That’s right, it’s Climate Change Season again! It’s that time of year when the imperceptible statistical creep of climate change becomes tangible for some subset of the US population, because it’s warm outside somewhere in February (Climate Change Mini-Season, of course, is in July, when we get our first seasonal heat waves).
Climate Change Season is when the media algorithms serve us climate change data and climate change think pieces, because the algorithms are smart enough to know that no one wants to hear about global warming when it’s snowing outside.
Seasonality and our short attention spans notwithstanding, climate change has recently become tangible to a broad swath of people during the past year in terms of its impact on their wallets. There is still room to deny or ignore individual anecdotal evidence of climate change after a big wildfire (Paradise) or hurricane (Ian), as we can claim they are no different from their analogs from 30 years ago (Oakland, Andrew). It is harder to do so when home insurance costs double overnight in response to updated risk modelling.
The free market abhors a vacuum, and highly competitive insurance markets would certainly yield lower pricing if the actuarial tables supported it. Instead, insuretech is filling that vacuum with parametric insurance. Parametric insurance differs from traditional insurance in that instead of agreeing to pay, for example, to fix a flooded garage or basement, it instead agrees to pay out a fixed amount if floodwaters achieve a certain depth, regardless of how much damage that causes or does not cause. This allows the insurer to dispense with the traditional inspection and adjustment process, and likely shields them from a certain degree of fraud, ultimately resulting in lower premia and faster claims processing. The risk of determining what level of payout covers the property’s actual damage and replacement costs gets transferred from the insurer to the property owner. With parametric insurance, homeowners who are confident that their unique individual circumstances can beat the actuarial tables can put their money where their mouths are, and further incentivize safety upgrades like brush clearing and asset hardening without imposing tedious reporting requirements.
Outside of cheapening insurance with more specific underwriting, financial engineers can protect investors from climate change-imposed insurance risks with additional transparency. The idea that climate change would first impact global finance through the home insurance market was an astutely early observation of Deltaterra Capital. They identified certain Credit Risk Transfer (CRT) securities backed by homes in Florida and California likely to face price pressure due to the increasing cost of home insurance. As insurers flee both states, this view has become mainstream enough to land Deltaterra a deal with securities exchange company, ICE. In theory, this incremental transparency should be reflected in the pricing of these pools relative to those in areas with cheaper insurance.
Of course financial engineering can make our lives cheaper or more efficient relative to a given quantum of risk, but saving money on insurance will not make pumping water out of a flooded basement or cancelling soccer practice due to wildfire smoke any less miserable. This interactive tool visualizes the impact of climate change nationally by county, and the results should be sobering for many housing market participants (notably those who moved from San Francisco to Miami during COVID). It appears that the best way to maintain our current lifestyle is to head North, to the West Coast, or up a mountain. Should these forecasts come to pass, it will make real estate investing more interesting, but life considerably less pleasant.
