The federal government needs to step in and avert a homeowner's insurance crisis

The federal government needs to step in and avert a homeowner's insurance crisis
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Climate change may not have hit your home yet with a wildfire, windstorm, or flooding, but it’s still barreling toward millions of people with an increasingly urgent threat: a homeowner’s insurance crisis.

Annual insurance bills are soaring in hurricane states such as Florida and Louisiana where, despite low construction costs, average home insurance premiums now exceed $3,000 a year. In California, premiums recently rose by 10 percent in areas directly affected by wildfires.  

An even more pressing problem involves policy cancellations. Insurers increasingly are pulling out of areas at higher risk for climate-related disasters — in mountain areas prone to wildfires, along coastal areas that face rising sea levels, and beside rivers and creeks where “100-year floods” now occur with unnerving frequency.

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Compounding matters, home mortgage loans typically require insurance, meaning that insurance unavailability raises the specter of widespread mortgage defaults and systemic financial risk. Climate change is creating a perfect storm of financial disaster, threatening 70 million U.S. homeowners and our entire financial system, witnessed by many but stopped by no one. 

Big issues are at stake, but policy makers so far have been unwilling to make the hard decisions required to keep homeowner’s insurance a fair and sustainable proposition.

In California, where massive fires have caused billions of dollars of insurance claims in recent years, over 40,000 homeowners were sent non-renewal notices in foothill counties in 2019 — a 75 percent increase over the previous year. 

In Florida, insurers this year dropped more than 50,000 policy holders just before the hurricane season. Insurers there had posted $1.5 billion in underwriting losses the prior year.

States like California have been stepping in to offer “minimum viable product” or “MVP” insurance policies of last resort through programs such as FAIR, which provides insurance to homeowners who live in high-risk areas and who cannot get insurance through other providers, but homeowners with dropped policies have been confronted with premiums that doubled or tripled their prior rates. 

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That is a heavy financial hit on the dream of home ownership, and the long-term solvency of publicly funded MVP insurance programs remains to be tested. Ultimately one must wonder if taxpayers will end up footing the bill.

Equally worrisome is how some insurers appear to be rushing into climate-challenged neighborhoods without pricing the risks into their policies. Cut-rate policies may help an insurer gain market share, but it's an extremely risky practice to sell actuarially unsound policies that can’t live up to the promise of coverage when disaster strikes.  

This is a dicey situation that cries out for increased oversight. But public insurance commissioners have been reluctant to block the spread of unsustainably cheap homeowner policies because of fears of a voter backlash. 

Few politicians have the courage to pass up short-term policy Band-Aids (allowing the sale of cheap homeowner policies that fail to factor in climate risks) in favor of long-term sustainable fixes.

Meanwhile, the unregulated reinsurance market is flashing red lights as prices increase and risky financial engineering is introduced to absorb demand for protection from climate risk.

The fear is that we have seen this movie before: The savings-and-loan crisis of the 1990s; the subprime mortgage crisis of the 2000s; and the continuing government and private pension crisis of today. 

Regulators keep kicking the can down the road until the problem becomes so big and so expensive that the government — that means taxpayers — will be forced again to cover the costs of a massive bailout. 

We need a fix today to head off a major problem in the future. Realistically, though, we see that state regulators are unlikely to rise to the moment, and it doesn’t make much sense anyway for 50 different states to come up with 50 different solutions to a global problem.

Our best hope in the United States may be the federal government: FHA, Fannie Mae and Freddie Mac set the standards for the home mortgage industry. It’s time for them to start taking a hard look at climate change and requiring insurance that truly reflects the risks posed by our changing climate. 

Justin Cooper leads Orrick’s Finance Sector and is a member of the firm’s Management Committee. He also chairs the Public Finance Department’s housing finance group.