The Insurance Protection Gap

Abstract

In a world of rising climate risk, how well insured are U.S. households? Using newly available individual-level homeowners insurance data spanning the United States over more than a decade, we document a substantial protection gap in household property insurance, concentrated among financially vulnerable borrowers. Mortgage lenders are a major force in shaping coverage: requirements generate pronounced bunching and kinks in insurance coverage choices, and lender rules alone explain nearly 67% of the variation. This leaves the protection gap largely on household equity rather than lender exposure. We then develop a conceptual framework that separates latent household demand from lender requirements and estimate it using quasi-exogenous regulatory shocks to insurance pricing. The evidence shows that lender-mandated coverage is highly inelastic, while household-chosen coverage above the mandate is much more price sensitive, implying that rising insurance costs will fall disproportionately on households.

Keywords: Climate Risk, Insurance Protection Gap, Property Insurers, Banks, Mortgages, Household Finance, Financial Stability