This blog was authored by Environmental Defense Fund economists Karina French and Carolyn Kousky. See their report: Inclusive Insurance for Climate-Related Disasters: A U.S. Roadmap.
Over the past year, the U.S. has seen yet again how climate-driven disasters threaten lives and livelihoods, from the devastating hurricanes, Ian and Fiona, in Florida and Puerto Rico to catastrophic rainfall flooding in California. These types of severe climate shocks cause disproportionate harm to people with low income and people of color, driven by inequitable housing and planning policies, underinvestment in resilient infrastructure and buildings, and barriers to accessing disaster recovery dollars.
Insurance is one key tool for financial protection from the economic shocks resulting from disasters. However, despite a relatively robust insurance market in the US, many of the people most in need of financial resources to recover face a disaster insurance system that is inaccessible, unaffordable, and/or not designed for their needs.
In a new report published this week in partnership with Ceres, we offer a roadmap for how local, state, and federal policymakers can improve the disaster insurance system to make it more inclusive.
The Economic Burden of Climate-Driven Disasters
Natural disasters create unexpected and widespread economic costs for households. In the short term, people face the immediate costs of evacuation, temporary housing, generators and fuel to deal with power outages, and direct damage to homes, personal items, and vehicles. In the long term, disasters can have a significant effect on economic well being, causing a loss of income or loss of a job when industry is disrupted, persistent increases in housing costs as housing stock suddenly declines, and permanent displacement and relocation. Without financial safety nets, the financial shocks of disasters can be tipping points into poverty and cause an increase in wealth inequality within a community.
Millions of Americans face these costs each year. The Federal Reserve estimates that in 2021, one in six adults were directly affected by a natural disaster, and this will only increase as climate change makes extreme rainfall, wildfire, and hurricanes more frequent and severe. Studies consistently find that more than one in four American households could not pay for an unexpected expense of $2,000; this economic precarity is even more acute for Black and Hispanic households, where 35 – 40% of households report facing difficulties paying bills if faced with a small emergency expense.
Households generally have four main sources of financial resources for disaster recovery: savings, loans, federal aid, and insurance. While the U.S. has more wealth to help in recovery compared to other countries, low-income households and people of color still face barriers to accessing all of these. On average, low-income, Black, and Hispanic households have lower cash savings and liquid assets to rely on for emergency expenses. Some households can make use of debt to finance recovery, such as federal Small Business Administration disaster loans, but research has shown that lower-income households face higher loan denials due to credit and debt-to-income requirements. Federal disaster aid, distributed through The Federal Emergency Management Agency (FEMA)’s Individual Assistance program, is not guaranteed, slow to distribute, and limited in quantity: from 2010 to 2022, FEMA provided grants to households in only 43% of major disaster declarations, and the average payment to impacted households was just $2,860 (Inclusive Insurance for Climate-Related Disasters: A U.S. Roadmap).
Insurance can be a financial resilience tool that fills some of these gaps. Insurance payment distribution is faster, as it does not rely on lengthy bureaucratic processes. Research shows that households with insurance recover better and faster after a disaster. But disaster insurance remains unaffordable and inaccessible to many low-income households.
The Challenge of the Disaster Insurance for Low-income Households
Why are so many households locked out of the disaster insurance market? Our research identified three main drivers of exclusion: unaffordability, direct and indirect discrimination, and lack of coverage for unprofitable market segments.
Natural disasters are inherently more challenging and expensive to insure. When a major storm or wildfire strikes, the losses across a community and group of policyholders are correlated, making it difficult for insurers to pool risk and cover costs over time. To do so, insurers must tap into large resources of capital (reinsurance, reserves, etc.), which makes disaster insurance expensive and less readily available. Advocates for frontline communities emphasize how low-income households simply cannot afford to purchase disaster insurance over other immediate costs, such as housing or auto payments.
Some households face systematically higher insurance costs or lower payouts. Insurers base underwriting and pricing decisions on how likely it is they will need to make payments back to policyholders; while insurers are banned from using factors like race and income to set rates in most states, there are many aspects of the insurance contract that can indirectly lead to differential impact along race, class, and gender lines, such as the use of proxy variables and procedural barriers to negotiating claims. A handful of qualitative and quantitative studies have shown discriminatory outcomes in insurance prices, payment times, and payment amounts.
On the supply side, it can be difficult for insurers to profitably offer products that are more widely affordable or that meet the needs of smaller market segments. There are also limited insurance products that address the many non-property losses that households incur. Insurers cite low profit margins and challenging regulatory environments for the lack of innovative or appropriate products that might address some of the needs low-income households and renters face. Because of this, there may be gaps in insurance that the private market cannot fill; providing affordable insurance to some households may require philanthropic support or public-private partnerships.
Policies for Regulatory Reform and Market Innovation
Given the increasing economic burden of climate-related disasters, systemic change is needed to ensure vulnerable households have tools for financial resilience. In our Inclusive Insurance report, we outline a suite of actions across sectors and scales that can be taken to create a disaster insurance system that is more affordable, accessible, transparent, people-centered, and just.
With legislation and new programs, federal and state policymakers can take action to:
- Target financial resilience funding to households and communities who need it the most by subsidizing disaster insurance for low-income households to provide lower-cost coverage, or mandating that insurers provide fair underwriting and insurance offerings to disinvested communities through a Community Reinvestment Act for the insurance sector. Policymakers could also provide funding to communities in the form of community grants for insurance innovation, enabling them to design and test their own programs.
- Increase transparency and monitor the market by mandating data disclosures from insurers about the demographics they serve, such as in the Home Mortgage Disclosure Act (HMDA). This would enable researchers to better assess any disproportionate impacts in disaster insurance markets.
Through regulatory reform, state insurance regulators can:
- Enable innovation in the insurance sector to meet the needs of underserved populations, by preemptively establishing regulatory frameworks for new insurance products like parametric or community insurance, or creating new regulatory sandboxes to enable insurers and regulators to test new products before scaling up.
- Provide more consumer protections and transparency to prevent differential treatment by reforming the claims contestation procedure to be more equitable and accessible and establishing complexity limits and coverage standards that give consumers the tools to better understand and compare insurance products. Regulators can also support research on the extent of direct and indirect discrimination in insurance markets, and the effectiveness of policies meant to address it.
Through innovative programs, local government leaders can:
- Provide community-scale insurance support tailored to each context, such as insurance consultations for households to help individuals navigate the procedural barriers and find cost savings, and community-based insurance models where the local government serves as the aggregator for insurance purchase and distribution.
Insurers and private sector leaders can:
- Expand product offerings to include innovative insurance products, such as parametric and microinsurance, that can be more affordable and serve households previously left out of the insurance market.
- Provide households tools for cost savings by increasing the transparency around the pricing of risk factors and offering opportunities for cost saving through risk mitigation that households can take advantage of, such as fortified roofs.
Promising First Steps
Already, local and federal leaders are taking action to better understand and fill the disaster insurance gap.
- In 2022, the Federal Insurance Office (FIO) announced a new initiative to assess the changing affordability and availability of insurance in climate-vulnerable areas, starting with gathering historic data from all major insurers about pricing and underwriting, a move EDF staff have advocated for.
- Puerto Rico passed the first microinsurance regulatory structure, opening up a new market for smaller policies with rapid payouts.
- At the local level, new innovative insurance pilots are emerging. In New York City, EDF and community partners are testing a novel community-scale parametric insurance product to support recovery of low-income households after flooding events.
Learn more about what state and local leaders can do to create a more inclusive insurance system in our report, Inclusive Insurance for Climate-Related Disasters: A U.S. Roadmap.