Opinion | Your Homeowners’ Insurance Bill Is the Canary in the Climate Coal Mine
If you don’t think you’ve been affected by global warming, take a closer look at your last homeowners’ insurance bill: The average cost of coverage has reached $1,900 a year nationwide, but it’s $4,000 a year in New Orleans and about $5,000 a year in Miami, according to Policygenius, an online insurance marketplace. And that is pocket change compared with the impact climate change may ultimately have on the value of your home.
We have reached a turning point: Climate risk is driving insurer decisions like never before.
After recent years of paying out claims for about 20 disasters a year with damages of over $1 billion, a sixfold increase from the 1980s, insurers are getting serious about new pricing models that incorporate the costs of a warming climate. Across the United States, premiums jumped 12 percent from 2021 to 2022, according to Policygenius estimates, and they are expected to continue to rise.
Even with higher premiums, unpredictable losses are wreaking havoc on insurers’ bottom lines. Ten insurers have gone belly up in Florida in just the last two years. And in many cases, insurers are pulling back in risky areas, leaving state-backed insurance plans holding the bag. Both private and government-backed insurers are undercapitalized for dealing with the potentially massive disasters we could be facing in coming years. This shortfall foreshadows more premium increases, which will drag down house prices. And losses will not be borne by those residing in higher-risk areas only; they will be borne by policyholders everywhere.
Thus far, housing markets have largely managed to ignore these potential exposures. Over the last three years, home prices are up around 37 percent nationwide. They are up even more in parts of Florida and the Southwest that are predicted to suffer significant impacts from a warming climate. Take Phoenix, which, by 2060, is forecast to endure 132 days each year with temperatures of over 100 degrees. Last summer, the water level in Lake Mead, a critical source of water for 25 million people in the Southwest, reached its lowest level since the reservoir was filled in 1937. And living in Phoenix requires energy-intensive amenities like air conditioning, which worsen these consequences. Yet Phoenix home prices are up 53 percent since January 2020.
Why are so many home buyers putting themselves in harm’s way? The simplest explanation is that they are choosing to focus on the short-term benefits of sunny weather rather than the longer-term problems. A defining feature of the pandemic housing boom has been Americans, particularly retirees, moving southward. And with about 10,000 Americans turning 65 each day, this pattern could continue for years to come.
It’s hard to make decisions based on things we haven’t experienced. But by ignoring the growing consequences of climate change, we are investing too much in potentially hazardous areas in a way that’s hard to unwind. In 50 years, the result could be miles of unlivable homes along waterfronts and in deserts. The financial consequences of these choices will be enormous, causing ripple effects through insurance markets and ultimately undermining home values.
Climate risks are difficult to forecast and are increasingly correlated: From insurers’ perspectives, it’s “Everything Everywhere All at Once,” with heightened risks of floods, droughts, wildfires and more. To have the necessary buffer to pay out claims after catastrophic losses, insurers will need more reserves and more reinsurance, and they will pass those costs on to policyholders in the form of higher premiums. That includes policyholders who live well out of harm’s way. The year after the Marshall fire destroyed over 1,000 homes and caused over $2 billion in damage near Boulder, Colo., average premiums rose over 17 percent statewide.
While insurers can choose to stop offering insurance, the homeowners and governments they leave behind will still have to deal with the risks. And as the costs go up, more households may decide to reduce their coverage or may choose to go without insurance entirely. It’s estimated that only one-third of households in flood zones have flood insurance — with many risking financial ruin if the “big one” hits.
Then there’s the housing market. There is $30 trillion in housing equity in the United States, and the most important source of wealth for most American households is the home. If homeowners have to pay more in premiums, can’t obtain insurance at all or can’t find buyers because of fears about climate change, property values can erode or collapse even without a hurricane making landfall. This dynamic has already started: My research partner Philip Mulder and I found that low-lying housing markets in coastal Florida began to price sea level risk in the 2010s, leading to a roughly 5 percent discount relative to houses in similar, but less exposed, communities. Climate risks are disproportionately borne by lower-income groups and racial minorities, who may already live in riskier areas, are less likely to be insured, and may lack access to resources for pre-disaster preparation or post-disaster repairs.
As some private insurers retreat from higher-risk areas, state-backed “insurer of last resort” plans are stepping into the void. The number of enrollees in these state-backed plans rose by 29 percent between 2018 and 2021. These plans are often more expensive, they offer less coverage than private insurance options, and they face the same concerns as private insurers about their ability to pay out in the event of a crisis without burdening policyholders statewide.
What can be done? The government needs to ensure that insurers, both public and private, are sufficiently capitalized to withstand significant climate-related risks. One way to start is by instituting “stress tests” for housing and property markets against climate risk. As the recent experience of Silicon Valley Bank has taught us, the balance sheets of players in the market may be weaker than previously believed, given recent swings in interest rates. If balance sheets can’t cover the losses, either claims go unpaid or the broader population is on the hook for the difference.
These stress tests should consider not only a severe natural disaster scenario, but also a sharp “revaluation” event responding to a change in climate forecasts. How would coastal housing markets respond to news that ice sheets were melting faster than anticipated, leading to more rapidly rising seas?
Current homeowners and those shopping for a house need to wake up. Some will undoubtedly dismiss these risks, reasoning that the impact is likely to be “beyond their investment window.” In making that assumption, however, they are ignoring that when they sell their home, they will need to find a buyer willing to bear the uncertainty. Other homeowners prefer to avoid publicizing risks that could harm their property value, abetted by uneven disclosure requirements across states.
Right now, those of us who elect to live in safer communities are quietly subsidizing those who do not. Homeowners who move to areas that are likely to be significantly impacted by climate change should pay for the potential risks they are assuming. One way to do that would be to have Fannie Mae and Freddie Mac incorporate climate risk into their pricing models. If you want to buy a waterfront home on Siesta Key, Fla., you would pay a higher interest rate on your mortgage, a surcharge you could reduce by climate-proofing your home. Note, however, that most climate proofing won’t help if, as scientists predict, the home is literally underwater.
The government should manage expectations through better disclosure and better assessment of climate perils. An easy first step would be to make detailed risk data more accessible and interpretable. Potential property owners deserve loud and crystal-clear warnings of climate-related risks, especially if prices are not yet providing a sufficient signal on their own.
Private insurers are sending a warning signal about heightened climate risks that homeowners and potential buyers need to receive. Insurers’ decisions are leaving households with fewer choices, less protection, and more financial distress. Homeowners should understand the potential hazards and find the right insurance policy or policies to protect them from harm. And they need to be aware that the costs of living in harm’s way are going to rise in coming years.
An era of complacency is ending. If you decide to buy that condo where you can hear the ocean’s waves, realize that you are likely to pay more for that privilege — one way or the other.
Benjamin Keys is an economist and a professor of real estate and finance at the University of Pennsylvania’s Wharton School.