Title: Climate Change, Volatility, and the Insurance Industry
Author(s) : Keeghan Cummings, Jim Mahar, Reed McElfresh ,Evan McCabe, Evan McCabe
Property insurance companies are facing challenges due to increased losses from inflation, construction near disaster-prone areas, and climate change volatility. This paper focuses on the impact of climate volatility on insurance payouts and the insurance industry. We use the Black-Scholes Option Pricing Model, to show that an increase in volatility increases the value of the put contract. We then show that the insurance industry risk profile is comparable to being short put contracts. This key insight demonstrates how rising climatic volatility negatively impacts the insurance industry. In efficient markets, premiums should rise with volatility, but insurers often cannot set prices unilaterally when volatility is especially high. Consequently, insurance companies will exit risky markets. Governments intervene with subsidized programs, which may distort market signals and encourage over-investment in vulnerable areas, potentially exacerbating future problems. These interventions, while politically expedient, can delay addressing the underlying issues, leading to larger future challenges.