Understanding the Evolution and Future of Climate Insurance

Climate insurance began as a simple community agreement: if one farmer's crops failed, others would pitch in to help. This early form of mutual assistance laid the groundwork for what we have today. In the late 1800s and early 1900s, formal insurance policies started to take shape to protect farmers from the financial repercussions of lousy weather ruining their crops.

These first insurance policies looked directly at the damage to a farmer's field to determine settlement amounts. It was a tricky system with room for error and even outright dishonesty, which could lead to protracted arguments about money – the last thing a farmer needed after losing their crops.

The Modern Landscape of Weather-Related Risk

Weather insurance has become more important than ever in the wake of recent climate-related disasters. (By way of example, from 1980 to 2023, approximately $2.645 trillion has been lost in the U.S. due to weather and climate events.) Wildfires, floods, hurricanes, and droughts have exhausted insurance reserves and contributed to an inflationary spiral in claims costs due to rising prices for building materials and labor. Consequently, premiums have risen, leaving more and more insurers to contend with hard markets. 

In September, Scientific American published an article that cites climatologist Adam Smith’s observation that since the 1980s the U.S. has gone from experiencing billion-dollar disasters about once every three months to, in recent years, about every three weeks. According to the National and Oceanic and Atmospheric Administration (NOAA), as of this November 2023, 25 natural disasters throughout the U.S. have resulted in over $1 billion worth of damages. In total, these disasters have resulted in over $60.2 billion.

Insurers, and those operating in the broader risk-management sector, need to consider not only the overt destruction caused by storms but also the subtler yet pervasive impacts of other climate phenomena. For instance, there's a growing awareness of the need to account for the repercussions of heat waves, which, despite their devastating potential, have not traditionally been included in disaster tracking by agencies like NOAA. Over the last year, several regions across the U.S. experienced weeks of record-breaking temperatures, a trend that is expected to continue into the foreseeable future.

Furthermore, the last decade saw more flooding disasters in the U.S. than the previous three combined, reflecting an alarming trend further exacerbated by human settlement patterns. For instance, the drive towards coastal development has placed more people and infrastructure in the path of hurricanes, which has contributed to some of the most expensive disasters on record. This expansion, often occurring without the benefit of strictly enforced building codes, has amplified the risk of significant damage and loss of life.

Equally concerning is the insidious nature of wildfire smoke, which has recently extended its reach well beyond its point of origin. When smoke from Canadian wildfires blanketed large swathes of the U.S. over the summer of 2023, it deteriorated local air quality and hampered other economic activities such as construction. 

The Scientific American article quotes Samantha Montano, an assistant professor from the Massachusetts Maritime Academy, stating that investment in emergency management is "not even remotely keeping pace" with the escalating challenges posed by these disasters. 

“The 9th National Risk Assessment" by First Street Foundation also notes that the insurability crisis is deepening in regions prone to wildfires, hurricanes, and floods. The report highlights the increasing costs and damage from wildfire events in the West and more intense and frequent tropical cyclones along the Gulf Coast. Inland areas are also not spared, with a noted increase in precipitation-driven flooding that exceeds the current capacity of stormwater infrastructure.

The report further warns that wildfires will continue to affect residential areas, citing projections of an average annual destruction of around 33,753 structures over the next 30 years. This signals a dramatic uptick from the current figures and foreshadows a possible annual damage cost of around $24 billion by 2053.

Climate Insurance for Homeowners

Homebuyers are increasingly withdrawing from home coverage deals due to the scarcity and surging costs of home insurance. In places like Louisiana, large-scale risk mitigations such as stronger levees have been implemented, yet insurers have been hesitant to factor in the value of such preventative measures. As a result, some insurance companies have not reduced their prices or allowed these improvements to influence their underwriting practices. Notably, this isn't just a regional issue but a growing problem affecting property owners across the U.S. 

According to a new CNN article, in a recent survey of the California Association of Realtors, “only 7% of agents said they had deals fall through. But of those, a whopping 61% said the deal fell through because insurance was not available to the client. An additional 19% fell through because the premium was too expensive.”

Echoing these concerns, the First Street Foundation’s report points to a dramatic rise in non-renewals of insurance policies, particularly in the most at-risk areas, with some California zip codes seeing nearly an 800% increase between 2015 and 2021. The report also notes that in Florida and Louisiana, the state's "insurer of last resort" has seen substantial increases in policies and premiums due to a departure of top providers from the market, driven by the associated risks from catastrophic events.

This evolving weather-risk landscape creates a 'climate bubble' in the real estate market, where the true cost of climate impacts has yet to be fully integrated into property valuations. If current trends persist, we may see a significant adjustment in property values, particularly in regions deemed high-risk by insurers.

A Path Forward for Climate Insurance

The insurance sector must adapt to surging climate risks by rigorously updating its risk models, providing alternative risk capacity to serve underinsured and at-risk markets, and adopting risk management approaches that scale coverage for underserved stakeholders, such as parametric coverage Parametric insurance offers the benefit of using objective, third-party data triggers to settle claims quickly and transparently after a catastrophic weather event without the need for manual claims assessment.

The Arbol Approach 

Arbol was launched in 2018 with the mission of bringing forward-thinking climate solutions to market. Since our founding, we’ve invested heavily in building out a proprietary data infrastructure capable of modeling, in granular detail, sweeping as well as hyper local changes in climate patterns, in addition to the risks they pose to stakeholders. Accomplishing this requires the collective efforts of a wide pool of talent that runs the gamut from data scientists, to pricing experts, to financiers that can attract sources of non-traditional risk capital to the weather-risk management space.

We know that each business is unique, therefore we pride ourselves on working closely with our clients to understand the pain points that they face across their operations and investment portfolios, to tailor solutions that meet their needs. We have helped businesses across various industries – from agriculture, to energy, to hospitality –  reduce their climate exposure.  In sum, we endeavor to ensure that as the planet changes individuals and businesses are insured, informed, prepared, and resilient.

To learn more, we invite you to contact our climate-insurance experts here.