Climate Risk Management of U.S. P&C Insurers

Project: Research

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Description

Climate risk has become an important global issue that affects a wide range of entities in the economy, including the financial sector. According to the National Association of Insurance Commissioners (NAIC), the total economic costs of natural disasters in the U.S. have reached $232 billion in 2019, of which $71 billion is covered by insurance and thus imply cash outflows from insurers, predominantly Property and Casualty (P&C) insurers. As severe natural catastrophes appear to occur with increasing frequency in recent years, both the Treasury and NAIC are recognizing the importance of understanding whether and how climate risk may contribute to the financial sector’s systemic risk through its direct impact on P&C insurers. Studies of this sort, however, have been very limited. This paper aims to systematically examine the climate risk management of U.S. P&C insurers. P&C insurers sell insurance policies that protect households against property and asset losses, which are recorded as liabilities, and make portfolio investments in financial assets, mostly corporate bonds, which are recorded as assets. When a natural disaster arrives, insurers are not only subject to claim payments to policyholders but also potential impairment in the value of their investment portfolio due to downgrades or defaults of security issuers affected by the disaster. In other words, both sides of a P&C insurer’s balance sheet may have materialexposure to climate risk. Thus, we will evaluate insurers’ climate risk exposure from an asset-liability-management perspective. We will start by extracting the Natural Risk Index reported by the Federal Emergency Management Agency at both the county and state level as the basis for our climate risk measures. Then, for each insurer, we will use annual product-market data that reports state-level market share and sales to estimate the overall climate risk exposure on the liability side and take advantageof security-level investment holdings data and the National Establishment Time-Series database to pin down the asset-side climate risk exposure. Next, using these measures, we will show whether insurers’ investment portfolios help diversify away or amplify their productmarket climate risk exposure. We will analyze the effect of climate risk management by comparing insurers with similar product-market exposure but different investment-portfolio exposure, where the outcome variables include both ex ante business and financial performance and ex post resilience to natural disasters. Finally, we will explore how competition may affect insurers’ incentives for climate-risk management. 

Detail(s)

Project number9043420
Grant typeGRF
StatusNot started
Effective start/end date1/01/23 → …