Assessing the potential for, and limits to, insurance and market-based mechanisms for encouraging climate change adaptation

Adaptation Research Grants Program
John McAneney
Macquarie University

Executive summary from the final report:

Insurance is a mechanism that makes the cost of managing risk more affordable through sharing the risks and the reduction in uncertainty resulting from this. This report comprises effectively three different insurance-related studies undertaken under the umbrella of NCCARF project S11-17 entitled: Assessing the potential for and limits to insurance and market based mechanisms for encouraging climate change adaptation.

Each study is presented in a different self-contained section. Section 3 provides an updated review of the peer-reviewed scientific literature looking at the causes of the rising insured and economic costs of natural disasters. Section 4 summarises various attempts by governments to get involved in the provision of natural catastrophe insurance and the degree to which this involvement encourages disaster risk reduction and climate change adaptation. The discussion has high currency in Australia, given the call from some quarters after the 2011 Queensland floods that the Australian government become involved in the insurance market. Section 5 deals with relatively new insurance structures called Catastrophe (CAT) Bonds, which transfer risk to the capital markets and which may present one option for insuring the legacy risk problem caused by the uninhibited development in at-risk locations and which could be amplified under a warming climate. Lastly, Section 6 discusses gaps and future research directions.

The peer-reviewed scientific literature shows that the rising costs of natural disasters from extreme weather is mainly explained by growing concentrations of population and wealth in disaster-prone regions, although a climate change contribution cannot be ruled out. At least in the case of US tropical cyclone, recent studies suggest that we may be several decades to centuries away from being able to detect with high statistical confidence an anthropogenic climate change signal in the losses. Given such long and uncertain time frames, policy-making in relation to climate change adaptation will of necessity take place in an environment of uncertainty and ignorance; this reality strengthens the case for encouraging adaptation to the current climate.

It is argued those hazard-resilient construction standards, risk-informed land use planning and flood defences are all key to reducing the cost of natural disasters. Building codes are normally considered at the level of an individual home and focussed on life-safety. However management of the overall economic impact means that building code design should also reflect the future impact of large disasters on the overall economy. 

In Section 4 we examine the potential for the insurance sector to be a positive actor in helping reduce this nation’s exposure to the risk of extreme weather. Since this is not a responsibility that the insurance sector can shoulder on its own, we also consider the regulatory environment, in other words, the role of government, who, by acting in concert with the free market, may be able to encourage community resilience to extreme weather events and manage any additional impacts caused by global climate change.

With this in mind, we have reviewed the provision of catastrophe insurance in a number of different countries and the involvement of government in various residual market schemes. Each scheme reflects particular history, hazard profile and culture. Government pools have certain advantages over the private sector in being able to spread losses across time onto future generations and being generally exempt of federal taxes on surpluses. 

View the final report