Pricing of Climate Risk Insurance: Regulatory Frictions and Cross-Subsidies
53 Pages Posted: 2 Mar 2021
Date Written: February 2021
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: Suggested Citation