and Fiona.


"After intense storms with high direct economic losses, the economy may need several years to recover, such that a complete recovery may not always be possible between subsequent intense storms. Our model accounts for these long-term effects of tropical cyclones on economic development that can be much larger than the immediate effects," explains Christian Otto, PIK scientist and one of the lead authors of the study.


For the study, the researchers assessed both the effectiveness and limitations of implementing insurance as an adaptation policy. The results show that comprehensive, tax-financed climate risk insurance accelerates economic recovery, and is thus an effective tool to mitigate climate-change-induced increases in economic losses.


A recent analysis by McKinsey and Company is in agreement, showing that by playing a more significant role in reducing risks and losses, climate-focused risk engineering is an attractive entry point for insurers, for both their financial benefit and in order to remain affordable for customers. This could be necessary, as the insurance industry is already feeling the heat of unaffordability due to climate change.


Still, there are caveats. The authors stress that in addition to climate adaptation, a rapid and massive reduction of greenhouse gas emissions is key to mitigating climate change-induced losses in the long run.


“Current climate protection policies are insufficient to meet the agreed 'well below 2° Celsius warming limit but may rather lead to 2.7° Celsius of warming,” Katja Frieler co-author of the study said in a statement.

“In consequence, U.S. growth losses could more than double compared to a Paris-compatible 2° Celsius scenario and increase more than sixfold compared to the historical period” of 1980-2014.


Plus, the authors note that while climate risk insurance would help mitigate loss in the U.S., the same can't be said for developing countries. For example, even if U.S.-level national climate insurance is implemented in the small island nation of Haiti, which is routinely affected by strong hurricanes, the losses would still be six times higher.


Thus, the researchers say that their findings demonstrate the importance of international climate finance to help strongly affected developing countries to cope with disastrous climate change impacts.


Plus, while better climate risk insurance may help as an adaptation strategy in the states, it can only be one in what Otto calls, a “broad portfolio of other adaptation measures such as investments in better building standards and resilient infrastructure.”


Several startups are making an effort to be a part of a solution that operates at the nexus of better climate-risk insurance and diversified adaptation.


While the federal government is the largest provider of flood insurance in the country through the National Flood Insurance Program (NFIP), millions of homes, including a significant portion of those impacted by Hurricane Ian, are not included in insurance maps made by the Federal Emergency Management Agency (FEMA).


According to an assessment by the First Street Foundation, there are 5.9 million at-risk U.S. properties absent from the maps, making up 76% of the country’s flood risk. Plus, communities of color are more likely to be both impacted and absent from the maps. In short, FEMA has a data gap.


According to McKinsey and Company, one potential solution to the data gap and the need for insurance as an adaptation strategy is for insurers to partner with data and analytics providers for risk modeling. Startups are combining this model to provide both data and insurance. One example is Cloud to Street whose satellite flood-tracking intelligence platform has enabled the United Nations and several national governments to improve flood disaster response.


Cloud to Street is one of many startups using data and machine learning to calculate climate risks including tornado-insurance startup Sola, hyperlocal climate risk engine Understory, Mitigrate which partners with banks and insurers, and Descartes Underwriting, which is helping businesses bounce back quicker after natural disasters.


Kettle is another startup using machine learning for climate risk, but instead of being consumer or business-facing, the startup reinsurers insurers for wildfires and other catastrophic events, providing what they call a new model for insurance companies that changes with the climate.


Others have emerged as facilitators in the wake of natural disasters such as Raincoat which launched in response to Hurricane Maria in Puerto Rico. Raincoat instantly processes claims after catastrophic weather events, covering not just property damage but also anticipated lost income.


Another startup operating post-disaster is Dorothy which is addressing the often extensive time it takes for FEMA to address disaster claims made by homeowners and small businesses.


Startups are stepping in where research shows they are needed. Still, there are a number of issues that startups likely cannot overcome, hindering insurance from acting as an adaptation measure.


As Hannah Perls, a Harvard Law expert, points out, more needs to be done to directly address the host of existing issues that are outside of the scope of insurance. These include FEMA’s outdated flood maps, displacement due to climate gentrification, and the fact that Florida law (among many others) does not require a seller to disclose a flood risk or past environmental damage to buyers.


Consequently, in rethinking the approach to insurance, Perls posits that people “look for and invest in community-led, long-term planning processes that assess climate change-related risks in the context of other adaptation goals."


Startup-led innovation in insurance can only go so far, from increasing access and making it more affordable, to expediting the payout process and making cash available in the wake of disaster.


As climate change worsens, the researchers at PIK show that insurance could help pay the bill instead of crippling the economy. But, as the U.S. insurance industry falls behind in the era of climate disaster, change is needed from all sides to realize the potential insurance has as an adaptation measure.


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