How Insurance Regulation Moves Climate Risk Across State Lines

The Setup

Homeowners' insurance in the United States insures roughly $15 trillion in housing stock. When natural disasters strike, insurers want to raise prices to reflect higher risk. But there's a catch: insurance rates are regulated at the state level, and some states are much stricter than others.

This creates an unexpected problem: when losses occur in tightly regulated states, insurers can't fully adjust prices there. Instead, they raise prices in states with looser regulation—moving climate risk across state lines.

State Regulatory Environment

High Friction (California)

Low Friction (New York)

The Mechanism

Step 1 of 5

A Wildfire Hits California

A major wildfire strikes California, causing significant insured losses. An insurer operating in multiple states experiences large claims payouts, reducing its capital reserves.

Insurer Balance Sheet

Assets

Investments $800M

Premium Receivables $200M

Total Assets $1,000M

Liabilities & Equity

Loss Reserves $400M

Capital (Equity) $600M

Total L&E $1,000M

↓ Capital down from $1,000M to $600M due to claims

Step 5 of 5

Rates Rise in New York Instead

To restore profitability and capital, the insurer raises rates where it can: states with low regulation like New York.

California

Losses: High

Regulation: High

Rate Change:

↑

→

New York

Losses: None

Regulation: Low

Rate Change:

↑

Key Insight: Losses in California cause prices to rise in New York—but losses in New York don't affect California prices. This asymmetric spillover means households in lightly regulated states partially subsidize those in tightly regulated states.

The Evidence

The paper establishes this mechanism using three complementary empirical designs:

1. Asymmetric Spillovers

Effect of $1B Loss on Rate Changes

High-friction state loss
→ Low-friction state prices

+5.2%

Low-friction state loss
→ High-friction state prices

+0.3%

Low-friction state loss
→ Low-friction state prices

+0.8%

Only losses in high-friction states spill over significantly to other states' prices.

2. Border Discontinuity

High-Friction State

Price ↑ 2%

Low-Friction State

Price ↑ 7%

After distant disasters, prices jump at state borders—rising more on the low-friction side for identical coverage.

3. Long-Run Consequences

📉

Price-Risk Decoupling

Prices become too low in high-friction states and too high in low-friction states relative to actual risk.

🚪

Insurer Exits

Insurers increasingly exit high-friction states, expanding state-backed insurance programs.

Read the Full Paper

This interactive summary covers the core mechanism. For complete empirical results, robustness checks, and policy implications, see the full research paper.

View Full Paper