The role of insurance in climate adaption

New research tests the promise of insurance to harden the U.S. economy to tropical storms.

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

A new study highlights a way to stave off economic effects by promoting a widespread public insurance plan for Americans. The research supports the growing movement to use insurance­­—a key tool for managing society’s risk—as a form of climate adaptation.

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

Climate Coverage

Global leaders and scientists gather at the Conference of the Parties (COP) each year to discuss the challenges of climate change. At the 2022 COP, “climate risk insurance was discussed as a main measure to adapt to climate change,” said lead author and economist Christian Otto from the Potsdam Institute for Climate Impact Research.

Still, researchers are debating how much insurance can help. Generally, insured economies grow slower than uninsured economies, Otto said. “It takes time to file an insurance claim. It takes time for the insurance payout to arise to reconstruct things. It was an open question for us if insurance can indeed be an effective means,” he explained.

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

The hypothetical insurance scheme used in the model is a mandatory nonprofit government-offered policy that is available everywhere at a flat fee. The scheme uses the average rate of insured losses from U.S. hurricanes over the past several decades (50%) tallied by the natural disaster database NatCatSERVICE from the German-based insurance company Munich Re.

The United States doesn’t have an insurance policy like this currently, although a close analog is the National Flood Insurance Program from the Federal Emergency Management Agency (FEMA). But the program isn’t compulsory and isn’t available to everyone.

An Economic Cushion

In the simplified U.S. economy, past annual economic growth losses would have been cut in half with a compulsory insurance policy in effect. The results also show that despite climate change supercharging storms, insurance could dampen future economic growth losses for the United States.

The model computes the percent annual average growth of the economy after a storm compared with the growth of an economy without a storm. By turning off and on different types of insurance caps and coverage and storm frequencies and intensities, the researchers sussed out the effectiveness of insurance as a climate adaptation tool.

In a 2°C warmer world, the percentage of direct asset losses covered by insurance would need to be raised to compensate for the losses from climate change–fueled storms. Depending on how tropical storms evolve with a shifting climate, insurance policies would need to cover 58% to 84% of direct asset losses—not 50%, the historical average. These numbers “seem within reach,” said Otto.

But insurance has its limits, said Otto. Current policies are pushing us toward a 2.7°C warmer world, according to the Climate Action Tracker. In the worst-case scenario projections for hurricanes, 100% of direct asset losses would have to be covered to account for increased losses from climate change. That’s unrealistic, said Otto.

Although the study suggests that better insurance coverage helps compensate for tropical storm–related economic growth losses in the United States, Otto stressed that their study couldn’t consider everything. Instead, they write, their work presents “an optimistic upper limit” of insurance in mitigating disaster.

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

No One-Size-Fits-All Solution

Insurance wouldn’t be as effective for all countries, however. 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, economic growth losses are too significant for the Haitian government to handle. Insurance coverage must be partnered with other measures such as better housing standards, resilient infrastructure, and community-led relocation.

“The case of Haiti stresses the importance of international climate finance,” Otto said. Aid for loss and damages, a term that describes the consequences of climate change that surpass what humans can adapt to, is one example.

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

“Otto and his coauthors develop a simple, transparent, and elegant model,” Lamperti said. He particularly applauded the model’s ability to consider the cumulative effect of multiple storms in sequence.

Derek Lemoine, an environmental economist at the University of Arizona who was also not involved in the work, concurred but urged the researchers to go further. He said two areas of focus are accounting for the possibility that surviving infrastructure would be less exposed after a storm and allowing for new infrastructure to be less vulnerable when rebuilt.

“For stakeholders and policymakers, I would stress that insurance can be an effective means,” Otto said. “Every one tenth degree of warming we can avoid really matters for the damages.”