CLIMATE
With Climate Impacts Growing, Insurance Companies
Face Big Challenges
BY RENEE
CHO |NOVEMBER 3, 2022
The impacts
of climate change are all around us: sea level rise, severe heat waves,
drought, extreme rainfall, more powerful storms. These impacts are making
natural disasters more intense and more frequent. Between 1980 and 2021, the
U.S. suffered 7 or 8 natural disasters per year, on average, but so far in 2022
there have already been 15. Losses from each disaster—drought and wildfires in
the southwest, severe storms in the Midwest, flooding in Kentucky and Missouri,
and hurricanes in the southeast—have exceeded $1 billion, with the cumulative
cost of disasters over the last five years reaching $788.4 billion.
As natural
disasters become more frequent and more costly, insurance companies are facing
big challenges — and when insurance companies struggle to survive, there are
implications for the real estate market and the entire economy. If insurers are
to weather the storms ahead, they’ll need to make some changes.
Why disaster costs are rising
Natural
disasters are becoming more expensive not only because climate change is
intensifying them, but also because of human factors. One of them is that more
and more people have been moving into areas with higher risks of climate
impacts. Redfin, a real estate company, found that from 2016 to 2020, more
people moved to high risk areas such as Florida, Texas, Arizona and Nevada,
than to low risk areas, drawn by cheaper housing, jobs, and warm weather. The
populations of Florida, Georgia, South Carolina, North Carolina, and Tennessee
are growing faster than the national average.
Wildland-urban
interface in Western Oregon. Photo: Bureau of Land Management Oregon and
Washington
In
addition, developers continue to build in areas with wildfire and flood risk.
From 1990 to 2010, the number of houses in the wildland-urban interface—the
area close to forests and thus at risk for wildfires—grew 46 percent. Redfin
reported that demand for these homes has grown with the pandemic and the
increase in remote work. Not only is vegetation more likely to burn in these
areas, but the presence of many people means fires are more likely to start by
accident. First Street Foundation, a nonprofit researching climate risk, found
that 10 million properties across the U.S. face major and extreme wildfire
risk.
The First
Street Foundation found that 14.6 million properties across the country are at
substantial risk of flooding, with 5.9 million of them not currently in a
designated Federal Emergency Management Agency (FEMA) floodplain—an area that
has a one percent or greater chance of flooding in a single year. On the East
Coast, new homes are being built two to three times faster than average in
areas vulnerable to flooding. Since Hurricane Sandy, which hit New York City 10
years ago, 225 permits have been issued for new apartment buildings in flood
zones. Charleston, SC, which is often battered by hurricanes, is moving ahead
on a 9,000-acre residential and commercial development where half the homes are
in a floodplain.
Another
challenge is that climate change is expanding the areas that are at risk for
various disasters. For example, flooding risk is rising even in areas that are
not on the coast or in floodplains. Hurricane Ian recently flooded communities
not only on the coast, but also in many areas of Central Florida that were not
designated flood zones.
In nine
Florida counties that were declared disaster areas, only 29 percent of the
households had flood insurance. In Hardee County, where a fifth of the
residents are poor, only 1.3 percent of households had it.
Problems with flood insurance
Because
standard homeowner insurance policies do not cover flood damage, homeowners who
live in a FEMA-designated flood zone must buy separate flood insurance.
While some
Floridians purchased private flood insurance, 80 percent of flood insurance
policies in the state were from the National Flood Insurance Program (NFIP)
managed by FEMA. Congress created the
NFIP in 1968 to share the financial risks of flood and restrict development in
floodplains. Even for those who have NFIP, however, payouts may not be enough
to cover their losses.
Until 2004,
NFIP was able to cover its payouts with its premiums, but after Hurricanes
Katrina and Sandy — the costliest and fourth most costly storms in U.S.
history, respectively — it has had to borrow funds from the U.S. Treasury. It
is currently $20.5 billion in debt.
The First
Street Foundation found that if all the homes it believes face substantial
flood risk were to be insured, NFIP’s rates would need to increase 4.5 times to
cover today’s actual risks, and 7.2 times to cover the increasing risks by
2051. FEMA recently established a new risk-rating system that will calculate
climate change impacts as NFIP sets premium rates. Currently, those rates are
based on FEMA’s flood maps. But FEMA’s director herself has acknowledged that
NFIP flood maps are outdated because they don’t account for extreme rainfall.
“FEMA is
required to update NFIP floodplain maps every five years, and it is required to
use the best available science relating to future risks in doing so,” said
Michael Burger, executive director of Columbia Climate School’s Sabin Center
for Climate Change Law. “FEMA can update the maps to be consistent with climate
risk, but the most important NFIP reforms are in the hands of Congress. And
Congress has continually kicked NFIP reform down the road. The Biden
administration has offered 17 legislative proposals [to reform NFIP] for
Congress to consider. The next deadline is December 16, but Congress, in
theory, could take on some of these proposals before then.”
How private insurance companies are responding to
climate impacts
As a result
of the increase in the number and intensity of natural disasters, insurance
companies are having to pay out more in claims. Hurricane Sandy was the
deadliest windstorm to hit the Northeast U.S. in four decades, with insured
losses of almost $26 billion. California wildfires in 2017 and 2018 resulted in
insurers paying out $29 billion in claims while they only collected $15.6
billion in premiums. The estimated total insured losses from Hurricane Ian
range from $53 to $74 billion, with flood-based losses projected to be another
$10 billion.
Incurring debt
Because of
their outlay for previous hurricanes — and in part because of other issues in
the litigation-friendly state — many major insurers have left Florida over the
last 20 years, including 12 that have closed down since 2020, leaving only
small in-state companies with fewer resources. Six insurance companies became
insolvent this year, unable to pay their debts, and 30 more Florida insurance
companies are being monitored by state regulators because their finances are
shaky.
Raising premium rates
When
insurance companies can’t pay their bills, they draw on their own reinsurance,
which is insurance for insurance companies to deal with very high claims. But
the reinsurance market is global, so if a natural disaster hits on the other
side of the world, the cost of a homeowner’s insurance policy in Florida could
go up as the reinsurance company itself raises its premiums. Reinsurers are
also beginning to leave the Florida market because of the large claims and its
litigious environment.
The
property losses from natural disasters due to climate change could increase
more than 60 percent by 2040 according to Swiss Re, the world’s largest
reinsurer. As a result, homeowner policy premiums are projected to increase 5.3
percent per year. Premiums already rose 12.1 percent across the U.S. from 2021
to 2022, with higher rates in states where natural disasters occur more
frequently, like Arkansas, Washington, and Colorado, according to the
Policygenius Home Insurance Pricing Report.
Because of
NFIP’s new risk rating system, 77 percent of current policy holders are
expected to face a rate increase. Some coastal property premiums have already
climbed to $4,000-$5,000 from $700 or $800.
Making it more difficult to get insurance
In addition
to increasing premiums, insurance companies are raising deductibles or
establishing higher deductibles for natural disasters that are more likely in
certain areas. Some policies will not cover “named storms.”
Insurance
companies are sometimes refusing to renew policies or denying coverage
altogether. The California wildfires of 2017-2018 resulted in 235,250
non-renewals, an increase of 31 percent. In 2019, however, California
prohibited insurance companies from not renewing homes in declared disaster
areas; this prohibition has been extended each year.
When
homeowners cannot get insurance from a private company, they can seek limited
temporary coverage through Fair Access to Insurance Requirements (FAIR) plans,
offered by 33 states and Washington D.C. These state-run insurance plans are
for homeowners whose properties are considered high risk. They are generally
more expensive than regular policies, and they are now likely to raise rates as
well. Citizens, Louisiana’s FAIR plan, was recently granted a 63 percent rate
increase by state insurance regulators.
The rising
cost for homeowners’ policies is making it more difficult for middle and
low-income households to purchase insurance. If premiums are too high,
lower-income residents could be priced out of their homes, or they might simply
do without insurance and face financial ruin when a natural disaster hits.
These communities are typically more vulnerable to climate impacts.
In
addition, some of these vulnerable communities are being blue-lined, whereby
banks or mortgage lenders define neighborhoods or communities that are more
susceptible to climate risks. Blue-lining can result in higher insurance
premiums, non-renewal, or denial of coverage. And blue-lined communities are
often the same ones that were once subjected to redlining which delineated
communities of color or low-income neighborhoods deemed too risky to invest in.
Redlined communities often received less public investment; consequently,
deteriorating infrastructure now leaves them more vulnerable to climate
impacts.
Incentivizing
adaptation measures
Some states
are offering incentives such as discounts on insurance or tax credits to
homeowners who make their homes more resistant to fires, wind, rain, and hail.
Buffer zone
around a California house. Photo: CAL FIRE official
In regions
that face wildfire risk, many fire insurance companies have left. Those that
remain may require residents to better protect their homes in order to get
insurance. This might include establishing a buffer zone between vegetation and
the home, using fire-resistant materials and designs for walls and roofs, and
installing sprinkler systems. These fire-proofing expenses can run thousands of
dollars. A new law in California now requires insurance companies to give
discounts to consumers if they implement fire-proofing measures.
Florida
insurance companies offer discounts for policyholders that fortify their homes
against hurricane force winds by strengthening and securing roofs and shutters,
and reinforcing garage doors. The state also offers sales tax exemptions for
impact resistant windows, doors, and garage doors.
NFIP policy
holders can lower their premiums by raising their properties up, moving
equipment off the bottom floor, and providing flood openings to allow
floodwaters to flow from the interior to the exterior.
Strategies
to fortify homes and make them more sustainable are effective. A case in point
is the Babcock Ranch, a 17,000-acre planned community in southwestern Florida.
It was designed to be sustainable and resilient, with 700,000 solar panels,
streets designed to flood so homes don’t, native landscaping to absorb
stormwater, and buried power and internet cables. The homes were built to the
latest building codes. When Hurricane Ian decimated nearby Fort Myers and
Naples, Babcock Ranch was unscathed except for a few downed trees, and never
lost power.
Potential repercussions of an insurance crisis
If climate
risks jeopardize the stability of insurance companies, what would be the impact
on the real estate market, and consequently the economy? “That’s a big question
that the entirety of the insurance industry, real estate sector, and financial
and investment communities are trying to figure out,” said Burger. “What does
climate risk mean for business as usual? What new opportunities does it
afford?”
Many states
are facing a homeowners insurance market crisis as policies get more expensive
and harder to come by. Florida’s and Louisiana’s homeowner insurance markets
are particularly precarious.
If
properties become uninsurable because of climate risks, mortgage providers
could refuse loans as well. Home values would fall as a result as people begin
to move away. Once they do, the tax base would decline, negatively affecting
school systems, fire departments, and other municipal services. The people who
cannot afford to move would be left behind, trapped in a community that
continues to deteriorate.
If we do
not curb our greenhouse gas emissions, climate change could eventually present
insurance companies with risks they can no longer afford to underwrite. In
2015, the CEO of Axa, a major insurance company said that a world warmed by two
degrees Celsius might be insurable, but a world warmed by four degrees
“certainly would not be.”
What should insurance companies do about climate
risks?
A 2019
global survey found that 72 percent of insurance companies believe climate
change will affect their business, but 80 percent of them have not taken
significant steps to lessen climate risks. Moreover, insurance companies invest
the money from the premiums they collect in the financial markets. They have
$582 billion invested in fossil fuels investments that could be devalued as
climate risks increase.
The
insurance industry needs to make substantial changes to deal with its own
climate risks. Some of these modifications could also enable insurance
companies to help speed the transition to a net-zero society. Here are some
recommendations.
The Center
for American Progress, a nonpartisan policy institute, recommends that:
Insurance companies should identify climate
risks, incorporate them into their business decisions, and disclose them in
public filings.
Companies should test their own resiliency by
running various climate scenarios.
States, the entities that regulate the insurance
industry, should collect data about climate risks, and use the findings to
create incentives for retrofitting and fortifying homes sustainably and to
develop resilient building standards.
Insurance companies could also help their clients
reduce their climate risks by providing risk assessments and engineering for
natural disasters, preconstruction advice about risks, and after a loss,
incentives to rebuild with more resilience or build in a less vulnerable
location.
To help
speed the energy transition, insurance companies can refuse to invest in or
insure fossil fuel projects. Swiss Re and Hannover Re, two of the largest
reinsurance firms have already refused to insure new oil and gas projects.
An outdated
FEMA map of Woodbridge Township, NJ. Photo: FEMA
To revamp
the National Flood Insurance Program, FEMA should:
Update its building and land-use standards
Include projected future flood conditions on its
maps
Increase the availability of buyouts for
repeatedly flooded properties
Prevent critical infrastructure such as hospitals
or water treatment plants from being situated in flood prone areas or make sure
they are elevated
The Climate
School’s Sabin Center also recommended that:
FEMA should offer a discounts for buyouts program
whereby homeowners get discounts on flood insurance premiums today, provided
they agree to accept a future buyout if their home is substantially damaged by
flooding.
Communities should adopt a lower threshold for
the designation of substantial damage or substantial improvement. This would
mean that when the amount of damage or the costs of improvement or repair to a
building surpass this threshold, the structure would have to be brought into
compliance with the most up-to-date floodplain regulations.
States and communities should have laws to
require disclosure about flooding risks to homebuyers; in addition, there
should be a national “homeowner right-to-know” provision about a property’s
flooding history.
Resources for home buyers
If you are
in the market to buy a house, you need to consider a prospective property’s
potential climate risks. These tools can be used to research specific
addresses.
RiskFactor.com
provides past, present, and future risk projections for floods, fire, and heat.
Climate
Check gives a risk rating for storms, heat, fire, drought, and flood.
Realtor.com
shows the flood and fire risk for specific addresses.
Redfin.com
shows flood, storm, drought, heat, fire risk for specific addresses.
Wildfires
Risk to Communities displays wildfire risks for communities, tribal areas,
counties, and states.
FEMA
National Risk Index map shows the level of risk for all natural hazards, as
well as social vulnerability and community resilience for all counties in the
U.S.
While the
insurance industry is still working out how to survive the impacts of climate
change, homebuyers need to look down the road to protect themselves.
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