By Umair Irfan
June 2, 2023
Source: Vox
Photo / Image Source: Unsplash,
Climate change is already making parts of America uninsurable
“We’re steadily marching toward an uninsurable future.”
In a report published in April, California Insurance Commissioner Ricardo Lara admonished the industry to better account for far-reaching risks like those wrought by climate change. “The insurance sector no longer has the luxury of thinking only of the year ahead,” he wrote. “Insurance companies, regulators, and consumers all must learn to consider and prepare for the long-term.”
A week ago, California’s largest insurer did just that — but perhaps not in the way Lara had hoped.
State Farm announced that it will not accept any new applications for business or personal property and casualty insurance in the Golden State. The company, accounting for 20 percent of bundled home insurance policies and 13 percent of commercial policies in California, said it was facing “historic increases in construction costs outpacing inflation, rapidly growing catastrophe exposure, and a challenging reinsurance market.” It will still keep existing policy holders on its books for now, but the announcement signals that risks are growing beyond what State Farm, a company worth $131 billion at the end of 2022, can bear.
Insuring property in California has been a dicey proposition in recent years. Torrential rainfall this past winter caused as much as $1.5 billion in insured losses this year. The state has also suffered the costliest wildfires in US history, including the 2018 Camp Fire, which led to more than $10 billion in losses. Human action is driving many of these risks. Real estate prices have been rising in California for decades, and populations are growing in the places most vulnerable to burning and flooding. Decades of suppressing natural fires have allowed fuel for wildfires to accumulate to dangerously high levels. Humans are also heating up the planet, lifting sea levels, amplifying downpours, and exacerbating the conditions for massive blazes.
So when disasters do occur, they cause extraordinary damage to lives, livelihoods, and property. These threats have led insurance companies to drop existing policies or stop issuing new coverage. “It’s not just the risk of loss but the magnitude of loss when a California house burns down,” said Dave Jones, who served as California’s insurance commissioner from 2011 until 2018. “That trend has only gotten worse over time.”
State Farm isn’t the first insurance company to cut back in California, and states like Louisiana and Florida have also seen insurers decline coverage due to mounting catastrophic losses. “We’re steadily marching toward an uninsurable future, not just in California but throughout the United States,” said Jones, who now leads the Climate Risk Initiative at the University of California Berkeley School of Law. That in turn stands to ripple throughout the economy. Insurance is the major financial signal of where risks lie, and changes in coverage availability and cost can spur individuals, businesses, and policymakers to change their behavior. Insurance can alter where people live and whether they can rebuild in the wake of a calamity. But climate change is just one of several issues at play here, and the march toward uninsurability began decades ago.
Bringing risks to a more manageable level will require systemic action to reduce the threat, from better building codes to reducing greenhouse gas emissions overall.
State Farm’s shift is a sign that climate change isn’t a far-off threat; it’s having effects today, on people’s lives and now in the financial sector. And more companies will likely follow their lead.
Climate change poses a conundrum for insurers The reasons State Farm gave for declining new insurance coverage — higher construction costs, more expensive reinsurance, and increasing disaster risk — are all interrelated, though not exclusively due to climate change. Remember that the goal of insurance is to spread out the risk of catastrophes like fires, floods, earthquakes, and storms. “Ideally, from the insurance company perspective, you have risks that materialize randomly,” said Sean Hecht, managing attorney at the California regional office for Earthjustice who studies insurance and climate change. The problem is that climate change often raises the chances of these events occurring at the same time and in the same place, an effect known as correlated risk.
At the same time, rising interest rates have made it more expensive to borrow money to buy property. Lingering supply chain disruptions for materials like lumber have driven up the costs of building new homes. California is facing a dire housing shortage, driving up the value of existing real estate and making it far more expensive to replace destroyed buildings. And new building codes intended to better withstand disasters and reduce greenhouse gas emissions are making construction more expensive.
That means a lot of money is on the line when it starts to pour or when a wildfire ignites. “There’s a lot of insured value that ends up in claims that have to be paid all at the same time. That creates risks for the solvency of insurers,” Hecht said. “More expensive housing and more expensive construction exacerbates that same problem.” Insurance companies can cushion these blows with reinsurance. It’s pretty much what it sounds like: insurance for insurance companies. Reinsurance providers act as a backstop and help front-line insurers cover claims when a massive disaster strikes. As a result, international reinsurers like Swiss Re keep a close eye on global systemic risks branching from rising average temperatures. “It’s actually reinsurers that have been sounding the alarm about climate change and disaster risk for decades,” said Hecht.
Reinsurers have also been grappling with massive payouts due to correlated disasters, and some have responded by raising their rates.
One bit of good news is that extreme weather events are killing fewer people. That’s due to a number of factors, including better warning systems, more robust evacuation strategies, and construction codes that can better withstand floods, fires, and winds. But the global population is growing in size, particularly in areas likely to see future disasters, and it’s growing richer, which makes these events more costly when they happen. NOAA reports that the US has already seen seven disasters this year with a damage tally exceeding $1 billion.
That’s a massive challenge for insurance companies and for policymakers. If insurers priced their policies in line with growing risks, they’ll soon be too expensive for all but the wealthiest people, leaving the most vulnerable with no protection. If rates are capped too low, insurers may not have enough money to cover all their claims or stay in business. In California, some insurance companies ended up leaving the market or dropping their customers altogether.
Policymakers imposed limits on how much insurers could raise rates, whether they could drop existing customers, and how much they could factor climate change into their calculations. Some of these restrictions have since loosened, but not enough for State Farm. There are other approaches as well. The federal government created the National Flood Insurance Program to cover flood losses since few private insurers would underwrite these policies. The program, however, is more than $20 billion in debt and had to raise rates last year, leading a number of homeowners to drop coverage.
California does have a program called the FAIR Plan, which is intended as an insurer of last resort for wildfires. But it has very expensive policies compared to private insurers. Jones suggested that one approach to expand coverage would be to subsidize these policies for low-income people in high-risk areas. The high price of the insurance plan, however, is an important warning sign. “What we shouldn’t do is artificially suppress insurance prices,” he said. “It’s expensive because it reflects the real risk of wildfire.”
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