The role of insurance in climate adaptation


Tropical storms and hurricanes cause immediate and direct economic damage to communities and can also reduce a country’s economic growth for more than a decade. The models that determine climate policy in the United States have been criticized for ignoring the impacts of these extreme weather events over time.

A new study highlights a way to avoid the economic effects by promoting widespread public insurance for Americans. The research supports the growing movement to use insurance – a key tool for managing societal risk – as a form of climate adaptation.

“Insurance can be a major component of future climate change adaptation strategies.”

“Insurance can be a major part of future climate change adaptation strategies, at least in developed countries,” wrote a team of German economists behind the work. Climate adaptation aims to change and prepare society for the effects of climate change now and in the future.

Climate coverage

World leaders and scientists meet every year at the Conference of the Parties (COP) to discuss the challenges of climate change. At COP 2022“Climate risk insurance has been discussed as a primary measure to adapt to climate change,” said lead author and economist Christian Otto from the Potsdam Institute for Climate Impact Research.

Still, researchers debate the extent to which insurance can help. In general, insured economies grow more slowly than uninsured economies, Otto said. “It takes time to file an insurance claim. It takes time for the insurance payment to occur to rebuild things. It was an open question for us if insurance can actually be an effective way,” he explained.

To find out, the researchers created a growth model for a simplified US economy. The model tracked losses to the stock of physical assets (buildings, roads, machinery and other tangible items) as increasingly destructive storms made landfall. The model accounts for accumulated storm losses over time, capturing the fact that communities can still recover from one storm when another hits.

The hypothetical insurance scheme used in the model is a compulsory policy offered by the not-for-profit government which is available everywhere at a flat rate. The program uses the average rate of insured losses caused by US hurricanes over the past decades (50%) counted by the Natural Disaster Database NatCatSERVICE of the German insurance company Munich Re.

The United States does not currently have an insurance policy like this, although a close analog is the Federal Emergency Management Agency (FEMA) National Flood Insurance Program. But the program is not compulsory and is not accessible to everyone.

An economical cushion

In a simplified US economy, annual losses in economic growth are halved when half the US population is insured.

In the simplified US economy, past annual economic growth losses would have been halved with a mandatory insurance policy in place. The results also show that despite the supercharging storms of climate change, insurance could mitigate future economic growth losses for the United States.

The model calculates the average annual growth percentage of the economy after a storm compared to the growth of an economy without a storm. By disabling and enabling different types of insurance and coverage caps as well as the frequency and intensity of storms, the researchers determined the effectiveness of insurance as a climate adaptation tool.

In a 2°C warmer world, the percentage of direct asset losses covered by insurance should be increased to compensate for losses caused by storms fueled by climate change. Depending on how tropical storms evolve with a changing climate, insurance policies should cover 58% to 84% of direct asset losses, not 50%, the historical average. Those numbers “seem within reach,” Otto said.

But insurance has its limits, Otto said. Current policies are pushing us towards a 2.7°C warmer world, according to the Climate action tracking. In worst-case hurricane projections, 100% of direct asset losses would need to be covered to account for increased losses due to climate change. That’s unrealistic, says Otto.

Although the study suggests that better insurance coverage helps offset economic growth losses related to tropical storms in the United States, Otto stressed that their study could not take everything into account. Instead, they write, their work presents “an optimistic upper limit” of insurance to mitigate disasters.

The authors will continue to test the effectiveness of insurance in other countries. They published work in Scientists progress in January.

No one-size-fits-all solution

However, insurance would not be equally effective for all countries. The researchers repeated the analysis using the economy of Haiti, a hurricane-prone island with a much less developed insurance market than the United States.

According to the study, even with insurance that covers 100% of asset losses, the losses in economic growth are too great for the Haitian government to manage. Insurance coverage should be combined with other measures such as better housing standards, resilient infrastructure and community-led resettlement.

“The case of Haiti highlights the importance of international climate finance.

“The case of Haiti highlights the importance of international climate finance,” Otto said. One example is loss and damage relief, a term that describes the consequences of climate change beyond what humans can adapt to.

“The authors show that reducing the share of uninsured assets is a simple and effective way to mitigate the negative effects on growth they estimate,” the economist said. Francesco Lamperti at the Sant’Anna School of Advanced Studies in Pisa, Italy, and at the European Institute of Economics and Environment in Milan, Italy. Lamperti did not participate in the research.

“Otto and his co-authors are developing a simple, transparent, and elegant model,” Lamperti said. He particularly applauded the model’s ability to account for the cumulative effect of multiple storms in sequence.

Derek Lemoine, a University of Arizona environmental economist who was also not involved in the work, agreed but urged the researchers to go further. He said two areas of focus take into account the possibility of surviving infrastructure being less exposed after a storm and allowing new infrastructure to be less vulnerable when reconstructed.

“For stakeholders and decision-makers, I would emphasize that insurance can be an effective medium,” Otto said. “Every tenth of a degree of warming that we can avoid really counts towards the damage.”

—Jenessa Duncombe (@jrdscience), personal writer

Quote: Duncombe, J. (2023), The Role of Insurance in Climate Adaptation, Eos, 104, Published February 1, 2023.
Text © 2023. The authors. CC BY-NC-ND 3.0
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