How Are Insurance Markets Adapting to Climate Change? Risk Selection and Regulation in the Market for Homeowners Insurance

In the face of escalating climate risk, property insurance markets have a critical role to play in helping households and firms reduce risk exposures and recover from natural disasters when they strike. Performing these functions efficiently requires a detailed understanding of property-level disaster risk and pricing that accurately reflects the costs of insuring this risk. We use proprietary data on parcel-level wildfire risk, together with insurers’ regulatory rate filings, to investigate how insurance is being priced and provided in California’s homeowners’ insurance market. We document significant differences between the risk pricing we observe in this market and benchmark measures of ‘fair’ pricing. We also find striking variation across firms in terms of both risk pricing and underwriting. A selection model of natural hazard insurance that incorporates both price regulation and asymmetries in information across insurers helps rationalize these findings. Our results highlight the underappreciated importance of the winner’s curse as a barrier to participation in insurance markets for large, hard-to-model risks.

Speaker: Meridith Fowlie, UC Berkeley