Mitigating Losses from Climate Change through Insurance

Climate change potentially amplifies catastrophe risks by raising the magnitude and frequency of certain extreme events in the long term. Its crucial feature is irreversibility. The availability and affordability of insurance will also be diminished in the presence of climate change. Weather losses can be mitigated by actions of the policyholder; however, the private returns from many mitigation investments may not be sufficient to warrant such investments on a short time scale. Insurance price could thus keep rising and catastrophe insurance could become less available in the near future. This study analyzes the potential implications of climate change for catastrophic risks and examines the appropriateness of longer term insurance contracts to protect insurers against catastrophic losses and changes in risk estimates over time. The major findings are as follows. Climate change essentially plays an important role in modeling catastrophic risks, especially in the tail of the loss distribution and for longer time scales. Mitigations can completely offset the impact of climate change. Longer term insurance contract may stimulate the incentive to invest on mitigation; however, risk capital required and annual premiums could increase due to the additional premium risk faced by the insurers.