As climate change reaches a boiling point, why are major insurers exiting disaster-prone states?
The insurance industry is facing a perfect storm. Hurricanes and wildfires are intensifying—wreaking havoc on some of the priciest real estate—while the cost of rebuilding continues to climb, and premiums remain locked in by regulation. In response, US insurance giants are pulling their property and casualty lines out of high-risk states such as California and Florida.
On a recent episode of Double Take, we asked Robert Gordon, senior vice president of policy, research and international for the American Property Casualty Insurance Association (APCIA), to unpack how insurers reached these decisions, and what would need to happen for them to reenter these markets.
Gordon believes that the main driver of weather-related losses for insurers is the steady accumulation of high-value assets in locations most susceptible to natural perils, such as coastal and forest areas. He also points out that while the price of homeowners’ insurance has risen in recent years, the rate of inflation and increase in home values has well outpaced the higher cost of insurance.
Economic inflation has surged over the last few years. The effect of inflation has been to increase the value of buildings, the value of vehicles. The home values have gone up by well over 50%. The cost of rebuilding construction materials and labor have gone up nearly as much. That’s really been the biggest impact. There is some additional impact from climate change…climate change is very important, but probably not the biggest driver in the short term.
Robert Gordon, senior vice president at American Property Casualty Insurance Association
A key issue, Gordon said, is that insurance companies cannot raise their rates dynamically to keep pace with inflation, as navigating the regulatory framework in jurisdictions like California takes too long.
You think about how retailers like your grocery store, they can adjust prices on a daily basis to reflect the cost of their goods. But in a state like California, it can take over a year for an insurer to gather the necessary documentation for a rate filing. Then they have to wait for approval, that can take up to 12 months. And then once you get approval from the state regulator, then you have to roll that into your policies, and those insurance policies are typically six months or 12 months, so it’ll take another six to 12 months to roll that inflation rate into that. So that can take a couple of years, there’s a long time lag.
Robert Gordon
According to Gordon, with inflation hitting record highs in recent years and the cost of construction and labor increasing, insurers have struggled to replace lost assets without adjusting their rates accordingly.
If you’re not able to charge adequate rates and the volatility is increasing, then you start going into an insurance market death spiral, it’s going to be very hard for the state to turn around…The insurance and reinsurance industries are well positioned to handle even these increasing costs from natural disasters, but they have to get an adequate rate to do it to attract the capital. And right now, in a lot of states like California, insurers have the severe challenges attaining the kind of rate that they need to attract new investment capital to cover these higher accumulations and exposures.
Robert Gordon
However, even if insurers did have free rein to raise rates, would their customers, who are already dealing with high inflation, be able to afford the policies? In Gordon’s view, they would.
That’s certainly a concern that’s been raised by policymakers, but you have to put it into perspective. Home values have increased, as I mentioned, 56% over the last five years, and that’s many times the increase in the cost of insurance. And generally, homeowners’ insurance continues to be just a fraction of 1% of home values, even in the higher risk states like Florida and California. If you look at the top recurring costs of home ownership in order, it’s mortgage payments and utilities, maintenance, home improvements, taxes. Cost of insurance is last on the list. Consumers are very sensitive to sudden spikes in homeowners’ insurance, and certainly we’re very sensitive and empathetic about that. But over the long term, the costs have actually been very low, particularly in return for protecting consumers’ single greatest asset, their home.
Robert Gordon
To hear more from Robert Gordon, subscribe to “Double Take” on your podcast app of choice or view The Insurance Climate episode page to listen in your browser.
Authors
Raphael J. Lewis
Head of specialist research
Jack Encarnacao
Research analyst, investigative, Specialist Research team
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