Imagine a free market economy where there is no government regulation of insurance markets and those who seek insurance can contract with for profit insurers. The for profit insurers will do their homework. They will research the emerging climate risks that different properties face. They will research the property's location, and the actions that the incumbent property owner has taken (stilts, trimmed vegetation) to protect the property from flooding and wildfire risk. The insurance company will quote a price for an insurance premium and the home owner will either accept it or reject it.
Riskier properties will face a higher premium to purchase insurance. Potential home buyers will get an insurance quote before they buy the home so that they know what the marginal cost of insuring the house will be. Firms like Jupiter can also provide a report about anticipated risks so the potential home buyer will know whether insurance rates for a specific home will rise sharply in future years. If this is the case, then the home buyer will bid less for the home and the current owner of the home will bear the expected future climate costs because the resale value of the home will be lower.
This free market system incentivizes insurers to do their homework . They will lose profit if they sell an insurance policy for too cheap of a price because the risky properties in expected value will require payouts. They will also lose profit if they price too high for a given property because a rival insurer will undercut them and gain the customer.
In this age of Big Data, insurers can make more profit by getting the conditional risk probabilities right.
They will make even greater profits if they can incentivize existing property owners to take self protection steps that lower disaster risks. If an insurer signs a medium term contract with a property owner that says; "if you take precautions x, y and z, we will charge you $X dollars per year for insurance and your premium will only rise each year by the state average for all other policies in our portfolio". Such a 10 year contract would provide the home owner with an incentive to invest in pre-cautions (especially if other home buyers are aware of the rising insurance costs if the current home owner doesn't take these precautions).
When government steps in and subsidizes insurance in flood zones and fire zones, this creates a moral hazard effect of reducing the likelihood that at risk property owners take these precautions. As the federal government crowds out private insurance sector investment in climate science, this slows down our nation's adaptation efforts.
My new economic consulting firm; Climate Economics, explores these issues.