Uneven US insurance regulation could lead to financial crisis, say experts

May 29, 2024|Written by

Insurance premiums in the US have skyrocketed in part due to climate change, with some states seeing as much as a 23% increase. But while this rise is likely to drastically change the real estate market in many parts of the US, very little is being done to address the inconsistencies in pricing and coverage, leading to fragile insurance coverage in areas that need it the most.

Still, some US regulators are taking note. Treasury secretary Janet Yellen has noted the threat that climate change and a lack of insurance coverage could have on the economy.

As climate change worsens and more areas become uninsurable, prices will get even more expensive and some areas may even see a drop in the number of people living there, climate and real estate experts say.

“There isn’t a place in the United States that isn’t at risk from climate impacts in different ways,” said Jesse Keenan, a sustainable real estate professor at Tulane University in New Orleans.

Limited coverage could cause banking crisis

The impacts of climate change on insurance and real estate will likely be priced in and could lead to inflation and high-risk areas being devalued, Keenan said. This will not only cause housing prices to increase, but would have an impact on local taxes and government support, meaning less money for things like infrastructure and schools, he added.

“This is, in a way, part of the adaptation of the financial economy to climate change,” he said.

While home insurance is not required by law, mortgage lenders do require homeowners to have insurance. Most of the insurance coverage is through private insurance companies, but those who can’t get private insurance can often get coverage through the state or nonprofits.

But there are concerns that some state-run insurance companies are not financially sound and are just a few catastrophic events away from going bankrupt. These state-run agencies also tend to be slow to pay out which can lead to mortgage delinquencies, said Ishita Sen, assistant professor of finance at Harvard Business School.

This lack of adequate insurance coverage feeds its way back into the banking sector, creating a cascading effect on the overall economy, she said. It’s not just households that are affected by disasters, but banks as well.

“If the home value is destroyed, and the insurance company is not able to pay up, obviously the homeowner is screwed. But the bank is also screwed because the bank is increasing its amount of default, which then starts hitting the banking sector and so on,” Sen said.

Lack of data on US insurance coverage

Insurance companies are not required to disclose data on the amount of insurance they sell at a granular level. Researchers don’t know how much coverage American homeowners have and whether it is enough to withstand catastrophic events, except in some specific areas.

Much of that lack of data is due to differences in state regulation, as there is very little federal oversight and insurance is regulated by each state. Some states, such as California and New York, have stricter regulations regarding coverage, pricing and disclosures.

That means premiums are not keeping pace with increased losses as some state regulators put a price cap on how much insurers can increase premiums, causing some insurance companies to leave the state or drastically limit coverage. This has put pressure on state regulators to loosen regulations or face an uninsured constituency.

Sen said some of the most regulated states like Florida and California tend to be the most risky.

“These are precisely the states where regulators have more incentives to keep insurance affordable because [premium] prices are rising,” she said.

In one study, Sen and other researchers found there was a correlation between risk and regulation in the US, and the prices of insurance and real estate is likely not accurately reflecting the climate risk of owning property in these states. In other words, there is no accurate measure of climate risk in home insurance in the US.

Because insurance companies have left some states, regulators are more willing to allow price changes. This has had a massive impact on households who have been used to low rates for a long time, making homeownership even more unaffordable, Sen said. This is likely to create tension as people come to realise there are some areas that should not be lived in.

“We are doing all sorts of things to delay the inevitable. But at some point, all of this has to catch up with the reality, which is that certain areas are just not where we should be building anymore,” Sen said.

But telling people not to build or live in certain areas doesn’t consider the racial and economic ramifications, said Jordan Haedtler, a climate financial policy consultant.

“If you look at many of these communities, where people’s homes have been their only source of wealth for many generations… it’s not really fair to say that someone who’s living in the Gulf Coast in Louisiana or Texas, who doesn’t have any other assets aside from a house that they inherited, they should be forced to leave without requisite compensation”.

The case for more federal oversight

Insurance is likely to stay regulated at the state level, experts say. However, many are pushing for more disclosures. The US Treasury’s Federal Insurance Office is pushing to collect national insurance data to help create a bigger picture of the potential impact that high premiums and climate change is having on insurance coverage. But it has been a slow process and has not gone as far as some advocates had hoped.

“Nobody in the industry wants that information public because then they’ll be held accountable for what they’re doing, which is largely cherry picking policies,” said Keenan.

Haedtler said insurance lobby groups and taskforces like the National Association of Insurance Commissioners are pushing for a low baseline of regulation which largely excludes climate as a systemic risk.

“The system that we have is very, very baked in and there’s broad, bipartisan consensus that it should remain in place,” he said.

Still, the US Treasury’s work on gathering insurance data is an important step in understanding insurance needs in the US, said Steven Rothstein, managing director of sustainable capital markets at Ceres.

“I am hopeful that the insurance industry, the insurance regulators, and stakeholders will act quickly and [find] creative solutions,” he said.

But while federal regulation is unlikely, it is possible there could be a nationalisation of some insurance policies, just as there is a national flood insurance programme, which was created in 1968 to protect homeowners who could not get coverage for flooding.

Keenan said a wind insurance programme is likely, and in the future he would not be surprised if some of the climate change risks that insurance companies prefer to avoid, like wildfires and wind, become nationalised.

“I think that, by and large, the insurance industry would not mind that because it moves the worst parts of their portfolio off the books [and] it would allow them to maintain some market share because then the federal carbon is going to take some of their risk off their books,” Keenan said.

This page was last updated May 29, 2024

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