tag:theconversation.com,2011:/uk/topics/reinsurance-4548/articlesReinsurance – The Conversation2024-03-07T13:28:59Ztag:theconversation.com,2011:article/2170552024-03-07T13:28:59Z2024-03-07T13:28:59ZHow Florida’s home insurance market became so dysfunctional, so fast<p>Imagine saving for years to buy your dream house, only to have <a href="https://www.insurancebusinessmag.com/us/news/property/homeowners-to-face-huge-premium-jump-as-insurers-seek-50-premium-hike-476805.aspx">surging property insurance costs</a> keep homeownership forever out of reach. </p>
<p>This is a common problem in Florida, where average insurance premiums cost homeowners an eye-watering <a href="https://www.newsnationnow.com/business/your-money/florida-home-insurance-prices">US$6,000 a year</a>. That’s <a href="https://www.npr.org/2023/10/26/1208590263/florida-homeowners-insurance-soaring-expensive">more than triple</a> the national average and about three times what Floridians paid on average for insurance premiums in 2018. </p>
<p>What’s more, several major insurance carriers have <a href="https://www.pnj.com/story/money/2023/07/12/florida-insurance-crisis-farmers-insurance-home-insurance-what-to-know/70407302007/">left the state</a> over the past year, leaving residents with <a href="https://www.bloomberg.com/news/articles/2023-08-10/hurricane-season-2023-florida-s-biggest-property-insurer-is-nonprofit-citizens?sref=Hjm5biAW">limited alternatives</a>.</p>
<p>As <a href="https://www.ju.edu/directory/latisha-nixon-jones.php">a law professor</a> who specializes in disaster preparedness and resilience, I think it’s important to understand what’s driving costs higher – not least because other states could soon face a similar predicament. </p>
<p>Three primary factors are driving the insurance challenge. First, natural disasters are becoming more common and costly. Second, <a href="https://www.investopedia.com/terms/r/reinsurance.asp">the price of reinsurance</a> is skyrocketing. And finally, Florida’s litigation-friendly environment compounds the issue by making it easy for customers to sue their insurers.</p>
<h2>Disasters, like sea levels, are on the rise</h2>
<p>With its location on the beautiful-yet-hurricane-prone Gulf of Mexico, Florida has long been vulnerable to the elements. Natural disasters cost the state <a href="https://edis.ifas.ufl.edu/publication/FE1075">$5 billion to $10 billion</a> every year, the federal government estimated in 2018, the last year for which data was available.</p>
<p>Yet that likely understates the case today, since disasters have only become bigger, more common and more expensive since then. For example, climate change has <a href="https://abcnews.go.com/US/climate-change-making-atlantic-hurricanes-strengthen-weak-major/story.">made oceans warmer</a>, which <a href="https://doi.org/10.1038/s41598-023-42669-y">research suggests</a> fuels stronger, more intense hurricanes. </p>
<p>As a result, Florida has experienced billion-dollar disasters an average of <a href="https://www.ncei.noaa.gov/access/billions/state-summary/FL">four times annually</a> over the past five years – up from about one each year in the 1980s.</p>
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<p>This surge in disasters doesn’t just put lives at risk; it also wreaks havoc with the insurance market, as carriers are inundated with claims from one catastrophe after another. This makes it harder for them to turn a profit or obtain reinsurance to protect their stakeholders.</p>
<h2>Why reinsurance matters</h2>
<p>Insurance companies, in essence, make money two ways. First, they <a href="https://doi.org/10.1038/s41562-021-01121-9">pool risk</a> among policyholders. Risk-pooling is the practice of taking similarly situated individuals or properties, grouping them together, and charging similar prices for insurance since they face the same risk.</p>
<p>Second, they reduce risk by acquiring reinsurance. Reinsurance acts as a safeguard for insurance companies – it’s essentially insurance for the insurers. Reinsurers pledge to cover a specified portion or type of insurance claim – for instance, catastrophic hurricanes – which provides a layer of financial protection.</p>
<p>The new era of climate disasters has thrown a wrench into the process. Reinsurance companies, grappling with a surge in claims due to more frequent and severe disasters, have found themselves forced to <a href="https://www.law.com/dailybusinessreview/2023/07/12/floridas-critical-reinsurance-market-improves-but-at-a-price/?slreturn=20231012224549">raise their premiums</a> for insurance carriers. Carriers, in turn, have passed the burden to policyholders.</p>
<p>To try to navigate these challenges, some companies have chosen to limit coverage for specific types of damage. For example, some insurance companies in Florida will no longer offer hurricane or flood coverage. And in extreme cases, insurance companies have withdrawn entirely from the state. </p>
<p>Understanding this complex relationship between insurers, reinsurers and policyholders is key to understanding the broader implications of the <a href="https://www.fox13news.com/news/florida-home-insurance-crisis-cost-price-premium-institute-rates">Florida insurance crisis</a>. It underscores the urgent need for comprehensive solutions and collaborative efforts to address evolving challenges in the insurance ecosystem.</p>
<h2>Learning from Florida … one way or another</h2>
<p>Florida isn’t taking all this sitting down. In December 2022, state lawmakers responded to growing property market instability by passing <a href="https://www.flsenate.gov/Session/Bill/2022A/2A">Senate Bill 2A</a>, a package of insurance reforms. </p>
<p>One major part was a rule change designed to discourage policyholders from suing their insurers. Previously, Florida law let insured individuals recover attorney fees if they secured any amount through litigation against their insurer. </p>
<p>The idea is that making this change will discourage needless lawsuits. However, my research as an <a href="https://engagedscholarship.csuohio.edu/clevstlrev/vol71/iss3/5/">environmental justice professor</a> shows that attempts to exclude attorneys from the negotiation process often lead to more expensive litigation and less access to justice.</p>
<p>The bill also restricts <a href="https://www.myfloridacfo.com/docs-sf/insurance-consumer-advocate-libraries/ica-documents/aob-consumer-protection-tips-brochure.pdf?sfvrsn=690bdde6_5">assignment of benefits</a>, a mechanism that permits third-party entities like roofing companies to negotiate with insurance companies on behalf of Florida residents. While assignment of benefits <a href="https://www.myfloridacfo.com/division/consumers/consumerprotections/assignmentofbenefits">increased advocacy</a>, it was also linked to skyrocketing claims costs.</p>
<p>The balancing act between providing ample opportunities and containing costs has <a href="https://floridaphoenix.com/2023/10/13/advocates-hailed-a-new-law-to-help-stabilize-fls-housing-crisis-but-implementation-has-been-rocky/">sparked debate</a> among justice advocates. Florida’s legislative response reflects an ongoing effort to strike an equilibrium, ensuring fairness and accessibility while addressing the challenges faced by both insurers and policyholders.</p>
<p>Florida’s actions to address the property insurance crisis raise a critical question: Will the state serve as a blueprint for disaster-prone regions, or act as a cautionary tale? After all, states such as California and Louisiana have also seen insurance companies withdrawing from their markets. Will their legislatures draw inspiration from Florida’s? </p>
<p>For now, it’s too early to tell: The policies have only been in place since the latest round of hurricanes. But in the meantime, the rest of the U.S. will be watching – especially policymakers who care about resilience, and those who want to make sure vulnerable populations don’t get the short end of the stick.</p><img src="https://counter.theconversation.com/content/217055/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Latisha Nixon-Jones does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Florida home insurance premiums have shot up threefold in just five years.Latisha Nixon-Jones, Associate Professor of Law, Jacksonville UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2071722023-06-07T12:24:20Z2023-06-07T12:24:20ZWhy insurance companies are pulling out of California and Florida, and how to fix some of the underlying problems<figure><img src="https://images.theconversation.com/files/530434/original/file-20230606-17-etpcwb.jpg?ixlib=rb-1.1.0&rect=22%2C6%2C2074%2C1367&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Wildfires can destroy hundreds of homes within hours.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/view-29-october-2003-from-a-sea-king-helicopter-assigned-to-news-photo/1249142472">PH2(AW/SW) Michael J. Pusnik, Jr / Navy Visual News Service / AFP via Getty Images</a></span></figcaption></figure><p>When the nation’s No. 1 and No. 4 property and casualty insurance companies – <a href="https://www.insurance.ca.gov/0400-news/0102-alerts/2023/Consumer-Alert-on-State-Farm's-Decision.cfm">State Farm</a> and <a href="https://www.sfchronicle.com/california/article/insurance-allstate-fires-18130622.php">Allstate</a> – confirmed that they would stop issuing new home insurance policies in California, it may have been a shock but shouldn’t have been a surprise. It’s a trend Florida and other hurricane- and flood-prone states know well.</p>
<p>Insurers have been retreating from high-risk, high-loss markets for years after catastrophic events. Hurricane Andrew’s unprecedented <a href="https://doi.org/10.1111/rmir.12222">US$16 billion in insured losses</a> across Florida in 1992 set off alarm bells. <a href="https://www.ncei.noaa.gov/access/billions/">Multibillion-dollar disasters</a> since then have left several insurers <a href="https://www.iii.org/sites/default/files/docs/pdf/triple-i_trends_and_insights_louisiana_03282023.pdf">insolvent</a> and pushed many others to reevaluate what they’re willing to insure.</p>
<p>I co-direct the Center for Emergency Management and Homeland Security at Arizona State University, where <a href="https://scholar.google.com/citations?user=JYLzOQgAAAAJ&hl=en">I study disaster losses</a> and manage the <a href="https://cemhs.asu.edu/sheldus">Spatial Hazard Events and Losses database (SHELDUS)</a>. As losses from natural hazards <a href="https://cemhs.asu.edu/sheldus/reports">steadily increase</a>, <a href="https://doi.org/10.1007/s11166-006-0171-z">research shows</a> it’s not a question of if insurance will become unavailable or unaffordable in high-risk areas – it’s a question of when. </p>
<h2>Reinsurers are worried</h2>
<p>Insurance is a vehicle to transfer risk. When an individual buys an insurance policy, that person pays to transfer the risk of expensive repairs to the insurer if the home is damaged by a covered event, like a fire or thunderstorm. Most policyholders don’t experience major disasters, so insurance companies make money.</p>
<p>However, disasters are extremely costly when they do occur, so insurers also buy their own insurance, called reinsurance.</p>
<p>Reinsurance <a href="https://www.insurancejournal.com/news/international/2023/06/02/723754.htm">costs have been rising fast</a> in response to expensive disasters around the world in recent years. <a href="https://www.ft.com/content/cddcae5c-2783-4b40-9715-06104774248a">Reinsurers’</a> risk-adjusted property-catastrophe prices rose <a href="https://www.howdengroupholdings.com/news/1st-june-risk-adjusted-property-cat-reinsurance-pricing-index-rises-to-highest-level-since-inception">33% on average</a> at their June 1, 2023, renewal, after a 25% rise in 2022, according to reinsurance broker Howden Tiger’s analysis.</p>
<p>If prices are too high and insurers can no longer transfer excessive risk to the reinsurance market, they are stuck “holding the risk” – meaning the cost of claims when disasters strike. A big enough disaster can put insurance companies out of business, or they can decide to leave the state, as seen in California, <a href="https://www.wwltv.com/article/news/investigations/david-hammer/louisianas-insurance-crisis-what-can-fix-it/289-a9fe2f3c-8701-4f75-959f-6ec7b5e7f380">Louisiana</a> and elsewhere.</p>
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<p>Responsible insurers are not in the business of gambling, so they do what State Farm and Allstate did: They reevaluate their portfolios – the various lines of insurance they offer, such as auto, life, property insurance and health insurance – and their prices. Insurance is a highly data-driven business and uses some of the most sophisticated climate and risk modeling in the world to forecast future risks, including the likelihood a property will be damaged by wildfire or other natural hazards.</p>
<p>State Farm cited “catastrophe exposure” as a reason for ending new high-risk personal and commercial property and casualty policies <a href="https://images.theconversation.com/files/530455/original/file-20230606-27-nycs2i.png">in California</a>. That refers to the likelihood that costly claims would exceed the risk State Farm was willing to accept.</p>
<h2>Why drop only California?</h2>
<p>So, why did State Farm and Allstate only stop new policies in California and not in other wildfire-prone states like Colorado or Arizona?</p>
<p>The answer can only be speculative since State Farm or Allstate don’t publicly disclose their exposure. That’s calculated based on how many personal and commercial property and casualty policies the company holds in the state, particularly in the wildland-urban interface where fire risk is higher, and at what value.</p>
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<img alt="Firefighters work on the remains of a high-end home, with its elaborate front entrance and fountain out front being about all the remains from a 2022 fire near Los Angeles that's recognizable." src="https://images.theconversation.com/files/530459/original/file-20230606-23-aus8yz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/530459/original/file-20230606-23-aus8yz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=371&fit=crop&dpr=1 600w, https://images.theconversation.com/files/530459/original/file-20230606-23-aus8yz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=371&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/530459/original/file-20230606-23-aus8yz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=371&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/530459/original/file-20230606-23-aus8yz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=466&fit=crop&dpr=1 754w, https://images.theconversation.com/files/530459/original/file-20230606-23-aus8yz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=466&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/530459/original/file-20230606-23-aus8yz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=466&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Expensive home building prices in California have also raised the risk for insurers.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/firefighters-puts-out-hot-spots-at-a-house-on-vista-court-news-photo/1397094373?adppopup=true">Paul Bersebach/MediaNews Group/Orange County Register via Getty Images</a></span>
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<p>State Farm did cite California’s increasing wildfire risk and home construction prices, but there are other influences to consider.</p>
<p>One is state insurance regulations that can limit premium increases, prohibit policy cancellations and require certain levels of coverage. Insurer Chubb’s chief executive mentioned restrictions that left it <a href="https://www.wsj.com/articles/wildfire-risk-in-california-drives-insurers-to-pull-policies-for-pricey-homes-11642593601">unable to charge</a> “an adequate price for the risk” as part of the reason for its 2022 decision to not renew policies for expensive homes in high-risk areas of California. California also has a unique “<a href="https://www.insurance.ca.gov/0250-insurers/0300-insurers/0200-bulletins/bulletin-notices-commiss-opinion/upload/notice-re-coverage-for-mudslide-and-earth-movement.pdf">efficient proximate cause” rule</a> that forces property insurers to also cover post-fire flooding, such as mudslides. Rainy winters like 2023’s often <a href="https://theconversation.com/atmospheric-rivers-over-californias-wildfire-burn-scars-raise-fears-of-deadly-mudslides-this-is-what-cascading-climate-disasters-look-like-197563">trigger destructive mudslides</a> in wildfire burn areas. </p>
<h2>What happens now?</h2>
<p>When insurers pull out of a community, residents and companies without access to property and casualty insurance are left holding their own risk – and paying the price if a disaster strikes. From a societal and political perspective, that’s a problem.</p>
<p>Residents and businesses without insurance <a href="https://doi.org/10.1080/17477891.2019.1608148">tend to recover more slowly</a>. Uninsured residents often depend on donations, loans or federal individual assistance. The latter, however, is only available for catastrophic disasters and covers only immediate needs.</p>
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<img alt="A one-story apartment building on stilts with the roof torn off after Hurricane Sally. Pink beach shoes and folded beach chairs sit on a porch." src="https://images.theconversation.com/files/530430/original/file-20230606-21-8n6hdp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/530430/original/file-20230606-21-8n6hdp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=414&fit=crop&dpr=1 600w, https://images.theconversation.com/files/530430/original/file-20230606-21-8n6hdp.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=414&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/530430/original/file-20230606-21-8n6hdp.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=414&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/530430/original/file-20230606-21-8n6hdp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=520&fit=crop&dpr=1 754w, https://images.theconversation.com/files/530430/original/file-20230606-21-8n6hdp.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=520&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/530430/original/file-20230606-21-8n6hdp.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=520&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Hurricanes cause so much damage, they can put small insurers out of business.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/an-aerial-view-from-a-drone-shows-jamie-cade-waiting-as-her-news-photo/1273167528?adppopup=true">Joe Raedle/Getty Images</a></span>
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<p>To fill the gap and provide access to insurance, states including <a href="https://www.eenews.net/articles/growing-insurance-crisis-spreads-to-texas/">California, Florida, Louisiana and Texas</a> have created either private or public insurance options of last resort with generally very pricey premiums.</p>
<p>Residents covered by these options transfer their risk to the state, such as in <a href="https://www.lacitizens.com/">Louisiana</a> and <a href="https://www.citizensfla.com/">Florida</a> – meaning state taxpayers, who fund the state insurance programs, hold the risk directly or indirectly. In California, the privately insured FAIR Plan, in existence since 1968, wrote close to <a href="https://www.insurance.ca.gov/01-consumers/200-wrr/upload/CDI-Fact-Sheet-Residential-Insurance-Market-Policy-Count-Data-December-2022.pdf">270,000 policies in 2021, nearly double the number in 2018</a>.</p>
<p>Similarly, anyone purchasing flood insurance through the National Flood Insurance Program since 1968 is transferring their risk to federal taxpayers. The NFIP currently insures <a href="https://www.fema.gov/flood-insurance">almost $1.3 trillion in value</a> across 5 million policies.</p>
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<p>Politicians are not catastrophe risk experts, though, and do not make decisions based on data alone.</p>
<p>In the short term, I expect that insurance pools, as well as federal- and state-run insurers of last resort, will add more policies, and that state legislators will incentivize the return of insurers. But while the <a href="https://www.wdsu.com/article/louisiana-house-insurance-incentive-proposal-passes/42735972">political willingness to support such a trend exists</a>, the financial resources do not.</p>
<p>The National Flood Insurance Program has plenty of lessons to teach about the challenges of balancing exposure and keeping premiums affordable: It is <a href="https://www.fema.gov/case-study/rising-interest-expenses">more than $20 billion in debt</a>. <a href="https://www.insurancejournal.com/news/southcentral/2019/12/10/550879.htm">Texas has resorted to charging</a> insurers operating in the state to help cover its program’s costs.</p>
<h2>Fixing insurance starts with the property itself</h2>
<p>Despite the risk of properties becoming uninsurable, communities today continue to permit development in floodplains, along coastlines and in the wildfire-prone wildland urban interface. Inadequate building codes allow developers to build homes that cannot withstand severe weather. These practices have placed millions of residents and the things they value in harm’s way.</p>
<p>As climate change continues to <a href="https://nca2018.globalchange.gov/">dial up the frequency and severity</a> of natural hazards, there are some steps states and communities can take involving property to lower the risk:</p>
<ul>
<li><p>Make smarter land use choices and limit development in high-risk areas to avoid placing people and the things they value in harm’s way.</p></li>
<li><p>Adopt more stringent building codes and safety standards at state and community levels.</p></li>
<li><p>Price risk into home sales, either through an insurance contingency that allows the buyer to withdraw when they cannot secure insurance or lower assessed property values for real estate in high-risk areas, which can dissuade builders and buyers.</p></li>
<li><p>Require comprehensive disclosures of all present and future risks along with historic claims associated with a property to educate potential buyers.</p></li>
<li><p>Make risk information accessible and understandable. My research shows that most people have a <a href="https://theconversation.com/flood-risk-ratings-translating-risk-to-future-costs-helps-homebuyers-and-renters-grasp-the-odds-186798">hard time fully grasping</a> how likely they are to be affected by a catastrophic event. They need better tools that communicate the information in a way that resonates with them.</p></li>
<li><p>Help residents in high-risk areas relocate <a href="https://theconversation.com/as-coastal-flooding-worsens-some-cities-are-retreating-from-the-water-164463">through buyouts</a> and <a href="https://theconversation.com/managed-retreat-done-right-can-reinvent-cities-so-theyre-better-for-everyone-and-avoid-harm-from-flooding-heat-and-fires-163052">managed retreat</a> that returns the land to nature or public uses such as parks.</p></li>
</ul><img src="https://counter.theconversation.com/content/207172/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Melanie Gall currently receives research funding from the National Academies' Gulf Research Program, HUD, USAID, DHS, Feeding America, and the Society of Actuaries. She is a member of the National Hazard Mitigation Association, the North American Alliance of Hazards and Disaster Research Institutes, the Association of State Floodplain Managers, and American Association of Geographers. </span></em></p>It’s not a question of if insurance will become unavailable or unaffordable in areas at high risk of wildfires, hurricanes and other damage – it’s a question of when. A disaster risk expert explains.Melanie Gall, Assistant Professor and Co-Director, Center for Emergency Management and Homeland Security, Watts College, Arizona State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1781432022-03-02T19:09:36Z2022-03-02T19:09:36ZAfter the floods comes underinsurance: we need a better plan<p>The floods affecting Australia’s eastern seaboard are a “<a href="https://www.smh.com.au/politics/nsw/flood-fears-for-city-fringe-as-savage-storm-cell-heads-toward-sydney-20220301-p5a0sg.html">1 in 1,000-year event</a>”, according to New South Wales Premier Dominic Perrottet. But that’s not what science, or the insurance industry, suggests.</p>
<p>Throughout Australia in areas prone to fires, cyclones and floods, home owners and businesses are facing escalating insurance costs as the frequency and severity of extreme weather events increase with the warming climate.</p>
<p>Premiums have risen sharply over the past decade as insurers count the cost of insurance claims and factor in future risks. The <a href="https://www.ipcc.ch/report/ar6/wg2/">latest report</a> from the Intergovernmental Panel on Climate Change, published this week, predicts global warming of 1.5°C will lead to a <a href="https://theconversation.com/mass-starvation-extinctions-disasters-the-new-ipcc-reports-grim-predictions-and-why-adaptation-efforts-are-falling-behind-176693">fourfold increase</a> in natural disasters.</p>
<p>Rising insurance premiums are creating a crisis of underinsurance in Australia.</p>
<p>In 2017 the federal government tasked the Australian Competition and Consumer Commission to investigate insurance affordability in northern Australia, where destructive storms and floods are most common. The commission delivered its <a href="https://www.accc.gov.au/focus-areas/inquiries-finalised/northern-australia-insurance-inquiry/final-report">final report</a> in 2020. It found the average cost of home and contents insurance in northern Australia was almost double the rest of Australia – $2,500 compared with $1,400. The rate of non-insurance was almost double – 20% compared with 11%.</p>
<hr>
<p><strong>Average premiums for combined home and contents insurance, 2018–19</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/449357/original/file-20220302-25-hd3gv4.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Average premiums for combined home and contents insurance in Australia, 2018–19" src="https://images.theconversation.com/files/449357/original/file-20220302-25-hd3gv4.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/449357/original/file-20220302-25-hd3gv4.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=585&fit=crop&dpr=1 600w, https://images.theconversation.com/files/449357/original/file-20220302-25-hd3gv4.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=585&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/449357/original/file-20220302-25-hd3gv4.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=585&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/449357/original/file-20220302-25-hd3gv4.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=735&fit=crop&dpr=1 754w, https://images.theconversation.com/files/449357/original/file-20220302-25-hd3gv4.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=735&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/449357/original/file-20220302-25-hd3gv4.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=735&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">ACCC analysis of data obtained from insurers.</span>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<hr>
<p>While the areas now experiencing their worst flooding in recorded history aren’t part of the riskiest areas identified by the insurance inquiry, the dynamics are the same. </p>
<p>Those not insured or underinsured will be financially devastated. Insurance premiums will rise. As a result, more people will underinsure or drop their insurance completely, compounding the social disaster that will come with the next natural disaster. </p>
<p>So, what do about it?</p>
<h2>Tackling insurance affordability</h2>
<p>There are two main ways to reduce insurance premiums. </p>
<p>One is to reduce global warming. Obviously this is not something Australia can achieve on its own, but it can be part of the solution. </p>
<p>The other is to reduce the damage caused by extreme events, by constructing more disaster-resistant buildings, or not rebuilding in high-risk areas. </p>
<p>The federal government, however, has put most of its eggs in a different basket, with a plan to subsidise to insurance premiums in northern Australia.</p>
<p>This won’t do much for those affected by the current floods. It won’t even do much to solve the insurance crisis in northern Australia. </p>
<h2>The reinsurance pool, a blunt tool</h2>
<p>In the 2021 budget the federal government committed A$10 billion to a <a href="https://www.pm.gov.au/media/morrison-government-deliver-reduced-premiums-through-reinsurance-pool">cyclone and flood damage reinsurance pool</a>, “to ensure Australians in cyclone-prone areas have access to affordable insurance”. The legislation to establish this pool is <a href="https://www.legislation.gov.au/Details/C2022B00003">now before parliament</a>. </p>
<p>The ostensible rationale is that the government can drive down insurance costs for consumers by stepping in and acting as wholesaler in the reinsurance market, in which insurers insure themselves against the risk of crippling insurance payouts. </p>
<p>The idea is that discounted reinsurance will lead insurers to lower their premiums. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/a-national-insurance-crisis-looms-the-morrison-governments-10-billion-pool-plan-wont-fix-it-163796">A national insurance crisis looms. The Morrison government's $10 billion 'pool' plan won't fix it</a>
</strong>
</em>
</p>
<hr>
<p>There is no guarantee, however, that insurers will pass on their cheaper costs to customers. This means the benefits of the pool are unclear. </p>
<p>So are its costs. Effectively, the government is shifting risk from insurers to itself, subsidising insurance premiums for those in some parts the country from the public purse.</p>
<p>The ACCC inquiry gave considerable attention to the idea of a reinsurance pool. While acknowledging there could be some benefits, it concluded the risks outweigh the rewards:</p>
<blockquote>
<p>We do not consider that a reinsurance pool is necessary to address availability issues in northern Australia. </p>
</blockquote>
<h2>Targeting and mitigating</h2>
<p>Above and beyond the aforementioned problems, there are two telling failures of the reinsurance pool plan.</p>
<p>First, subsidising insurance companies doesn’t target help to those who need it most: low-income households. </p>
<p>There is a growing body of research showing that natural disasters, and the ways governments respond to them, is <a href="https://theconversation.com/underinsurance-is-entrenching-poverty-as-the-vulnerable-are-hit-hardest-by-disasters-152083">contributing to greater inequality</a>. </p>
<p>As the South Australian Council of Social Service makes clear in a <a href="https://www.sacoss.org.au/protecting-basics-insurance-report">report published this week</a>, improving insurance access for people on low incomes at risk from natural disaster requires targeted support, such as promoting non-profit “mutual” insurance schemes.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/natural-disasters-increase-inequality-recovery-funding-may-make-things-worse-131643">Natural disasters increase inequality. Recovery funding may make things worse</a>
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</em>
</p>
<hr>
<p>Second, only mitigation can bring the overall cost of natural disasters down. Ways to do this include public works (building levees, upgrading stormwater systems, conducting planned burns) and improving buildings (reinforcing garage doors, shuttering windows, managing vegetation around homes, and so on). </p>
<p>The ACCC’s insurance report identifies a range of ways mitigation strategies can be tied into insurance pricing. Yet none of these has been incorporated into the Morrison government’s response to the insurance crisis. </p>
<p>There is little support for the reinsurance pool outside of the federal government. Neither the ACCC, the insurance industry nor community sector advocacy organisations support reinsurance as a meaningful solution. </p>
<h2>A reinsurance pool for the whole of Australia?</h2>
<p>For the areas of NSW and Queensland now flooded, as well as the rest of the country outside the ambit of the reinsurance pool, the relentless rise in insurance costs will continue, tipping ever more homes out of the insurance safety net. </p>
<p>We must find better solutions to the insurance crisis than what is being offered to northern Australia. A reinsurance pool cannot be a national solution because it isn’t the solution for northern Australia.</p>
<p>There are no cheap and easy solutions, but the terrain is clearly mapped out across an array of inquiries and reports into insurance and climate vulnerability. More than a blanket subsidy for the insurance industry, the time has come for climate vulnerability to be taken seriously by the federal government.</p><img src="https://counter.theconversation.com/content/178143/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Antonia Settle does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Natural disasters are driving up insurance costs. The Australian government’s plan to drive them down won’t help much.Antonia Settle, Academic (McKenzie Postdoctoral Research Fellow), The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1631402022-01-09T17:24:15Z2022-01-09T17:24:15ZHow Covid broke supply chains, and how AI and blockchain could fix them<figure><img src="https://images.theconversation.com/files/439518/original/file-20220105-19-2ocyl0.jpg?ixlib=rb-1.1.0&rect=2001%2C12%2C4460%2C3040&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/fr/image-photo/aerial-view-panoramic-oil-tanker-moving-1206527953">Studio concept/Shutterstock</a></span></figcaption></figure><p>When the coronavirus crisis erupted in 2020, it became apparent that the medical emergency was accompanied by severe shortages, especially in some medical devices.</p>
<p>The pattern was first observed for <a href="https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7737425/">ventilators</a>: demand spiked everywhere and the supply chain was disrupted. This was because production of the devices spanned multiple countries, with each part dependent on other parts manufactured in different locations. The longer the chain and the more complex the dependence, the greater the exposure of any point to the disruption of another one, and to mandated shutdowns.</p>
<p>Now, two years since Covid first hit, this pattern has affected almost every sector of the global economy. “Supply chain issues” have become so widespread that they are now a <a href="https://qz.com/2092878/supply-chain-is-finding-its-way-into-memes-and-the-dictionary/">running joke</a>, affecting everything from <a href="https://www.theguardian.com/business/2021/dec/11/the-great-furniture-delay-well-be-eating-christmas-dinner-on-our-camping-tables">furniture</a> to <a href="https://www.abc.net.au/news/2022-01-04/food-shortages-at-major-supermarkets-covid-rises/100737066">groceries</a>. But why has Covid had such a severe effect on how we receive products and goods?</p>
<p>In recent decades, supply chains became lean, and they lengthened as they became more cost-efficient: more and more steps were added in the manufacture and transportation of any given product in the name of speed and cost. This means there are more and more places where something can go wrong between you ordering something online and it arriving to your door.</p>
<p>Today, downstream suppliers – such as those who provide vehicle control systems to your car manufacturer – depend on upstream suppliers – such as chip manufacturers – to deliver on time so they can in turn deliver on time to you.</p>
<p>With long chains, risks are now shared between multiple entities all around the world.</p>
<h2>Using AI and blockchain to protect trade</h2>
<p>Supply chain problems have a knock-on financial effect known as trade credit contagion. This is where firms delay payments to suppliers because their customers delay payments to them. The pay-on-delivery model can lead to cancelled or delayed shipments which can in turn lead to bankruptcies.</p>
<p>While a high proportion of trade credit risk remains uninsured today, a post-pandemic world may see insurance and reinsurance firms fill in this protection gap.</p>
<p>Researchers are currently working to develop methodologies to identify vulnerabilities in global supply chains and to understand their trade credit contagion risks. The goal is to make these systems more <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3669363">robust overall</a>.</p>
<p>How can we design ways to design insurance and reinsurance contracts in order to effectively share the risk and mitigate vulnerabilities? How can reliable trade credit lead to fewer delays in supply chains and replace the familiar predicament we face now, of paying for something in advance with an unknown delivery date?</p>
<p>Artificial intelligence and complex network theory are helpful in identifying the <a href="https://pubsonline.informs.org/doi/abs/10.1287/mnsc.2019.3389">structures that could pose systemic risk</a>. They help us ask: which patterns of connections are likely to lead to delay and trade credit contagion and which are more robust?</p>
<p>Using these tools, we can create large-scale simulators of global supply chains responding to a wide variety of shocks and then use machine learning techniques to detect the problematic parts of the chain. This knowledge can then be used in market designs that strengthen the system before another pandemic or disaster occurs.</p>
<p>Other novel technologies such as blockchain bring the promise of using high quality data to analyse supply chain dependencies. blockchain technology uses real-time data and transparent verification carried out by multiple parties. In combination with other features, such as smart contracts, this could lead to timely resolution in cases of disputes along the supply chain.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/439514/original/file-20220105-23-8n7skg.jpg?ixlib=rb-1.1.0&rect=50%2C0%2C5568%2C3667&q=45&auto=format&w=1000&fit=clip"><img alt="An aisle in a warehouse with shelves stacked with boxes" src="https://images.theconversation.com/files/439514/original/file-20220105-23-8n7skg.jpg?ixlib=rb-1.1.0&rect=50%2C0%2C5568%2C3667&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/439514/original/file-20220105-23-8n7skg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/439514/original/file-20220105-23-8n7skg.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/439514/original/file-20220105-23-8n7skg.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/439514/original/file-20220105-23-8n7skg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/439514/original/file-20220105-23-8n7skg.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/439514/original/file-20220105-23-8n7skg.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">We need to insure each link in the chain.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/fr/image-photo/warehouse-largescale-shopping-center-541183837">dreamnikon/Shutterstock</a></span>
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</figure>
<p><a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3914284">My research</a> involves</p>
<p>using blockchain to streamline record-keeping and payments. This problem is challenging because the adoption of blockchain depends both on the specifics of the technology and the cost.</p>
<p>The problem of adopting technology in the presence of positive externalities (whereby firms adopting the technology in turn improve the operations of external parties) is an old one in economics, but now these externalities are systemic in nature: the effects propagate along the chains. The cost of the technology depends on how many firms adopt it, and each one faces business specific costs based on its position in the supply chain, its risk tolerance and its costs to insure these risks.</p>
<p>Real-time recording keeping, the traceability of transactions, and the immutability of blockchain can all help supply chains become more efficient. This is all the more true if we consider the full length of the chain, where transactions need to be verified by several parties: participants in the supply chain, insurance and reinsurance firms.</p>
<h2>The future of supply chains</h2>
<p>Trade credit insurance is likely to grow after the pandemic. It may rely on private-public partnerships – the pandemic has shown that governments become important players when they impose shutdowns in certain areas.</p>
<p>These funds can be used to make up for payment delays, reduce losses and jump-start critical production where necessary. But not all links in a chain can be insured, and an important challenge is to identify the most important stages under different shock scenarios.</p>
<p>Supply chains can also be rewired – large-scale algorithms can identify which suppliers need to be replaced and which new ones need to emerge.</p>
<p>In a few years, supply chains may look different, as the overall goal shifts from minimising costs, as was the case before the pandemic, to minimising delays and trade credit risks. The end consumer will drive the need to rewire the network, as demand shifts. Ultimately, the flexibility of the customer determines the resilience of the supply chain.</p>
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<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=158&fit=crop&dpr=1 600w, https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=158&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=158&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=198&fit=crop&dpr=1 754w, https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=198&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=198&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<p><em>Created in 2007 to help accelerate and share scientific knowledge on key societal issues, the AXA Research Fund has been supporting nearly 650 projects around the world conducted by researchers from 55 countries. To learn more, visit the site of the <a href="https://www.axa-research.org">Axa Research Fund</a> or follow on Twitter <a href="https://twitter.com/axaresearchfund?lang=fr">@AXAResearchFund</a>.</em></p><img src="https://counter.theconversation.com/content/163140/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andreea Minca has received funding from AXA Research and NSF.</span></em></p>Covid has led to delays in consumers receiving everything from furniture to groceries. This is how we might reshape supply chains after the pandemic.Andreea Minca, Associate Professor, Cornell UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1637962021-07-07T02:35:35Z2021-07-07T02:35:35ZA national insurance crisis looms. The Morrison government’s $10 billion ‘pool’ plan won’t fix it<p>As climate change intensifies extreme weather events, home and building insurance premiums have been rising, particularly in northern Australia. </p>
<p>As premiums rise, more people are choosing drop their insurance coverage, risking financial disaster when the next natural disaster hits. </p>
<p>The consequences of this are so dire that the Morrison government has committed A$10 billion to a “reinsurance pool” to bring home insurance premiums down in northern Australia. </p>
<p>It’s an attractive policy option — simple and quick. Though it exposes the government to potentially huge costs, these won’t need to be paid until the next big disaster hits. </p>
<p>But it’s not the kind of policy we need. Analysis by myself and colleagues at the Melbourne Institute indicates it won’t be sufficient to stop record numbers of households — and not just in northern Australia — forgoing home insurance due to rising premiums.</p>
<p>The policy needed, for northern Australia now and the rest of the country in the coming years, must also mitigate the damage of fires, floods and cyclones to homes.</p>
<h2>The coming crisis</h2>
<p>As extreme weather events become more frequent and more ferocious, Australian households are making bigger claims more often.</p>
<p>This means higher costs for insurers. From the 1980s to the 2010s, insurers paid out about A$1.3 billion a year (adjusted for inflation) on claims for damage from natural disasters. Over the past 10 years, payouts doubled to an average annual cost of A$2.6 billion.</p>
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<a href="https://images.theconversation.com/files/409823/original/file-20210706-23-4424m3.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/409823/original/file-20210706-23-4424m3.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/409823/original/file-20210706-23-4424m3.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=350&fit=crop&dpr=1 600w, https://images.theconversation.com/files/409823/original/file-20210706-23-4424m3.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=350&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/409823/original/file-20210706-23-4424m3.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=350&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/409823/original/file-20210706-23-4424m3.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=440&fit=crop&dpr=1 754w, https://images.theconversation.com/files/409823/original/file-20210706-23-4424m3.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=440&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/409823/original/file-20210706-23-4424m3.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=440&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<p>Higher payouts by insurers means higher insurance premiums for households. The average home insurance premium for all Australians now costs almost <a href="https://insurancecouncil.com.au/industry-members/data-hub/">four times as much</a> as it did in 2004, according to Insurance Council of Australia data. These patterns are only going to intensify. </p>
<p>Our <a href="https://melbourneinstitute.unimelb.edu.au/publications/research-insights/search/result?paper=3769030">research</a> indicates many more households will drop their insurance coverage than experts have previously anticipated. </p>
<p>Those who decide premiums are no longer worth the money are more likely to be lower-risk customers. With a smaller pool of customers who are higher risk, insurers push premiums up further, prompting yet more households to opt out. This vicious circle will accelerate as costs climb with greater impacts from climate change. </p>
<p>So an insurance and social crisis looms, with financially devastating consequences for the uninsured.</p>
<h2>No easy policy fixes</h2>
<p>So what can policy makers do?</p>
<p>One option would be for the government to directly subsidise households’ insurance costs, similar to how it subsidises child-care costs.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/underinsurance-is-entrenching-poverty-as-the-vulnerable-are-hit-hardest-by-disasters-152083">Underinsurance is entrenching poverty as the vulnerable are hit hardest by disasters</a>
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</em>
</p>
<hr>
<p>The federal government has instead opted for an indirect subsidy, by stepping into the “reinsurance” market. </p>
<p>Reinsurers are like wholesalers, providing insurance to retail insurance companies. By providing reinsurance at a cheaper cost than commercial reinsurers, the government can bring household premiums down. </p>
<p>The downside is it exposes the government to the risk of huge costs when insurers draw on that reinsurance to pay out households in the event of a disaster. That risk will rise as the climate warms. So in the long run it simply shifts risks and costs to the public purse. </p>
<p>The idea of a government providing a reinsurance pool has been rejected by the industry, regulators and consumer groups because it exposes the government to potentially massive costs without having any impact on the root of the problem. </p>
<p>The Australian Competition and Consumer Commission said in its <a href="https://www.accc.gov.au/focus-areas/inquiries-finalised/northern-australia-insurance-inquiry/final-report">Northern Australia insurance inquiry</a> (finalised in December 2020):</p>
<blockquote>
<p>We do not consider government reinsurance pools or government insurers are well-suited to address affordability concerns in a targeted way.</p>
</blockquote>
<p>It went on to conclude:</p>
<blockquote>
<p>Improving the resilience of properties and communities to natural hazards will have significant benefits now and into the future, including through lower insurance claims costs. Greater consideration of the likely benefits (and costs) of mitigation and other resilience measures is required. </p>
</blockquote>
<h2>Mitigation activities</h2>
<p>By mitigation the commission report means reducing the effects of extreme weather events. (Climate scientists tend to refer to this as adaptation, while mitigation is reducing global warming by cutting greenhouse gas emissions.) </p>
<p>The federal budget did commit A$600 million to a <a href="https://www.pm.gov.au/media/helping-communities-rebuild-and-recover-natural-disasters">national mitigation program</a> but this nowhere near as bold as needed. </p>
<p>Mitigation requires work at multiple levels. </p>
<p>Some efforts involve limiting the severity of disasters. Strategic fuel reduction, for example, can make bush fires less extreme.</p>
<p>Other efforts involve limiting the effect of disasters on the built environment. A key change is reforming land use regulations to stop more housing development on flood plains.</p>
<p>We can also do more to limit the damage that extreme weather events have on buildings. Construction codes have been improving to make the design and materials used in new houses more resistant to fire and heavy winds, but more can be done.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/it-cant-all-be-insured-counting-the-hidden-economic-impact-of-floods-and-bushfires-157882">It can't all be insured: counting the hidden economic impact of floods and bushfires</a>
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<h2>Investment at all levels</h2>
<p>Our best hope to bring premiums down and help the households that need it most is comprehensive mitigation combined with targeted direct subsidies for low-income households, as the <a href="https://www.accc.gov.au/publications/northern-australia-insurance-inquiry-final-report">Northern Australia insurance inquiry recommended</a>. </p>
<p>This requires a multi-pronged policy package looking far beyond the next electoral cycle. It must support investment in mitigation by all levels of government as well as households. But unless this is done the insurance crisis is only only going to intensify. </p>
<hr>
<p><em>This story is part of a series The Conversation is running on the nexus between disaster, disadvantage and resilience. It is supported by a philanthropic grant from the Paul Ramsay foundation. You can read the rest of the stories <a href="https://theconversation.com/au/topics/disaster-and-resilience-series-97537">here</a>.</em></p><img src="https://counter.theconversation.com/content/163796/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Antonia Settle does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Morrison government’s reinsurance pool is the exact policy the Australian Competition and Consumer Commission recommended against.Antonia Settle, Academic (McKenzie Postdoctoral Research Fellow), The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1152172019-05-06T21:18:50Z2019-05-06T21:18:50ZWhy climate change won’t spur a 2008-style global financial crisis<figure><img src="https://images.theconversation.com/files/271623/original/file-20190429-194612-8zeji5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Residents, friends and volunteers work to hold back floodwaters on the Ottawa River in Constance Bay, Ont., earlier this week. THE CANADIAN PRESS/Sean Kilpatrick</span> <span class="attribution"><span class="source">THE CANADIAN PRESS/Sean Kilpatrick</span></span></figcaption></figure><p>Amid the very legitimate dire warnings from scientists and others about the <a href="https://changingclimate.ca/CCCR2019/">future worsening impacts of climate change</a>, there is also, unfortunately, a great deal of hyperbole about how much worse things will get. Often it is difficult to separate truth from mere speculation.</p>
<p>Essentially, it has become fashionable to portend the disastrous end of many things due to climate change.</p>
<p>This includes foreshadowing <a href="https://www.sciencedaily.com/releases/2018/05/180515081720.htm">the coming demise of the insurance industry</a> due to spiralling natural disaster claims costs resulting from such events as Hurricanes Harvey, Irma, Maria, Florence and Michael or the current floods <a href="https://globalnews.ca/video/5214763/eastern-canada-struggles-to-deal-with-historic-flooding">in eastern Canada</a>. Related is talk of the almost certain implosion of the non-traditional reinsurance sector, whose catastrophe or “cat” bonds have been likened to the <a href="https://www.investopedia.com/terms/m/mbs.asp">sub-prime mortgage-backed securities</a> that nearly caused a complete meltdown of the international financial system in 2007-2008.</p>
<p>The theory is that severe weather claims driven by climate change will force numerous cat bonds to be triggered simultaneously, meaning investors would lose part or all of their investment in the securities. These bonds transfer insured catastrophe risk to bond investors in a way that some argue is similar to how mortgage-backed securities transferred sub-prime mortgage risk to investors a decade ago. </p>
<p>This simultaneous triggering of multiple cat bonds, according to grim predictions, will essentially precipitate another global financial crisis as a contagious domino effect ensues from the failure of these bonds.</p>
<p>This theory is problematic on several fronts, not the least of which is scale.</p>
<p>But first let’s define both reinsurance and cat bonds.</p>
<h2>Traditional vs non-traditional reinsurance</h2>
<p>For laypersons, traditional <a href="https://www.swissre.com/Library/the-essential-guide-to-reinsurance.html">reinsurance</a> is often described as “insurance for insurance companies.”</p>
<p>Essentially, just as a motorist or homeowner can purchase <a href="https://www.irmi.com/term/insurance-definitions/insurance">insurance</a> to pass on financial risk, insurers can purchase protection of their own called “reinsurance.” Reinsurers themselves can also pass on risk via what’s known as the “<a href="https://www.irmi.com/term/insurance-definitions/retrocession">retrocession</a>” market.</p>
<p>Through reinsurance, insurers are able to pass on some of their risk via payment of a premium. The system is essentially designed to spread risk geographically and over several pools of capital, with the intent of preventing a large unexpected loss from taking down insurers or even the entire insurance system.</p>
<p>Since about the mid-1990s, innovation in the reinsurance sector led to the rise of the <a href="https://www.artemis.bm/library/what-is-traditional-nontraditional-alternative/">non-traditional</a> reinsurance market. While there are a few different products that can be classified as non-traditional, the cornerstone of the market has been the <a href="https://www.artemis.bm/library/what-is-a-catastrophe-bond/">catastrophe or cat bond</a>.</p>
<p>Cat bonds are <a href="https://www.investopedia.com/terms/f/fixed-incomesecurity.asp">fixed-income securities</a> that normally pay investors (in this case, bond-holders) rates of interest that are often higher than other bond offerings on the market, thereby rewarding investors for the somewhat unique risk being taken on.</p>
<p>However, if a natural disaster plays out in a manner specified in the <a href="https://www.investopedia.com/terms/p/prospectus.asp">bond prospectus</a> (the type of event, location and damage threshold, for example), the bondholder could lose some, most or all of their invested principal or interest.</p>
<figure>
<iframe width="440" height="260" src="https://www.youtube.com/embed/Bc2dFO1jf4g?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
<figcaption><span class="caption">A segment about cat bonds by ‘Forbes.’</span></figcaption>
</figure>
<h2>Cat bonds: Why there won’t be a meltdown</h2>
<p><a href="https://www.vice.com/en_ca/article/wjm78x/the-dollar1-trillion-storm-how-a-single-hurricane-could-rupture-the-world-economy">Some have argued</a> the cat bond <a href="https://www.youtube.com/watch?v=ehZzU8hWv-4">climate change meltdown theory</a> portends a coming disaster for the sector.</p>
<p>Conversely, others have <a href="https://www.artemis.bm/news/ils-and-catastrophe-bonds-are-not-sub-prime-mortgages/">written about the many flaws of comparing cat bonds</a> to <a href="https://theonebrief.com/alternative-capital-why-are-alternative-investments-becoming-more-popular/">sub-prime mortgage-backed securities</a>. However, it appears that no one has addressed the elephant in the room — there can be no serious comparison made in scope or scale between cat bond issuance and the total issuance of sub-prime mortgage-backed securities that existed in the lead-up to the 2007-2008 financial crisis.</p>
<p>According to the <a href="http://thoughtleadership.aonbenfield.com//Documents/20190403-ab-analytics-rmo-april-2019.pdf">latest data</a> of April 2019, there’s about US$97 billion in non-traditional capital currently available to insurers and reinsurers worldwide compared to the US$595 billion currently available in traditional reinsurance capital.</p>
<p>The $97 billion is not made up entirely of cat bonds. <a href="http://thoughtleadership.aonbenfield.com//Documents/20190403-ab-analytics-rmo-april-2019.pdf">Data indicate</a> that cat bonds represent just $29 billion of the alternative reinsurance capital currently available, with the remainder allocated to other forms of alternative reinsurance (including what are known as <a href="https://www.artemis.bm/library/what-is-a-reinsurance-sidecar/">sidecars</a>, <a href="https://www.artemis.bm/library/what-are-industry-loss-warranties-ilws/">industry loss warranties</a> and <a href="https://www.artemis.bm/library/what-is-collateralized-reinsurance/">collateralized reinsurance</a>).</p>
<p>Further, while the majority of the $29 billion currently in force in cat bonds is largely allocated to weather-related risks, several billion is allocated to earthquake risk, terrorism risk, life insurance-related longevity risk and mortgage risk.</p>
<p>Securitized mortgages in the run-up to the financial crisis, on the other hand, overshadowed these numbers by several magnitudes.</p>
<h2>Trillions, not billions</h2>
<p>According to researchers <a href="https://www.jstor.org/stable/20869292?seq=1#page_scan_tab_contents">Yuliya Demyanyk and Otto van Hemert</a>: </p>
<blockquote>
<p>“The total amount of mortgage-backed securities issued almost tripled between 1996 and 2007 to $7.3 trillion. The securitized share of sub-prime mortgages increased from 54 per cent in 2001 to 75 per cent in 2006.”</p>
</blockquote>
<p>That is trillion with a T, compared to $97 billion with a B.</p>
<p>In addition to problems with the actual sub-prime mortgage-backed securities themselves came a sub-crisis precipitated by the triggering of large values of <a href="https://www.investopedia.com/terms/c/creditdefaultswap.asp">credit default swaps</a>, financial instruments that act as credit insurance for mortgage-backed bonds if bond issuers are not able to pay investors what they’re owed.</p>
<p>Since 2000, the market for CDS went from US$900 billion to more than $45 trillion. The amount of outstanding CDS reached $60 trillion in 2007. As more and more issuers of sub-prime mortgage-backed bonds were unable to meet their financial obligations, underwriters of CDS were tapped to make good on their promises. </p>
<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/272347/original/file-20190502-103085-der42o.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/272347/original/file-20190502-103085-der42o.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/272347/original/file-20190502-103085-der42o.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/272347/original/file-20190502-103085-der42o.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/272347/original/file-20190502-103085-der42o.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/272347/original/file-20190502-103085-der42o.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/272347/original/file-20190502-103085-der42o.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">CDS played a role in the collapse of investment bank Bear Stearns in 2008.</span>
<span class="attribution"><span class="source">The Associated Press</span></span>
</figcaption>
</figure>
<p>This led to the failure of investment bank <a href="http://nymag.com/intelligencer/2008/03/a_quickie_guide_to_the_fall_of.html">Bear Stearns</a> and serious crises at firms that included global financial services company <a href="https://www.washingtonpost.com/news/wonk/wp/2013/10/21/everything-you-need-to-know-about-jpmorgans-13-billion-settlement/?utm_term=.dfedd067c97e">JPMorgan Chase</a>, <a href="https://insight.kellogg.northwestern.edu/article/what-went-wrong-at-aig">global insurer AIG</a> and international reinsurer <a href="https://www.ft.com/content/1a4d67be-9676-11dc-b2da-0000779fd2ac">Swiss Reinsurance Company</a>.</p>
<p>It’s quite clear by these numbers that the crisis precipitated by the flameout of sub-prime mortgage-backed securities in 2007-2008 — and, as a result, of CDS markets as well — was entirely different in size, scope and impact than if the $29 billion cat bond market (or even all of the $97 billion in non-traditional reinsurance) were to simultaneously implode.</p>
<p>So while the theory of climate change causing a collapse of the global cat bond market, thus precipitating a global financial crisis like we saw in 2007-2008 seems plausible — perhaps even inevitable — in reality, it is highly unlikely.</p><img src="https://counter.theconversation.com/content/115217/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Glenn McGillivray is affiliated with the Institute for Catastrophic Loss Reduction, a non-for profit research Institute of Western University.</span></em></p>The unlikely failure of the catastrophe bond market won’t trigger a financial crisis like the one a decade ago.Glenn McGillivray, Managing Director, Institute for Catastrophic Loss Reduction, Western UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/848542017-10-06T14:36:16Z2017-10-06T14:36:16ZHow a billion-dollar insurance industry protects Florida’s risky real estate game – for now<figure><img src="https://images.theconversation.com/files/189181/original/file-20171006-25779-1r5u44a.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/cawayne/4839985336/sizes/l">cawayne/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span></figcaption></figure><p>After dodging the worst of Hurricane Irma, Florida’s coastal <a href="https://www.nytimes.com/2017/09/18/us/florida-flood-irma-growth-.html">real estate boom</a> shows no signs of slowing. In Miami and nearby waterfront cities, a survey of local records show that more than 90 luxury high-rise apartment blocks are under construction or have been completed since 2015, increasingly financed by <a href="https://www.usatoday.com/story/news/world/2015/05/31/miami-real-estate-foreigner-money/26245513/">overseas investors</a> looking for “safe” opportunities in a turbulent global economy. </p>
<p>Yet, since 1886, the Sunshine State has been hit with almost twice as many hurricanes as the next two states, Texas and Louisiana. Currently, 2.4m people and 1.3m homes sit just <a href="http://sealevel.climatecentral.org/news/floria-and-the-rising-sea">1.2 metres above</a> the high tide line and sea levels are expected to rise up to two metres by the end of the century. </p>
<p>What enables Florida’s staggering growth against environmental odds? The answer, in part, comes down to how property insurance protects the state’s real estate against disasters. In 2015, Floridians spent <a href="https://www.citizensfla.com/documents/20702/93160/20160331+Market+Share+Report/ab841adc-d5fb-45ca-bff6-8dbd15d5cac5">US$10.8 billion on homeowners’ insurance</a> to protect more than 6m properties. The total insured value protected by the state’s homeowners’ market is a soaring $2.1 trillion, roughly equal to the annual economic output of India. </p>
<p>I have dedicated the past three years to researching how this massive market works – and whether it can really sustain Florida’s real estate boom in the long run.</p>
<h2>From risk to reward</h2>
<p>Property insurance balances Florida’s unusually high vulnerability to natural disasters against the growth pressures of the state’s real estate and construction industry. By requiring property insurance to protect loans, US mortgage lenders and investors have created a massive insurance market in Florida – and a costly necessity for property owners.</p>
<p>The global insurance-linked securities (ILS) industry plays an increasingly important part in this story, converting Florida’s hurricane risk into an attractive financial asset class. </p>
<p>The catastrophe bond – the most widely used ILS product – was created after Hurricane Andrew’s Miami landfall devastated Florida’s homeowners’ insurance industry in 1992. “Cat bonds” and other types of “alternative” insurance turn investment capital – from pension funds and other firms – into reinsurance, or insurance for insurers. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/189182/original/file-20171006-25772-1xq9zmu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/189182/original/file-20171006-25772-1xq9zmu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=347&fit=crop&dpr=1 600w, https://images.theconversation.com/files/189182/original/file-20171006-25772-1xq9zmu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=347&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/189182/original/file-20171006-25772-1xq9zmu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=347&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/189182/original/file-20171006-25772-1xq9zmu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=437&fit=crop&dpr=1 754w, https://images.theconversation.com/files/189182/original/file-20171006-25772-1xq9zmu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=437&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/189182/original/file-20171006-25772-1xq9zmu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=437&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">A perfect storm?</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/lilith121/311708470/sizes/l">Lilith121/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc/4.0/">CC BY-NC</a></span>
</figcaption>
</figure>
<p>Here’s how ILS works: insurance companies send a portion of the premium they collect from property owners to special trust companies in tax-friendly nations such as Bermuda, which then raise money from investors, who agree to repay a given range of losses if disaster strikes. And if not, investors walk away with the property owner’s premium, plus a tidy profit.</p>
<p>This complex financial market provides nearly <a href="http://thoughtleadership.aonbenfield.com/sitepages/display.aspx?tl=687">US$90 billion of protection</a> worldwide. Large institutions ranging from the World Bank to the Rockefeller Foundation celebrate ILS as a key <a href="https://www.rockefellerfoundation.org/blog/innovative-finance-has-a-major-role-to-play-in-tackling-climate-change/">financial solution</a> to help humanity adapt to climate change, particularly in developing countries. </p>
<h2>Meet the specialists</h2>
<p>Despite these global prospects, Florida’s hurricane risk continues to be the bread and butter for ILS investors. According to one of the biggest cat bond investors, up to half of the ILS market’s capital is pooled in the Florida homeowners’ market. The concentration of ILS capital in Florida can partly be explained by <a href="https://www.iii.org/sites/default/files/paper_HurricaneAndrew_final.pdf">changes to the homeowners’ insurance market</a>, in the 25 years following Hurricane Andrew. </p>
<p>Once led by national firms offering multiple insurance products, the market is now dominated by smaller firms that specialise in Florida homeowners’ insurance. Unable to spread their risk over a nationwide portfolio of business, these Florida “specialists” have become highly dependent on global reinsurers. </p>
<p>Several Florida specialists have deep relationships with reinsurers, including direct ownership ties and their own private ILS “vehicles”, which enable them to directly transfer billions of dollars of Florida hurricane risk to buyers in dozens of countries.</p>
<p>Ultimately, Wall Street’s growing demand for insurance-based products may be changing the fundamental public purpose of property insurance, from one that aims to protect the wealth of communities, to one that sees insured risk as the fodder for financial speculation. Some experts <a href="http://onlinelibrary.wiley.com/doi/10.1111/ecge.12048/abstract">have pointed out</a> unsettling parallels between these new financial mechanisms and the lending model that led to the 2008 subprime mortgage crisis.</p>
<h2>A high price</h2>
<p>The rise of ILS capital has made new financial resources available to Florida’s rocky property insurance market. But this service has come at a significant cost to homeowners. Floridians pay the <a href="http://www.tampabay.com/news/business/banking/homeowners-insurance-floridians-pay-more-than-double-us-average/2214581">highest homeowners’ insurance rates</a> in the nation, while stagnant wages and skyrocketing house prices make south Florida cities among the <a href="https://www.bizjournals.com/southflorida/news/2016/10/05/miami-has-the-highest-income-inequality-in-the.html">most unequal</a> in the country. </p>
<p>The billions of dollars that Floridians spend annually on homeowners’ insurance secures financial protection for those fortunate to be property owners. But it does little to fundamentally change the state’s exceptional exposure to disaster. </p>
<p>Florida’s state officials have taken a <a href="http://www.83degreesmedia.com/features/raminifications-of-sea-level-rise-in-Florida-072517.aspx">limited, piecemeal approach</a> to minimising the state’s vulnerability to sea level rise, while continuing to encourage development in vulnerable areas and directly subsidising the state’s property insurance market. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/189184/original/file-20171006-25749-k4idwu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/189184/original/file-20171006-25749-k4idwu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=264&fit=crop&dpr=1 600w, https://images.theconversation.com/files/189184/original/file-20171006-25749-k4idwu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=264&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/189184/original/file-20171006-25749-k4idwu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=264&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/189184/original/file-20171006-25749-k4idwu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=332&fit=crop&dpr=1 754w, https://images.theconversation.com/files/189184/original/file-20171006-25749-k4idwu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=332&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/189184/original/file-20171006-25749-k4idwu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=332&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Miami: alright if you’re wealthy.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/skynoir/11288734984/sizes/l">Sky Noir/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span>
</figcaption>
</figure>
<p>The prospect of <a href="http://edition.cnn.com/2017/09/15/us/climate-change-hurricanes-harvey-and-irma/index.html">stronger and more destructive hurricanes</a>, along with the potential for higher, risk-adjusted insurance rates, could put a massive strain on the affordability of Florida’s housing market in the future. </p>
<p>What’s more, the flow of global investment capital into Florida’s high-risk homeowners’ insurance sector may actually be making the state more vulnerable to hurricanes, by keeping insurers solvent and real estate markets in motion.</p>
<p>Indeed, Hurricane Irma appears unlikely to significantly upset the dynamics within the Florida homeowners’ insurance or global catastrophe reinsurance markets – even if at least one catastrophe bond <a href="http://www.artemis.bm/blog/2017/09/25/safepoints-manatee-2016-1-class-c-cat-bond-notes-priced-for-total-loss/">may have to pay out</a>. The ratings agency <a href="http://www3.ambest.com/ambv/bestnews/presscontent.aspx?refnum=25698&altsrc=9">A.M. Best estimates</a> that it would take a US$75 billion insured loss to do so – up to three times the <a href="http://www.insurancejournal.com/news/southeast/2017/09/22/465115.htm">expected US insured losses</a> for Irma. </p>
<p>So the ultimate limits of the multi-billion-dollar ILS market remain untested. But for now, the storm clouds have cleared, and Florida’s real estate boom continues.</p><img src="https://counter.theconversation.com/content/84854/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Zac Taylor's research is partly supported by a scholarship from the Federal Alliance for Safe Homes.</span></em></p>Climate change will increase the risk of owning properties in coastal cities like Miami – but the insurance industry isZac Taylor, PhD Candidate in Geography, University of LeedsLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/843652017-10-02T23:28:06Z2017-10-02T23:28:06ZThe stormy outlook for insurance-linked securities<figure><img src="https://images.theconversation.com/files/188244/original/file-20170930-21594-1g23pfx.jpg?ixlib=rb-1.1.0&rect=1251%2C61%2C3335%2C2558&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Water from Addicks Reservoir flows into Houston neighborhoods following hurricane Harvey in August. Allstate expects US$593 million in insurance losses for August due to the hurricane. </span> <span class="attribution"><span class="source">(AP Photo/David J. Phillip, File)</span></span></figcaption></figure><p>The world has witnessed a shocking series of disastrous events in the past several weeks. Devastating hurricanes and Mexico’s 7.1 magnitude earthquake are just some of the latest catastrophes to captivate our collective attention. </p>
<p>Hurricanes, earthquakes and other extreme events aren’t always unexpected, especially given the wealth of knowledge available about Earth’s geophysical system. But the recent rapid succession of them is remarkable even to longtime observers of such events.</p>
<p>What do these recent events mean for the significant changes that have taken place in the insurance and reinsurance sectors to cope with the mounting exposure of private and public actors to disaster risk?</p>
<p>The latest series of disasters represents a serious test to what are known as insurance-linked securities (ILS). They’ve been adopted by insurers, reinsurers — the insurers of insurers — and public entities to limit their exposure to disaster risk and transfer it to financial markets.</p>
<p>The performance of these securities is significant as the U.S. federal government is in the process of integrating ILS into other disaster financing mechanisms within the United States — namely, the <a href="http://www.artemis.bm/blog/2017/06/22/nfip-reform-bills-progress-including-calls-for-flood-cat-bonds/">National Flood Insurance Program</a>.</p>
<h2>Hurricane Andrew and its aftermath</h2>
<p>ILS, a relatively recent financial innovation that traces its origins to the mid-1990s, are largely a response by insurers, reinsurers and others being exposed to the increasingly costly impacts of <a href="http://www.nytimes.com/2007/08/26/magazine/26neworleans-t.html?mcubz=3">disastrous events</a>.</p>
<p>Effectively, ILS is a way to securitize disaster risk or transfer the exposure of these firms — and, more recently, governments — to the chance that they may have to pay claims in the aftermath of a hurricane, earthquake or other extreme event. </p>
<p>ILS, and their best known variant catastrophe bonds (cat bonds), act both as an insurance policy for those seeking to reduce some of their exposure to disaster risk and an as investment vehicle for those seeking to accept and gain access to that risk by buying into the <a href="http://roadtoparis.info/2014/11/18/cat-bonds-cashing-catastrophe/">bonds</a>.</p>
<p>The securitization of storms began in the aftermath of 1992’s Hurricane Andrew and its enormous costs to the state of Florida. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/188435/original/file-20171002-3124-14jsdgr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/188435/original/file-20171002-3124-14jsdgr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/188435/original/file-20171002-3124-14jsdgr.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/188435/original/file-20171002-3124-14jsdgr.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/188435/original/file-20171002-3124-14jsdgr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/188435/original/file-20171002-3124-14jsdgr.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/188435/original/file-20171002-3124-14jsdgr.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Rows of houses destroyed after Hurricane Andrew struck Florida in 1992.</span>
<span class="attribution"><span class="source">(AP Photo/Mark Foley, File)</span></span>
</figcaption>
</figure>
<p>Following the catastrophic damages and the bankruptcies of nine insurers, new financial architecture began to emerge to facilitate new, larger pools of capital being brought into the insurance and reinsurance sector. </p>
<p>This included the establishment of new reinsurance firms in the tax haven of Bermuda, a revolution in using statistical analysis to better model disaster exposure, as well as the creation of state-sponsored public insurers of last resort.</p>
<p>These public entities play an important role in the increasing integration of insurance and financial markets. </p>
<p>They create the underlying asset through the provision of insurance policies to those customers and property owners that private insurers do not want to insure and, later, via ILS and cat bonds, they transfer that risk to financial markets.</p>
<h2>Bigger storms, bigger pools</h2>
<p>ILS and cat bonds operate on this simple market-based logic: By providing insurers and others seeking to reduce their exposure to disaster risk with larger and more diverse sources of capital, they’ll be better equipped to handle extreme events when they occur. </p>
<p>Proponents of the securitization of storms also argue that by increasing competition between traditional reinsurance firms and new investors seeking to gain access to the market, homeowners and the public more broadly reap benefits by paying less for their insurance policies and enjoying a solvent and secure insurance sector.</p>
<p>These novel financial mechanisms also potentially benefit investors, providing a new source of diversification for their investment portfolio and an attractive yield, especially important in the low interest rate era of the past decade.</p>
<p>For all these reasons, there’s been significant growth of ILS as a source of both insurance and investment. </p>
<p>But larger questions remain unanswered, most importantly how they’ll perform in response to the latest spate of hurricanes and earthquakes. </p>
<p>From a political perspective, the market-based logics of ILS and the growing integration of insurance and finance remain underanalyzed and critiqued.</p>
<h2>Crisis and opportunity</h2>
<p>Harnessing financial markets to offset disaster risk and exposure for insurers may result in unforeseen or unanticipated results.</p>
<p>There’s currently a great deal of <a href="http://www.artemis.bm/blog/2017/09/21/reinsurer-profit-warnings-begin-with-hannover-re/">uncertainty</a> about what impact Hurricanes Harvey, Irma, Maria, as well as the recent Mexican earthquakes, <a href="http://www.artemis.bm/blog/2017/09/29/ils-funds-face-august-losses-on-hurricane-harvey-impact/">will have on ILS and cat bonds.</a> </p>
<p>Regulators set up following the 2008 financial meltdown have warned that insurance-linked securities bear remarkable similarities to mortgage-backed securities (MBS), the financial instrument designed to transfer sub-prime mortgage risk to financial markets that sparked the <a href="http://www.artemis.bm/blog/2014/05/16/eiopa-report-highlights-risk-of-underpricing-catastrophe-bonds/">crisis</a>.</p>
<p>Rather than reducing disaster risk, ILS and cat bonds may actually amplify it by spreading exposure and impacts further than those immediately suffering the disaster’s effects. </p>
<p>While the size of the ILS market and the number of outstanding bonds remain small in comparison to mortgage-backed securities prior to 2008, regulators are concerned that investors may be buying into risk they do not fully understand. That’s a situation eerily close to the one that precipitated the 2008 crisis.</p>
<p>With mortgage-backed securities, sub-prime mortgages posed the risk. With ILS, it’s the exposure of insurers and others to the chance a disaster may strike a particular area during a particular period of time.</p>
<p>The latest series of storms and earthquakes represents a serious test to insurance-linked securities. How they perform will have important consequences for disaster risk management going forward, especially in the era of climate change and the increasing development of disaster-prone areas.</p><img src="https://counter.theconversation.com/content/84365/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Korey Pasch does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Insurance-linked securities aim to shield insurers and governments from huge costs following disasters. But they bear eerie similarities to the securities that caused the 2008 financial meltdown.Korey Pasch, PhD Candidate in Political Science and International Relations, Queen's University, OntarioLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/666642016-10-07T18:00:24Z2016-10-07T18:00:24ZWhen catastrophe strikes, who foots the bill?<p>Hurricane Matthew <a href="http://www.chicagotribune.com/news/nationworld/ct-hurricane-matthew-florida-20161007-story.html">has slammed into the Florida coast</a> after hammering Haiti. Close to 2 million people were asked to evacuate to escape its winds and rain. </p>
<p>While any loss of life will be the biggest concern, the hurricane is expected to cause extensive damage to buildings and infrastructure, leaving Floridians saddled with heavy losses – some insured and some not. </p>
<p>For a category 4 storm in this area – as it was deemed at one point – the <a href="http://www.bloombergquint.com/markets/2016/10/05/hurricane-matthew-is-a-15-billion-threat-headed-to-florida">economic disruption</a> is expected to cost anywhere from $5 billion to $15 billion, according to Bloomberg. The storm was later downgraded to category 3.</p>
<p>Real estate analytics firm CoreLogic <a href="http://www.corelogic.com/about-us/news/media-advisory-hurricane-matthew.aspx">estimates</a> that more than 954,000 homes in Florida are at risk of surge damage from a Category 4 storm, with another million at risk in South Carolina, North Carolina and Georgia. </p>
<p>So who’s going to pay for it? </p>
<h2>First lines of defense</h2>
<p>One consequence of climate change is that <a href="https://cdn.americanprogress.org/wp-content/uploads/2016/09/21081429/CostsOfClimate.pdf">extreme weather events</a> are occurring more often with the potential to cause catastrophic damage more frequently. According to the <a href="http://www3.weforum.org/docs/Media/TheGlobalRisksReport2016.pdf">2016 Global Risks Report of the World Economic Forum</a>, extreme weather events rank second as the most likely threat to global stability going forward. And my research on the safety and soundness of financial institutions suggests this trend may also threaten the stability of the insurance industry. </p>
<p>The first line of defense to deal with the costs are the insurance companies operating in Florida, which will be busy in coming weeks and months assessing and paying the insurance policy claims of the insured home and business owners. </p>
<p>But most of Florida’s property insurers <a href="http://www.businesswire.com/news/home/20160526006307/en/Fitch-Florida-Specialist-Insurers-Largely-Untested-Hurricanes">are relatively new</a> because the market went through a fundamental restructuring after Hurricane Wilma in 2005, transitioning from large national insurers to smaller ones focused almost exclusively on the state. Wilma caused $12.3 billion in insured losses (in 2015 dollars), <a href="http://www.tampabay.com/news/business/banking/hurricane-matthew-has-the-florida-insurance-industry-bracing-for-its/2296864">ranking it fifth</a> among the most costly U.S. hurricanes. </p>
<p>This has made the next line of defense, reinsurers, much more important. </p>
<p>Insurance companies buy backup policies with reinsurers to reduce their exposure to insurance claims that require potentially large payouts in extreme weather events. This allows firms to reduce their liability on individual claims and achieve a reduced overall risk exposure from greater diversification. </p>
<p>The costs of all these policies are rising, though, as the historical and mathematical models used to price the policies factor in the more recent and more severe storms. </p>
<p>If weather-related events in the future do turn out to be more costly for insurers than in the past, historical data and traditional policy pricing models may not support equity valuations in this industry sufficiently to keep the firms financially stable. In other words, the firms may not have enough financial firepower to cover future calamities. </p>
<p>So, while insurers, reinsurers and their regulators try to develop better models and tools to manage climate and other catastrophic risks, global financial markets have provided some relief. </p>
<h2>Cat bonds to the rescue</h2>
<p>The issuance of catastrophe (aka “cat”) bonds has become an important source of funding for the insurance industry and an effective tool for shifting some of the largest risks to capital market investors. </p>
<p>Essentially, cat bonds are like most debt securities in that the issuer (in this case an insurer or reinsurer) gets access to financing (held in escrow) from investors in exchange for regular coupon payments and the eventual return of principal. The difference with this type of debt is that if a loss greater than a pre-specified amount occurs as a result of a hurricane or earthquake, the issuer is allowed to delay or skip interest and/or principal payments, while the bondholders incur losses that can be substantial. </p>
<p>Yet, in a near-zero interest rate environment, investors have largely benefited from the higher yields associated with catastrophe bonds. And <a href="http://www.naic.org/cipr_topics/topic_insurance_linked_securities.htm">few cat bonds</a> have suffered losses as a result of hurricane or earthquake, making them (so far) very rewarding for their holders. </p>
<p>And those attractive returns have increased the demand for these bonds and boosted issuance of the debt. Currently, there are about <a href="http://www.wsj.com/articles/hurricane-matthew-to-test-catastrophe-bond-market-1475791599">$12 billion worth of catastrophe bonds</a> with at least some exposure to Florida storms. That’s a little over half of all $22 billion cat bonds outstanding. (Only $5.55 billion of the debt was outstanding in 2005.)</p>
<p>But these bonds <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2140653">are not entirely immune</a> to financial crises or natural catastrophes. And some argue that the good times could end as the Florida market <a href="http://www.tampabay.com/blogs/the-buzz-florida-politics/as-hurricane-matthew-nears-a-reminder-that-insurance-market-is-untested/2296854">is heavily reliant</a> on reinsurance and also cat bonds, which means pension plans and other holders of the debt <a href="http://www.wsj.com/articles/hurricane-matthew-to-test-catastrophe-bond-market-1475791599">could face substantial losses</a> in case of extreme damage. </p>
<h2>Flooding losses</h2>
<p>These types of insurance <a href="https://www.allianz.com/en/press/news/financials/stock_bonds/news_2007-04-10.html/">typically</a> only cover wind-related damage from hurricanes. Yet such storms are also associated with extensive flooding. That’s covered by a different type of insurance altogether. </p>
<p>The National Flood Insurance Program (NFIP) administered by the Federal Emergency Management Agency (FEMA) works with several insurance companies to provide flood insurance to individuals and businesses in communities that have joined NFIP and adhere to sound floodplain management standards. </p>
<p>This is an example of a public-private partnership <a href="http://ascelibrary.org/doi/abs/10.1061/(ASCE)NH.1527-6996.0000201">that could be extended</a> to help protect against other extreme threats. The recent flood in Louisiana, for example, <a href="http://www.claimsjournal.com/news/southcentral/2016/09/09/273375.htm">is estimated</a> to have caused economic losses in the range of $10 billion to $15 billion. </p>
<p>FEMA has limited resources available to help the uninsured who often face daunting financial losses. According to the <a href="https://www.americanprogress.org/issues/green/report/2016/09/22/144386/the-costs-of-climate-inaction/">Center for American Progress</a>, FEMA provided about $67 billion in financial assistance to communities and individuals, or about $200 per U.S. resident, from 2005 to 2015. </p>
<h2>No insurance, no problem?</h2>
<p>But who pays when there’s no insurance? In the recent Louisiana flooding, for example, a <a href="http://www.claimsjournal.com/news/southcentral/2016/09/09/273375.htm">model suggested</a> 80 percent of damaged homes didn’t have flood insurance. </p>
<p>In Florida’s case, Citizens Property Insurance covers homeowners who cannot find insurance on the open market. This state-run company has reportedly spent a decade <a href="http://www.tampabay.com/news/business/banking/hurricane-matthew-has-the-florida-insurance-industry-bracing-for-its/2296864">increasing its reserves</a> and reducing the number of policies it covers. </p>
<p>Its $7.5 billion surplus, access to the Florida Hurricane Catastrophe Fund and reinsurance backup should help it handle a 1-in-100 year storm without having to levy new assessments on property owners, according to Citizens. </p>
<h2>More extremes lie ahead</h2>
<p>Extreme weather is expensive for insurance companies and their reinsurers, communities, taxpayers and also, potentially, capital market investors. </p>
<p>And it’s only getting more expensive as climate change increases the frequency of storms and their severity. </p>
<p>While more can be done to improve risk pricing and risk management, climate change mitigation is critical for our ability to continue to survive and recover from the catastrophes that lie ahead.</p><img src="https://counter.theconversation.com/content/66664/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Carolin Schellhorn does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Even though Hurricane Matthew has been downgraded to category 3, it’s expected to cause substantial damage to Florida and other states in the region. The question is, who pays.Carolin Schellhorn, Assistant Professor of Finance, St. Joseph's UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/527912016-01-14T12:20:18Z2016-01-14T12:20:18ZFlagship plan to rescue flood-hit home owners already looks out of its depth<figure><img src="https://images.theconversation.com/files/107736/original/image-20160111-6996-xb7cr3.jpg?ixlib=rb-1.1.0&rect=0%2C3%2C1729%2C1125&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Reflecting on flood insurance </span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/truckintim/23400740933/in/photolist-BDQV1z-CBe9Yc-CBe66c-C1Bwbn-CwPg1q-BBB5v7-CrPJyX-CwPbcs-BBJhgB-BABVfs-BABmyW-BAB8LS-Cy7Jni-Cq2n4R-BzVQWB-BYP67x-Cq2kFF-BYP64r-Cv1A6Q-C6bVtL-Cv1zX3-BzNzMy-BzNzis-BzVPji-Cj5AfF-BdBVMG-BzP6Y1-BtqBqt-BzNXdA-BtqyPX-BSkWQq-BSkVQu-BSkUBC-BzNQMj-BzNPqw-B3wdMz-BP5V1b-BWnEmQ-BWErWe-BUBMti-AX6VwS-Bs4GR7-BRLztN-BLCEjF-BRS34a-BRQjtD-BCRHbf-Bm5ogL-ANkvnL-BHxQRf">TruckinTim</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span></figcaption></figure><p>The Environment Agency still had <a href="https://flood-warning-information.service.gov.uk/">25 “red” flood warnings</a> and 140 “yellow” flood alerts in force across the UK on Monday. This comes as the <a href="http://www.theguardian.com/business/2016/jan/11/flooding-bill-will-hit-13bn-say-insurers">Association of British Insurers estimated</a> that flood damage this winter will have cost the industry about £1.3 billion. It has been a devastating time for many, and government spending on flood defences has come in for intense scrutiny. Close attention is also needed of the industry’s plan to insure the most at-risk homes.</p>
<p>From April 2016, <a href="http://www.floodre.co.uk/">Flood Re will come into operation</a>. It is a private reinsurer, created with legislative support, which will allow insurance companies to surrender the highest risks. Flood Re will allow affordable insurance for those living in vulnerable areas. In the short term, it will be funded by collecting a levy on insurers operating in the market, estimated at around £10 per house insured per year. </p>
<p>Flood Re will also charge for the reinsurance it sells, but the price is capped by reference to council tax bands. This means that high-risk properties will be subsidised by low-risk properties, but Flood Re is required by law to reduce this level of subsidy over time. This gives the government time to deal with high risk areas while shifting towards charging on the basis of the actual risk of flooding. Home owners will not notice any difference: Flood Re will deal exclusively with the primary insurers. But those setting up Flood Re face some unique challenges.</p>
<h2>Risking it all</h2>
<p>The reinsurer is charged by law with pursuing two goals: a move towards “risk reflective pricing” for flood insurance; and maintaining available and affordable flood insurance for residential properties.</p>
<p>These goals are conflicting. Current premium levels in the market do not reflect the risk borne, meaning that the flood component of home insurance for high-risk households is subsidised by low-risk households. If premium levels for high-risk households reflected the true risk, they would be unaffordable for some. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/107737/original/image-20160111-6972-mpcthi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/107737/original/image-20160111-6972-mpcthi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/107737/original/image-20160111-6972-mpcthi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=401&fit=crop&dpr=1 600w, https://images.theconversation.com/files/107737/original/image-20160111-6972-mpcthi.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=401&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/107737/original/image-20160111-6972-mpcthi.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=401&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/107737/original/image-20160111-6972-mpcthi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=504&fit=crop&dpr=1 754w, https://images.theconversation.com/files/107737/original/image-20160111-6972-mpcthi.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=504&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/107737/original/image-20160111-6972-mpcthi.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=504&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">State protection?</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/jaypeg/6089948633/in/photolist-fBb9YG-cGd6a7-aYstMX-ebciGm-o8R5so-981VLo-eSSQFx-c1N2dJ-bXiGyp-dUWKkM-2ooPJs-8xZwm7-9VetLq-ah9zyn-aRnxFt-ebciL5-eb6Fha">Jay Peg</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc/4.0/">CC BY-NC</a></span>
</figcaption>
</figure>
<p>Meeting both of the stated goals requires a future where the risk of flooding has been steadily reduced by preventative measures and the price of flood insurance has become naturally low, because the risk has also become low. This could prove a dangerous assumption.</p>
<p>In fact, some might say that the global uncertainty of climate change and the political uncertainty around spending on flood protection make such a future a Utopian ideal but the statute expects it to be made real in less than 25 years. </p>
<h2>Making compromises</h2>
<p>Flood Re’s conflicting statutory goals raise the question of which goal will have to give way: “risk based pricing” or “affordability”? The <a href="http://www.legislation.gov.uk/ukpga/2014/21/contents/enacted">Water Act 2014</a> contains provisions supporting Flood Re but does not indicate the priority. In the short term, those in charge of Flood Re will have to determine which is more important. Since Flood Re and the insurance market it supports cannot ultimately be permitted to become insolvent or dysfunctional, risk-based pricing at a higher level may well become a necessity, pushing insurance premiums upwards.</p>
<p>There are other issues too. Flood Re can provide advocacy and policy advice to government, but its core role is as a reinsurer, and as such it does not have any tools to directly influence homeowner behaviour as an insurer might do, through premiums or rewards for risk averse protection measures. </p>
<p>It can potentially influence the level of “excess” that the insured must bear before the home insurer becomes liable. But it has no regulatory powers and its influence over primary insurance will probably only ever be marginal. It is also limited to homes; it will not cover buy-to-let properties, small businesses or apartment blocks, and it is worth noting too that council tax bands are a comparatively poor indicator of disposable income, given the differences in the bands across the country.</p>
<p>There is also the issue of increasing costs. The initial direct cost borne by each householder is relatively low at £10.50 a year – the premium passed on to Flood Re – but this can be increased. In the event of a costly policy year, Flood Re can call for additional contributions from insurers. Even where necessary, price increases and additional calls for funds may well cause Flood Re to be unjustly perceived as a costly white elephant. </p>
<h2>Social imperative</h2>
<p>Flood Re can achieve some important goals. In the immediate term, it will be able to absorb the worst risks, allowing insurers to establish realistic market price levels for the vast majority of commercially valid risks. Over time, it will collect UK flood insurance data, which – depending on how it is made available – should help in monitoring the effectiveness of government and private action to control the effects of climate change.</p>
<p>Flood Re’s intended lifespan ending in less than 25 years should hopefully spur significant government action in high-risk areas. It seems doubtful that successive governments over four parliaments will uniformly treat the massive capital investment necessary as a priority, but Flood Re can at least encourage government to invest in flood prevention, mitigation and resilience to allow the phasing out objective to be met.</p>
<p>This new reinsurer is a necessary measure. Market distortions designed to protect homeowners and consumers have caused prices to remain artificially low. The unavailability of flood insurance is not an option for social reasons – misery and social disruption would result if large neighbourhoods became permanently uninhabitable. But the extent of this year’s flooding and the prospect of more to come undermines both the central assumption in the establishment of Flood Re and its ambitious, conflicting targets. No one can guarantee that the climate will play ball, or that politicians will dig deep to honour a previous regime’s commitments.</p><img src="https://counter.theconversation.com/content/52791/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Johanna Hjalmarsson has previously received Public Policy@Southampton and ESRC Impact Acceleration funding for flood insurance related research.</span></em></p><p class="fine-print"><em><span>James Davey has previously received ESRC Impact Acceleration funding for flood insurance related research.</span></em></p>Insuring the most at-risk homes should become easier after April, but the latest deluge makes the new scheme look fragile.Johanna Hjalmarsson, Senior Research Fellow, University of SouthamptonJames Davey, Professor of Law, University of SouthamptonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/420092015-06-05T14:25:28Z2015-06-05T14:25:28ZExtreme hurricanes show benefits of pooling catastrophic risks across states<figure><img src="https://images.theconversation.com/files/83982/original/image-20150604-3397-16x8bzj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">When will the next big one strike? </span> <span class="attribution"><span class="source">Hurricane via www.shutterstock.com</span></span></figcaption></figure><p><em>This article is part of The Conversation’s series this month on hurricanes. You can read the rest of the series <a href="https://theconversation.com/us/topics/hurricanes-2015">here</a>.</em></p>
<p>The official starting date for the Atlantic hurricane season was June 1, which happens to coincide with one of the major renewal dates for catastrophic wind reinsurance coverage. </p>
<p>Reinsurance is the process of insurers transferring risk they take on – by offering protection to homeowners and others – to other insurance companies (that is, reinsurers). It plays a critical role in the management of catastrophic risk, as it provides a mechanism for insurers to transfer some of their exposure and helps protect them when losses surge after extreme wind events like hurricanes. </p>
<p>Typically, this risk is spread further still, either by the insurer purchasing policies from multiple reinsurers or when a reinsurer sells part of the risk to other reinsurers operating in that market. </p>
<p>In addition to providing a mechanism for insurers to manage their exposure to catastrophic risk, catastrophe reinsurers potentially benefit through diversification by covering different types of catastrophes (such as from extreme winds, floods or earthquakes) and covering those risks across a wide geographic area. For the largest reinsurers, this could be on a global basis.</p>
<p>But these important benefits may be less valuable in a market where reinsurance pricing does not sufficiently reflect the risks. That’s been happening in recent years as the reinsurance market has experienced “soft” conditions – a decline in the pricing of catastrophic wind risk combined with ample reinsurance capacity. The trend has continued this year. </p>
<p>While lower prices provide obvious benefits to regular insurance companies (and potentially consumers) in the short to medium term, it also increases the likelihood of price spikes and a sharp drop in reinsurance capacity in the event of a very large catastrophic loss or a series of substantial shock losses. </p>
<p>The experience of the Florida market following the combined losses from the 2004 and 2005 hurricane seasons illustrates the potential problems when large shock losses result in significant price volatility. </p>
<p>The last significant hurricane event in Florida before that was Andrew in 1992. Typically, major hurricanes (category 3-5) <a href="http://www.nhc.noaa.gov/climo/images/return_mjrhurr.jpg">occur</a> once every 14 to 20 years across south Florida.</p>
<p>Following Hurricane Andrew, homeowners’ insurance showed small <a href="http://flains.org/fact-book-othermenu-38/904-property-insurance-background/2080-iii-key-facts-about-property-insurance.html">gains</a> in underwriting profitability in each of the 10 years prior to 2004 – when four major hurricanes hit the state from August 13 to September 26. </p>
<p>However, those underwriting gains <a href="http://www.myfloridacfo.com/pressoffice/documents/florida%20hurricanes%20take%20financial%20toll06.htm">were wiped out</a> after the market experienced almost US$36 billion in combined hurricane losses for 2004 and 2005. </p>
<p>Given the size of the losses, a jump in insurance rates was expected. But the magnitude was even greater due in part to substantial price increases from the reinsurance market. <a href="http://www.nytimes.com/2007/01/23/us/23florida.html?_r=0">Concerns</a> about affordability of insurance for property owners in Florida were one of the key issues in the 2006 gubernatorial election, and this led to a special legislative session on property insurance reform. </p>
<p>There also were <a href="http://www.insurancejournal.com/news/southeast/2006/05/04/67909.htm">calls</a> for a national solution through the <a href="http://www.myfloridacfo.com/hurricaneinsurancetaskforce/TaskforceRS2/draftlts6.pdf">creation</a> of a federal catastrophic wind risk pool, in which coverage for extreme wind events would be provided by the US government. While there was little support outside Florida for this type of approach at the time, the debate in the US about establishing a mechanism for insuring catastrophic wind risk at the national level has been ongoing and predates the substantial losses from the 2004 and 2005 hurricane seasons. </p>
<h2>Pooling the risks</h2>
<p>In order to better understand geographic diversification of catastrophic risk, two colleagues and I <a href="http://dx.doi.org/10.1057/gpp.2014.20">used</a> a catastrophe model and property data from the 2010 American Community Survey to calculate damage from tropical cyclone events (hurricanes and lesser tropical storms). We also looked at relevant causes of losses (wind, rain and storm surge) on property portfolios that ranged from single structures to an amalgamation of every residential exposure within the state of Florida to a larger risk pool of multiple combinations of coastal states in the southeastern US. </p>
<p>We wanted to understand whether and where diversification benefits accrued as risks were aggregated over an increasingly wide geographic area. We found that benefits began to accrue when the distance between exposures was around 140 nautical miles (about the average swath width of a tropical cyclone). </p>
<p>For the less severe but more frequent losses that result from hurricanes and tropical storms that strike once ever 20 to 25 years or less (known as the return period), there appeared to be no benefit of greater geographic diversification. </p>
<p>However, for less frequent, more severe events – those that have a return period of more than 25 years, including 1-in-100-year hurricanes like Katrina and Andrew – there were clear diversification benefits from spreading the risk over more states. Additionally, those gains increased with the return period. </p>
<p>The impact of these benefits becomes more meaningful when they are quantified. For example, the claims-paying capacity (how much capital would be needed to cover all anticipated losses) required for a 1-in-100-year event for the eight coastal states from Texas to Virginia, each operating in isolation, would be just over $130 billion. </p>
<p>But as a combined risk pool, such an event for the entire region is just over $71 billion, or $59 billion less. Based on these results, the risk pool requires significantly less capacity across time than would be required by treating each state in isolation.</p>
<h2>Benefits versus costs</h2>
<p>The most common argument against establishing such a risk pool is that it creates a subsidy for the higher-risk members of that particular pool. The <a href="http://www.insurancejournal.com/news/southeast/2006/05/04/67909.htm">debate</a> is not limited to property insurance; in Obamacare, for example, younger individuals subsidize older ones.</p>
<p>For catastrophic risk coverage more broadly, the question takes the form of: why should someone in the state of Alabama subsidize the catastrophic wind risk of a resident of Florida or Texas? Or why should inland residents subsidize those living on the coasts? </p>
<p>While the debate from these types of questions is important, it typically occurs in the absence of meaningful empirical evidence that compares the cost of subsidies with the benefits of pooling and potential reduction in taxpayer losses after catastrophe has occurred. </p>
<p>As our results indicate, those arguments become less valid as we look at longer return periods because each state in the pool that we evaluated benefits from geographic diversification. As such, we would argue that these benefits across time outweigh the subsidy costs. </p>
<p>As we begin the 2015 hurricane season, we do not know with certainty whether or not we will experience a major hurricane event this season or where it would occur. We do know, however, that the pooling of catastrophic risk – whether in a private market, through reinsurance, in a regional or national public pool or some combination – can provide meaningful benefits in terms of geographic diversification.</p><img src="https://counter.theconversation.com/content/42009/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Randy Dumm received a financial award from the International Insurance Society (Shin Excellence in Research award) for the research described in this paper. He is the Chairman of the Board of Sawgrass Mutual Insurance Company and he serves as an expert witness for a Florida based property and casualty insurer. He is a past member and Chair of the Florida Commission on Hurricane Loss Projection Methodology and he was a member of the State of Florida’s Task Force on Long-Term Solutions for Florida’s Hurricane Insurance Market. </span></em></p>A look at the Florida insurance market following the flurry of severe hurricanes in 2004-2005 shows that pooling risk can cut losses.Randy E Dumm, Hold Professor of Risk Management and Insurance, Florida State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/181752013-12-04T14:54:19Z2013-12-04T14:54:19ZGovernment flood insurance plan is already treading water<figure><img src="https://images.theconversation.com/files/36802/original/vb4rqsws-1386067490.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Is the government's scheme already in deep water?</span> <span class="attribution"><span class="source">Steve Parsons/PA </span></span></figcaption></figure><p>The government’s long-awaited plans on how to help the insurance industry provide flood insurance to those homes and properties most at risk was presented. They are promising, but have fundamental shortcomings, according to the <a href="http://www.cccep.ac.uk/Home.aspx">Centre for Climate Change Economics and Policy</a>.</p>
<p>The main criticism is that the scheme does not take into account the effects of climate change. This is likely to raise the risk of flooding, increasing the number of uninsurable properties eligible for the scheme, and thereby making it financially unviable. The government’s proposed scheme is designed to cover the 2% of homes most at risk, but if this has been substantially underestimated, then the scheme may prove unworkable.</p>
<p>The proposed model creates a reinsurance pool called <a href="https://www.abi.org.uk/News/News-releases/2013/06/%7E/link.aspx?_id=E483D07DA3BD43BDB730A671A1C853CA&_z=z">Flood Re</a> to which insurers may cede the worst flood insurance risks. This way an insurer can retain only the risks it considers of commercial value in its own portfolio. Flood Re acts as a reinsurer that takes on only the very worst risks, removing them from the market and saving those in high-risk households the high premiums they would otherwise have to pay for flood insurance.</p>
<p>The scheme would be mandatory for all home insurers, and the pool would require funding – from the insurers, calculated on the basis of the cross-subsidy currently applied in relation to high risk flood insurance policies, and through a small fee added to each home insurance policy that covers flooding.</p>
<h2>All the risk, none of the reward</h2>
<p>The practice of ceding risks to a reinsurer is not uncommon; commercial reinsurers decide what types of risks they are willing to accept and what premium they require in return, a relationship much the same as between policy holders and insurers. But in the case of Flood Re, though the scheme will accept the worst risks, it will not be able to set a premium reflecting the risk.</p>
<p>This is crucial. Home insurers will try to cede as many high-risk properties as possible. If there is an increasing number of properties at high flood risk, this may put a financial strain on Flood Re. The effects of climate change will exacerbate this problem. The government in its report puts forward figures of <a href="https://consult.defra.gov.uk/flooding/floodinsurance/supporting_documents/20130626%20FINAL%20Future%20of%20Flood%20Insurance%20%20consultation%20document.pdf">around 250,000 UK households</a> at significant probability of flooding. The figures from CCCEP estimate 370,000, although the long term effects of climate change are not laid out.</p>
<p>As the economics of the scheme are vital to its survival, this criticism is important. The consultation document refers to a “list of high flood risk properties”, but if there is a closed list of properties, eligibility for the scheme is pre-determined, and no subsequent additions can be made. This would help shore up the economics of the scheme, but the question must be asked whether it is politically feasible to restrict it so tightly. Homeowners just the wrong side of the scheme’s boundaries will find that their premiums are higher than their immediate neighbours. In addition, CCCEP’s projection is that the effects of climate change may push the real costs of damage and loss beyond first estimates.</p>
<h2>Costs rise, but income is fixed</h2>
<p>The government’s aim is that Flood Re should be introduced to provide protection for the most at risk properties. Over 20-25 years, premiums will be allowed to gradually rise to market level while flood prevention measures continue to be taken, to bring insurance costs down to a reasonable level. But as the CCCEP report notes, flood risk is rising, losses are increasing, and there is no detailed explanation of how the scheme will be phased out.</p>
<p>The difficulty arises from the need for the income of the scheme to be determined in advance. The whole point of the scheme is that it covers risks that are not insurable at current market prices. Flood Re cannot simply raise the premium to a level where it covers its expected costs. Instead the premium has been calculated in advance and is paid by an insurer levy and a charge to insurance policy holders. Without a clear definition of what properties can be ceded to the scheme, insurers will have free rein to offload all their worst risks, but the scheme’s ability to raise cash to cover costs will not rise correspondingly.</p>
<p>Another problem that CCCEP highlights is that a scheme like Flood Re sends the wrong message to the insurance market, homeowners and local authorities. The <a href="https://www.abi.org.uk/Insurance-and-savings/Topics-and-issues/Flooding/Government-and-insurance-industry-flood-agreement">Statement of Principles</a>, the agreement between the insurance industry and the government following the <a href="http://news.bbc.co.uk/1/hi/uk/8464717.stm">particularly severe floods in 2007</a> entails that the government continue to invest in flood defences. It is vital this continues, but by providing guaranteed reinsurance for the porperties most at risk, the sense of urgency to build flood protection measures is reduced.</p>
<p>Worse, CCCEP note that far from alleviating the problem, the Flood Re scheme may actually make things worse. For example, mortgage providers and developers profit from building properties on flood plains, and while an uninsurable property cannot be mortgaged, Flood Re provides low cost insurance to the otherwise uninsurable. CCCEP’s response emphasises that mortgage providers and developers should also contribute to reducing flood risks.</p>
<p>Essentially, Flood Re as outlined steps away from the Statement of Principles, by failing to emphasise the urgent need for flood protection measures. As the CCCEP reponse notes, “insurance alone, without complementary risk reduction efforts, is not a sustainable solution, particularly in the context of climate change”. To get it right requires an integrated approach, one that considers the incentives of all the parties involved – mortgage providers, builders, local government planning authorities and central government – and ensures they are all working toward the same goal.</p><img src="https://counter.theconversation.com/content/18175/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>In early 2013, Johanna Hjalmarsson received funding from Public Policy@Southampton to produce a report comparing catastrophe insurance, including flood insurance, in a number of countries other than UK. The report is entitled 'Future Availability of Flood Insurance in the UK' and is publicly available.</span></em></p>The government’s long-awaited plans on how to help the insurance industry provide flood insurance to those homes and properties most at risk was presented. They are promising, but have fundamental shortcomings…Johanna Hjalmarsson, Senior Research Fellow, University of SouthamptonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/114802013-01-21T19:31:50Z2013-01-21T19:31:50ZClimate change is everybody’s business<figure><img src="https://images.theconversation.com/files/19034/original/ttf4nfxc-1357618360.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">As natural disasters happen more often, rising insurance premiums will force the private sector to take action on climate change.</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>Hurricane Sandy <a href="http://theconversation.com/hurricane-sandy-mixes-super-storm-conditions-with-climate-change-10388">may or may not be</a> a direct result of climate change, but what is certain is that the incidence of extreme climate events is increasing.</p>
<p>Such events are <a href="http://ipcc-wg2.gov/SREX/images/uploads/SREX-SPM_FINAL.pdf">predicted</a> by climate models, according to the IPCC, which has warned that “a changing climate leads to changes in the frequency, intensity, spatial extent, duration, and timing of extreme weather and climate events, and can result in unprecedented extreme weather and climate events”.</p>
<p>Breaking records in terms of wind ferocity, Hurricane Sandy hit land in a densely populated area on the East Coast of the US as well as devastating large parts of the Caribbean. The storm surge caused widespread flooding and damage. Not only was it a human tragedy, but property damage is likely to <a href="http://www.investopedia.com/financial-edge/1112/how-much-will-hurricane-sandy-cost-insurance-companies.aspx#axzz2G6PJUYEI">cost</a> $50 billion. The direct costs to the insurance industry are lower, in the order of between $10 and $20 billion.</p>
<p>It should come as no surprise that with expected payouts escalating rapidly over the next few years, the insurance industry is ringing warning bells.</p>
<p>They are already too high, according to Swiss Re, which <a href="http://www.swissre.com/media/news_releases/nr_20121219_sigma_natcat_estimates_2012.html">announced</a> that “economic losses from natural catastrophes and man-made disasters will likely reach at least USD 140 billion in 2012”.</p>
<p>Munich Re, the world’s largest reinsurance company, published <a href="http://www.munichreamerica.com/ks_severe_weather_na_order.shtml">“Severe weather in North America”</a>, which showed that during the past thirty years of weather-related disasters there was a clear rising trend for both extreme weather events and the costs of recovery. The report also identifies the probable cause for this trend. “The view that weather extremes are becoming more frequent and intense in various regions due to global warming is in keeping with current scientific findings.” Commenting on this report, Tony Kuczinski, CEO of Munich Re America warns: “What is clearly evident when the long-term data is reviewed is that losses from weather events are trending upward.”</p>
<p>The insurance industry faces another challenge. To stay commercially viable, actuaries need to be able to accurately calculate risks. In the past, they have calculated these risks by using historical data. For climate change, such data are seldom available, and so insurers will need to rely more on climate projections and models. Although these predictors are getting more reliable, they are nowhere as accurate as required. To play it safe, actuaries are likely to use conservative estimates of climate impact, meaning insurance costs will be based on the upper boundary of potential losses. That’s more bad news for business.</p>
<p>What all this means is that climate change presents unprecedented risks that the insurance industry may not be able or willing to cover. In areas that are particularly vulnerable, some insurance companies have already started to withdraw or steeply increase their premiums. For example, Allstate, a major US insurer, <a href="http://tristansturm.org/wp-content/uploads/2012/04/Geoforum-article-economic-crisis-and-insurance1.pdf">scaled back</a> its insurance in the Gulf region due to “unacceptable” losses following Hurricane Katrina, dropping 16,000 commercial customers in 2005.</p>
<p>As disasters caused by climate change increase in frequency and intensity, insurance will become increasingly unavailable or unaffordable.</p>
<p>Unfortunately, the private sector is not paying sufficient attention. But what would happen if insurance premiums increased 50%? 100%? 200%? Companies would have the impossible choice of deciding whether to continue to accept increases in their overheads or operate without insurance (euphemistically referred to as “self-insuring). For most, either solution would not be sustainable.</p>
<p>The risk to the affordability of insurance should focus the minds of the private sector. And it should force it to revise its comfortable assumption that climate change is someone else’s problem. In fact, now is the time to realise that climate change is very much its problem.</p><img src="https://counter.theconversation.com/content/11480/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>I do not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.</span></em></p>Hurricane Sandy may or may not be a direct result of climate change, but what is certain is that the incidence of extreme climate events is increasing. Such events are predicted by climate models, according…Harry Blutstein, Adjunct Professor, School of Global Studies, Social Science and Planning , RMIT UniversityLicensed as Creative Commons – attribution, no derivatives.