Climate Change And Home Fire Insurance: Evolving Risks – If you don’t think you’re affected by global warming, take a closer look at your latest homeowner’s insurance bill: The average cost of coverage has reached $1,900 per year nationally, but it’s $4,000 per year in New Orleans and about $5,000 a year in Miami, according to Policygenius, an online insurance marketplace. And that’s pocket change compared to the impact climate change could ultimately have on your home’s value.
After recent years of paying claims for about 20 disasters a year with damages of more than $1 billion, a six-fold increase from the 1980s, insurers are getting serious about new pricing models that reduce the cost of include a warm 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.
Climate Change And Home Fire Insurance: Evolving Risks
Even with higher premiums, unpredictable losses wreak 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 to deal with the potentially massive disasters we may face in the coming years. This shortfall predicts more premium increases, which will drag home prices down. And losses will not be borne by those living in higher risk areas alone; they will be carried by policyholders everywhere.
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Until now, housing markets have largely managed to ignore these potential exposures. In the last three years, house prices have risen nationally by 37 percent. They are even more elevated in parts of Florida and the Southwest that are predicted to suffer significant impacts from a warming climate. Take Phoenix, which by 2060 is expected to have 132 days each year with temperatures 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 facilities such as air conditioning, which are decreasing . these consequences. Still, Phoenix home prices are up 53 percent since January 2020.
Why do so many home buyers put themselves in harm’s way? The simplest explanation is that they choose 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 that Americans, especially retirees, are moving south. And with about 10,000 Americans turning 65 every day, this pattern may continue for years to come.
It’s hard to make decisions based on things we haven’t experienced. But by ignoring the increasing impacts of climate change, we are overinvesting in potentially dangerous areas in a way that is difficult to unwind. In 50 years, the result could be miles of uninhabitable 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 predict and are increasingly correlated: From the perspective of insurers, it is “Everything everywhere at once”, with increased risks of floods, droughts, wildfires and more. In order to have the necessary buffer to pay out claims after catastrophic losses, insurers will need more reserves and more reinsurance and 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 more than 1,000 homes and caused more than $2 billion in damage near Boulder, Colo., average premiums rose about 17 percent in the state.
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While insurers may choose to stop offering insurance, the homeowners and governments they leave behind will still have to deal with the risks. And as costs rise, more households may decide to reduce their coverage or may choose to go without insurance altogether. It is estimated that only one third of households in flood zones have flood insurance – with many risking financial ruin if the “big” hits.
Then there is the housing market. There is $30 trillion in housing 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 get insurance at all or can’t find buyers because of climate change fears, property values can erode or collapse even without a hurricane making landfall. This dynamic has already begun: My research partner Philip Mulder and I found that low-lying housing markets in coastal Florida began to price in sea-level risk in the 2010s, leading to a roughly 5 percent discount relative to homes in similar but less exposed locations. , communities. Climate risks are disproportionately borne by lower-income groups and racial minorities, who already live in at-risk areas, are less likely to be insured, and may not have access to resources for pre-disaster preparedness or post-disaster repairs.
As some private insurers withdraw from higher-risk areas, state-backed “insurer of last resort” plans are stepping into the void. Enrollment in these state-backed plans increased by 29 percent between 2018 and 2021. These plans are often more expensive, offer less coverage than private insurance options, and have the same concerns as private insurers about their ability to pay out. to be paid in the event of a crisis without taxing policyholders nationally.
What can be done? The government must ensure that insurers, both public and private, are sufficiently capitalized to withstand significant climate-related risks. One way to start is to institute “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 the recent swings in interest rates. If balance sheets can’t cover the losses, claims aren’t paid or the wider population is on the hook for the difference.
History Of Insurance
These stress tests should not only consider a scenario for severe natural disasters, but also a sharp “reevaluation” event that responds to a change in climate forecasts. How would coastal housing markets react to news that ice sheets are melting faster than expected, leading to faster rising seas?
Current homeowners and those shopping for a home need to wake up. Some will undoubtedly dismiss these risks, reasoning that the impact is likely to be “outside their investment window.” In making that assumption, however, they ignore that when they sell their home, they need to find a buyer who is willing to bear the uncertainty. Other homeowners prefer to avoid publicizing risks that could damage their property value, encouraged by uneven disclosure requirements across states.
Right now, those of us who choose to live in safer communities are quietly subsidizing those who don’t. Homeowners who move to areas likely to be significantly affected by climate change must pay for the potential risks they assume. One way to do that would be for Fannie Mae and Freddie Mac to incorporate climate risk into their pricing models. If you want to buy a waterfront home on Siesta Key, Florida, you would pay a higher interest rate on your mortgage, a surcharge that you can reduce by weatherproofing your home. However, note that most climate proof will not help if, as scientists predict, the house is literally under water.
The government needs to manage expectations through better disclosure and better assessment of climate risks. An easy first step would be to make detailed risk data more accessible and interpretable. Potential owners deserve loud and crystal clear warnings of climate-related risks, especially if prices do not yet provide a sufficient signal on their own.
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Private insurers are sending a warning signal about increased climate risks that homeowners and potential buyers should receive. Decisions by insurers leave households with fewer choices, less protection and more financial distress. Homeowners must understand the potential dangers and find the right insurance policy or policies to protect them from harm. And they should be aware that the cost of living in harm’s way will increase in the coming years.
An era of complacency is ending. If you decide to buy that condo where you can hear the waves of the ocean, realize that you will probably pay more for that privilege – one way or another.
Benjamin Keys is an economist and professor of real estate and finance at the Wharton School of the University of Pennsylvania.
To the editor. We would love to hear what you think about this or one of our articles. Here are some A car sits in a flooded garage in Mamaroneck, New York, after Hurricane Ida in September. Kena Betancur/AFP via Getty Images
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