Rising Insurance Premiums Could Pose An Existential Threat To Housing Market

It's no secret that climate change-related insurance premium increases are making life difficult for homeowners. 

The premium increase pain is particularly acute in states like California and Florida where many insurance companies are not only raising premiums, they are dropping policies and refusing to write new ones. In some cases, they are leaving these states altogether. Now, a new study shows that a long-term continuation of this trend could pose an existential threat to the housing market. 

A study by First Foundation Inc. paints a gloomy picture of the future of home insurance. It found that despite many insurers' efforts to raise premiums to reflect the increased risk of climate change-driven losses such as increased storms and more potent storms, flooding and fires, nearly 40 million homes in America may be overvalued because of their potential exposure to climate change. 

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What that means is that insurance premiums paid by policyholders are still too low in relation to climate risk. At the same time, property values may be too high because of the increased risk of more frequent and more severe natural disasters. Those factors combined threaten to leave home insurers with the worst of all worlds: insuring properties for too much money while not being able to take in sufficient premiums to cover the risk. In other words, insurers would be left holding the bag after a major catastrophe. 

Insurance Companies Can't Afford To Cover "Likely" Disasters

Imagine a charity basketball contest that would give a $100,000 Mercedes-Benz to one of three people who could hit a shot from half-court. These types of events are made possible because the organizer can take out an insurance policy to protect themselves from losing it all in the unlikely event that someone makes the shot. 

Now imagine if all the players in the tournament were former college or professional basketball players. The insurance premium would increase because the possibility of three experienced basketball players making a half-court shot is higher than if three fans who never played organized basketball were contestants. Now imagine if the three contestants were Steph Curry, Larry Bird and Luka Doncic. 

You probably couldn't get an insurance company to write a policy on that because those are three of the best shooters of all time. The likelihood of any of them hitting a half-court shot is too high for an insurance company to charge a premium that would protect it from losses. At its core, insurance is designed to cover damages for things that are unlikely to happen, not those that are likely to happen. 

When the waters off the coast of Florida are 90-plus degrees Fahrenheit, as they have been all summer long, the risk of a powerful hurricane becomes so high that it's difficult for an insurance company to post a premium that covers the risk while still making a profit. This risk gets even more severe if water temperatures remain constant while the value of the properties they insure increases every year. 

Insurers Of Last Resort

Increasingly in Florida, homeowners are relying on the state-provided coverage option. Meanwhile, in California, the insurance commission recently cut a deal allowing the state's remaining insurers to factor in the cost of climate change and reinsurance into rate increases. Those increases must still be approved by the insurance commission, but if the commission doesn't approve them, more insurers could leave the state. 

The Effect On Home Values

As insurance companies refuse to write policies on houses with potential exposure to climate change — there is nowhere in America that is immune to all its potential effects — the homeowner's ability to sell the house for its appreciated value is also compromised. Carrying this insurance is a precondition of most mortgages. If buyers can't get policies to insure them at the sale price, that leaves only cash buyers, who almost always want significant discounts.

There may not be nearly enough cash buyers to sustain the higher asking prices, which means sellers will have no choice but to drop the prices on their properties. This downward pressure could become even more severe as buyers shy away from areas with high exposure to natural disasters because even with insurance, the process of going through a claim on a totaled house can be excruciating. 

What Does the Future Hold?

The good old days of properties appreciating value could be placed under threat by climate change-oriented losses. Accessible, affordable insurance is as key to the health of a housing market as accessible, affordable financing. Increasingly, both of those things are becoming harder to come by. If that trend continues, home prices will suffer. The only question is how far into the future the suffering becomes so acute that it drags down the entire market. 

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