Editor’s Note: Capitol Gains is a member of the ImpactAlpha Podcast Network. The show is made possible by Court Street Group.

Discussions about equitable community development and the environment must consider what is happening in the insurance industry. 

Climate volatility and the cost in terms of human life, destruction of property and sustainability center around the way in which modern economies transfer risk through the property insurance model. This model has proven to be largely unreliable in recent years. On this edition of Capitol Gains, we explore how communities can mitigate risk and adapt to changing climate. 

In the latest podcast, we had the pleasure of hosting Carolyn Kousky of the Environmental Defense Fund. With an extensive background in climate risk management and policy approaches, Carolyn provided a compelling discussion on the evolving risks of climate change, the critical role of disaster insurance and the challenges within the current dynamic. 

“Effective disaster risk management requires coordinated efforts across all levels of government, coupled with innovative insurance models and robust community support systems,” Kousky said on the podcast. “This holistic approach can mitigate the impacts of disasters and help communities recover more swiftly and equitably.”

Climate crisis

Carolyn began by highlighting the unsettling reality that we are living in an era of ever-increasing climate risk. Unlike some traditional risks, climate change doesn’t have a foreseeable plateau; it’s a growing problem that requires both public and private institutions to adapt continuously. 

“What worries me most is that we are now in this period of ever-growing risk,” Kousky said on the podcast. “Risks are going to keep growing, and we, meaning individuals as well as our public and private institutions, I don’t think are very good or well designed to address that.”

We are experiencing record-breaking temperatures and other climate anomalies with alarming regularity. March of this year was the 10th hottest month on record. This continuous breaking of temperature records underscores the urgency of addressing climate change (and also was maintained in April, May and June of this year). 

Carolyn’s emphasis on the growing and evolving nature of climate risks calls for a dynamic and proactive approach to risk management. The need for continuous adaptation and resilience-building is more critical than ever, as traditional methods and standards are insufficient in the face of such an unprecedented and escalating crisis.

Disaster insurance

Policy limits are a principal issue facing the country as disasters strike with more frequency and intensity. For instance, standard homeowners insurance excludes flood coverage, which is instead handled by a separate federal program. This fragmentation creates significant challenges for those living in high-risk areas, who must juggle multiple policies to ensure comprehensive protection.

“Homeowners might think their insurance has them covered, but that’s not the case when it comes to many natural disasters,” Carolyn explained. Floods, for example, have been excluded from standard homeowners policies for over 50 years. 

Instead, she notes, homeowners must obtain separate flood insurance. The complexity extends to other disaster-specific coverages. “In the U.S., there’s no such thing as hurricane insurance. Residents in high-risk areas must navigate the maze of acquiring flood policies for storm surge and separate homeowners policies for wind damage.”

Carolyn underscored the problematic nature of this fragmented system, noting that it leaves many homeowners inadequately protected and often unaware of their actual coverage gaps until it’s too late. This lack of awareness and preparedness exacerbates the financial and emotional toll on individuals and communities in the aftermath of disasters.

System under strain

The rising frequency and severity of natural disasters has put immense strain on the insurance industry. Carolyn noted that climate impacts have materialized faster than anticipated, with the 2017-2018 wildfire seasons in California serving as a wake-up call. Insurers lost over a quarter-century of cumulative underwriting profits in just two years, highlighting the unsustainable nature of the current model.

“Climate impacts have started materializing faster and with greater severity than many in the industry were prepared for,” Carolyn noted. “The 2017-2018 wildfire seasons in California wiped out more than a quarter-century of cumulative underwriting profits for the entire homeowners insurance industry in the state. That’s just not a profitable business model anymore.” This situation has led many insurers to reassess their strategies and, in some cases, withdraw from high-risk markets altogether.

The financial strain is further compounded by the rising cost of rebuilding, driven by high inflation, supply chain disruptions, and labor shortages. Carolyn explained, “The cost to rebuild has skyrocketed due to inflation, increased materials costs, and labor shortages in the construction industry. These factors have led to higher premiums across the country, but especially in the areas of highest risk.”

Parametrics and beyond

Carolyn discussed the potential of innovative insurance models like parametric insurance, which provides payouts based on predefined triggers such as wind speeds or rainfall levels. These models can offer immediate financial relief to those impacted by disasters, filling crucial gaps in the current system. However, she stressed that such innovations need to be coupled with broader policy and regulatory changes to be truly effective.

“Parametric insurance has been around since at least the 90s, but there’s been renewed interest lately in harnessing this model to fill holes in our safety net,” Carolyn explained. “It’s not a replacement for traditional homeowners coverage, but it can address gaps by providing immediate financial relief for needs right after a disaster. For instance, parametric policies can offer fast, flexible dollars for immediate recovery efforts, which are crucial for lower-income households that lack liquid savings.”

She pointed out that parametric insurance can also benefit renters, small businesses, and local governments by covering non-property-related losses such as business interruption or spikes in rental prices. “By utilizing independent triggers, like wind speeds exceeding a certain threshold within a specified distance, these policies eliminate the need for lengthy claims adjustments and provide quicker payouts,” Carolyn noted.

However, Carolyn emphasized that innovation in insurance products alone isn’t sufficient. “These new models need to be part of a larger strategy that includes regulatory and policy changes. We need to lower risks to make homes more resilient and easier to insure. This involves improving building standards, offering incentives for risk mitigation, and ensuring that builders and contractors are equipped to meet these new standards.”

Community resilience

The role of government in enhancing disaster resilience cannot be overstated. Carolyn highlighted that while programs like FEMA and state-level initiatives play a crucial part in disaster response and recovery, there are significant gaps and procedural inequities that must be addressed to protect vulnerable communities more effectively.

“FEMA serves as our national first responder to large-scale disasters that receive a presidential disaster declaration,” Carolyn explained. “While FEMA manages the National Flood Insurance Program (NFIP) and provides essential aid, the assistance to households is typically limited to a few thousand dollars. This aid is intended to make homes safe, not to restore them to pre-disaster conditions, which leaves many families struggling to rebuild their lives fully.”

Carolyn noted the procedural inequities in disaster aid distribution, where more affluent and less affected communities often receive more support than those in dire need. “Research has shown that disaster aid dollars tend to flow more readily to wealthier, whiter communities, exacerbating inequalities. However, recent reforms under the Biden administration aim to streamline the process and ensure fairer distribution of funds.”

She pointed to Alabama’s fortified homes program as an exemplary model of integrated policy solutions. “Alabama has taken a holistic approach by mandating stronger building codes for new constructions in coastal areas and providing grants for fortifying existing homes. This multifaceted strategy not only enhances resilience but also ensures that communities are better prepared for future disasters.”

Additionally, Carolyn emphasized the importance of local government initiatives in fostering resilience. “State and local governments are pivotal in implementing building codes, land-use planning, and providing financial incentives for homeowners to adopt mitigation measures. For example, in Louisiana, efforts are underway to align various resilience programs to create a cohesive strategy that includes regulatory, financial, and educational components.”

Carolyn stressed the need for a comprehensive approach that integrates government policies, private sector innovation, and community engagement to build resilience against future climate risks. 

Looking ahead

In wrapping up this podcast episode, Carolyn emphasized the need for a comprehensive approach to risk management that includes both immediate and long-term strategies. Insurance can indeed be a lever for change, but it must be part of a larger ecosystem that supports building stronger, more resilient structures and communities. She called for a coordinated effort to bridge the gap between sophisticated risk assessments and actionable solutions for local governments, businesses, and households.

Our discussion with Carolyn Kousky shed light on the complexities of disaster insurance and the pressing need for innovative and equitable solutions to manage the growing risks of climate change. Her insights are a call to action for policymakers, insurers, and communities to work together in building a more resilient future. For a deeper dive into these issues, tune in to our latest podcast episode.

Matt Posner is a principal at Court Street Group.

James McIntyre is an expert in municipal, affordable housing, and clean energy finance. The opinions expressed in his writing or any other media publication are his own and do not necessarily represent the views of his employer or any affiliated organizations.