California climate insurance (with parametrics, risk pools & even cat bonds)

The California Climate Insurance Working Group has issued a report detailing 40 state and local policy recommendations covering resilience building and risk transfer, with an over-arching theme that suggests innovative climate insurance and risk transfer is required, especially integrated solutions that consider communities alongside risk reduction.

Within the recommendations parametric insurance solutions are singled out as a preferred avenue to follow, as the State of California looks to become more resilient to the climate risks its population face.

They call the goal of the Working Group the development of a “First-of-Its-Kind Climate Insurance” and the initial report details recommendations related to wildfires, extreme heat events and floods, three of the major climate linked perils California is particularly exposed to.

The recommendations are designed with input of the State’s Insurance Commissioner, as the Working Group was established by Ricardo Lara and he participates in the continuing work to develop a climate insurance approach for California.

“We know it can take families years to recover from the effects of wildfire disasters and floods made worse by climate change, while communities of color and our urban residents and outdoor workers labor under intensifying heat waves with fewer insurance protections,” Commissioner Lara explained. “There should be no gaps between the wealthiest and the rest of us on how quickly we can bounce back. By acting now, we can save lives and save communities from the increasing costs, health impacts, and social inequities of climate change.”

“We know that when people have insurance, they have better outcomes in the wake of an extreme event. And with climate change, we’re going to have more extreme events,” added working group co-chair Alice Hill, David M. Rubenstein Senior Fellow for Energy and the Environment at the Council on Foreign Relations and a former senior advisor on climate to former President Barack Obama. “With insurance, people and communities can recover quickly when climate-worsened disasters strike.”

There’s a significant focus on community, nature based and other forms of resilience linked risk transfer, but reading the report it’s also clear that a more commercial approach is going to be needed alongside this, to truly get climate insurance distributed to those that really need it.

As with all of these initiatives, we’d advocate for a tiered approach, of State, community and corporate risk pools funded by government and industries, while the poorest will immediately benefit from those owning the assets in their communities being covered and the State can work to cascade down responsive protection, in an affordable manner, to those most in-need.

When it comes to climate related risk, or catastrophe risk, you really need all actors in the economy to take greater responsibility for the exposure sitting on their balance-sheet, be that public or private, as well as taking greater responsibility for their workforces and those in the communities around them.

The cost of coverage is always a challenge and this is referenced in the report. As a result, we’d suggest California would be well-advised to ensure it looks to capital market solutions for risk transfer, given the appetite of capital markets to assume insurance risk premia, as well as investors appetites to allocate to socially responsible opportunities, which climate insurance surely has to qualify as.

Encouragingly, the report calls for “innovative insurance strategies” to create responsive products that protect and mitigate climate related costs, while also encouraging risk reduction at the same time.

In order to close the climate risk protection gap, as so much of the losses typically go uncovered by insurance or reinsurance capital, the report calls for a pilot program to be run to develop a basic level of disaster insurance to ensure basic coverage for as many people as possible in California.

Which sounds like something that would certainly require risk pooling and reinsurance capital support as it scales.

The report also says that it recommends development of nature-based solutions, which the Working Group believe can reduce risk and should be linked to insurance through science and policy.

Here, they recommend exploring nature-based insurance solutions such as investments in wetlands and floodplains to reduce flood risk, as well as the use of ecologically managed, open space buffers to provide protection from wildfires.

In addition, new types of insurance policies could be developed to provide more affordable and effective insurance to renters, homeowners, businesses, and communities, the report suggests.

Within this segment are an extreme heat risk pool and insurance initiative, which its hoped could be state-wide and provide coverage to commercial and personal lines protection buyers that are exposed to the impacts of extreme heat events.

Importantly, the Working Group state, “For all perils, consider parametric insurance policies and insurance for entire communities to guarantee that all residents have some degree of coverage.”

Community-level insurance products would enable the risk to be pooled and shared, adding financial incentives for greater risk reduction and also, we would add, offering a chance to benefit from economies of scale when it comes to accessing risk capital and reinsurance.

The report notes that risk pools, state or community based, could leverage reinsurance, catastrophe bonds, state funds, or even become part of a multi-state approach to risk management, which shows the Working Group is thinking broadly about leveraging the most appropriate and effective techniques to support climate insurance in California.

The report could have gone a lot more deeply into the economics and efficiencies of different forms of risk transfer, making suggestions for how a state, or multi-state, approach to climate risk transfer, insurance and risk reduction could utilise state and government funding, insurance and reinsurance market capacity, as well as the capital markets and institutional funding for bearing the peak exposures and perhaps also tying risk reduction to investments in other asset classes such as infrastructure and municipal development.

But hopefully we’ll seem more detail in a later iteration of the Working Group’s activities and we look forward to reading more concrete proposals, that show an appetite to provide the most responsive and efficient risk transfer solutions available to help California fund response and recovery, as well as incentivise resilience to, climate and related catastrophe risks.

The full report and recommendations can be found here.