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Donald Trump makes no secret of disliking state intervention in most things. But free market forces are looking increasingly untenable on an existential issue that confronts his administration. As the world warms and weather becomes more extreme, the traditional commercial insurance system is looking like a decreasingly viable way to protect against the prospect of fire, flood and other natural disasters.
The wildfires that wreaked apocalyptic havoc on some of the swankiest parts of Los Angeles this month destroyed about 17,000 buildings, with losses estimated at between $20bn and $30bn. Floods, wildfires, severe thunderstorms and other so-called non-peak perils cost the world $136bn last year, according to Munich Re, the world’s biggest reinsurer, sharply up on a 10-year inflation-adjusted average of $110bn. About half of the total is insured.
But as the losses mount, and premiums rise, the economics of commercial insurance arrangements are starting to crack. In many climate disaster hotspots, this has happened directly, as the rising cost of insurance has rendered it unaffordable. In some, such as California, a slower-moving second-order effect is playing out as regulatory efforts to cap premium rises have prompted insurers and reinsurers to withdraw from the market. According to one Citigroup estimate, reinsurers — the companies from which insurers normally buy insurance — will absorb less than 3 per cent of insured losses from the LA fires, a fraction of the typical proportion.
The state-run California Fair Plan does provide a backstop option of bare-bones cover for homeowners. But the set-up leaves big gaps in cover. The Federal Emergency Management Association also plays a role in such catastrophes, and operates a nationwide flood insurance programme, which helped Florida homeowners after last autumn’s Hurricane Milton. But just like private sector insurers, FEMA’s flood insurance arm, the National Flood Insurance Program, has had to hike prices to remain solvent. Even with vast taxpayer support, estimated by the US Government Accountability Office at $27bn despite a doubling of flood insurance rates, the GAO reckons just 4 per cent of US households have flood cover.
If commercial operators can’t make the numbers work, and taxpayer-funded schemes are under pressure amid stretched government budgets, what options are viable?
Spain’s Consorcio de Compensación de Seguros believes it may have the answer. The state-owned insurer operates not as an emergency backstop to a failed commercial market but in partnership with private-sector insurers. By levying an annual €7 on every €100,000 of property insured in a commercial policy, it raises an annual €700-800mn to provide cover against extreme risks, including natural catastrophes and terrorism. Last autumn’s record-breaking floods in the eastern Valencia region are ultimately expected to trigger more than €3.5bn of CCS payouts. Even then, thanks to years of profitable operation, it will retain a reserve of more than €7bn.
Similar versions of public-private insurance partnerships operate elsewhere. The New Zealand Natural Hazards Insurance scheme, for example, covers the first $300,000 of flood, fire and storm damage provided by commercial insurers. The UK’s Flood Re reinsures underwriters who take on flood insurance in high-risk areas, funding the cover through a mix of reinsurance premiums and an industry levy. (Similar structures do exist in the US, for example Florida’s Citizens not-for-profit group relies on a mix of premiums and levies, though it is undermined by being focused on a high-risk state, rather than underwriting diversified risks nationwide.)
Such schemes are tackling head-on a fundamental and growing shortcoming in commercial insurance underwriting: as data collation and analysis becomes ever more sophisticated, so the ability to pinpoint risk increases to such an extent that the original risk-pooling concept of insurance is pushed to breaking point. If you know where a cyclone is likely to hit, there is a commercial incentive not to insure people in those areas in the first place.
When it comes to climate risk, there are obviously risk mitigation measures that should be taken. Housebuilders should not put up new homes on flood plains. Fire breaks should be built into known wildfire spots. But as climate risks mount, and actuarial analysis becomes ever more sophisticated, it may be that public-private partnerships that combine commercial smarts with risk-blind, government-run (though not government-funded) schemes are the only viable model for a decent society. As a sceptic on both climate change and big government, just don’t expect the new US president to be an early adopter.
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