Regulatory Reform of the Insurance Industry in the Face of Rising Climate Risk
Reuters and the Financial Times reports that the industry industry is lobbying against the Federal Department of Treasury’s efforts to increase its access to data about how the insurance industry is affected by recent natural disasters. As I understand it, an office of the Treasury Department wants to access data for each insurer on how many policies it has outstanding in each zip code and how many of these policy owners have filed an insurance claim in the aftermath of each major recent natural disaster such as Hurricane Ian.
Such data would allow the Treasury Department to observe in real time which insurers are holding a “risky portfolio” in terms of ex-ante risk exposure and ex-post shock realizations. Permit me to explain.
First Street Foundation is a not profit that provides for each address and for each zip code its best prediction of each property’s future fire risk, flood risk and heat risk. A data scientist who can access the FSF data can measure the ex-ante risk exposure for an insurer’s portfolio.
Calculating this weighted average is useful for a regulator because the national regulator can then form a ranking of which insurers face the greatest ex-ante risk exposure and compare this to filed claims after natural disasters.
If an insurer is “over-exposed” to disaster risk, then this insurer faces bankruptcy risk and re-insurers and other entities who trade with it or are considering lending the insurer money or buying the insurer’s stock would want to know this updated risk information.
The recent news states that insurers do NOT want to share their geocoded portfolio of premiums data with the regulators. The news does a bad job of explaining why this is the case. The insurance industry mumbles about “regulatory costs of compliance” but a data scientist could comply with 2 minutes of work here.
What is Really Going on Here?
The insurance industry is saying that the states should continue to be in charge on insurance regulation. A cynic might have a “capture theory” in mind. Has the insurance industry already captured State Regulators to enact policies that help the industry? Would Federal Oversight challenge such a cozy status quo relationship?
Free Market Climate Change Adaptation
As I argue in my 2010 Climatopolis book and expand upon in my 2021 Adapting to Climate Change books, I want insurers in risky places (fire zones and flood zones and tornado zones) to price risk in an actuarial fair way. Insurance should be more expensive in riskier places! If an insurer “over-charges” then in a competitive industry, a rival will enter and will offer insurance at a lower price. This competition means that regulation and placing "price caps” on insurance isn’t needed to protect those who seek insurance.
For those who live in a fire zone, they should pay more for insurance but in a competitive industry they will be offered cheaper insurance if they take verifiable precautions that lower physical risks caused by extreme weather.
In states such as California, those who choose to live in fire zones are currently receiving subsidized insurance (the subsidies are shrouded!) and thus they are implicitly insured by everyone else in the state.
This is a classic Mancur Olson asymmetric pressure group case. As the social cost of these subsidies rise, I expect that we will observe reform and they will be phased out.
Why should people who live close to USC be subsidizing home ownership miles away in a fire zone?
As I discuss in my 2021 book, we need to up zone and change our land use zoning codes to build more housing in areas that are projected to face less climate risk going forward. This approach will reduce our risk exposure to extreme events. Fewer people will suffer and fewer assets will be destroyed. The insurance industry’s finances will be more resilient.