Introduction and summary
Over the past year, the United States has experienced a series of destructive natural catastrophes. For example, 2025 began with weekslong wildfires affecting Los Angeles and its surrounding areas, taking the lives of 29 people; burning more than 58,000 acres of land; destroying 16,000 homes, businesses, and other structures;1 and displacing more than 100,000 residents.2 In September 2024, Hurricane Helene demolished the American Southeast,3 with destruction not only ravaging the coastlines but also devastating inland areas. Many residents believed that Asheville, North Carolina, situated in the Blue Ridge Mountains, was a “climate haven.”4 But this “one-in-one-thousand-year event”5 resulted in unprecedented flooding6 that took more than 100 lives, caused millions to lose power,7 and destroyed crucial infrastructure and hundreds of roads.8
Due to climate change, events such as the Los Angeles wildfires and Hurricane Helene are becoming more frequent and intense.9 In 2024, the United States sustained 27 different billion-dollar weather and climate disasters, totaling $183 billion in damage.10 Clearly, the physical world has changed, the cost of climate-related events is increasing, and more must be done to lower these risks and move away from carbon-intensive activities worsening these conditions.
Climate change-fueled extreme weather events strain household finances, in part, through their impact on insurance markets. By taking on risk and paying out claims for covered losses, the insurance sector enables households and businesses to recover financially in whole or in part from catastrophic events. But insurers are responding to heightened losses by reducing coverage, exiting high-risk markets, and dramatically raising premiums. For many, insurance coverage is unavailable or unaffordable, leaving them unprotected from disaster. As former California Insurance Commissioner Dave Jones has warned, “We’re marching steadily toward an uninsurable future.”11
A faltering insurance market comes at significant personal and economic costs. Continued service pullbacks will disproportionately harm low-income communities and communities of color, who are most likely to live in climate-vulnerable geographies, are the least able to prepare for and recover from natural disasters, and have long had the fewest insurance options.12 Further dysfunction will affect economic activity broadly, particularly as insurers’ risk-bearing role in mortgage markets becomes less dependable. As climate conditions are expected to worsen, it is reasonable to assume that insurance challenges will persist.13
As costs from extreme weather events are increasingly difficult to insure, governments are relying on programs designed to allocate these losses more widely. Examples of this risk spreading include Fair Access to Insurance Requirements (FAIR) plans established by state governments, which can seek after-event revenue when needed from insurance companies and, in some cases, may be passed through to companies’ policyholders, and the federal government’s National Flood Insurance Program (NFIP), which uses federal tax revenue to subsidize uninsurable flood losses that are not met from program premiums.
This report discusses how heightened, correlated losses from extreme weather events have impeded insurers’ capacity to adequately diversify risks, resulting in coverage reductions and a growing share of homes and infrastructure vulnerable to major economic losses from future disasters. To improve insurance availability and affordability challenges, policymakers should consider solutions that reduce the risk of loss and protect communities from climate disasters; provide better public climate-related risk data and analysis to guide households, insurers, and government actors; and enable a strong financial system that can withstand shocks and serve the economy. In balancing the allocation of climate costs and spreading risk, policymakers must weigh complex and, at times, competing incentives.
Rising insurance costs and reduced availability are market signals of increased physical risks from climate disasters
Insurance serves several important economic functions. By purchasing an insurance policy, households and businesses can transfer the risk of future damage onto insurers and obtain coverage for losses they might otherwise be unable to handle financially. This allows policyholders to protect their financial well-being and helps preserve economic activity more broadly.
Insurance is central to the ability of many to purchase homes and to build wealth. Mortgage lenders generally require borrowers to purchase sufficient insurance to cover a home’s full replacement cost.14 Doing so protects the lender against potential default if the home is damaged or destroyed. Nearly $13 trillion of outstanding household mortgage debt relies, in part, on insurance coverage.15 Without insurance, banks, taking on greater risk, would charge more interest on mortgage loans. Borrowing costs would rise, and the size and liquidity of the mortgage market would likely decline as fewer households could afford mortgages. In his February 2025 testimony before the Senate Banking, Housing, and Urban Affairs Committee, Federal Reserve Chair Jerome Powell warned of the pullback from insurers and banks: “If you fast forward 10 or 15 years, there will be regions of the country where you can’t get a mortgage, there won’t be ATMs, banks won’t have branches and things like that.”16
Insurance is also important to preserve the market value of existing properties. Rising insurance rates, or a lack of coverage altogether, increase household operating costs in the immediate term and imply future catastrophic risk in the longer term. These factors discourage prospective buyers, thus decreasing demand and lowering home values. A 2025 report by First Street Foundation projects $1.47 trillion in net property value losses over the next 30 years due to “insurance pressures and shifting consumer demand.”17
The cost and availability of insurance coverage also provide important market signals about the scale of expected loss. Insurance is a business based on pooling financial risk. Policyholders pay a premium determined, in part, by the expected losses for all insureds, as well as the relative risk their home faces. The combined premiums are used to compensate those who experience a covered loss. Premiums need to be set at a level that allows sufficient reserves to be built up over time from all policyholder payments—both from those who experience a disaster and those who do not—to pay for losses.
Insurers, unable to adequately diversify large, correlated climate risks, are reducing coverage
A central way of lowering the cost of insurance is to diversify exposure across insureds. This occurs when losses are not correlated—that is, when the likelihood of individual policyholders’ covered losses is independent of the likelihood of other policyholders’ losses. Where risks are not correlated, large risk pools mean that realized losses are less likely to be higher or lower than estimated averages across the whole pool. Insurers have more confidence about the size of total losses for the whole pool they may need to cover. This confidence enables them to charge lower premiums to handle the range of possible outcomes. This also helps create more competitive conditions that benefit customers. Where many insurers are vying for business, insurance premiums will be driven toward the level of expected losses in the pool of insureds, plus amounts to cover operational costs and reasonable profits for the insurer.18
However, as climate-related disasters become more frequent and intense, and given that losses from these events tend to be costly and geographically correlated, the diversification benefits from pooling are reduced. Catastrophes are increasingly being felt throughout the country, further limiting insurers’ ability to diversify risks across different markets.
Climate change is upending historical patterns, increasing the incidence of catastrophic events that have long been considered low probability (also called “tail risk” events).19 Indeed, insured losses in the United States reached $112.7 billion in 2024, a 36 percent increase over the prior year.20 As the likelihood of extreme, correlated losses grows, insurers are reducing coverage; raising premiums; and retreating from risky markets, spurring availability and affordability challenges.21 In recent years, for example, several insurers announced they would stop writing new policies in California and Florida.22 A Senate Budget Committee investigation also found that in various parts of the country—including in areas not generally thought of as being most vulnerable to the effects of climate change, such as southern New England—policy nonrenewal rates are increasing.23 Moreover, novel academic research calculating households’ insurance expenditures from mortgage escrow information found that premiums shot up by an average of 33 percent from 2020 to 2023.24
Insurers attempt to diversify their exposure to tail risks by shifting some of it to global reinsurers, which provide insurance to insurance companies. Reinsurers cover a very large and more diversified risk pool than is generally available to insurers. While an insurer must pay for reinsurance, buying it reduces the likelihood of being forced to cover large losses. Under competitive conditions, this can reduce the premiums that the insurer charges.
However, reinsurance premiums have also risen sharply as extreme weather, exacerbated by global climate change, has expanded the scale and correlation of property losses worldwide. By some estimates, property reinsurance rates in the United States rose between 45 percent and 100 percent in 2023 alone.25 These reinsurance costs are typically passed through to insurance premiums charged to consumers.
The declining ability to diversify risk has led insurers to sharply raise premiums throughout the United States, but especially in those communities most exposed to climate risk. A recent report from the U.S. Department of the Treasury found that insurance premiums are outpacing inflation. From 2018 to 2022, those living in areas most affected by disasters saw premiums rise 14.7 percent faster than inflation compared with the national average of 8.7 percent.26
Simplified example of risk diversification
Insurance Company A operates in two regions. Region 1 is a coastal area at risk of hurricanes and Region 2 is heavily forested and at risk of wildfires.
Under ideal conditions
While disasters occur in both regions, they correspond with historical predictions and are uncorrelated. This risk diversification allows Insurance Company A to price premiums with greater certainty. Insureds in both regions pay premiums relative to their own risk and the risk of the broader pool. Insurance is affordable, so all homeowners in both regions purchase coverage, not just those most at risk of disaster.
One year, a hurricane hits Region 1. The hurricane is confined to Region 1 and does not affect policyholders in Region 2. The pool is geographically diverse and balanced among those least and most at risk, so Insurance Company A can pay out claims without draining reserves or relying on reinsurance. Insurance Company A can continue offering services in both regions at reasonable rates.
Under conditions strained by climate change
Due to climate change, disasters in regions 1 and 2 are becoming more erratic and frequent. Year over year, regions 1 and 2 are experiencing record-breaking losses from hurricanes and wildfires, respectively. Disaster is affecting a greater share of insureds in both regions at the same time.
Insurance Company A has raised premiums to account for the increased uncertainty and heightened losses. However, it is still unable to collect enough premiums to pay claims from its reserves. Insurance Company A purchases global reinsurance coverage to backstop losses. Since catastrophes are on the rise throughout the world, reinsurance is expensive. Insurance Company A may pass those costs along to its policyholders, exacerbating affordability concerns. Many policyholders are priced out of insurance, shrinking the size of the pool. Those who perceive themselves to be at lower risk may choose to forgo insurance cover or to self-insure. Only the highest-risk policyholders are willing to insure, generating a “death spiral” that further strains the market.
The insurance industry has pointed to regulation as a driver of market dysfunction. In states such as California, where insurers are required to justify their rates to regulators, insurers have argued they cannot raise rates fast enough to cover significant losses from climate disasters, causing them to retreat from those states.27 But blaming regulation may be easier than explaining that climate change is driving the inability to diversify risks. Regulators in Florida, for example, have approved private insurance rate increases of up to four times the national average, and the state government has enacted a host of deregulatory laws sought by the insurance industry to reduce their costs.28 Despite these actions, national insurance companies have exited the Florida insurance market,29 and the market has been left to lower-rated regional or state-based insurers. Nine Florida insurers failed between 2021 and 2023.30
Declining insurance coverage has profound personal and economic effects
For many middle-class Americans, their home is their most valuable asset. However, the soaring cost of property insurance has made protecting that asset prohibitively expensive. As insurance becomes increasingly out of reach, more and more homeowners are forgoing insurance coverage.31 In addition, households in the riskiest areas are being dropped by their insurers and having their policies canceled for missed payments at a higher rate than those in other areas.32 A 2024 Consumer Federation of America analysis found that 1 in 13 homeowners is uninsured, leaving “at least $1.6 trillion in unprotected market value.”33
Climate change and escalating insurance costs are widening economic inequality. The United States’ sordid history of racist housing practices, the effects of which still resonate today, is being amplified by climate change. The flood risk maps of many major cities resemble the redlining maps of the 1930s that served as the basis for the systematic denial of financial services to specific geographies based on their racial makeups and disproportionately affected Black communities.34
Other research shows racial disparities associated with measuring wildfire vulnerability, a measure that considers both wildfire risk and adaptive capacity.35 Census tracts that are majority Black, Hispanic, or Native American are 50 percent more vulnerable than other census tracts.36 As insurance becomes increasingly unaffordable and unavailable, those most exposed to climate change will bear the greatest share of the burden.
Those on fixed incomes will also struggle to keep up with growing insurance costs. Florida and other Sunbelt states have long been a destination for retirees, but the unavailability and unaffordability of insurance stands to leave older Americans at risk.37
Additionally, recent reporting has highlighted how dramatic premium increases stand to threaten the already limited supply of affordable housing. In some instances, premiums have increased by more than 400 percent over the prior year.38 Unlike market-rate apartment owners, affordable housing providers are limited, for good reason, in the rent they can charge and thus cannot pass along the rising costs of insurance to tenants. This has caused developers to put new projects on hold or sell off units to the for-profit private market.39
The insurance protection gap—the difference between insured and actual losses—“can have significant consequences for homeowners and the values of their assets. In turn, these developments can have cascading effects on the financial system,” according to former U.S. Secretary of the Treasury Janet Yellen.40 Indeed, major financial institutions’ condition is affected by insurance market developments. Many banks with mortgages and mortgage-backed securities on their balance sheets reduce their risk of climate-related (and other) loss by requiring that the properties purchased with the mortgages they guarantee or hold on their books are protected by insurance.41 Inadequate insurance under those mortgages can lead to bank losses.
Declining availability and quality of insurance will also increase the risk of loss to Fannie Mae and Freddie Mac, which provide liquidity and stability in the mortgage markets and were placed under the conservatorship of the U.S. government following the 2007–2008 financial crisis.42 These government-sponsored enterprises (GSEs) guarantee trillions of dollars in mortgages.43 If the quality of insurance coverage diminishes or the financial condition of insurers is inadequate to handle the increasing risks from climate change-fueled weather events, the GSEs that back most mortgages and many banks will be at risk of increased losses.
Moreover, because insurance is a precondition for most mortgages, as coverage declines, it will be more difficult for families and businesses to purchase new homes or commercial properties. Flagging demand could drive down real estate values. This lowers state and local government tax bases, affecting their capacity to provide critical services, and causes the economy to suffer.44
Governments have taken steps to spread risk and costs when diversification fails and private insurance coverage diminishes
When effective risk diversification is not possible, ruling out private insurance coverage, governments still have the option to spread risk. That is, the costs of catastrophic, concentrated losses can be shared with people currently unaffected by them.
Governments engage in risk spreading in several ways. One example is FAIR plans, also known as residual plans, created by most states to offer coverage for risks the private market will not cover.45 These plans, by law, establish an involuntary pool of private insurers writing in the state. FAIR plans are not required to hold the same reserves as an insurance company, although they can buy private reinsurance to help cover claims. If claim payouts exceed reserves and available reinsurance coverage, FAIR plans can assess private insurers to cover the shortfall. In California, Louisiana, and Florida, insurers can recoup assessment costs in part or entirely through a surcharge to policyholders.46 In these examples, households, including those not experiencing loss, are forced to cover the costs of a disaster.
The federal government has a limited role in insurance markets because insurance is regulated at the state and territorial level by 56 separate regulatory regimes.47 However, the federal government has stepped in when the private market has refused to offer coverage for specific risks. For instance, the U.S. Department of the Treasury began serving as a reinsurer for terrorism risk when private insurers pulled back from this market following the 9/11 attacks.48 Although it does not have the authority to promulgate regulations, the Federal Insurance Office (FIO) monitors the insurance sector as a whole and can collect from the industry data that are needed to fulfill that mission.49
The federal government also plays a role in flood insurance, which private insurers stopped including in their policies following the Great Mississippi River Flood of 1927. In 1968, Congress created the National Flood Insurance Program. NFIP premiums have historically been kept artificially low and have not covered the actual costs of flood risks. Taxpayers, including those not living in flood-prone areas, cover these deficits.
The challenges experienced by state FAIR plans and NFIP show how growing losses from climate disasters challenge the government’s ability to effectively spread risk in the absence of a healthy private insurance market. It is apparent that this market is faltering, and private insurance for increasingly common climate-related risks will continue to be unavailable or unaffordable in many parts of the country, with potentially large negative spillover consequences for households and the economy writ large.
FAIR plans
Homeowners have turned to state-established FAIR plans in places where private insurers have reduced coverage. FAIR plans are intended to be a last resort for households, but as losses from natural disasters skyrocket and private insurers pull back coverage, they are the only option for many.50 In practice, private insurers can more easily cherry-pick the least risky, most profitable customers, shifting the most exposed households onto the FAIR plan.
The 2025 Los Angeles wildfires—with total losses that could exceed $250 billion—provide a dramatic example of how large climate-related events can affect FAIR plans and homeowners.51 Several high-profile insurers exited California, and others limited coverage, prompting a surge of new policyholders to the FAIR plan in recent years.52 By current estimates, the FAIR plan exposure from the Los Angeles wildfires sits at nearly $5 billion, and the plan has received nearly 4,800 claims.53
In February 2025, California regulators approved a $1 billion assessment by the FAIR plan on insurers operating in the state.54 Due to a recent regulatory change designed to incentivize private insurers to return to the market, insurers can now pass as much as $500 million onto policyholders in the state.55 In this case, the FAIR plan spreads the risk to all insured homeowners, even those not experiencing loss.
NFIP
The Great Mississippi Flood of 1927 affected nearly 13 million acres of land, displaced more than 700,000 people, and totaled $236 million in property damages—worth more than $4 billion today.56 The magnitude of losses shuttered the private flood insurance market. In 1968, Congress created the NFIP, administered by the Federal Emergency Management Agency (FEMA). More than half a century later, the NFIP is the United States’ predominant flood insurance provider, writing more than 90 percent of all residential flood coverage nationwide, because private insurers continue to refuse to include flood insurance coverage in their home insurance policies.57 Flooding is the most common and costly natural disaster in the United States.58 The NFIP was intended to cover flood risk by charging actuarially fair premiums in the long run while giving the program access to borrowing from the Treasury Department to cover large, correlated losses when accumulated premiums were inadequate. But NFIP prices have historically been heavily subsidized by taxpayers to maintain affordability—about 30 percent below actuarially fair rates.59 As a result, the program’s outstanding debt to the Treasury has risen to more than $20 billion,60 not including the $16 billion forgiven by Congress in 2017.61
Policy recommendations to support the availability and affordability of insurance
Given the declining affordability and availability of insurance, there is an acute need for policy action to increase the viability of insurance markets. Policymakers must recognize the need to reduce the risk of loss, promote more informed decision-making, and support a more stable financial system. These actions can make insurance coverage more accessible and thereby protect households and communities from worsening and more frequent weather events. Several steps can help meet these goals.
Reduce the risk of loss and protect communities from climate disasters
Invest in climate resilience
Promoting widespread climate resilience has historically been difficult and fragmented across states and localities. Investing in loss mitigation measures, such as expanding flood and wildfire defenses, protects communities from harm and saves money in the long run.62 Every dollar invested in disaster preparedness and resilience saves $13 in damage costs, cleanup, and economic impact.63 Despite the substantial cost savings and public health and safety benefits of resilience investments, upfront costs may be greater than some local governments can afford. Through grants and other financing programs, the federal government can and should incentivize state and local governments to undertake resiliency measures, as well as update building codes to ensure new construction meets more durable standards and assess zoning to mitigate building in areas at present or future risk of destruction.64
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Government action has been limited in confronting the challenges faced when areas become “unlivable.” State and local governments have an interest in preserving their tax base and housing stock.65 Property buyouts, if carefully designed, can be important mechanisms for mitigating rebuilding in known disaster areas and helping people move to safer land. However, existing buyout programs are underfunded, unscaled to need, and time intensive.66 Individuals relocating to new areas can lose more than their homes: Their route to work may no longer be feasible; their children may need to change schools; and communities may become untethered from cultural traditions. Policymakers should address existing inadequacies in buyout programs and support community-led relocation efforts. Helping to minimize disruption for individuals when they move and ensuring they prosper in new locations while maintaining a connection with their community is crucial.
Require insurers to consider effective mitigation efforts in pricing decisions
There are empirically proven mitigation measures that reduce the risk of loss at the property level, such as creating defensible space to protect against wildfires or meeting enhanced construction and roofing standards, such as the Insurance Institute for Business and Home Safety’s FORTIFIED program, to reduce the risk damage from hurricanes and other wind events67; at the community level, such as implementing stronger building codes so structures can better withstand disasters68; and at landscape-scale, such as conducting forest management through prescribed fire and ecological thinning to reduce the risk of loss from severe wildfires.69
In many states, insurers are not required to consider these mitigation activities in their rating and underwriting models. This means that despite paying for these mitigation activities—either out of pocket for property-level mitigation or through their state, local, or federal taxes for community and landscape-level mitigation—households may see little or no insurance benefit from undertaking these measures. This undermines incentives to reduce loss and the opportunity to keep private insurance available in areas or for homes where mitigation is undertaken. States should require insurers to consider these activities in their rate and underwriting models.
Provide better public climate-related risk data and analysis to guide households, insurers, and government actors
Create a national, geospatial climate modeling tool and establish routine insurance data reporting
If the federal government is to be effective in its role in bridging the insurance protection gap, it must be well informed about the risks it is attempting to cover and mitigate. This will require connecting the output of reliable climate models, which forecast trends in precipitation, temperature, and other weather-related variables; hazard models, which estimate fire, flood, and wind risk for particular geographies; and economic models based on insurer loss and other economic data,70 which can be used to correlate risk to losses and coverage in a specific area. Using geographic information system technology,71 all these models and the data on which they are based can be linked to soil, groundwater, and other spatial infrastructure data to better understand the impacts of weather-related events in specific geographies.
A national geospatial (or map-based) modeling tool incorporating climate prediction data with extensive information on hazards—as well as economic data including local property values and income levels, building codes, zoning, and resilient infrastructure and home hardening investments—could dramatically improve federal, state, and local governments planning efforts. Such a tool, in partnership with the private sector, could help protect people, businesses, and communities from the impacts of climate disasters. It could also help the federal government prepare for and prevent potential threats to financial stability such as those resulting from widespread mortgage defaults stemming from a future disaster and could reduce future taxpayer emergency disaster spending and bailouts for affected financial institutions, including insurance companies.
The value of such a centralized climate risk geospatial information tool cannot be overstated. Cities, counties, and states could establish better-informed evacuation routes and prioritized emergency plans, including budgeting for related expenditures. Small and large businesses could make better decisions about locating facilities and protecting workers. The construction industry could more realistically consider improvements and infrastructure needed to build resilience in specific locations, along with the associated costs. Moreover, potential homebuyers could have access to more streamlined, higher-quality information about climate risk associated with properties.72 Evidence suggests that homebuyers with access to information on a property’s flood risk end up bidding on lower-risk homes.73
Regardless of whether such a tool is developed, additional effort is needed to obtain the data necessary to further the measures called for in this report. For example, efforts to collect insurance data74 are limited in scope and lack full participation from high-risk states, including Florida, Louisiana, and Texas, among others.75 The fact that states regulate insurance has complicated attempts to promote consistent and robust data collection standards. Additionally, insurers have resisted reporting requirements, claiming that source data are proprietary.76
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As part of this research effort, the federal government should establish routine, granular, and public reporting of insurance data. The process established by the Home Mortgage Disclosure Act (HMDA) could serve as a model.77 Data collected under HMDA have been invaluable for understanding how mortgage lenders are meeting the needs of the communities they serve and identifying troublesome trends, such as discrimination.
Ensure homebuyers and renters know their exposure to climate risks
Prospective homebuyers and renters should have access to a property’s history of climate-related incidents and, where possible, information about potential future climate risk to enable informed decision-making.
Laws and regulations to disclose flood risk, for example, vary from state to state and, in many places where they exist, are inadequate. An estimated 14.6 million properties face substantial flood risk, but about 5.9 million are located outside of FEMA’s Special Flood Hazard Area designation.78 Households and businesses may be unaware of their flood risk and forgo flood insurance altogether.79 Information on a property’s history of climate-related events and potential risk in future events should be reported and centralized in a public data repository in a format that will be useful to households making decisions about their welfare. This could be part of the geospatial information system described above.
Enable a strong financial system that can withstand shocks and effectively serve households, businesses, and the economy
Address gaps in climate-related risk supervision of insurers
Robust climate risk supervision is important to insurers’ safety and soundness. Fragile insurers are ill positioned to continue offering services that communities rely on to bear risk and recover following disaster. In June 2023, the FIO reported that “there are nascent and important efforts to incorporate climate-related risks into state insurance regulation and supervision. … However, these efforts are fragmented across states and limited in several critical ways.”80 The report recommends steps state regulators should take to address gaps in climate risk oversight.81
As a first step, state regulators should require insurers to have adequate reserves to deal with rising risks. Regulators also should issue guidance outlining climate-related risk management expectations of insurers. For example, guidance could detail how insurers can incorporate climate risks into annual financial planning, risk management procedures, and data reporting.
Regulators also should educate consumers about their rights when canceling their insurance policies. Additionally, insurers should be required to provide plain-English disclosures of policy terms and conditions to ensure consumers know exactly what types of events the policy covers.
Identify and respond to negative effects of climate change on financial institutions and markets
The Financial Stability Oversight Council (FSOC) monitors the health of the financial system. As climate change continues to challenge insurance markets, FSOC and federal banking regulators must play an active role in evaluating risks threatening the health of the financial system. FSOC and regulators must closely monitor how changes in the condition of insurance companies affect the risks borne by GSEs and banks and forestall threats to overall financial stability.
Framework for analyzing proposals to address diminished insurance coverage
Steps such as those discussed above could improve the affordability and availability of insurance largely by promoting climate resiliency, reducing the likelihood of loss, and supporting the stability of insurers. However, given the scale and correlation of climate-related losses, policymakers will likely need to go beyond these actions and consider measures to spread the costs of the risk across a larger population. They should consider the following questions when designing additional risk-spreading programs.
Is the program economically rational?
As climate-related losses grow and insurers reduce coverage, policymakers looking to spread risk should consider how best to balance the benefits of investing in protecting households and communities for the long term with the near-term costs of doing so. Examples of this tension include:
State FAIR plans
There are obvious benefits when a FAIR plan spreads the cost of a catastrophic event to insurance companies or their customers through ex-post assessments. Homeowners who experienced losses can rebuild, and affected local economies can more quickly be restored. Lenders, who otherwise may have seen now-uncollateralized loans go into default, are protected from loss, which allows them to continue extending credit to other households and businesses. But there may be drawbacks. Take California, for example: At risk of running out of money, the state’s FAIR plan will now assess private insurers to cover the $1 billion shortfall.82 These insurers, as permitted by regulation, will likely pass as much as half of these costs along to policyholders across the state, including those unaffected by the Los Angeles fires, making insurance coverage even more unaffordable.
Building resilience
As noted above, investments in home and infrastructure resilience are necessary to lower the risk of future loss and generally pay for themselves in the long run.83 However, the upfront costs of implementing resiliency measures will likely require significant public expenditure and more stringent building and zoning restrictions. In some areas, the increased likelihood of disruptions from large catastrophes may cause businesses and households to avoid the affected areas, regardless of the restoration and increased resilience of damaged properties. As entire areas become uninhabitable, there may be consequences for state and local tax bases, challenging their ability to provide critical public services.
Does the program create perverse incentives?
The NFIP is a prime example of conflicting goals. Providing flood coverage for at-risk households abandoned by the private market will allow such homes to better recover following a catastrophic flood. NFIP also enables individuals to purchase a home, since mortgage lenders require flood coverage if the home is in a risky area.
However, there is evidence that the NFIP, as currently structured, enables households to remain and rebuild in flood-prone areas.84 The NFIP has made some progress toward mitigating such concerns, including improving risk-based pricing, but it has not done so consistently. Since private insurers remain unwilling to offer flood insurance, and given the program’s large deficits, it seems clear that NFIP coverage still underprices risk and allows households to remain in areas where they are likely to experience repeat losses.
Making NFIP contingent on a commitment to relocate after repeated losses, for instance, could mitigate unwanted outcomes. In fact, FEMA does offer a property buyout program where it purchases at-risk properties and turns them into open space to reduce the risk of future loss. Still, it has been historically underfunded and time-consuming for applicants to access.85
How is social equity taken into account?
It seems reasonable that any risk-spreading scheme should deliver aid in an equitable manner. However, it may be challenging to operate according to this simple principle. To use the example above, an NFIP program that required relocation would mean communities in flood-prone regions would be fundamentally disrupted. There also is evidence that people of color and lower-income people are more likely to live in climate-vulnerable areas.86 History has shown that, given disparities in political power, the needs of these communities could be discounted or ignored altogether.
Policy interventions to subsidize the cost of insurance may relieve communities of affordability pressures. However, if not carefully conditioned, subsidies can dampen price signals and further delay needed action to invest in resilience and risk reduction, causing prolonged harm in the medium to long term.
Given the problems created by diminished affordability or availability of insurance, significant risk spreading is likely to be needed going forward. As these examples demonstrate, producing a risk-spreading program that is sensible is extremely complicated. The state and federal programs already in operation clearly need work, and it remains to be seen what can be accomplished in the current policymaking environment.
Conclusion
As losses from climate disasters grow, insurers will continue to retreat from whole markets and raise prices to prohibitively high levels, leaving households and economies financially vulnerable. The risks are increasingly too great and too correlated to be adequately insured. More must be done to lower climate risks and move away from carbon-intensive activities fueling climate change.87 Unfortunately, the new administration’s policies are moving in the wrong direction.88
In the meantime, while governments and insurers can and should pursue policies to improve insurance availability and affordability, more robust risk-spreading programs will likely be needed. Policymakers will play a crucial role in thoughtfully navigating complex and, at times, competing priorities to come up with comprehensive solutions.
Acknowledgments
The authors are immensely grateful to Dave Jones, Dr. Ben Keys, Carly Fabian, and Oriana Chegwidden for their invaluable feedback on this report. The authors also thank Emily Gee, Trevor Higgins, Cathleen Kelly, Shannon Baker-Branstetter, Madeline Shepherd, Kevin DeGood, Mariam Rashid, Bill Rapp, Beatrice Aronson, Carl Chancellor, and Cindy Murphy-Tofig for their contributions. Mimla Wardak and Kyle Ross provided exceptional research assistance.
Views expressed in this report are solely those of the authors.