The Efficiency and Equity Impacts of Risk Classification in Catastrophe Insurance

Judson Boomhower; Meredith Fowlie

The Efficiency and Equity Impacts of Risk Classification in Catastrophe Insurance

Judson Boomhower & Meredith Fowlie

This is a preliminary draft and may not have been subjected to the formal review process of the NBER. This page will be updated as the chapter is revised.

CONFERENCE HELD May 22, 2025

Book: Environmental and Energy Policy and the Economy, volume 7

Book editors: Matthew J. Kotchen, Tatyana Deryugina & Catherine D. Wolfram

PUBLISHER: University of Chicago Press

Series: Environmental and Energy Policy and the Economy

Insured losses from natural disasters are increasing, prompting insurers to adopt more sophisticated approaches to modeling and classifying natural catastrophe risk. We study the efficiency and equity implications of increasingly granular risk classification in homeowners’ insurance markets. Insurance pricing that reflects variation in assessed hazard exposure can strengthen incentives for cost-effective mitigation, but it also exposes households to classification risk. The distributional consequences of more granular pricing depend on the correlation between assessed risk and wealth. We evaluate these trade-offs empirically using data from California’s homeowners insurance market. Focusing on wildfire risk, we show that more granular pricing raises insurance costs substantially for properties in the tail of the hazard distribution and increases take-up of cost-effective risk mitigation investments. Because wildfire risk is negatively correlated with income, granular pricing shifts more insurance costs onto lower-income households. These results underscore a central tension in catastrophe insurance: improving risk pricing efficiency can have undesirable distributional consequences.

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Thanks to Tatyana Deryugina, Catherine Wolfram, and Kimiko Barrett for very helpful comments. Boomhower gratefully acknowledges funding via an Andrew Carnegie Fellowship from the Carnegie Corporation of New York. CoreLogic, Inc. is a source of data for this analysis. CoreLogic was not involved in the preparation of any aspect of the report. Any conclusions/interpretations of the CoreLogic data are those of the authors of the report, and not CoreLogic. CoreLogic is not responsible for any use of, nor any decisions based on or in reliance on, the CoreLogic data used in the report. CoreLogic does not represent or warrant that the CoreLogic data is complete or free from error and does not assume, and expressly disclaims, any liability to any person or entity for any loss or damage caused or resulting in whole or in part by any reliance on the CoreLogic data including, but not limited to, any loss or damage caused or resulting in whole or in part by errors or omissions in the CoreLogic data, whether such errors or omissions result from negligence, accident, or other cause. CoreLogic� is the registered trademark of CoreLogic, Inc. and/or its subsidiaries or affiliates. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
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The Efficiency and Equity Impacts of Risk Classification in Catastrophe Insurance

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