With Climate Impacts Growing, Insurance Companies Face Big Challenges
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.
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.
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.
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.
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.
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.