In April, a senior European insurance executive warned in a viral LinkedIn post that climate change threatened his industry’s existence and, in turn, capitalism itself. “Flooded homes lose value. Overheated cities become uninhabitable. Entire asset classes are degrading in real time, which translates to loss of value, business interruption, and market devaluation on a systemic level,” wrote Günther Thallinger, of Allianz.

Alarms had been sounding about the threat that climate change poses to housing markets for some time. It was no longer simply the case that weather events threatened to destroy people’s houses; it was that whole swathes of property would no longer be insurable, as companies began to turn down high-risk areas. A year before Thallinger’s warning, the cover of The Economist exhorted, “Climate Change is Coming for Your Home.” It was, the newspaper informed its readers, not just countries like Bangladesh and low-lying Pacific islands that were at risk, but also US housing—the asset class that helped set off the 2008 global financial crisis.

The real-estate industry, think tanks, and countless media stories since have warned of the coming ruination— a doom loop. At a congressional hearing earlier this year, US Senator Sheldon Whitehouse described the loop: “Climate risk makes things uninsurable. No insurance makes things unmortgageable. No mortgages crashes the property markets. Crashed property markets trash the economy.”

A 2018 Bank of England paper laid out this scenario, in which insurance is at the heart of a new “Minsky moment” related to climate change: climate change-induced sudden shocks devalue assets that in turn trigger systemic risks to global financial systems, which would look something like this:

A new consensus is emerging that the destruction wrought by increasing fires, floods, and storms has not only exposed basic amenities like housing to new risk, but that this risk itself is now so extreme and so far-reaching that it threatens the smooth functioning of markets in general. But to date this hasn’t happened, and it’s not entirely clear that it will ever play out as a system-wide financial catastrophe—more likely is that we see more of the same, with intensifying and unevenly distributed social consequences.

The view from the insurers

Insurance companies are not in the business of going out of business. If they judge that payouts are becoming too large and frequent to maintain profits, they can—and do—raise premiums, reduce hazards covered, or simply refuse to offer insurance in certain “high-risk” areas.

In California, where record-breaking wildfires earlier this year collectively accounted for $37.5 billion in insured losses—roughly 70 percent of global insured disaster costs—insurance providers are adapting their models. State Farm and Allstate, the two largest insurers in the country, have both since quit offering insurance across the golden state. They blame California’s government for not allowing them to raise their premiums to a level consistent with profitable underwriting.

Far from presaging the insurance industry’s collapse, these sorts of steps—higher premiums, the withdrawal of insurance from particular areas—protect the industry, and put the risk burden on home owners themselves.

Insurance premiums are generally set in one of two ways. In the “risk pooling” approach, there isn’t much differentiation between premiums charged to high and low risk households. If the premiums are “risk-based” they are calculated on the specific risk of each customer (or at least, the insurance company’s estimate of it). 

The pooled approach helps to socialize losses, but insurers mostly oppose it, arguing that this approach misses an opportunity to signal the risk to oblivious households and even governments—especially as climate change is increasing those risks. When governments provide last resort insurance, or restrict price rises as in California, insurers argue that this cross-subsidizes and encourages the building of ever more valuable structures in ever more hazard-exposed places. 

Researchers like Paula Jarzabowski, however, point out that this “risk signalling” is barely effective in practice. Housing is not liquid and fungible as an asset class—and neither are the homes and communities that inhabit it.

Steep insurance-premium hikes are, unsurprisingly, deeply unpopular with voters, and property insurance is often heavily regulated by the state. If not by direct price intervention, this can be in the form of subsidising premiums, backstopping the insurers’ risks, or offering a state-backed insurer of last resort.

For insurers, these are questions of profitability and market share. But for huge numbers of people, these are existential questions. In the Anglophone countries, for example, housing represents the largest asset for most individuals (not to mention a place to live), and so the political economy of insurance is intrinsically tied to mass politics.

Even when a government uses insurance mechanisms to incentivize itself to reduce exposure to climate risks, there is no guarantee it will work. In the UK, a public insurer, Flood Re, was created in 2014 with the explicit goal of addressing the trade-off between moral hazard and near-term insurance affordability. It pools flood risk by applying a levy to every household’s insurance policy (of 10 GBP), and puts it into a capital fund that cuts the cost of insurance for those most likely to flood.

The proposal was that, over twenty-five years, insurance would transition back to full risk-based premium pricing. For this to work would require the UK government to both undertake resilience work and stop development in exposed areas. But that hasn’t happened. Flood Re’s chief executive has warned that not only has the country’s total flood risk grown since the scheme was established, but its ability to source enough re-insurance of its own is probably limited.

This shaky promise of a pathway to market based operations in the future is what Brett Christophers calls “allusive”: governments’ vaguely gesture to market-based solutions to preclude them from having to substantively deal with flooding in the present. The US equivalent, the National Flood Insurance Program (NFIP), is not attached to any similar goal of eventually leaving high-risk households to the mercy of the insurance market. Instead, it is perversely subsidising building and rebuilding in risky areas—a regressive measure whose benefits skew towards wealthier coastal households.

Half of the NFIP payouts have gone to just twenty-five counties. The scheme that covers 4.7 million insurance policies has frequently run out of funding and is scheduled to expire again at the end of September with the GOP’s fiscal brinksmanship of shutting down the federal government. The NFIP’s authorization to borrow from the US Treasury will be struck down from $30 billion to $1 billion.

Meanwhile, in Australia, where home-property insurance is commercially priced and where the state doesn’t act as the “insurer of last resort,” the market-based “risk signal” premium has been less constrained for most of the last few decades. Australia’s population hugs the coastlines and forested hinterland, both of which are frequently buffeted by increasingly dramatic floods, cyclones, and bushfires. Segments of the country have already become uninsurable. In the tropical north, which is exposed to cyclones, a public re-insurer was finally established to underwrite compulsory cyclone insurance in the area, thanks to the pressure mounted by dozens of public inquiries and reviews. The scheme also provides discounts to households and buildings that “harden” their roofs, doors, windows, and gutters to mitigate damage.

Engineering financial hope

How might the insurance industry respond to the problem of shrinking insurability? There is one relatively new development in the industry that is being rolled out to offer more insurance—namely, courting non-specialist finance. Traditionally, insurers hedged against massive payouts by buying their own cover from re-insurers; often in deals struck during the industry’s “conference season” which begins each year in Monte Carlo, and continues in Baden-Baden and Singapore. In the last couple of decades, though, capital from portfolio investors, asset managers, hedge funds, pension funds and the like have been selling this risk cover by buying catastrophe bonds: a debt instrument that pays a handsome interest rate, but defaults if a particular damage or event threshold is reached.

About 10–15 percent of re-insurance is done via cat bonds and similar instruments. It is growing fast, although not necessarily faster than “traditional” re-insurance capital. But these markets add an external driver to the supply and demand of re-insurance capital.

Insurers offer finance capital something more valuable than juicy returns: an asset uncorrelated with market risk. Asset managers have something to gain in the form of diversification: it’s not just that these catastrophe bonds have higher yields than many other assets. The prospect of losing the investment altogether, if the weather and climate systems work against them, is seen as an acceptable risk due to its low correlation: a wildfire or hurricane won’t be connected to, say, a crash in the value of US tech stocks. Or so the logic goes. For managers of large pots of investment money held for purposes like pensions, diversification is an important goal and often, a regulatory requirement. Retail investors too don’t want to miss out on the returns, and are currently fighting for the right to bet on natural disasters.

Cat bond issuers and investors say that they’ve enabled insurance where it wasn’t otherwise available, and there are attempts to incentivize homeowners to harden their homes to save money on their insurance. They could be a positive externality from financial innovation—or an accident waiting to happen.

There are signs that we may be in the calm before a storm. For now, between traditional firms and new investors, there is enough re-insurance money available to keep global catastrophe insurance underwriting ticking over. But industry participants like Verisk suggest that the baseline is shifting: average annual losses are rising slowly but steadily in the background as smaller perils like storms and wildfires become more frequent. This might not be obvious—especially to the non-specialist investor—until it suddenly is. Catastrophe insurance is about accounting for the outliers, not the average.

Parametric insurance

A more recent and much-hyped innovation in property and disaster insurance is “parametric” triggers. Rather than insurance claims being based on the amount of damage incurred, parametric insurance is paid out when a pre-defined parameter is reached: say, a category 5 hurricane makes landfall in a particular place or with certain wind speeds. If such an event doesn’t quite meet the agreed criteria, but still does a lot of damage, there is no payout. The insurers presumably benefit from their superior ability to model disasters. Benefits to the insured party mostly involve speedier payouts, skipping the time-consuming claims process of traditional insurance.

Parametric triggers feature in many of the insurance-based climate solutions pitched for developing countries; the history of such initiatives is rich with failures. Last year, Jamaica, despite suffering millions of dollars worth of damage to crops and infrastructure, did not get an insurance payout from its catastrophe bond. Why not? The air pressure from Hurricane Beryl narrowly missed the threshold level specified in the contract. Similarly in 2017, a G7 government backed parametric insurance scheme had a disastrous and erroneous delay in triggering a Malawi famine event payout.

Political reckoning?

A dramatic climate-insurance breakdown that shocks the financial system of entire national economies will be preceded by something more banal, but perhaps equally sinister: years of more vulnerable communities getting more squeezed by a combination of ongoing extreme climate events, huge insurance premiums, and with it the quiet retreat of commercially-provided essential services like supermarkets, banking, and telecommunications. More affluent communities, on the other hand, may succeed, for a time, in obtaining public funding to protect themselves and their housing wealth.

At stake is not the narrow insurers’ view of the “pooling of risks” or a dramatic wake-up moment of a doom loop prophesy, but rather a citizenry bound in “communities of fate” and the moral economy of the welfare state. The politics of insurance, Rebecca Elliot has argued, is ultimately about “what is fair and valuable, what needs protecting and what should be let go, who deserves assistance and on what terms, and whose expectations of future losses are used to govern the present.” On the twentieth anniversary of Hurricane Katrina, those who are devalued, displaced, and disinvested already know what the future on an uninsurable earth looks like for the beautiful and the damned.

The Polycrisis is a publication focusing on macro-economics, energy security & geopolitics.