Republished with permission from Governing, by Carl Smith

In Brief:

• Record numbers of climate and weather disasters are creating risks that exceed the coverage capacity of insurance companies.

• There are models at both the state and federal levels for mitigating risks for private insurers.

• Design of these programs is key, because shifting risk onto government is both costly and encourages bad behavior.

The insurance industry is built on the notions that risk can be distributed across a client base and that only some of those insured will need help at any given time. For property insurers, this mathematics is being turned on its head by rising numbers of floods, fires and windstorms and the growing number of states affected by them.

There were 28 billion-dollar climate and weather disasters in 2023, the most ever in a single calendar year. Disasters causing $1 billion or more in damage occurred at a rate of about three per year in the 1980s, but have hovered at 20 or more since 2019. Last year, the U.S. suffered about a third of the total global economic losses from natural disasters, but accounted for 70 percent of global losses covered by insurance.

GOV_In_Article_1_640x480_300x250_0__container__”>Increasingly, insurers are feeling pressure to go beyond raising rates. Some are deciding they won’t renew policies in high-risk areas or offer new coverage. Others are leaving states altogether — and not just those prone to wildfires and hurricanes.

This is now a problem in nearly 20 states, including some in the Midwest and New England, as well as the West and Southeast.

“The insurance crisis is the price we’re paying for the failure to address climate change,” says Dave Jones, who served as California’s insurance commissioner from 2011 to 2018. “The insurers are the canary in the coal mine and the canary is expiring.”

Ground-Shaking

This isn’t the first time the insurance industry has been forced to reconsider just how much risk it is being asked to cover, says Laurie Johnson, a catastrophe risk management expert who has written two books examining post-disaster recovery plans and policies. “We went through a similar crisis after the 1994 Northridge earthquake,” she says.

That earthquake, in a section of Los Angeles, caused $20 billion in residential damage, which altered insurers’ perceptions of the risk they were carrying. California requires homeowner insurers to provide earthquake coverage, so some began to pull out of the market.

In response to these developments, the California Legislature established the California Earthquake Authority (CEA) in 1996. Privately funded by participating insurers and policyholders but state-governed, it enables insurers to write homeowners insurance and offer earthquake coverage on behalf of the CEA. “It allows the insurer to continue to operate in California, but shed its earthquake risk,” says Johnson.

The legislation that created the CEA requires rates and premiums for earthquake policies to be actuarially sound, so the CEA can accumulate capital and investment income to cover a large event. The state also helps fund this partnership by waiving the taxes on the earthquake premiums that insurance companies collect on behalf of the CEA, due to CEA's tax-exempt status.

Nearly 30 years after it was created, the CEA is the country’s largest provider of earthquake insurance, with more than $20 billion available to pay claims.

The insurance crisis is the price we’re paying for the failure to address climate change.

Dave Jones, former California insurance commissioner

Subsidizing Risk

The country’s oldest program for protecting insurers and homeowners is at risk of becoming unsustainable as the frequency and magnitude of flooding grows. Congress passed the National Flood Insurance Act in 1968. It was a response to a decision by insurers to exclude flood risk from standard home insurance policies, says Jones, the former California commissioner, who now directs the Climate Risk Initiative at the Center for Law, Energy and Risk at the University of California, Berkeley. The National Flood Insurance Program is managed by the federal government, which also subsidizes it.

Homeowners can get flood coverage through the program, but only if their community participates in a floodplain management plan. Premium discounts can be as high as 45 percent, depending on a community’s score on the program’s rating system.

Unlike the CEA, the flood insurance programs’ rates aren’t set on an actuarial basis, which means that Congress has to continue to pour billions in to keep it afloat. The program must be reauthorized annually. Lapses in this process — which have occurred in recent years — interfere with its ability to sell and renew policies, or to borrow money from the Treasury to pay claims.

“I’m very skeptical about some big national scheme of disaster risk insurance, because the tendency is to subsidize it to mask the price signal,” Jones says. “We’re basically subsidizing new development in higher risk flood areas, as opposed to discouraging it by making sure the rates are setting the right pricing.”

Johnson thinks the alignment of rates and community action built into the flood insurance program could be implemented in other contexts to bring both risks and rates down. She’d like to see a “mitigation data commons” where cities could upload the work they do to disaster risks and impacts. “It could be transparent to the catastrophe risk modelers who work for the insurance industry and other vendors who provide risk scores,” Johnson says.

Storms may be more frequent and severe, but there are well-established strategies for helping communities withstand them. In the short run, state and local governments could do more to mitigate the impact of storms, whether changing building codes, forbidding new development in high-risk areas or implementing natural solutions such as wetlands preservation, green infrastructure or forest management.

The Insurance Institute for Business and Home Safety has a building-level program that sets construction standards for “fortified homes” that are better able to withstand high winds, severe thunderstorms and hail. Some insurers offer discounts to buildings certified to meet these standards.

Last Resort for Last Resorts?

A federal program more focused than the flood insurance program could provide reinsurance for state Fair Access to Insurance Requirements (FAIR) Plans, Jones says, tied to both mitigation and efforts to reduce the number of people and businesses in areas of high risk. This could help bolster a system created as a last resort for those unable to find coverage elsewhere.

More than 30 states have FAIR Plans. Like the CEA, these are administered by states but funded by insurance companies. Wildfires and hurricanes are driving more and more residents to FAIR plans in California and Florida.

These are meant to be insurers of last resort, but Florida’s FAIR Plan, Citizens Property Insurance Corporation (CPIC), has become the state’s leading insurer as recurring seasons of major storms have blown companies out of the state. (National Weather Service forecasters have predicted that the 2024 Atlantic hurricane season could have even more major hurricanes than 2023.)

The Florida Legislature has taken steps to prop up CPIC, including taxpayer-funded reinsurance for companies that issue policies. But as mainstream companies leave, others with lower ratings have come in to fill the gap. Twelve have gone broke in the last three years, Jones says.

In some cases, mortgage lenders writing mortgages for homes insured by companies rated by a lower-standard agency are offloading them to the federally subsidized secondary markets, Jones says. “So now that risk is sitting on the balance sheets of Fannie Mae and Freddie Mac — it’s not sufficient to bring them down but it tells you something.”

Some who own their homes are taking risk on themselves, Johnson says, foregoing insurance altogether or opting for policies that wouldn’t give them enough to build back if their home is destroyed. “There was some testimony at the California Department of Insurance’s hearing a couple of weeks ago in which a jurisdiction up in the Sierras said that they weren’t able to get insurance for their fire stations,” she says. “It’s not just a homeowners problem, it’s all lines of business.”

This story has been updated to describe CEA's earthquake insurance role more precisely.