Pricing of Climate Risk Insurance: Regulation and Cross-Subsidies

Abstract

We study the pricing of homeowners’ insurance, a $15 trillion market essential for hedging climate-related losses. We show that insurance premiums are subject to starkly different regulations across states, creating persistent cross-subsidies and price distortions. We employ states’ regulatory rules in an instrumental variable estimation and a border discontinuity design to show insurers do not adjust rates in highly-regulated states and compensate by raising rates in less-regulated states. Rates and risks diverge in the long-run, distorting cross-state risk-sharing and increasing insurer exits from highly-regulated states. We argue these patterns stem from  interactions between rate regulation and financing frictions. 

JEL Classification: G22, G52, G28, G32, Q54