Dr. Carolyn Kousky, Environmental Defense Fund, on Insuring Against Climate Risk

Are there climate risks we shouldn’t be insuring anymore? Listen to Jason Mitchell discuss with Dr. Carolyn Kousky, Associate Vice President for Economics and Policy at the Environmental Defense Fund, about how climate change is reshaping insurance, what’s at stake if insurance markets begin to break down, and who ultimately bears the financial burden when the private market pulls back.

Recording date: 12 August 2025

Dr. Carolyn Kousky

Dr. Carolyn Kousky is Associate Vice President for Economics and Policy at the Environmental Defense Fund and founder of Insurance for Good. Carolyn’s research examines climate risk management and policy approaches for increasing resilience. She is the author of Understanding Disaster Insurance: New Tools for a More Resilient Future and an editor of A Blueprint for Coastal Adaptation. She is the vice-chair of the California Climate Insurance Working Group, a member of the Federal Advisory Committee on Insurance at the U.S. Department of Treasury, a member of the High-Level Advisory Board on the Financial Management of Catastrophic Risks at the OECD, a university fellow at Resources for the Future, and a non-resident scholar at the Insurance Information Institute.

Episode Transcript

Note: This transcription was generated using a combination of speech recognition software and human transcribers and may contain errors. As a part of this process, this transcript has also been edited for clarity.

Jason Mitchell:

I'm Jason Mitchell, Head of Responsible Investment Research at Man Group. You're listening to A Sustainable Future, a podcast about what we're doing today to build a more sustainable world tomorrow.

Hi, everyone. Welcome back to the podcast and I hope everyone is staying well. So the origin of this episode started out with the premise that the Florida insurance market is basically teetering on collapse. All it needs is two or three more extreme hurricanes to push it over. Now, from everything I've read, that statement sounds fairly intuitive to me, but there's also a part of me that wonders if there's an element of hyperbole in there. I mean, what about government backstops? Can't markets adapt? Could mechanisms like parametric triggers ensure against hurricane risk? I mean, for everything that's been thrown at Florida, it's been remarkably resilient, at least up to now.

But to take a few steps back, extreme weather has gone from being a remote actuarial outlier to a central and systemic challenge. One that is reshaping the very foundations of how we finance risk, which is why floods, wildfires, hurricanes and other climate-driven perils are pushing traditional insurance markets to a breaking point. From California to Florida, the retreat of insurers from high-risk areas isn't just a worrying trend, it's a flashing red light for the broader financial system. When coverage disappears, so do mortgage loans and investment. A home that can't be insured can't be financed, and when finance disappears, entire communities often the most vulnerable are left exposed. It's why it's great to have Dr. Carolyn Kousky, one of the leading minds at the intersection of climate change and insurance, on the podcast. She brings both the analytical rigour of an economist and the policy fluency of someone working at the front lines of resilience. We talk about how climate change is reshaping insurance and what that means for households, markets, and governments, as well as systemic risk and the potential for a climate-induced credit crunch.

We look at public insurers like Florida's Citizens in California's FAIR Plan, explore the growing role of parametric insurance and tackle the difficult question, "Should we stop insuring certain places altogether?" Carolyn is Associate Vice President for Economics and Policy at the Environmental Defence Fund and founder of Insurance for Good. Carolyn's research examines climate risk management and policy approaches for increasing resilience. She's the author of Understanding Disaster Insurance: New Tools for a More Resilient Future, and an editor of A Blueprint for Coastal Adaptation. She's the vice-chair of the California Climate Insurance Working Group. A member of the Federal Advisory Committee on Insurance at the US Department of Treasury. A member of the High-Level Advisory Board on the Financial Management of Catastrophic Risks at the OECD, a university fellow at the Resources for the Future, and a non-resident scholar at the Insurance Information Institute. Welcome to the podcast, Dr. Carolyn Kousky, it's great to have you here and thank you for taking the time today.

Carolyn Kousky:

Thanks for the invitation to join you. Looking forward to the conversation.

Jason Mitchell:

As am I. So Carolyn, let's start with some scene setting. Gunther Thallinger, a board member at Allianz, one of the world's biggest insurers, recently warned in a post on LinkedIn... he said, "The insurance industry has historically managed extreme weather phenomena, but we are fast approaching temperature levels - 1.5 C, 2 C, 3 C - where insurers will no longer be able to offer coverage for many of these risks. This isn't a one-off market adjustment. This is a systemic risk that threatens the very foundation of the financial sector. If insurance is no longer available, other financial services become unavailable too. A house that can't be insured, can't be mortgaged. No bank will issue loans for uninsurable property. Credit markets freeze. This is a climate-induced credit crunch." So my question to you is what's at stake in your view if insurance markets begin to break down at scale?

Carolyn Kousky:

Yes, I completely agree with his statement that if we get to a two degree, a three degree world, that is not insurable. And not only will the economic impacts be profound, but so will the impacts on society, on human wellbeing. I would like to think despite the setbacks in the US with this administration, that we can still avert the climate chaos that comes with a two or three degree world by focusing serious private and public sector efforts on decarbonization. Because if we don't, I think that insurance might be the least of our problems. And while we don't have decades for the needed emissions reductions, we do have decades until those sort of profoundly uninsurable impacts arise. And so, what we're seeing now and what we'll likely continue to see in the coming years near term is growing market stress, increasing volatility in insurance markets, and I think related to that, increasing public sector involvement in insurance markets.

I'm most familiar with the US market and we've seen just growing concerns about declining availability of insurance coverage, increasing prices. Now, we should be clear at the start that some of that is related to macroeconomic conditions and not climate risk. Our prior period of higher inflation when we had sort of supply chain and labour market disruptions coming out of COVID, the tariffs, anything that increases the cost of rebuilding is going to increase costs on insurers and thus increase premiums. And sometimes you also see pricing impacts related to regulatory dynamics, but I think the biggest impacts are in the areas of greatest growing climate risk and that's also the ones that in my mind are harder to deal with. And it's the fires and the hurricanes, it's severe storms and hail and flooding and insurance really starts to break with those types of severe disaster risks.

Maybe it's worth saying a bit on how insurance works. Technically, you need uncorrelated losses and you need thin tails in your loss distribution to get the benefits of risk pooling. A maybe more intuitive way to talk about it is that if you get a bunch of people together and you put money in a pot every year and something bad happens to one person, like a tree falls on their house, they can take the money and make the repairs and deal with that financial shock. But if everybody needs the money in the pool at the same time, the pool's bankrupt.

And so, you can kind of extrapolate that intuition to an insurance market. To make more money available in the pool, insurers have lots of tools. They purchase their own form of insurance, that's reinsurance. They might put risk into the financial markets, but all of that costs a lot. And so, those costs are passed on. And so, we see not just technical limits to insurability with climate risk, but economic limits where the cost to provide it is just more than people are willing or able to pay. And so, we see those types of breakdowns happening now and that's when the public sector steps in too.

Jason Mitchell:

That's some great context. You've obviously written a lot about the intersection of climate change and insurance, so maybe talk more about this pool. How is the insurance industry being reshaped by climate-related risks? Are we adapting fast enough? I guess what I'm asking is what would a truly climate resilient insurance market look like? One that blends technical, regulatory, economic and financially innovative elements and how far are we from it?

Carolyn Kousky:

Yeah, that's a really great question and I think one of the challenges in answering it is that to get to a really climate resilient insurance market, you need lots of things that are not insurance per se, which is to kind of your top question, I don't think we are adapting fast enough. We need much greater investments in lowering our losses from growing climate impacts and those sort of investments are a necessary condition to get the kind of stable resilient insurance market. And maybe I think one of many challenges with doing more and faster climate adaptation is that it's really hard for people, I think, to wrap their minds around the fact that we are in an era of ever-growing risk. It's really easy to say "Record-Breaking is the New Normal." Those are headlines and that's true, but it's harder to internalise what that means for decisions that we're making all the time and how to think about growing risk over the life of investments, over the life of a building, over the life of infrastructure.

And I think our brains are just much better at sort of easier problems, which are like, "Oh, maybe some new standard we need to build to or adjust for." But really the goalposts are constantly moving now and not only is change difficult for us, but long-term thinking, there's lots of behavioural economics research that as individuals, as institutions, we're really bad at long-term thinking as well. And so, dealing with the fact that the climate is no longer stable is not our default way of making decisions. And that impacts lots of things like we were just saying. So things like land use, where are we putting our people and our capital? How are we building? How safe are those structures against our growing climate impacts? And as well as just those kind of choices of where and how we build, the investments we need, and loss reduction infrastructure, which are things like nature-based solutions like wetlands to absorb floodwaters, but also grey investments like bigger stormwater systems.

And that whole range of investments to lower losses from hazards when they occur are foundational to insurability. And we can't, I don't think, financially engineer our way into a stable insurance market. We have to address the risk directly through these types of loss reduction investments. Now to get to your question, I do think insurance can help with that. So one option we've been looking at recently, we have a report just out and another one coming soon, looking at this idea of climate ready rebuilding endorsements. So endorsements are an add-on to an insurance policy, like an additional coverage you might choose. And so we've been looking at the possibility of having some additional coverage where at the time of a loss, your insurer gives you more money in order to make choices in your rebuilding that make the home safer and decarbonize the structure as well.

There's been some related examples. There was some experimentation with green building endorsements. And here in the US, we've seen really successfully some resilience endorsements in our state created programmes where several of them offer a free fortified endorsement, which just means that if your roof is damaged and you need a new roof after a storm, you get a roof that's fortified against hurricane winds. So I think there are ways like that that insurance can help drive some of the loss reduction and maybe be better advisors around what types of investments we need, but we're also... to support that resilient insurance system, we're also going to need better public policy, like strong building codes and that type of thing.

Jason Mitchell:

Yeah, I guess the big question is are there insurance risks we simply shouldn't be insuring anymore? I know you've written a lot about the importance of equitable disaster recovery, but in practise, doesn't subsidising insurance in high-risk areas at least sometimes encourage people to stay in harm's way? In other words, should insurance systems play some kind of role in encouraging people to relocate or is that asking too much of insurers and what's basically a financial product?

Carolyn Kousky:

Yeah, I think this is a difficult topic. I think economists would like to think and hope that insurance can be an information and a financial incentive around risks, but it's maybe not living up to that potential right now. So in the extreme, private markets will decide if there are risks that we can't insure anymore by walking away from those risks or asking prices that people can't afford as we were talking about earlier. And I think the big question then is what does government do in response? And we've seen that lots of governments are under enormous political pressure to continue to make insurance available and as inexpensive as possible. Nobody wants expensive insurance and insurance is really foundational as we know to a lot of economic activity. So when you have a volatile insurance market, it disrupts many other markets as well. Hence, this pressure to kind of keep it stable and affordable.

The kind of concern where that's biting a lot or I should say, getting a lot of media attention here in the US is that you need property insurance for a mortgage. So pullback from the private sector has these immediate impacts potentially on housing and mortgage markets if there's not an alternative. But we haven't really seen that play out yet because the alternative has always been our publicly created programmes. And so, now many of those publicly created programmes, this is maybe taking us on a little bit of a tangent, but we're created to be markets of last resort to not price compete with the private sector, but now they're offering less expensive insurance, which is getting to your question about the incentives that creates when these programmes directly subsidise or more often what we see here is cross-subsidise the risk then that can potentially fail to provide those important market signals.

So we're getting market signals from the private market, "This is too risky, we can't offer coverage there or certainly not at a price point..." but that signal is not translated fully because we have publicly created programmes that step in and make that coverage available or make it less expensive. We see this in other countries too. They have different structures, but places like France and Spain have flat charges for catastrophe coverage that are not risk-based. So you see the same kind of concern about incentive effects. I think some of the tension is that to get a better financial signal and incentive from insurance, it's going to be expensive in high risk areas because the risk is high. And so, we do have to think about the equity impacts of that and what to do with lower income or small businesses and high risk areas that couldn't afford that coverage.

But then also, how do we get ourselves out of this growing problem, which I think was to come back to your question about relocation and is our development in places that make sense as the planet continues to warm? And we've seen some interesting policy proposals around that, but none of them, as far as I know, have really been adopted. One suggestion made for the Flood Insurance Programme here in the US was that maybe we say federal flood insurance is not going to be available for new construction in high-risk areas. So we're not penalising the construction that's already there, but we're trying to stop making the problem worse and say, "In these high-risk areas, you're not going to get government-backed insurance anymore." So things like that might go further to providing those incentives.

In terms of actually helping with sort of deconstructing areas where the risk is getting too high and it's becoming uneconomic to continue to live, I think insurance can also potentially play a role there, but it's institutionally a little bit challenging. So insurance is typically to rebuild what was there before, to just put back what you had before. And there's a lot of requirements and regulations around it that make it hard to not do that, and those were necessary or maybe useful to prevent fraud and other things like that. But now as we don't want to build the same thing and we maybe want to build somewhere else, they can be red tape in that process. We see an example from California that's tried to kind of undo this. Now in California, if you lose your home completely in a wildfire, you were entitled to every last dollar you would've gotten from your insurance company to rebuild. But take that money and go somewhere else, rebuild somewhere safer, relocate, buy a home somewhere else.

So that's great, that helps that household relocate out of harm's way if that's what they want to do, but it doesn't make sure that societal risk is lower because it doesn't do anything to that property. So you see people who care less about the risk, are less informed, or developers trying to make money just kind of swoop in and purchase those properties. And so, societal risk hasn't changed. So we need some way to kind of couple that to taking that land into open space in perpetuity. And I haven't seen any systems developed to do that yet.

Jason Mitchell:

That's super interesting. I definitely want to come back to the public insurance programmes and some of the issues there, but insurance companies in Florida are often seen as the climate canary in the coal mine. In fact, that really was the genesis of my interest here. I recently had a discussion with the head of sustainability from one of the major US banks who told me that Florida is two major hurricanes away from insurers exiting the market, just getting up and completely leaving. Now, on one hand that's intuitive from everything I've read. I guess on the other hand, I sort of wonder how much of that is fact or how much of that is hyperbole. You yourself have described Florida's insurance market as teetering on crisis, but Florida has actually managed to survive through the last several CAT 4 and CAT 5 hurricanes. So what would one or two catastrophic events expose about the market structures and public programmes in Florida?

Carolyn Kousky:

Yeah. There's been some minor recent improvements in capacity and in the Florida market, but I think that the Florida market is still not robust. Big name insurance companies left Florida years ago. I mean, going back to Hurricane Andrew in 1992, the retreat of companies from the state accelerated again after the 2004 and five hurricane seasons. Those that have stayed have created often... not all, but often walled off subsidiaries so that losses in Florida don't impact the parent company. So the market in Florida looks really different than the rest of the country. Instead, it's lots of local and regional insurers.

The last data I looked at is a couple of years old now, but at that point, Florida only, they sometimes call them Florida specialist insurers, were over 50% of the market there. That's much higher than any other state where instead, you'd see these sort of big household name insurers taking up a large share of the market. This kind of structure of the Florida market is already really different given the high risk. It tends to be less robustly capitalised than in other states. It recently had the lowest levels of policyholder surplus. We've seen after recent storms that the amount insurers have been reserving has tended to be too low. So there are lots of warning signs about the stability of the Florida market. And then you add to that the fact that the risk is high and is getting higher.

Since 1980, our National Oceanic and Atmospheric Administration had estimated that Florida had over 30 tropical storms and hurricanes, each one causing more than a billion dollars in damages with total cost to the state between 300 and 400 billion. So we're talking very damaging storms and a third of those have occurred in the last five years. And so, if we look back over the history of the Florida market, multiple kind of state commissioned reports and analyses going all the way back to Andrew and then again after the '04, '05 season, have stressed that the economic losses from extreme hurricanes, as you said, one big one or many in quick succession might exceed what could be covered by the private market and by the public programmes in Florida and thus need some type of federal intervention.

So maybe it's useful to quickly note the state programmes in Florida. Florida has three state created insurance programmes. And like many other states prone to hurricanes in the US, it has what's referred to as a residual insurance programme, which is a sort of state created entity to provide insurance to those who can't find it in the private market. Over the decades, that's kind of oscillated back and forth between policies that make it a true market of last resort, meaning you have to be declined by the private market before you can get a policy, meaning the prices are higher than the private sector and not competitive, things like that, and the coverage is less good to being more of a market of first resort, meaning it's easy to get in and the prices are affordable and the coverage is great. And so, it's kind of gone back and forth over the years.

I think right now it's around 15 to 20% of the market. It has long been the state's largest insurer is this government created programme. It's called Florida Citizens, and the risk in it is really concentrated in the higher risk areas of the state, sort of southern for those who know Florida, sort of like Palm Beach, Broward, Miami-Dade counties represent a huge chunk of the policies in the programme. But sorry to come back to maybe some of the interesting financial questions here is that like the other residual markets, it does not pre-fund losses fully the way a private insurer would. So a private insurer takes its premium purchases, reinsurance purchases, financial risk transfer so that it can cover the claims of a really big event.

These publicly created programmes instead, they do a little bit of that, but for a big event or a series of events in a year, instead what they do is issue debt post-disaster to pay all the claims and then repay that debt over the coming years through assessments first on their own policy holders and then all policy holders in the state. The exceptions are workers' comp, medical malpractice, and flood. So that means that the big one hits Miami and you are in North Central Florida with an auto insurance policy, you will be paying the losses in Miami. And I don't think people will appreciate how much cross-subsidy exists. And it's not just Florida, it's all of our state programmes are sort of set up this way intentionally to keep prices lower today. So that's maybe a whole interesting other conversation on incentives. I got kind of down in the weeds there, but in addition to Florida Citizens, Florida also has the only state level reinsurance programme, the Florida Hurricane Catastrophe Fund, which was created after Andrew to provide a stable level of reinsurance to both Florida Citizens and the private market.

It also functions on this assessment model, so it has some coverage, but it also takes on debt and issues assessments to pay big claims. And then Florida has the Guarantee Association like other states in the US that backs insolvent insurers. So the kind of risk in Florida is that with all these sort of small local insurers that they can go bankrupt and when that happens, the policyholders are protected through this state programme which pays their losses. And so since 2019, they've had to cover claims from 10 different insolvencies costing one and a half billion or more than that. So you have these three programmes, all of which function with this assessment model. And so we've noted this in a recent report, there's some systemic risk here. That in a big event, all three have to go to the bond market at the same time and they might not find enough investors or high costs. So that comes back to why they want the federal government to step in and kind of help them.

Jason Mitchell:

That is super interesting.

Carolyn Kousky:

Sorry, it was a long-winded detour on Florida.

Jason Mitchell:

I did not know that about the cross subsidisation on auto loans, et cetera. That's really, really interesting. I guess I'm wondering what sort of climate informed stress testing methodologies do you think are appropriate for publicly backed insurers like as you said, Citizens, Property in Florida or even California's FAIR plan, the kind of stress testing that banks are expected to do?

Carolyn Kousky:

Yeah, think that is important. I mean, we were just talking about that systemic risk in Florida across all three programmes. And what we noted in our recent report was that there has not been a type of holistic stress test on all three programmes. So they're managed independently, but then you're not getting the assessment you need for what the systemic risk is to the state or what the holistic risk is. And so, I do think we need to be kind of explicit about those risks, quantifying those risks and then allocating them. So undertaking that comprehensive risk assessment in Florida. Insurers themselves have to face a lot of stress tests and stuff for regulation to make sure that they can stay solvent. But I think the bigger gaps right now are, like you noted, around our publicly created programmes and sort of what it means for societal impacts.

That said, I want to flag that doing that good quantification of risk and risk assessment is the first step, but then you have to take the appropriate risk management actions. And what we see with the publicly created programmes is it's really hard to insulate the risk management from politics. And I'm actually not sure how you really get around this, but a recent example here in the states is from Texas. They also have one of these so-called wind pools, residual markets, and they had been required to have enough claims paying ability to cover a 1-in-100 event, and that was expensive. The program's been growing, they have a lot of exposure, that meant they had to purchase more reinsurance and that's expensive. So instead of dealing with that risk directly through say, investing in loss reduction and these types of things, instead the legislature said, "Oh, you can just manage to a 1-in-50 year event."

Now that doesn't change the risk that they face, that doesn't make them more fiscally prepared. It makes them less fiscally prepared because essentially now they just buy less reinsurance, buy less cap bonds that translates into lower rates. But then when the big storm comes, they're going to use the same assessment model, so it's really... what that is doing is shifting the cost of extreme events from the policy holders themselves who face that risk to everybody else in the state. And so again, it's that type of cross subsidisation, but it's sort of hidden in these technicalities of... I'm not sure how many people realise that going from a 1-in-100 to a 1-in-50 level for the programme actually is increasing cross subsidisation. I keep coming back to this. We keep hammering on the same point, which is that to better manage this, you actually have to do the loss reduction.

And the truth is that a lot of our risk, I think this is probably true globally but it's definitely true here, is really geographically concentrated. There are smaller geographies, whether it's individual structures or individual communities where the risk is a disproportionate share of total exposure. And I think we need equally concentrated efforts at targeting risk reduction in those areas. And this is now coming back to things I already said. I don't mean to sound like a broken record, but it's things like strong building codes and land use regulations that take account of existing risk. And we're talking about what Texas did. Texas doesn't like those things. The state just faced devastating, heartbreaking floods. But what makes me angry about that is that loss of life and that damage was so preventable. It was not a secret that was a high flood risk area. So okay, I've gotten off here, but I think it comes back to the fact that improving our fiscal position does require facing the risk and doing that risk management better.

Jason Mitchell:

Interesting. I really like how you framed this question in a recent Wall Street Journal article, which is to say you asked, "Is climate insurance a private market good or is it social protection to make sure everyone has the resources to recover from disaster?" How would you respond to that question? Especially in light of a 2006 paper of yours in the Journal of Risk and Uncertainty titled Private Investment and Government where you wrote, "We show that if private capital is more likely to locate in better protected areas as would be expected, then the marginal social value of protection will increase with the levels of protection provided." I just keep wondering... basically, what have the last 20 years since that article was published, what have they taught us about the tension between the principles of private markets and social protection from climate change?

Carolyn Kousky:

Yeah, it's a good question and it's complicated, and I'm not sure how much progress we've made in understanding the feedbacks between policy and the market and your point at the top of the question between what we as a society want from insurance. So there's a lot of really good research that insurance provides enormous social good. Some of this is my own work with colleagues, people with insurance recover better, they recover faster, local economies do better. Insurance can prevent widening income inequality post disaster. It can protect lenders, the mortgage markets and so on. So it provides all these really important benefits to both the policyholder and the broader economy and society broadly. But when it's so great, how come so many people hate their insurance company? How come when you poll people, there's enormous distrust and frustration with insurance and how come after events like the LA fires, there is so much anger at insurance?

And I think we need to start digging in and helping answer those questions. And I do believe that insurance can be a force for good like you see in some of this research. But right now, the markets and the policies and the business models are just broken in a lot of places. And actually as an aside, that's why I founded my new nonprofit, Insurance for Good, that's working with communities in the public sector here in the states on some of those solutions. I think there's a lot of reforms and innovations that can help better align incentives to have insurance deliver on its promise. But that said, I also think that this tension between sort of market good and social protection, it's maybe worth saying, varies a lot by the type of insurance coverage. So I've been talking a lot with you about property insurance and mainly for households, maybe for businesses, but insurance rate is really heterogeneous and covers a lot of risks, a lot of players where these questions aren't coming up as much, where it's much more accepted and used as more of a private sector product.

Where we see this kind of bleeding into like, well, is this part of our social safety net are things like health insurance or disaster insurance, which is what we've been talking about and I do most of my work where there's really this kind of deeper concern about people's welfare and where activities in the private market then have these broader social consequences. When we have people who can't access private sector insurance and have the recovery need, that comes back onto the public sector and public sector recovery efforts. So there is this interaction there, and I don't think we've gotten to solutions that give everyone the protection they need, but also minimise, as you were saying, these maybe perverse incentive effects by just providing assistance. Yeah, I mean, I think there's several possible pieces to the solution. We could talk about some of them if you want to, but it's going to take a number of changes across sectors, I think.

Jason Mitchell:

Yeah. What role should governments play in ensuring insurance remains accessible, especially as private insurers, as we've talked about, are retreating from certain markets, California for instance. It seems like we're seeing a creeping shift in catastrophic climate risk from private balance sheets to the public sector in markets. We just talked about Florida, for instance, but what are the moral hazards that need to be taken account of? This sort of reminds me, it was kind of a big issue in a podcast episode I did with the ECB on the climate insurance protection gap that they saw in many southern European countries.

Carolyn Kousky:

Yeah, exactly. I think we are around the world seeing this shift from private balance sheets to the balance sheets of these publicly created entities, whether that's directly to the public sector or through these kind of created entities we have here in the US. And I do think we're going to need transition strategies to manage that as the risks continue to grow. Because as we see just growing climate-related impacts, we're going to see that transfer from the private sector to the public sector continue to increase. And then, that's just going to start stressing our publicly created programmes, which is to say that just because we've moved the risk into a public insurance programme, again, we haven't done anything with the risk and they're subject to the same difficult economics of catastrophe risk as the private sector. So they have another option, which is to make general taxpayers help cover those losses.

But beyond that, it's the same challenge if we don't do more to kind of lower the risk. And so, I think we keep coming back in this conversation that we need to kind of have that insurance protection, but also provided in a way that doesn't disincentivize that needed risk reduction. And I think part of that is the incentives to actually do the risk reduction, but part of it maybe that we haven't talked about yet is also the kind of risk signalling and communication piece. And it seems maybe very intuitive that insurance can and should play some type of role there because they're very obviously pricing risk.

But I guess I want to make two points on that. One is that insurance is almost everywhere in the globe with a few exceptions, a one-year policy, which means that it is signalling or incentivizing only this year's risk. So coming back to our conversation at the top that we're in this era of increasing risk and the climate is no longer stable and we need to be making decisions with that growing risk in mind, today's risk is not a good signal of that changing risk and insurance is never going to be the mechanism that signals or incentivizes around that growing risk.

So one, we need robust policy in place to do that, but we also need to be talking about all the other markets equally pricing risk too. It can't just be on the backs of insurance. So we need lenders to be pricing this in loans. We need our mortgages to be pricing climate risk. And again, that comes back to these difficult questions too though, we've seen challenges with thinking about lending and mortgages in the US fully priced climate risk because it's very hard to think about the equity impacts of that and how that doesn't just turn into a new form of red lining. So I think squaring those things is still something that we haven't quite figured out, but we're going to need to do going forward.

Jason Mitchell:

Interesting. If you dig into climate risks, I mean you've got primary perils like hurricanes, which tend to dominate the focus of disaster insurance markets. Yeah, it's interesting because seeing increasing evidence that secondary perils, I think chronic flooding, hail storms and extreme rainfall are contributing to equal or even greater annualised insured losses. How much of a blind spot do you think secondary perils pose in current climate insurance models and what are the implications of underestimating them?

Carolyn Kousky:

Yeah, that's a really good point. If you look at say, premiums in the US for example, they've been going up in many places far from those things that capture the headlines, the fires, and the hurricanes because of just like you said, severe storms, hail is getting worse. As the planet warms, we're seeing an energised water cycle, more rains coming as intense precipitation events that are overwhelming. Local drainage, we're seeing that in many places around the world. So all of those secondary apparels are creating more damage, which means more payouts, which means the need for higher premiums. I'm not sure how much that's a blind spot within the industry as opposed to another type of risk that needs to be managed better. I talked to a lot of insurers who are very aware and concerned of these growing risks. I think the challenge is that for an insurance company managing that might be pulling back coverage, might be putting restrictions in policies.

And so, how does the insurance sector management of those risk translate into societal management of those risks? I think is potentially an area not getting enough attention. I think it probably is the case that there are not as robust or advanced simulation-based models of these secondary apparels. So the types of models called catastrophe models that the insurance industry uses for pricing and underwriting, those might not be as well-developed for these types of apparels than for say, earthquake and wind, which have been developed and tested and validated going back to the early 1990s. So I do think there probably is a need for greater investments in those models, including how climate is altering those apparels so we can stay ahead in our management of them instead of always playing catch-up.

Jason Mitchell:

Got it. Where do parametric products fit into climate-resilience strategies? I'm wondering how can governments and insurers leverage parametric models to address risks that don't neatly fit into existing frameworks? We talked earlier about the Florida insurance market teetering on a crisis, and I wonder, do you think a move towards event-specific parametric insurance could help stabilise Florida's insurance market?

Carolyn Kousky:

Yeah, so parametric approaches have been around for a long time, but as you know, they've been getting increased attention over maybe, I don't know, the last decade as potential ways to fill insurance gaps. And yeah, as you're saying, help address some of the challenges we're seeing as climate risks accelerate. So these are policies that pay a fixed amount in response to observation of a measure of the hazard itself typically. So the payouts tend to be fast and they tend to be very flexible. And those are, I think, the two benefits of parametric and where you can think about the places that they could potentially help us. So parametric is helpful when you need speed and when you need flexibility. So an example might be it's really difficult for commercial entities to get non-property business interruption coverage. So that is when you lose revenue but your property wasn't damaged.

So to come to Florida, this is a strategy hotels can use because if there's a hurricane warning or a hurricane nearby, all the tourists might stay away and you might take a huge revenue hit, but your building might be fine. And so, your property insurance isn't going to cover that even though you've had this large economic loss. And so, parametric can be really good for that type of thing, for non-property losses. And so, it can be used to cover those types of events. We've also seen multiple applications globally of what's often called micro insurance, so smaller scale policies designed for lower income populations and parametrics opens up a business model with lower transaction costs. So you observe some independent data set, you see that this has happened, you can transfer the money automatically in some of these micro insurance products. It's a mobile money platform, so right into people's cell phones. And so, that's all just cheaper to administer than a kind of standard property insurance, which requires a loss adjuster to show up at your home and actually look at it.

And so, that decrease in the transaction cost of providing it has enabled these types of lower limit policies to be provided, which is providing enormous financial protection to many different market segments that might not otherwise be able to afford or access the policy. So I think that's also another promising application, and we're now doing some work, as many others are, to try to bring those types of models to help lower income populations throughout the developed world as well. So I think there are these niches where parametrics can be really helpful, but it's also probably worth saying that it's not going to replace a standard indemnity property insurance when that's what you need. If you need standard homeowners coverage, this is not a replacement for that. It's another tool to cover the types of economic losses that we can sustain from disasters.

Jason Mitchell:

Yeah, that's really interesting. I mean, as you said, it sort of allows for these rapid payouts based on some objective criteria. Maybe it's wind speed or surface pressure thresholds. I guess the problem is it leaves room for very difficult situations where let's say a community needs to deal with damages that have been caused by a lower intensity hazard and that community doesn't get any benefit. So how do you think about the trade-offs around this style of insurance, and is there a danger of some kind of over-dependence on capital markets for this form of public resilience?

Carolyn Kousky:

Yeah, great question. So the parametric product, as you said, pays based on some objective measure, and so it could pay out too little compared to your damage or too much, and you make a windfall, and that's often referred to as the basis risk. And when we're thinking about using parametric approaches as a tool for say, households or communities and not as say, a financial hedge, it really shouldn't be bought or used with... in my mind, this is a personal opinion, without the beneficiary being really clear on the details and the likelihood of the trigger, to your point. You have to have some degree of sophistication to understand the likelihood of whatever your trigger design is and if it's going to pay out. And so, what that means for the types of risks you're still holding on your own balance sheet and the kind of art of the parametric is to get that trigger as close as possible to matching when the purchaser is going to have an economic need.

We've seen some changes in trigger design to try to make that less dramatic. I mean, the concern is that you set some wind speed and it's one mile per hour below that and it doesn't pay, and yet you have all this damage. And so, to kind of get around that, we've seen things like stair step triggers where... So we had a parametric pilot that we worked on in New York City, and it had 10 steps of payout as the flood intensified. So as the flood gets more... well, here it got larger, the recipient would get more and more funds. And so, you can kind of do things like that to help smooth that and prevent the kind of binary yes, no, but I think you still need to be careful.

Maybe one bit of warning comes from a parametric catastrophe bond that was used by the World Bank for pandemic impacts for lower income countries. That was taken out back in 2017 before the pandemic because prior public health threats, pandemics had shown that government aid can often be slow to arrive to these countries. And so the thought, which is I think still a good thought, is that these types of financial instruments, because they have clear triggers and pay automatically could get money faster, and then the receiving country can use it for whatever they need so they can target it most effectively.

But we got COVID and it took months and months and months before it triggered, the policy turned out to not have one trigger. It had many triggers. It was complicated and confusing, and a lot of critics argued that the bond really profited investors without failing to pay out when needed. And so it was actually just something to help global investors and not the developing countries it was meant to serve. Now, it did ultimately at least partially trigger, but it was really too late if what you were trying to do is stop the spread of disease, which requires money in advance for the measures that would help limit spread, not once you've already lost people in your population. So it could have been designed differently for that, but it does kind of highlight I think some of the challenges here around transparency and use.

Jason Mitchell:

I definitely remember that. I think it certainly sort of stigmatised CAT bonds or the structures, created this notion that it's sort of a casino for investors where they generally win if the structure's right, which is unfortunate. But insurance is often seen as a post-disaster rebuilding process. What are markets doing in terms of developing resilience beyond, let's say, the simple reduction in insurance premiums? A number of states, I've heard you talk about this, Alabama, Louisiana, California already mandate that insurers give a premium reduction if homeowners fortify against hazards, but what can be improved and expanded in this process?

Carolyn Kousky:

Yeah, I think there's some pre-disaster and post-disaster places where insurance can help with driving those needed resilience. So pre-disaster are the things like the premium reductions that you mentioned. We've seen several states mandate premium reductions for certain very well-tested cost-effective things like we talked about earlier, fortifying your roof against hurricanes dramatically reduces losses, good payback period and so forth. And forcing insurers to provide premium reductions for those, which I think can really help make a tighter link between risk reduction and insurance. It has to also though be coupled to the outreach and education for consumers so that they know that benefit's available and that they can incorporate it into their decision making. It might be worth making that investment. We've seen less progress on reductions in premiums for other types of perils. There's now a lot of work to try to get those going around wildfire.

I think one area we still need to work on is that the models that insurers use for underwriting and pricing really need to be updated faster and reflect the investments in risk reduction the communities and households are making so that you can see that outcome in the pricing or the availability. We work with a lot of communities, and I've heard multiple times, "Hey, we're doing this resilience work, we're doing this risk reduction work, we're really taking our climate risk seriously, and we're not seeing changes in the insurance market. Why is that?" And I think there's a number of complicated answers to that question, but one is that a lot of the models are just behind, and it's too difficult for these modellers to go community by community and figure out every single localised investment to incorporate. So we've seen some really, I think, exciting and promising efforts to try to aggregate that data and make it more easy to integrate and interoperable with all the models.

For example, Milliman's leading an effort around this with Wildfire. And I think we're seeing that some standards and certifications can help with that too. Here, the Institute for Business & Home Safety has a certification process for a hurricane, for wind and also for fire, and those then can just be handed to your agent or your insurance company to try to get the needed reduction. So I think we're seeing those links start to tighten, but there's probably more to do. And then we also need insurance to be helping post-disaster. And that was what we were talking about earlier. I think providing more money and information during rebuilding to make sure that what we put back is safe for our climate future. And yeah, we have a lot... we need to do that more too. Too often, you see communities post-disaster sort of wave all building codes and just put back what was there before with the intention of making the rebuilding process easier and faster. But what it does is just set people up for future losses, which is really unfortunate.

Jason Mitchell:

So final question. One of the biggest tensions, we've talked about this a little bit in climate insurance, seems to be around risk-based pricing. On one hand, it sends a clear signal about risk and helps insurers stay solvent. On the other hand, it can make coverage completely unaffordable for the most vulnerable communities, often the ones most exposed to climate risks. Can you kind of finish by talking about your Insurance for Good work on this? How do we reconcile the goals of let's say, fairness, affordability, and fiscal realism and climate insurance markets? How can insurance be structured to support vulnerable communities rather than deepen disparities?

Carolyn Kousky:

Yeah, this is an ongoing challenge we're trying to work on. So maybe a couple of things to say about it. First is there's been a bit of a policy consensus among those working on this issue for a while now, that we need risk-based pricing in insurance markets for all the things we were talking about earlier, the incentives it creates and the signals it provides. But that imposes a lot of challenge on lower income households and communities, and there's no empirical evidence that I'm aware of that the incentive effects of below risk-based pricing for lower income communities in particular are very large. A lot of those communities are higher risk because they don't have the money to locate to safety because they don't have the money to invest in risk reduction. And so the moral hazard concerns, I think are not as strong there.

And so, the kind of consensus has been that you do risk-based pricing and then you have a sliding scale of subsidy based on financial need to make insurance more affordable based on people's income and ability to pay because of the huge important benefits it has, not just for the household, but the spillover benefits to the local economy with people having that insurance. But that takes policy, that takes a public programme to provide that and we just haven't seen politicians willing to adopt it. It's been introduced in the US Congress for our flood insurance programme for, I don't know, a decade or more, and it's never passed. And of course it's probably not going to happen now either.

But beyond sort of that direct thing on the pricing, I think there's a lot of other things that need to be done to think about creating a more inclusive disaster insurance market. And that includes things like transparency and literacy around insurance policies. We see there's a lot of exclusions and limitations hidden in the fine print of homeowners policies, and nobody reads the fine print. Some people probably wouldn't even follow some of the fine print. And so, there's been thinking around how to make sort of easier to understand policies or to sort of mandate baseline coverage so that everybody just has the coverage at some baseline level. And then if you need to top up with additional things, that's fine, but at least you know that everybody has some basic coverage for rebuilding. A really good example of that kind of baseline coverage is in California actually, where they have mandated that everyone with a kind of replacement cost homeowners policy has to have 10% building upgrade coverage associated with it.

Now, that's an extra coverage that most people would probably not necessarily choose to add on and pay more for. But it means that at rebuilding, you can come into compliance with updated building codes, which is important for safety and structural soundness, but is also important for say, wildfire building codes, because when building codes have been updated, it then unlocks insurance dollars to build back safer. So I think there's a number of things like that. Maybe the last point is looking at different types of innovations that could also support more socially vulnerable communities. And again, coming back to some of the parametric models, including micro insurance available, communities harnessing parametric approaches to help certain populations and so on. So I think there's a number of promising approaches that hopefully will start to grow in the coming years.

Jason Mitchell:

Great. So it's been a fascinating discussion rethinking what types of risks are still insurable in a warming world, how to accurately price those risks in ways that reflect both physical exposure and social vulnerability, and who ultimately bears the financial burden when the private markets start to pull away. So I'd really like to thank you for your time and insights. I'm Jason Mitchell, Head of Responsible Investment Research at Man Group here today with Dr. Carolyn Kousky, Acting Chief Economist at the Environmental Defence Fund. Many thanks for joining us on A Sustainable Future, and I hope you'll join us on our next podcast episode. Carolyn, thanks so much for your time today. This has been super interesting.

Carolyn Kousky:

Thanks so much for having me on. This was a great discussion.

Jason Mitchell:

I'm Jason Mitchell. Thanks for joining us. Special thanks to our guests and of course everyone that helped produce this show. To check out more episodes of this podcast, please visit us at man.com/ri-podcast.