Insurers are walking away. But who holds the risk?

The insurer is the trade that puts a price on the future of a place. When it stops insuring a region, it does not offer an opinion, it delivers a costed verdict: before climate makes a house uninhabitable, it makes it uninsurable, hence hard to sell, to finance, to live in. The insurance market thus acts as a sentinel, signalling danger before anyone else.

An insurer does not know whether your house will burn, but across a hundred thousand houses, it knows with striking precision how many will burn in a year. The larger the group and the more independent the losses, the more reliable the forecast. That is the law of large numbers: individual uncertainty turns into collective near-certainty, and it is what allows a fair premium to be set.

The whole mechanism assumes independent losses: your fire has nothing to do with your neighbour's. A natural disaster breaks this assumption. A hurricane, a wildfire, a flood strike thousands of homes at once. Losses cease to be independent, they become correlated, and pooling seizes up: there are no longer enough spared to pay the stricken.

The idea predates modern finance by nearly four thousand years. The Code of Hammurabi, around 1750 BCE, already released a merchant from his debt if his caravan was plundered, in exchange for a premium paid to the lender. At the same time, Chinese navigators spread their goods across several boats to disperse the risk. Greeks then Romans learned to share the risks of trading expeditions among several investors, while medieval guilds paid dues to compensate members struck by fire, theft or death. In the 14th century, the merchants of Genoa, Venice and Florence took a decisive step, gradually detaching the cover of the risk from the financing of the voyage. Modern insurance was in the making.

Around 1689, in London, Edward Lloyd's coffee house becomes the meeting point of merchants and shipowners. There they exchange maritime news and spread the risks of crossings, each underwriter taking only a fraction: this is syndicated underwriting. Lloyd's does not invent insurance; it gives it a place, rules and soon an institution able to turn an ancient practice into a true market of risk.

So as not to fall at the first big loss, the insurer insures itself with a reinsurer, which takes on the upper tranche of losses. The reinsurer in turn covers itself with other reinsurers: this is retrocession. The risk you transferred climbs a chain of ever more distant players, whose existence you do not even suspect, all the way to companies in Bermuda or the Cayman Islands.

Since the 1990s, insurers transfer part of the risk directly to the capital markets through catastrophe bonds, cat bonds. The investor earns a high coupon as long as nothing happens; if the forecast hurricane strikes, they lose all or part of their capital, which then pays the stricken. Climate risk has become an asset class in its own right.

Who holds these securities? Pension funds among others, seeking a yield uncorrelated with equities. In other words, the climate risk the insurer expelled from its balance sheet lands in households' retirement savings. The ultimate counterparty for a home in California may be the pension of a worker on the other side of the world.

When the private market retreats, public insurers step in: the FAIR Plan in California, Citizens in Florida. Conceived as a temporary net, they swell as insurers leave, and concentrate the worst of the risk, the kind no one wants.