Property Insurance: An Environmentally Endangered Species

By Mike Koetting April 9, 2024

I believe one of the reasons that people discount the threats to our environment is that they imagine them as some really catastrophic events resulting in the kind of dystopian science fiction scenario portrayed in a Mad Max movie. Since that is, literally, unthinkable, it gives license to lower the immediate threat level.

However, it is not likely it will happen like that. It is much, much more likely that things will come apart gradually, one problem after another, each compounding the previous. It has already started to happen, poking successive holes in the fabric of our life. Today’s conversations are no longer just about the future.

This post addresses one of these clear and present problems—the retreat of home owners’ insurance in the face of environmental threats.

The modern insurance industry started during the Enlightenment and has become an essential element of our day-to-day lives. We have all come to expect some degree of protection against bad events, but increasingly that’s problematic.

The industry works on a simple concept—if bad events are relatively unlikely, insurers can collect more from the totality of the insured than they pay out to the unlucky few. The logical consequence of this model is stark: as the odds of bad events increase, rates need to increase proportionately. And, whereas the industry’s entire business model depends on the estimates of those risks, its survival depends on realistic assessments, uninfluenced by any political or cultural baggage.

What they are seeing is unsettling. Losses from natural disasters in the U.S. continue to rise at record rates, as summarized by an insurance industry newsletter:

The U.S. experienced twenty-eight climate disasters last year with losses of at least one billion dollars with a total cost of over $93 billion. For context, since 1980 the U.S. has averaged eight billion-dollar weather events per year (CPI-adjusted) with damages averaging $59.4 billion. These events have become much more frequent in recent years, averaging more than twenty such events causing an average of $121.1 billion in losses per year from 2019 to 2023.

World-wide trends are similar, with almost twice as many events with greater than $20 billion losses in the past 8 years as in the entire previous 16 years.

Source: Aon Insurance

To stay in business, insurers must raise rates, lower risk probabilities, or both. Thus, it is not surprising that costs of homeowners’ policies in Florida have tripled in the last five years. Or that 15 major insurance companies have left that state. Or that companies are simply refusing to provide coverage in areas they deem particularly vulnerable. Same is true in those parts of California judged to be at wildfire risk. Fox News reports one homeowner in California whose policy was cancelled for being in a ”wildfire-prone zone”. And replacement insurance was eight times more expensive. Louisianna, Mississippi, Virginia and other states have been similarly affected.

More people are being forced to go without insurance, falling victim to the actuarial imperative that the more likely you are to need insurance, the more difficult it will be to obtain.

This is not to flagellate the insurance industry—although they continue to make reasonable profits, thank you very much—but it is more symptom than problem. It is the environment that is changing.

Insurance companies are realistic about the causes of the changes in their industry and the prospects for the future. They unequivocally link their condition to climate change and only see it getting worse. A report from McKinsey on the future of the insurance industry is fairly lurid in the problems that will grow exponentially as climate issues worsen. Christian Mumenthaler, CEO of Swiss Re, one of the world’s biggest insurers, told the grandees at Davos that the struggles of insurance companies were the first of many climate related bills that consumers will have to pay as a consequence “of the way we have been living”.

But they are no more sure what to do about this than the rest of us. The McKinsey report mentioned above lists several strategies but, other than helping clients build more environmentally resilient communities, they are focused on strategies for predicting risk and avoiding it. Good strategies for the insurance company. Not so good for consumers. (The Economist is even more bleak, announcing in a headline “Changing weather could put insurance firms out of business.”)

We are just starting to think about the consequences of insurance becoming unavailable or available only on a limited basis. There are several parts of our economic system that assume the availability of insurance–many home loans and most home-owners associations require it. Perhaps more importantly, it adds a degree of stability to life by reducing the possibility of devastating economic losses from events over which we have minimal control.

Right now the most severe problems are relatively focused. But it is highly likely to spread. Forty percent of the American population lives in states categorized as “high risk” for damage from natural disasters. Those states have higher insurance rates and, both predictably and paradoxically, have lower rates of insurance coverage despite the greater risk. Equally unsurprisingly, insurance coverage is lower among vulnerable populations.

The inability of Florida, the epicenter of the insurance crisis, to deal with this issue is symptomatic. Some of the problems are idiosyncratic to Florida, but the broad outlines of the issue are fairly typical. The legislature holds hearings and tries to find a simple solution. Last year they passed legislation designed to limit the ability of consumers to sue insurance companies. It’s too early to tell how much this might slow the rate of insurance cost growth, but even proponents don’t think it will solve the problem. They note the rates being charged to insurance companies from re-insurers, those bigger companies that write policies to cover excess loss, are increasing and, of necessity, that will continue to impact rates to consumers.

Florida does provide an alternative to the private sector — the state-sponsored Citizens Property Insurance Corporation–which was set up in 2002 as an insurer of last resort for those who couldn’t find coverage in the private market. It has grown by 50% over this time last year and there no sign of the growth slowing down. A few legislators have suggested that the future of insurance in Florida is to deliberately engineer a major expansion of this pool. That’s not likely. It runs against too many political interests, but more fundamentally there are questions about its feasibility. Citizens’ finances are not robust. It is unlikely it would be able to cover all its obligations in the event of a major hurricane. It asked for a 12.3% rate increase in the last cycle but state regulators would only allow a smaller increase. All of this has made Florida legislators, and even some U.S. Senators, nervous about who would cover the shortfall if (when?) it ran out of money.

Frankly, it is inevitable that more costs will be shifted to government entities, since they become the payor of last result. The recent changes to FEMA regulations around individual disaster losses is a modest step in that direction. Very modest, adding only $512 million to the federal budget. But as private insurance can no longer keep up with the cost of escalating losses without pricing consumers out of the market, the bill for government will rise by a lot more than $512 million.

This will, in turn, create the need for really hard choices. For openers, at what point do various government entities conclude that building in some areas is just too risky or that building without certain safeguards is unacceptable? These kinds of decisions will have all kinds of ramifications—for the housing and real estate industries and for existing owners—and they simply feel “un-American”. But when does the larger society decide that it is a poor use of their resources to subsidize these levels of risk? And what about individuals who decide on their own to take the risk without insurance? The reason private insurance companies have bailed in the first place is that their assessments show these investments are too risky. This is powerful information. Should taxpayers ignore it?

The issue also reflects the time dimensions that impact these hot button issues. No conceivable set of climate initiatives is going to bend the curve of increasingly frequent climate induced losses in anything like the near future. Even if, miraculously, every country on earth started to achieve the climate change goals adopted in the Paris accords, it would be years before those changes impacted weather related events; in all likelihood, the short-run situation will get worse no matter what we do. There is no getting away from the fact that property insurance as we have come to take for granted is going to undergo major changes in much of the country. Whether there will be concerted action and what form it will take—and what will happen if we don’t–is unclear.

What we should be clear about, however, is that we are not talking years from now. It is as if the soldiers of an enemy army are starting to appear in our suburbs. Too late to wish it away.