The effects of climate change are all around us: rising sea levels, severe heat waves, drought, extreme rainfall, and more powerful storms. Natural disasters are becoming more intense and frequent as a result of these effects. Between 1980 and 2021, the United States experienced 7 or 8 natural disasters per year on average, but 15 have already occurred in 2022. 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, bringing the total cost of disasters to $788.4 billion over the last five years.
As natural disasters become more common and costly, insurance companies face significant challenges — and when insurance companies struggle to survive, the real estate market and the entire economy suffer. If insurers are to weather the coming storms, they will need to make some adjustments.
Why disaster costs are rising?
Natural disasters are becoming more expensive not only as a result of climate change, but also as a result of human factors. One of them is that more and more people are moving to areas where climate impacts are more likely. According to Redfin, a real estate company, from 2016 to 2020, more people moved to high risk areas like Florida, Texas, Arizona, and Nevada than to low risk areas, drawn by cheaper housing, jobs, and warm weather. Florida, Georgia, South Carolina, North Carolina, and Tennessee are experiencing faster population growth than the national average.
Furthermore, developers continue to build in areas prone to wildfire and flooding. Between 1990 and 2010, the number of houses in the wildland-urban interface (the area near forests and thus vulnerable to wildfires) increased by 46%. According to Redfin, demand for these homes has increased as a result of the pandemic and an increase in remote work. Not only is vegetation more likely to burn in these areas, but the presence of many people increases the likelihood of fires starting accidentally. The nonprofit
First Street Foundation discovered that 10 million properties in the United States face major and extreme wildfire risk.
According to the First Street Foundation, 14.6 million properties in the United States are at high risk of flooding, with 5.9 million of them not currently located in a designated Federal Emergency Management Agency (FEMA) floodplain—an area with 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 the national average in flood-prone areas. Since Hurricane Sandy hit New York City ten years ago, 225 permits for new apartment buildings in flood zones have been issued. Charleston, South Carolina, which is frequently battered by hurricanes, is moving forward with a 9,000-acre residential and commercial development, with half of the homes in a floodplain.
Another issue is that climate change is expanding the areas that are vulnerable to natural disasters. Flooding risk, for example, is increasing even in areas that are not on the coast or in floodplains. Hurricane Ian recently flooded communities not only along the coast, but also throughout Central Florida in areas that had not been designated as flood zones.
Only 29 percent of households in nine Florida counties declared disaster areas had flood insurance. Only 1.3 percent of households in Hardee County, where one-fifth of the population is poor, had it.
Flood insurance problems
Homeowners who live in a FEMA-designated flood zone must purchase separate flood insurance because standard homeowner insurance policies do not cover flood damage.
While some Floridians purchased private flood insurance, the National Flood Insurance Program (NFIP) managed by FEMA provided 80 percent of flood insurance policies in the state. The National Flood Insurance Program (NFIP) was established by Congress in 1968 to share the financial risks of flooding and to limit development in floodplains.
Even if you have NFIP, the payouts may not be enough to cover your losses.
NFIP was able to cover its payouts with premiums until 2004, but after Hurricanes Katrina and Sandy — the costliest and fourth most expensive storms in US history, respectively — it had to borrow funds from the US Treasury. It currently owes $20.5 billion.
The First Street Foundation discovered that if all of the homes it believes are at risk of flooding were insured, NFIP rates would have to rise 4.5 times to cover today’s actual risks, and 7.2 times to cover rising risks by 2051. FEMA recently established a new risk-rating system that will calculate the effects of climate change as the NFIP establishes premium rates. Those rates are currently based on FEMA flood maps. However, FEMA’s director has admitted that NFIP flood maps are out of date because they do not account for extreme rainfall.
“FEMA is required to update NFIP floodplain maps every five years, and it is required to do so using the best available science relating to future risks,” said Michael Burger, executive director of the Sabin Center for Climate Change Law at Columbia Climate School. “While FEMA can update the maps to reflect climate risk, the most important NFIP reforms are in the hands of Congress.” And Congress has repeatedly pushed NFIP reform down the road. The Biden administration has presented Congress with 17 legislative proposals [to reform NFIP]. The next deadline is December 16, but Congress could take up some of these proposals sooner.”
How private insurance companies are dealing with the effects of climate change
Insurance companies are having to pay out more claims as the number and severity of natural disasters increase. Hurricane Sandy was the deadliest windstorm to hit the Northeast of the United States in four decades, causing insured losses of nearly $26 billion. Insurers in California paid out $29 billion in claims in 2017 and 2018, but only collected $15.6 billion in premiums. Total insured losses from Hurricane Ian are estimated to range from $53 to $74 billion, with flood-related losses estimated to be another $10 billion.
Incurring debt
Because of previous hurricane outlays, as well as other issues in the litigation-friendly state, many major insurers have left Florida over the last 20 years, with 12 closing since 2020, leaving only small in-state companies with fewer resources. Six insurance companies declared insolvency this year because they were unable to pay their debts, and 30 more Florida insurance companies are being monitored by state regulators because their finances are precarious.
Increasing premium rates
When insurance companies are unable to pay their bills, they use their own reinsurance, which is insurance for insurance companies to deal with extremely high claims.
However, because the reinsurance market is global, if a natural disaster strikes on the other side of the globe, the cost of a homeowner’s insurance policy in Florida may rise as the reinsurance company raises its own premiums. Because of the large claims and litigious environment, reinsurers are also leaving the Florida market.
According to Swiss Re, the world’s largest reinsurer, property losses from natural disasters caused by climate change could increase by more than 60% by 2040. As a result, homeowner insurance premiums are expected to rise by 5.3 percent per year. According to the Policygenius Home Insurance Pricing Report, premiums in the United States have already risen 12.1 percent from 2021 to 2022, with higher rates in states where natural disasters occur more frequently, such as Arkansas, Washington, and Colorado.
Because of the new risk rating system implemented by the NFIP, 77 percent of current policyholders are expected to see a rate increase. Some coastal property premiums have already risen to $4,000-$5,000 per square foot from $700 or $800.
Making insurance more difficult to obtain
Insurance companies are raising deductibles or establishing higher deductibles for natural disasters that are more likely in certain areas, in addition to raising premiums.
Some policies exclude coverage for “named storms.”
Insurance companies will sometimes refuse to renew policies or will deny coverage entirely. The 2017-2018 California wildfires resulted in 235,250 non-renewals, a 31% increase. However, in 2019, California prohibited insurance companies from refusing to renew homes in declared disaster areas; this prohibition has been extended year after year.
When homeowners are unable to obtain private insurance, they can seek limited temporary coverage through Fair Access to Insurance Requirements (FAIR) plans, which are available in 33 states and Washington, D.C. These state-run insurance plans are for homeowners with high-risk properties. They are generally more expensive than standard policies, and rates are likely to rise as well. Citizens, Louisiana’s FAIR plan, was recently approved by state insurance regulators for a 63 percent rate increase.
The rising cost of homeowner’s insurance is making it more difficult for middle- and low-income households to obtain coverage. Lower-income residents may be priced out of their homes if premiums are too high, or they may simply go without insurance and face financial ruin if a natural disaster strikes. These communities are typically more vulnerable to the effects of climate change.
Furthermore, some of these vulnerable communities are being blue-lined, which is a process by which banks or mortgage lenders identify neighborhoods or communities that are more vulnerable to climate risks. Blue-lining can lead to higher insurance premiums, non-renewal, or coverage denial. And blue-lined communities are frequently the same as redlined communities, which delineated communities of color or low-income neighborhoods deemed too risky to invest in. Because redlined communities often received less public investment, their infrastructure is deteriorating, making them more vulnerable to climate impacts.
Providing incentives for adaptation measures
Some states provide incentives to homeowners who make their homes more resistant to fires, wind, rain, and hail, such as insurance discounts or tax credits.
Many fire insurance companies have left areas where wildfires are a risk. Those that remain may require residents to improve their home security in order to obtain insurance. Establishing a buffer zone between vegetation and the home, using fire-resistant materials and designs for walls and roofs, and installing sprinkler systems are some examples. These fire-proofing costs can run into the thousands of dollars. A new California law now requires insurance companies to offer discounts to customers who install fire-proofing measures.
Florida insurance companies provide discounts to policyholders who strengthen and secure their roofs and shutters, as well as reinforce garage doors, to protect their homes from hurricane force winds. The state also exempts impact resistant windows, doors, and garage doors from sales tax.
NFIP policyholders can reduce their premiums by raising their properties, moving equipment off the ground floor, and installing flood openings to allow floodwaters to flow from the interior to the exterior.
Home fortification and sustainability strategies are effective. Babcock Ranch, a 17,000-acre planned community in southwestern Florida, is a prime example. With 700,000 solar panels, streets designed to flood so that homes do not, native landscaping to absorb stormwater, and buried power and internet cables, it was designed to be sustainable and resilient. The houses were constructed in accordance with the most recent building codes. When Hurricane Ian wreaked havoc on nearby Fort Myers and Naples, Babcock Ranch escaped with only a few downed trees and never lost power.
The Potential Consequences of an Insurance Crisis
What would happen if climate risks jeopardized the stability of insurance companies, and thus the real estate market, and thus the economy? “That’s a big question that the entire insurance industry, real estate sector, and financial and investment communities are attempting to answer,” Burger said. “How does climate risk affect business as usual?” What new possibilities does it open up?”
Many states are experiencing a homeowners insurance market crisis, as policies become more expensive and difficult to obtain. The homeowner insurance markets in Florida and Louisiana are particularly precarious.
Mortgage lenders may refuse loans if properties become uninsurable due to climate risks. As a result of people moving away, home values would fall. If they do, the tax base will be reduced, which will have a negative impact on school systems, fire departments, and other municipal services. People who cannot afford to relocate would be left behind, trapped in a deteriorating community.
Climate change may eventually present insurance companies with risks they cannot afford to underwrite if we do not reduce our greenhouse gas emissions. Axa, a major insurance company CEO,’s stated in 2015 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 in the face of climate risks?
According to a 2019 global survey, 72 percent of insurance companies believe climate change will have an impact on their business, but 80 percent have not taken significant steps to mitigate climate risks. Furthermore, insurance companies invest the money they collect in the financial markets. They have $582 billion invested in fossil fuels, which may lose value as climate risks increase.
To deal with its own climate risks, the insurance industry must make significant changes. Some of these changes may also enable insurance companies to help accelerate the transition to a net-zero society. Here are some suggestions.
According to the nonpartisan Center for American Progress, insurance companies should identify climate risks, incorporate them into business decisions, and disclose them in public filings.
Companies should put their own resilience to the test by simulating various climate scenarios.
States, which regulate the insurance industry, should collect data on climate risks and use the findings to create incentives for sustainable home retrofitting and fortification, as well as to develop resilient building standards.
Insurance companies could also assist their clients in reducing their climate risks by providing risk assessments and engineering for natural disasters, preconstruction risk advice, and incentives to rebuild with greater resilience or in a less vulnerable location after a loss.
Insurance companies can refuse to invest in or insure fossil fuel projects to help accelerate the energy transition. Two of the largest reinsurance companies, Swiss Re and Hannover Re, have already refused to insure new oil and gas projects.