“Our insurance markets to protect people from climate-related disasters are breaking at the very moment we need them more than ever,” writes Carolyn Kousky, Associate Vice President for Economics and Policy at Environmental Defense Fund.
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Over the last couple years, insurance has exploded into the global discourse, especially in the United States. Why? Our insurance markets to protect people from climate-related disasters are breaking at the moment we need them the most.
Disaster insurance can be thought of as many things. At base, it is a financial risk management strategy. Policyholders pay a small amount each year to be protected against a very large loss. For many, though, insurance is a box-checking or compliance exercise: something that must be purchased to comply with a regulation or to obtain a loan to buy a house, for example. For some consumers, it is just another product we buy, subject to market forces. For disasters, though, it could be an unfamiliar relationship with the government, blurring the line between a product and benefit.
But most importantly, insurance is a critical component of our disaster safety net. That role makes it deeply troubling that in many places around the US right now, disaster insurance is becoming scarce, unaffordable, and the quality of coverage is degrading.
Disasters impose an enormous range of costs on households. Damages to property can be very severe, with losses to buildings, their contents, and vehicles. Those impacted can also face a range of non-property expenses, such as those associated with evacuation, temporary housing, coping strategies for when power, water, or transit is down, and cleaning up debris. Businesses may not be able to operate, leading to declines in revenue for the firm and loss of income to households at the same time they face mounting expenses.
Most households cannot manage these financial impacts on their own. They simply do not have enough liquid savings. Credit can be limited, unavailable, or too burdensome. Our current patchwork of programs to help people make it through the recovery process has a lot of holes. And it is our most vulnerable that are falling through those holes, with recovery stretching into years, financial conditions worsening, and very little help available.
While we need to undertake reforms to our federal disaster aid programs, insurance will remain a critical part of any disaster safety net. In research with a colleague, we found that households with insurance have fewer unmet needs and fewer financial burdens. We also saw that insurance has positive spillovers to local economies: as more households are insured, visitations to local commercial establishments increase. Research has also found those with insurance are more likely to rebuild, and that insurance can prevent worsening inequality post-disaster.
So, insurance plays a critical role in protecting people financially after a disaster. And once they have this financial protection, it benefits other areas of life, too. Having the resources needed to repair, rebuild, and recover reduces stress and anxiety, allows for continued spending on important items, like healthcare, and can make it faster for people to resume work and education. All of this is why it is so troubling when households cannot get the disaster insurance coverage they need. And now, far too often, they can’t.
As climate change advances, risks for insurers are increasingly leading to bankruptcies, skyrocketing prices, hallowed out coverage, and, in some places, insurers are completely abandoning certain locations or entire states. Before delving into current challenges, a bit of background is needed on why disasters have always been difficult for the private sector to insure.
Uninsurable
Insurance relies on mathematical laws that have built the modern insurance industry: when we pool independent risks together – risks that can’t be too extreme – a lot of great things happen. Losses become more predictable, uncertainty is reduced, and the maximum probable loss declines. What does all this mean? It means that it is easier for insurance companies to price policies and to be sure they will not face losses that will send them into insolvency.
These lovely mathematical laws do not hold, however, when everyone experiences losses at the same time and when those losses can be very large. That’s why a hurricane is so much harder for the insurance industry to cover than a single tree falling on someone’s roof, or why wildfires are so much harder than a one-off kitchen fire.
This means that losses from disasters are not stable year-to-year. Instead, losses may be low for many years and then incredibly high. For example, actuarial consulting firm Milliman has estimated that the severe wildfires in California in 2017 and 2018 wiped out twice the accumulated underwriting profit from the previous quarter century for California homeowners insurers, meaning that after the wildfires, the industry overall had a $10 billion underwriting loss since 1991.
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Such severe losses can simply put insurers out of business. To protect against insolvency, insurers hold more reserves, they purchase reinsurance (insurance for insurance companies), and they might transfer some risk to financial markets. But all of that raises costs, which are passed onto the policyholder. And so we have long seen that disasters might not be able to be profitably covered by the private sector at a price that people are willing and able to pay.
In response, governments have stepped in to provide insurance. The federal government began doing this over 50 years ago with the National Flood Insurance Program (NFIP).
Every state prone to hurricanes has a so-called wind pool or beach plan. California uses its Fair Access to Insurance Requirements (FAIR) plan, programs born during high levels of urban riots to increase insurance in cities, to provide wildfire insurance. Colorado just last year created its first state program for wildfire.
Now, growing risk is stressing both private and public insurers even more as we face the troubling implications of our failure to rapidly reduce carbon emissions coupled to continued development in areas at high-risk of climate extremes. Weather-related losses are on a constant upward trajectory and we are not building with that reality in mind.
Rising risk means insurers are paying more claims, paying them more often, and face a rising probability of bankrupting levels of losses from weather-related extremes. Insurers aren’t going to hurt their bottom line. So what are we seeing right now?
Five Concerning Trends
First is bankruptcies. A dozen insurers in Louisiana have gone bankrupt the last few years with almost that many going under in Florida since 2017, with five liquidated just in 2022. Frequent and high storm losses coupled to insufficient capital for many smaller insurers have put policyholders at risk and taxed state programs that help pay claims when an insurer goes under.
Second is escalating prices around the country. Some insurers had rate increases this year in the double digits. While prices are up everywhere, hot spots of risk like Florida, Louisiana, and Texas are seeing particularly high premiums. In addition, the federal flood program recently aligned its rates with property-level risk, which has meant higher premiums for homes in areas of higher flood risk.
Third is insurers pulling out of markets. State Farm and Allstate left the California market in the last year, along with multiple smaller insurers. Many national carriers left Florida years ago, but those that remained are now retreating, too. Farmers announced it will stop offering coverage in Florida last year, as did an AIG subsidiary, Lexington Insurance. Insurers are also abandoning Louisiana. And even when insurers don’t leave entire states, they are reducing coverage they offer in certain regions, such as along the coast, or in disaster-prone zip codes.
Fourth, insurers are starting to restrict the coverage they are offering. While many consumers think homeowners insurance policies are all the same, they are actually quite heterogenous. Insurers are noting they will need to revise policy terms as climate extremes accelerate in order to manage their exposure. Homeowners policies already exclude flood and now some insurers are excluding wind and fire, too. In addition, policies can have sublimits that cap the amount insurers will pay for certain losses like hail, mold, or burst pipes, for example. And high hurricane deductibles in the southeast mean insurers don’t start paying until after policyholders have paid a large share of the loss.
Finally, all of these trends are leading to a migration of risk from the private market into public sector programs. Enrollment in CA’s FAIR plan, which provides coverage in high wildfire areas, has more than doubled since 2018. In Louisiana, as of this fall, the number of homeowners with policies in their state program had tripled since Hurricane Laura in 2020. And in Florida, the state program has seen a growth in policies of over 200% since their low point in 2018, putting them at over 1.3 million policies and making them the largest insurer in the state. This is stressing the fiscal position of many of these programs, which were not designed to assume massive levels of risk. The programs, like the private sector, are thus needing rate increases and exploring various programs to lower their policy counts, such as paying insurers to take policies out of the programs.
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To be sure, there have been other factors driving these trends apart from climate change. This includes higher interest rates, inflation, higher rebuilding costs, and, in Florida, legal challenges for insurers. These are important forces that have, in some sense, created the perfect storm for insurance breakdown the last few years. Some, though, are now being addressed – inflation is coming down and Florida has adopted reforms for its market.
But this is the really hard problem we face: how do we maintain available and affordable insurance for climate extremes in the face of ever-increasing risks? The only long-term answer: transformative levels of investment in lowering risks and in climate adaptation.
What Insurers Should Do
While there have been important increases in federal dollars for resilience investments and several communities that have made serious commitments to invest in climate adaptation, we are not going nearly far enough or fast enough to maintain insurable communities in the highest-risk locations.
What is needed sounds easy: stronger building codes, zoning and permitting that requires consideration of climate risk, retreat from the highest risk areas, expanded investments in green and gray protective infrastructure, home hardening, and commitments to resilient landscapes. But in practice, it is hard.
In too many places there is still a mistaken belief that building codes to make our construction better able to withstand hazards are too expensive, even when research shows that benefits far outweigh the costs. There are often communities that think they should waive those codes in the rebuilding process to make it easier on folks to get back in their homes when it just sets them up for growing losses and greater suffering in the future. And in many places, prohibiting development – even in an area of high risk that will lead to high damages in the future and put people in harm’s way – is anathema to residents and local leaders.
There is a lot insurers could do to support greater investments in risk reduction. First, insurers need to play a role as advisors. They need to be more transparent about their risk information and risk tolerance to help communities identify and implement risk reduction strategies that will maintain insurability for their populations. Insurers, however, do not typically see such engagement as their role. And no firm wants to announce the need for escalating prices, but that information is essential to making sound development choices.
Any advisory role can be hindered, however, by the fact that many of the models insurers use for underwriting and pricing – catastrophe models – may not adequately account for investments in risk reduction. They may not include data on which homes have been hardened against hurricanes or wildfires, for example, or the models may have no way to account for investments in wetlands that store flood waters or larger pipes to control rainwater.
However, without inclusion of these measures, insurance is not providing accurate information on the true risk and households and communities that invest in important resilience measures will still face insurance market stress. Insurer pressure on vendors to make sure all models transparently include risk reduction and climate adaptation would be a crucial step forward. Governments and different startups are also working to fill key data gaps. Regulators could do more by requiring disclosure of how insurers, and the models they use, incorporate risk reduction to inform their underwriting and pricing.
But insurers can do more than provide information and guarantee they are accounting for the hazard mitigation investments made by policyholders and their communities. The time of rebuilding is a critical opportunity to build stronger and more resilient communities. At that moment, households need two things: funding to pay for the needed investments and support figuring out what to do and who to call to do the work (who is trustworthy, skilled, and has fair prices). Insurers can help on both counts.
We know how to build homes that can withstand much of the impact of severe storms and hurricanes. The Institute for Business and Home Safety researches how homes perform under disaster-like conditions (literally mimicking hurricane strength winds on fake houses or embers flying at a house). They have used their findings to develop the Fortified building standard for protection against high winds and Wildfire Prepared against wildfires. The demonstrated success can be striking: photos of complete destruction from a hurricane, but the Fortified homes are left standing, as if immune to the storm.
Insurers could provide funding to build to these standards during disaster recovery through a specified endorsement on all the property insurance policies. Fortified endorsements have been used in Alabama already, where the state required insurers to offer them as an add-on option to policyholders. It has been estimated that the additional costs to upgrade a roof to Fortified standards are between $700 and $1700, excluding the certification, which costs an additional $300 and $600. A fortified endorsement would pay these costs for policyholders during rebuilding.
It is also worth noting that in addition to supporting stronger buildings, insurance can be made more flexible to support relocation when risk has gotten too high and a household just wants to be able to move somewhere safer. Right now, there can be restrictions in policies – or from lenders for those with a mortgage – that make it difficult for a policyholder to walk away from their disaster damaged home and relocate elsewhere. California can offer lessons on how to make this work. Insured property-owners in the state have the legal right to collect the full claim payment that would have been owed to them for rebuilding but to instead use the payout to rebuild or buy a home at a different location instead. Nevertheless, if the replacement home in the new location costs less, they cannot pocket the difference. Problematically, this does not put the land into open space, such that some other person can move in, perpetuating risk cycles. To be effective, such an approach needs to be coupled to a state buyout program, such as New Jersey has for flood-prone properties, to permanently keep people out of harm’s way.
One final action insurers could be taking around risk reduction is drawing the links for policymakers, as well as their clients, between weather extremes and greenhouse gas emissions because ramping up the phase out of fossil fuels is the most comprehensive risk reduction strategy. This could be done through informational outreach and support for federal and state climate policy. In addition, insurers could also support reducing emissions in the building and automotive sector at the time of rebuilding with a climate endorsement. This add-on would provide extra funds for energy efficient rebuilding, electrification, adding rooftop solar on the rebuilt home, or allowing for a totaled car to be replaced with an EV. While some of those changes do come with higher price tags, the greater social good could justify public dollars to pay for reasonably priced climate endorsements on behalf of policyholders.
Final Thoughts
Motivating actions that lower risks is harder than it should be. One problem is that, as a species, we are often prone to short-termism. We are myopic. We also know that many of our institutions – private and public – have baked in incentives for short-term thinking.
This could lead us to try and prop up property values in the short-term through subsidized insurance and lending that is not pricing climate risk, or lead certain stakeholders to argue against information disclosure because, in the short-term, such knowledge might devalue some properties. It could also lead others to lobby against strong building codes or relax them during rebuilding because of a few extra dollars now. But all these things do is set us up for far worse consequences in the future. They just delay the day of reckoning.
Stabilizing markets and adapting for what’s to come might require recognizing that, while there aren’t always wins in the short term, we can shift the narrative and change the course of things in the long-term. We can focus on the savings over the longer term from stronger building and investments in strategies like protecting wetlands. We can develop policies to protect the most vulnerable in the short-term, while helping ensure our communities remain viable and thriving in the longer-term.
Let’s not be hasty to preserve the status quo while ignoring growing risks, but instead set our sights on a vision of the long-term resilience of our communities.
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