The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

By Aimee Donnellan

LONDON, Feb 26 (Reuters Breakingviews) - Natural disasters are becoming more frequent, deadly and damaging. At the same time, insurers are pulling coverage from areas most vulnerable to wildfires, floods, droughts and hurricanes. Their efforts to dodge the costs will be in vain, however. Governments won’t tolerate permanent insurance dead zones and can’t afford to pay up themselves. That means property and casualty firms like AIG AIG.N, AXA AXAF.PA and Chubb CB.BN will have to end up footing much of the bill one way or another.

Every main continent has endured an extreme weather event in recent years. January’s California wildfires may have caused up to $150 billion worth of damage, according to AccuWeather estimates. In 2019 and 2020, bush fires ripped through Australia. In 2019, Cyclone Idai became one of the most damaging disasters on record in the southern hemisphere, killing more than 1,000 people in Mozambique, Zimbabwe and Malawi. Flooding in Germany in 2021, meanwhile, caused $40 billion worth of damage according to Munich Re, making it the most expensive natural catastrophe to hit the country.

The costs of these devastating events are rising. In 2024, global economic losses from natural disasters hit $368 billion, according to Aon. That was 14% above the inflation-adjusted annual average since 2000, the insurance broker reckons. Climate-related disasters, like tropical storms and flooding, were the main perils. This year could be worse if the initial Los Angeles wildfire damage estimates prove correct.

Given the extent of such destruction, it stands to reason that insurers would be on the hook. And to an extent that is true. Insured losses, which in industry parlance means the amount of damage that’s covered by a policy, have accounted for about 40% of total economic costs from natural disasters in recent years, according to Breakingviews calculations using Aon data. Still, that leaves 60% uncovered. Moreover, the two-fifths number is inflated by the contribution of publicly backed schemes like the U.S. National Flood Insurance Program or Spain’s Insurance Compensation Consortium.

Private insurers, by contrast, seem to be trying to minimise their exposure. State Farm and Allstate ALL.N, two large property and casualty groups, in recent years have pulled back from certain forms of cover in California. That meant they avoided some of the more expensive damage caused by January’s flames. They’re not alone. In Louisiana, for example, nearly 20 companies pulled out of the state's market in the past two years, according to the findings of a U.S. congressional investigation released in December. Advances in data science and artificial intelligence may help insurers swerve even more disasters, by allowing them to trawl through satellite images and historical records to spot patterns.

From customers’ point of view, it’s a bad time for insurers to be dodging risk. The cost of climate change could tip $3 trillion by 2050, according to estimates from the World Economic Forum. And cash-strapped governments can hardly foot the whole bill, which would require politically unpopular tax hikes. Nor does it seem sustainable to let insurance dead zones persist, effectively leaving residents to their fate.

Different countries are trying different solutions. In Britain, for example, insurers and the government have clubbed together to cover flood-prone houses. Known as Flood Re, the initiative requires insurers like $17 billion Aviva AV.L to pay into a pot. The companies provide policies directly to customers, but can offload risk to Flood Re. The problem is that the scheme, which is due to expire in 2039, only covers a fraction of Britain’s homes right now, and it’s unclear whether future governments will be willing to backstop the costs if the damage and necessary cover grows.

Switzerland has a more extensive model. In areas with high risk of floods or other perils, 12 private insurers pool the risk and cover 90% of the natural perils market. Customers pay premiums based on the value of their house, rather than the risk of damage, which essentially means costs are no higher for flood-prone properties. This system is arguably easier on the public purse and insurers, because low-risk customers essentially subsidise high-risk ones. But it’s unclear whether that would work in a less wealthy country, or in a scenario where losses suddenly ballooned.

The recent U.S. wildfires illustrate how sensible-sounding schemes can fall short after a disaster. Many states, including California and Texas, have an insurer-of-last-resort under the Fair Access to Insurance Requirements $(FAIR.UK)$ plan. Private insurers effectively share the risk of covering highly vulnerable areas.

But the Californian FAIR plan recently buckled under the strain of the wildfires. In February, it lacked the money to pay out claims and had to seek $1 billion of fresh funding from insurers. Under California state law, the private players are allowed to pass half the cost of this emergency charge on to customers through higher prices, but they must eat the other half themselves.

The lesson is that, when disaster strikes, publicly mandated schemes will often need some extra cash, and insurers will look like the most plausible source of it. It won’t matter to policymakers that the sector’s return on equity is barely in the double digits, using data from Swiss Re, implying that there isn’t much excess profit to go around.

It’s possible to imagine a better future. Governments could step in with beefy building-code regulations to make sure that disaster-prone buildings are more resilient to floods, hurricanes or fires. Once a house or office had withstood some damage, insurers could step back in. That would also get around the incentive problem inherent in offering state-mandated policies in these areas, which only encourages people to keep living and building there, ultimately increasing the losses.

But getting to that future will take decades. In the meantime, it’s likely that governments will keep calling on insurers to pick up more of the tab.

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(Editing by Liam Proud and Streisand Neto)

((For previous columns by the author, Reuters customers can click on DONNELLAN/Aimee.Donnellan@thomsonreuters.com))