what does climate change mean for home insurance?

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Disaster insurance is essential in protecting homeowners and ensuring the economic and social stability of a nation. It mitigates the direct financial consequences of disasters, creates a recovery safety net for those affected, and reduces the burden on public resources. However, the effects of climate change mean it is becoming increasingly inaccessible and, in some areas, unavailable.

Global warming has made disasters more frequent and more severe, increasing losses and recovery costs. In 2022 alone, floods in Australia and South Africa, hail storms in France, winter storms in the US and Europe, and droughts in Europe, China and America led to economic losses of $275 billion.

While only half of these losses have been insured, the cost of weather and climate disasters to the global insurance industry is increasing. In 2023, they reached $118 billion: 31% above the 21st century average. Some estimates suggest that such losses could double within a decade.

Consequences for insurers and owners

One result is a significantly higher financial burden on insurers. In response, they charge higher premiums, making insurance unaffordable for many. In the UK, home insurance costs in 2024 are 36 per cent higher than the previous year. In the US, some states saw an increase of 40 to 60 percent. And in Australia, 12.5% ​​of households in 2023 experienced extreme insurance affordability stress – up from 10% in 2022.

Another consequence is that insurers de-risk their portfolios by withdrawing cover in areas highly prone to natural disasters – leaving those most in need exposed. For example, many insurers have limited the sale of policies in US states, including California and Florida, or pulled out of some states altogether. The lack of affordable home insurance is forcing many homeowners into financial hardship.

Economic and social implications

Prohibitively expensive policies inevitably leave some properties completely uninsured. Many homeowners find that the monthly insurance payment is greater than the mortgage payment. Some of them choose to sell, while others will find it difficult to do so.

A fragile insurance market also poses a significant threat to the wider economy. As banks don’t want to risk giving mortgages, they reduce access to home ownership.

The secondary effects exacerbate inequality in societies. They deny many an asset that can be a source of wealth and future retirement funds. Furthermore, residents moving out of high-risk areas can reduce revenue for local governments that depend on property tax revenue. This risks leaving the community left with budget shortfalls, hogging funding for schools, police and other essential services.

Insurers withdrawing coverage or losing business due to the rising cost of premiums also undermines their own market. The continued increase in extreme weather events, particularly in high-value areas, is contributing to increased losses and threatening insurers’ ability to maintain coverage and financial stability. Managing risk effectively while maintaining market share means balancing declining business opportunities or increasing exposure to climate-related losses.

Policy response and risk groups

Governments, regulators, insurers and homeowners are increasingly recognizing the serious and widespread nature of disaster risk. Governments often intervene to establish national insurance or reinsurance risk pools to ensure the availability of insurance products and reduce their costs. Examples of these risk pools, which are usually not-for-profit or reinsurance schemes, include Flood Re in the United Kingdom; EQC Toka Tũ Ake from New Zealand; and NFIP in the US.

One approach is to reduce the premium paid, as is the case with Flood Re in the UK, a reinsurance group that receives a £10 fee from each home insurance policy.

This mechanism, known as risk redistribution, diversifies risk across the entire insured population to allow affected households to remain in the insured pool. Flood Re has proven to be effective since its inception in April 2016, cutting insurance premiums in high flood risk areas by more than half.

Dilemmas and their implications

For people in high-risk areas, subsidized insurance allows them to stay in their homes and maintain community ties, knowing they have disaster coverage to support recovery. However, this reliance on subsidized insurance can diminish awareness of increased climate change risk – reducing the urgency of relocation or adaptation measures.

A high insurance premium is a signal of the impact of climate change. When suppressed, however, it desensitizes societies to the urgency of adaptation. Consequently, individuals may face repeated disasters as climate impacts intensify, perpetuating a cycle of vulnerability.

For governments, subsidizing insurance using risk pools ensures that coverage remains affordable, supporting social stability and mitigating economic disruptions. These interventions can increase the total capital available for disaster recovery.

However, this approach can also create moral hazard, where at-risk individuals and businesses rely on government insurance for recovery. This strategy may strain public finances and may not adequately address long-term climate adaptation needs, leaving future generations to bear the costs of today’s inaction.

Meanwhile, insurers face a delicate balance in managing financial viability while providing coverage in high-risk areas. Raising premiums or withdrawing from these markets may protect their financial health, but may result in a shrinking customer base and public backlash.

High premiums can make insurance unaffordable, undermining the industry’s role in protecting against disaster-related financial losses. Insurers must therefore innovate and adapt, developing new risk assessment tools and insurance products, and even potentially a new operating model adapted to the evolving climate landscape.

Conclusion

The interaction between property insurance, climate change and economic stability presents a complex challenge that requires coordinated efforts from all stakeholders. The effectiveness of policy responses and the willingness of societies to adapt will significantly shape the future landscape of disaster risk management and insurance. Balancing immediate needs with long-term resilience is crucial for sustainable development in a changing climate.