Pricing of Climate Risk Insurance: Regulatory Frictions and Cross-Subsidies

53 Pages Posted: 2 Mar 2021

See all articles by Ishita Sen

Ishita Sen

Harvard University - Harvard Business School

Ana-Maria Tenekedjieva

Board of Governors of the Federal Reserve System

Date Written: February 2021

Abstract

Homeowners’ insurance provides households financial protection from climate losses. To improve access and affordability, state regulators impose price controls on insurance companies. Using novel data, we construct a new measure of rate setting frictions for individual states and show that different states exercise varying degrees of price control, which positively correlates with how exposed a state is to climate events. In high friction states, insurers are more restricted in their ability to set rates and adjust rates less frequently and by a lower amount after experiencing climate losses. In part, insurers overcome pricing frictions by cross-subsidizing insurance across states. We show that in response to losses in high friction states, insurers increase rates in low friction states. Over time, rates get disjoint from underlying risk, and grow faster in states with low pricing frictions. Our findings have consequences for how climate risk is shared in the economy and for long-term access to insurance.

Keywords: Climate Risk; Homeowners' Insurance; Price Controls; Financial Regulation; Cross-Subsidization; Financial Institutions

JEL Classification: G22, G28, G32

Suggested Citation

Sen, Ishita and Tenekedjieva, Ana-Maria, Pricing of Climate Risk Insurance: Regulatory Frictions and Cross-Subsidies (February 2021). Available at SSRN: https://ssrn.com/abstract=3762235 or http://dx.doi.org/10.2139/ssrn.3762235

Ishita Sen (Contact Author)

Harvard University - Harvard Business School ( email )

Soldiers Field
Baker Library
Boston, MA 02163
United States

Ana-Maria Tenekedjieva

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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