Climate Change Poses Challenges to Insurance Sector, Potential Major Economic Impact for U.S.

A Climate Crisis in the Insurance Industry

The Rising Cost of Coverage

For Diane Wolf and many of her neighbours in the quaint, wooded hills of Berkeley, California, a climate change reckoning is underway.

“We’ve been here 26 years, and had car/home umbrella insurance with AAA,” said Wolf, faculty assistant to the vice provost of academic affairs at the University of California, Davis. “We got a notice last spring that we wouldn’t be renewed because we didn’t have fire insurance.”

Wolf and her husband acted swiftly, securing additional fire insurance coverage for roughly $7,000 per year. However, AAA then embarked on a full policy review, requiring a property inspection. This has become quite common in California, a state that has endured 16 of the 19 wildfires in U.S. history that have resulted in losses over $1 billion.

The FAIR Plan

In response, Wolf approached California’s insurer of last resort, the FAIR Plan, which offers subsidised coverage when private companies refuse. However, they responded with a similar list of required upgrades. Faced with losing coverage, Wolf went ahead with the repairs, costing $60,000.

“That’s a big chunk of change for us,” Wolf, 70, said, adding, “We have minimal coverage now, but we were lucky. My neighbours were dropped without any warning.”

Financial System Repricing

Susan Crawford, a senior fellow at the Carnegie Endowment for International Peace and former science adviser to President Obama, has spent years researching and writing about the economic dangers posed by climate change.

“I think what we’re seeing is elements of our financial system repricing in acknowledgment of physical climate realities,” she said, adding that the first markets experiencing that adjustment are based on risk assessment.

The Rising Tide in Florida

No state has been hit harder by the unfolding insurance crisis than Florida. This peninsular bullseye consisting of 8,436 miles of heavily developed coastline tempts hurricanes and tropical storms yearly. Residents in Florida pay four times the national average for homeowners insurance, and the cost of premiums has risen there by more than 40% over the past year and a half.

That’s no real surprise given that in 2022, Hurricane Ian caused a record $112 billion in damages when it made landfall on the Gulf Coast.

Economic Repercussions

Earlier this month, Senate Budget Committee Chairman Sheldon Whitehouse of Rhode Island held a series of meetings in Florida on the topic of skyrocketing insurance rates. At a panel discussion in Hollywood, he issued a warning about what he called “the next big economic shock that is going to clobber the U.S. economy.”

With insurance becoming unaffordable or unavailable, Whitehouse said, the next shoe to drop is “the mortgage market going into crisis, because if a property is uninsurable, that property is unmortgageable. And then that mortgage crisis cascades into a property values crash.”

The Florida Experience

For Steve Swanson, a 57-year-old trial lawyer, the soaring insurance rates that followed Hurricane Ian caused him to recalibrate his plans. Instead of buying a condo on Sanibel Island, which had been ravaged by the storm, in 2023 he purchased a 400-square-foot tiny home and parked it in a Sanibel mobile home park.

"I thought, OK, I’ll take my chances. If another hurricane hits when I’m 75 years old, well, I’ve self-insured," Swanson said, adding he had funds set aside to cover potential losses.

Self-Insurance Dilemma

A recent study by the Insurance Information Institute found that the number of people foregoing insurance coverage is rising sharply. “Twelve percent of homeowners are now voluntarily not purchasing home insurance versus 5% before the pandemic,” noted Mark Friedlander, the institute’s director of corporate communications.

This trend is notwithstanding that most Americans don’t have $1,000 set aside for a family emergency, making the decision to go without insurance highly risky.

Last Resort Insurers

Many homeowners are forced to turn to last-resort insurers subsidised by the very insurance companies who denied coverage in the first place.

“The California FAIR Plan has been growing at a record level. That’s never a good thing,” Friedlander said. “In Florida, Citizens Insurance is the largest market for home insurance in the state, which is really a bad scenario.”

Cascades

When an unforeseen catastrophic loss on the scale of the Camp Fire in 2018 occurs, private insurers will inevitably increase premiums.

In such cases, “ordinary homeowners who have car insurance policies, life insurance, will be on the hook for the failures of the insurance in that state,” Crawford said. If state funds fall short, a federal bailout might become necessary.

The Bigger Picture

Whitehouse emphasises that rising global temperatures aren’t a localised problem. “While Florida is first and worst for the destruction of its insurance industry by climate change, it’s not only other coastal states that are behind Florida in the same lane of risk, but it’s coastal flooding’s evil twin, wildfire risk, that is popping up with the identical risk profile but in different geographical areas.”

The Bill is Coming Due

When Hurricane Francine, a relatively minor (Category 2) storm, made landfall in Louisiana on Sept. 11, it left behind an estimated $1.5 billion in damages. Five days later, an unnamed tropical rainstorm dumped 20 inches of rain on coastal North Carolina, accruing another $7 billion in estimated damages.

“Last year, NOAA measured 28 billion dollar loss events, the most ever on record,” Friedlander said. So far this year as of Sept. 23, there have been 22.

Climate Change and Insurance

The reality of climate change’s impact on insurance drives home a critical point. Short of a scientific breakthrough, the question becomes how best to adapt.

“That means incentivising state and local officials to change building codes, zoning, accelerate building in safer areas, provide incentives to shift to those areas, buy them out of places that will flood or burn,” Crawford said. “It will be painful. It will take time, but it’s essential for the long term.”

The Way Forward

Crawford underscores the challenge, “No one has an incentive to change the status quo. Local officials need the property tax, and developers need to build.”

For some, the wake-up call might be moving out for safety. “It’s really made me think about leaving Berkeley,” Wolf said. “It’s getting more expensive, and I don’t think we’re done with this crazy situation.”

Swanson puts it succinctly, “We’ve reaped benefits from industrialisation. Now it’s time to pay the bill for the last 150 years.”