As climate risks continue to escalate, understanding how risk-sharing mechanisms such as insurance can mitigate these impacts is more important than ever. Designing an insurance system that can cope with increasing losses attributable to natural disasters is complex. This complexity arises due to the low-probability high-impact nature of these disasters, the high spatial correlation of losses, and the uncertainty in future climate risk projections.  

Insurance models provide key insights, such as climate risk faced by consumers and insurance companies, premiums, and optimal insurance arrangements. These insights not only provide directions for future research but can also aid in designing insurance arrangements that can cope with future climate risk.  

A recent study conducted by the Institute for Environmental Studies (IVM) at VU Amsterdam, reviews the state of the art of climate risk insurance modelling and has been published in Annals of the New York Academy of Sciences.  

The study analysed 38 climate risk insurance models and identified several gaps in the literature, such as: 

• Climate risk insurance is rarely studied in the context of developing countries 

• Few studies have focused on assessing climate risk insurance for the commercial sector such as for small-medium enterprises 

• It is not yet common practice to include climate change or socioeconomic scenarios in assessments of climate risk  

Furthermore, the analysis indicates that including climate change and socioeconomic scenarios in the models is crucial to assess the long-term viability of insurance systems given the significant increase in risk. Moreover, implementing risk-based premiums is shown to incentivise policyholders’ climate adaptation efforts, fostering climate resilience. Proactive government involvement in providing natural disaster insurance coverage improves insurance affordability.  

The study provides policy recommendations and identifies directions for future research, which we are already implementing in a new study on flood insurance arrangements for the commercial sector. 

The full paper can be found here.

For more information contact Michiel Ingels m.w.ingels@vu.nl