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Storms Surge, So Do Premiums |
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FORECASTS & TRENDS E-LETTER Storms Surge, So Do Premiums IN THIS ISSUE: Home Insurance Cost Soaring
The cost of property damage due to extreme weather is front and center in the news. Damage estimates due to Hurricane Helene range as high as $48 billion. Fitch Ratings, one of the “Big Three” corporate credit rating agencies, estimates Hurricane Milton could reach $50 billion in insured losses for Florida property owners. Florida state officials say if Milton had reached Category 4, the losses would have easily doubled. Even before these calamities struck, homeowners had seen insurance costs increase. And it seems like natural disasters take a bigger toll each year. What can be done to curb the meteoric rise in premiums? Today we’ll take a look at the problem, the underlying causes and what can be done to help. Home Insurance Cost Soaring Home insurance premiums are already rising across the country. Last year, US home insurance rates jumped 11.3 percent on average. However, Florida homeowners pay the highest rates – on average about $3,600 per year, according to the Florida Office of Insurance Regulation. That’s 50% higher than the national average. Worse yet, Florida’s 10 largest cities see rates of more than $10,000 per year. Some Floridians have seen rate hikes as high as 400 percent over the past five years.
Meanwhile, the National Flood Insurance Program (NFIP), a federal program that provides flood coverage to 4.7 million policyholders, is more than $20 billion in debt to the US Treasury and accrues $1.7 million in interest daily. In September, Congress reauthorized the program for a few months. The next funding deadline is December 20, 2024. If authorization lapses, the NFIP would stop selling and renewing flood insurance for millions of people. Part of my homestead in the Texas Hill Country lies in the 100-year flood plain, so I purchase flood insurance through NFIP. I can tell you from personal experience my flood insurance premiums have nearly doubled in five years. Insurers like State Farm point to several factors behind these trends. Prices for reinsurance — insurance for insurance companies — have shot up. Insurers are also bearing more catastrophic risks as more people and property take root in high-risk areas like flood zones and neighborhoods that are more wildfire prone. When a blaze ignites or a storm passes over, the losses are greater. The Math Behind Premiums Now this is a very simplified explanation of what is actually a complex discipline of mathematical and statistical analysis called actuarial science. I’m a bit of a math guy myself and have taken my fair share of upper-level math and statistics. But I’ve known several actuaries over the years, and those folks work at an entirely different level. Their job is to put a number to risk and factor in uncertainty to ensure that insurance companies remain solvent. The formula for the losses that an insurer can expect has three key components. The first is the hazard, such as the probability of a severe storm or wildfire occurring. Next is exposure, which is the value of the insured property in the path of danger. And the third is vulnerability, or whether the property floods, burns, collapses or survives the disaster. Insurers then distribute these costs across their customers. Companies are competing with one another, so they can’t set their rates too high. In many states, they face further limits on their pricing and must meet minimum coverage requirements. Insurers themselves cover their risks with reinsurers. When a major earthquake, hurricane, or wildfire demands more payouts than a company can afford at once, insurers can file a claim with their reinsurer, which has their own team of actuaries and in turn is balancing disaster threats among insurance companies all over the world. What If They Get It Wrong? If insurance companies balance these factors properly, it can be a lucrative line of business. The US property and casualty insurers netted $823 billion in premiums last year, posting record profits in the hottest year on record with dozens of extreme weather disasters with tolls in the billions of dollars. Insurers have already reported even higher profits this year, and the sector is poised to do better in 2025. But if they tip too far in any direction, it can lead to a financial collapse. Hurricane Andrew rammed into the tip of Florida at Category 5 strength in 1992, causing $25 billion in insured losses (1992 dollars). Afterward at least 16 insurance companies became insolvent. The storm was a major turning point for the insurance sector. It showed that the old formulas for calculating risk underestimated how much destruction could end up on an insurer’s books. Companies began to adopt catastrophe models, computer programs that use the physical traits of extreme weather events in a given area to estimate how much an insurer might have to pay out. This raised rates for many homeowners, but also led insurers to advocate for stronger building codes and defensive infrastructure like sea walls. The Biggest Factor Behind Premium Hikes Were you thinking I’d say the biggest factor is climate change? It is a factor, but a relatively small one. Insurance companies would definitely say climate change is a long-term risk. But only about 1 percent of the annual increases is due to climate factors. The larger force to date is inflation. Homes have become more expensive to build due to increased labor and material costs. The relatively inexpensive starter home that was built 30 years ago now costs far more to repair or replace.
In addition to inflation, there are other local factors that have driven up the costs of insurance in some states. Last year, major insurance firms like State Farm and Allstate announced they would not sign new property insurance policies in California. The losses they were facing from devastating wildfires were too much to bear at the rates they were allowed to charge. Other insurers dropped thousands of Californians from their existing policies. Similarly, Florida has also seen private insurers leave the state and drop customers in recent years. The Bottom Line States are taking steps to lure insurance companies back. California now allows insurers to incorporate catastrophic hazard models into rate calculations. Florida Gov. Ron DeSantis signed sweeping insurance reform legislation aimed to limit insurance litigation. Building code updates seek insurance discounts for people who use fire-resistant materials or strengthen the frame of their homes in severe storm areas. But even with these measures, companies like Farmers Insurance are still canceling coverages. Despite the challenges, the insurance industry is still profitable, investors continue to demonstrate an appetite for risk and insurance requirements to get a home loan haven’t changed. At the right price, there is theoretically an insurance policy that can cover even the most at-risk home. But there is no guarantee that the homeowner could afford the premium. It’s also important to remember that insured losses are only the starting point for dealing with a disaster. More than half of natural disaster losses were not insured. Many of the people facing the greatest dangers from weather extremes are also the least equipped to deal with them and most likely to suffer in the aftermath. The dollar values don’t convey the entire social cost.
The pictures of areas affected by Helene and Milton are beyond heart wrenching. We spent last Christmas in Asheville, NC and we have several friends who live in and around Tampa, FL. Seeing places we have visited wiped away by flood waters or destroyed by hurricane winds have deeply affected us. I encourage you to consider contributing to a group that gives aid to those people severely affected. They have a long road of recovery ahead. All the best, [Henry]
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