Photo Credit: Shutterstock.com/Michael Vi
CA FWD, Insurance for Good, and Resilient Cities Catalyst recently convened a small and diverse group of stakeholders to discuss how insurance markets could better reflect investments in risk reduction made by communities and their residents. The conversation was wide-ranging, but stakeholders agreed on some ongoing challenges and initial solutions for near-term action. In this post, Carolyn Kousky and Nuin-Tara Key summarize their takeaways.
As climate change drives up risks around the country, there is growing recognition of the urgent need for greater investments in risk reduction at all scales. There is also growing appreciation that stress in insurance markets must fundamentally, although not only, be addressed through risk reduction. With this growing understanding of the resilience imperative and the tight link between risk levels and insurance market outcomes, what are the barriers to greater integration of risk reduction and insurance? Our dialogue identified five key takeaways:
1. Risk is changing fast. Long-term thinking is rare. How do we keep up? Climate risks are growing fast and record-breaking has become the new normal. Yet our construction of buildings and infrastructure and our land use decisions are not always incorporating this new reality. Failing to consider future risks, however, sets us up for growing future losses. Individuals and institutions are not good at long-term thinking, but we will always be behind if we do not look ahead.
2. Change requires aligned incentives and information shared across sectors and markets. Insurers cannot be the only institution correctly pricing risk. When insurance is pricing risk, but other markets are not, and the government does not consistently acknowledge growing risk, it sends confusing signals to consumers and communities. In addition, annual insurance policies are not well suited to price climate risk since they only reflect a narrow snapshot of increasing risk. However, other financial actors, like lenders and Government-Sponsored Enterprises (e.g., Fannie Mae and Freddie Mac), make longer-term commitments and could price this growing, longer-term risk into loans. Rating agencies could price climate risk into municipal bonds. Realtors could communicate place-based risk and risk mitigation (e.g., home hardening) to consumers. The public sector has a role in codifying cost-effective risk mitigation in building codes and supporting risk reduction through tools such as tax credits and grants. When information and pricing are aligned across all these areas, it will drive and incentivize the needed cost-effective investments in resilience.
3. Risk reduction generates many benefits across multiple stakeholders, necessitating coordination of contributions and convincing all players to support financing and funding for risk reduction. How do we communicate that this is a collective challenge and in need of collective solutions? Investments in lowering risk create benefits for property owners, insurers, lenders, and the broader community in improved post-disaster economic outcomes. Loss reduction also produces savings to the public sector at all scales. With such wide-ranging benefits, no entity has the incentive or ability to fully fund all of the cost-effective risk reduction measures that could be adopted. Investment is needed in durable public and civic institutional structures that unite multiple beneficiaries in pursuit of the common objective of greater resilience.
4. There are many drivers of insurance market outcomes, not just risk levels. There are a number of factors driving insurance availability and pricing beyond just property and community risk levels. This includes an insurer’s concentration of exposure, macroeconomic conditions such as inflation, regulatory restrictions on pricing, legal system dynamics, and other drivers of rebuilding costs, such as supply chains, labor market conditions, and tariffs. At times, these other factors can swamp any improvements made through investments in resilience and can mute the signals of risk reduction to the market. Improved insurance market outcomes, however, are only one benefit of investments in risk reduction and need to be maintained in spite of noisy economic and regulatory signals in the insurance market.
5. There are many drivers of consumer behavior and consumer investments in risk reduction beyond insurance incentives. Household level investments in risk reduction are driven by many factors—cost being one. There is the time it takes, the challenges with finding a trusted contractor, competing priorities, and lack of information on the risk or the efficacy of measures. While securing insurance market outcomes that reflect risk reduction investments is critical, it may not always motivate substantial investments in mitigation if other barriers are not also addressed.
Building on these observations, the discussion identified several areas for insurance to provide greater support for risk reduction and highlighted the need for a broader coalition to support such efforts. Five future priorities emerged:
1. The insurance sector should offer more guidance to households and communities on which risk reduction efforts to prioritize and how those investments will translate into insurance availability and pricing. Individuals and communities do not have access to the sophisticated risk assessment tools of the insurance sector, nor do they have as deep a familiarity with risk reduction measures. They are looking to insurers for guidance, especially for priority investments, but few insurers are currently providing the needed information. There are examples, however, of insurers engaging their policyholders on this topic, such as CSAA offering premium discounts for policyholders that adopt specific wildfire protection measures certified by IBHS. To further such efforts, the industry and IBHS could work together to make the mitigation standards easier to understand and implement for households and communities and provide detailed information on costs, benefits, and financing tools.
2. Insurance sector models need to better account for risk reduction and insurance policies need to promote and reflect risk reduction measures. Many of the models used by insurers for underwriting and pricing do not include all household or community level mitigation measures, nor do they include timely updates when mitigation is undertaken. While this may seem straightforward, it requires multiple actors across the insurance value chain to not only adjust common practice, but to also coordinate these adjustments. For example, modelers need to update their methods to account for mitigation, which means they need to draw from research studies that can quantify and demonstrate the material benefits in terms of avoided insured losses. Insurers then need to adjust their pricing models to account for verified risk reduction. Both of these need to occur in real-time as investments are undertaken. These changes not only require improved coordination, but also improvements in data collection. Promising steps are being taken by startups such as Firebreak and by collective efforts like the WUI Data Commons. Regulators have also taken steps to push the industry to better account for risk reduction, such as the Safer from Wildfires effort of the California Department of Insurance or states that have mandated discounts for homes built to the FORTIFIED standard, which can withstand high winds.
3. Insurers could support financing of risk reduction measures through premium endorsements for safer rebuilding, robust code upgrade coverage, and innovative underwriting that reflects resilience. Insurers could expand their offerings to support investments in resilience and risk reduction. This could include endorsements that provide extra dollars at the time of a qualifying loss to rebuild stronger. Such endorsements are offered for free by the North Carolina and Mississippi wind pools so policyholders that need to replace a roof can install a FORTIFIED one to protect against hurricanes. Insurers could automatically include code upgrade coverage in all insurance policies so that policyholders have needed funding to comply with building code changes during rebuilding; this is required by law in California and can unlock dollars for safer rebuilding. Other groups are exploring new policy approaches that can include risk reduction in underwriting, such as a parametric policy for a homeowners association that took account of forest management in surrounding areas to lower wildfire risk. And new startups, such as FutureProof, are harnessing data and technology to price for resilience.
4. All sectors need to be transparent and share information on how risks are changing and what it means for future market outcomes. Individual and community-scale decisions must account for growing risks, and these changes in risk need to become routinely priced and communicated. With the current federal administration removing important climate change related data and tools from federal websites, states and local governments will need to do more to fill the void. Local governments can also adopt disclosure laws so sellers of property must note current and future risk levels or partner with data providers to create online tools to make sure information is easily available. Housing websites, such as Redfin, have already incorporated current and future risk data from the data provider First Street. Changing risk information now needs to be incorporated consistently into lending and municipal bond markets, as well.
5. Align the public sector and all markets as complements and not substitutes. All sectors need to work together to address our growing climate risks. The public sector needs to adopt strong building codes, provide funding for risk mitigation and adaptation, and create regulatory guidance for insurers to support resilience. The private sector needs to innovate financing approaches for resilience, incorporate risk reduction incentives across markets, and be a strong public voice for climate risk management.
From these conversations has emerged a new CA FWD and Insurance for Good partnership, including a workgroup that brings together experts from across municipal finance, adaptation and risk reduction, insurance, banks, and lending institutions to produce an actionable guidebook that outlines replicable financing strategies for risk mitigation.
These insights directly inform the work we’ll continue at the California Economic Summit through the Resilience Track sessions in Stockton this October, where we’ll dive deeper into unlocking sustained funding for climate risk reduction and building fiscal resilience tools that help communities weather what’s next.
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Cross-posted at Insurance For Good here.
