Climate Change and Insurance

Climate Change Is Here

Climate change is widely acknowledged to be underway and intensifying.¹ Temperatures are rising around the globe, bringing with them rising sea levels and more frequent, intense, and destructive droughts, wildfires, rains, floods, hurricanes, and tornadoes.

At the same time, growing numbers of people are moving to coastal and other areas at high risk for extreme weather events, increasing the potential for losses.

Last year, for instance, natural disasters caused worldwide losses of $280 billion (roughly $120 billion of which were insured). The U.S. saw approximately $145 billion of losses (roughly $85 billion of which were insured). This compares with losses of $100 billion ($67 billion insured) in 2020, and $52 billion ($26 billion insured) in 2019.²

Put differently, last year, the U.S. experienced 20 weather and climate disasters with losses greater than $1 billion each. According to NOAA (the National Oceanic and Atmospheric Administration), the annual average from 1980 to 2021 is 7.4 such events; from 2017 to 2021, however, the average is 17.2 events.³

Climate Change and the Insurance Industry

Insurance companies are increasingly acknowledging that climate change is the biggest long-term risk facing their industry,⁴ and its effects are already having an impact.

The insurance model is deceptively simple — to spread risks so that no one person has to bear a loss on their own. Insurers try to take in more in premiums than they pay out in claims. Premiums are based on the assessed risk, and so they’re higher in fire and flood areas.

When the model is working, many people buy insurance and only a few experience losses that require large payouts.

But a major catastrophe can cause enormous damage and devastating losses — and many large and diverse insurance claims that need to be paid at the same time.

The problem: Climate change means more frequent and larger disasters, sometimes in geographies that have rarely had them in the past. For instance, who could have anticipated last year’s crippling deep freeze in Texas?

Faced with greater and more unpredictable damages and claims, insurance companies are strictly underwriting new policies, vigorously enforcing existing contract terms, and tightening up coverage on policies — for instance, limiting the amount paid to rebuild.

Sometimes, they’ll require risk-mitigation measures to better protect homes and property from severe weather events.

Most impactful, when it comes to contract renewals, insurance companies are hiking premiums and deductibles, lowering coverage amounts, changing or removing certain types of coverage from their policies, declining to renew policies, and even exiting certain markets entirely.

In the following sections, we take a closer look at trends in specific types of coverage.

Wildfires

In reaction to worsening wildfire trends and increasing losses, insurance companies are responding in a variety of ways:

• Raising premiums. For some policyholders, premiums have increased anywhere from 1.5 to 10 times their prior rates.
• Adding wildfire deductibles. Levied as either a fixed amount or a percentage of insured value, these deductibles can be very large. We’ve seen deductibles as large as $1 million.
• Limiting the amount of coverage. This can take the form of setting maximum payouts, changing coverage terms, or capping a home’s insured value — sometimes well below its replacement cost.
• Adding risk-mitigation requirements. These measures can make a home less vulnerable to wildfires. Some can be inexpensive, such as adding screens to attic vents or requiring the removal of combustibles (wood mulch, brush, trees, and overhanging tree limbs) from within 10 to 100 feet of a house. Others can be more costly, such as fireproofing roofs, adding a water source (such as a cistern) to your property, or making an existing water source usable for fighting fires (such as adding a hydrant to a pond). They can also be burdensome from an aesthetic and lifestyle perspective.
• Canceling policies and/or exiting wildfire regions. This is particularly the case among companies providing coverage for high-value homes in wildfire-prone areas. Even where fires have not yet occurred, the risk alone has been sufficient for some companies to abandon their homeowners’ lines. AIG, for instance, recently announced that it is pulling out of California. And Chubb, PURE, and others are reducing their exposure in that state.

For homeowners, securing new or replacement coverage has become increasingly difficult, particularly for those looking to replace a good policy with another good policy. That said, alternative solutions may be available for those willing to be flexible and creative. These include accessing wholesale brokers and surplus lines insurance, considering state-run programs where available, and combining several options into an integrated insurance strategy.

Windstorms and Hurricanes

Most homeowners policies cover windstorm damage, but in areas at high risk for severe weather events, insurers are changing the specifics of that coverage:

• Adding separate deductibles. Homeowners policies usually have a single deductible for all types of damage, but in areas prone to storm damage, insurers will frequently impose a separate wind and hail, or hurricane, deductible that can range from 2% to 15% of the insured value of the dwelling.
• Imposing coverage limitations. Insurers are increasingly adding a variety of restrictions, including decreasing the amount they’ll pay for additional living expenses, among others.
• Limiting the amount of coverage. This can take the form of setting maximum payouts, changing coverage terms, or capping a home’s insured value — sometimes well below its replacement cost.
• Insurers may be unwilling to provide you with windstorm coverage on your homeowners policy — or even decline to provide you with a homeowners policy altogether. In these cases, you would need to seek coverage from a secondary-market insurance carrier, known as surplus lines insurers, or a state-run facility, such as a FAIR Plan or Joint Underwriting Association. Unfortunately, these policies are often not as comprehensive or generous as regular homeowners policies in their amounts of coverage, and some of these insurers may not pay claims well.
• Importantly, windstorm insurance is expensive. Your total insurance premium can rise significantly, sometimes even doubling. In Florida, for instance, half of a homeowners insurance premium can be for windstorm coverage.

Floods

Since homeowners insurance does not cover flood damage, most people purchase flood insurance through the National Flood Insurance Program (NFIP), which is run by the Federal Emergency Management Agency (FEMA).

FEMA recently revamped its insurance rates and how they’re calculated; its previous approach relied on outdated flood zone maps and wasn’t actuarily sound. Known as Risk Rating 2.0, the new system is designed to reflect the actual, specific risks facing individual homeowners as well as the replacement cost of the home, among other updates. The new system took effect on October 1, 2021, and will apply to renewing policies beginning on April 1 of this year.

For many homeowners, Risk Rating 2.0 will mean higher premiums; larger homes near the ocean will see the biggest premium increases. Depending on the size of your increase, since the maximum allowed increase is 18% per year, it may phase in gradually over years until you reach the new rate. FEMA estimates that roughly 90% of policies will reach that mark in 10 years.

In certain cases, private primary flood insurance might present a useful alternative. These policies can sometimes be less expensive than NFIP policies, particularly in higher-risk flood zones. They can also provide broader coverage for houses in traditionally lower-risk areas:

• For instance, unlike NFIP policies, some private policies will pay out if heavy rains have only flooded your residence — say, if your property has poor drainage or your house is located at the bottom of a hill.
• They will also pay for the replacement cost to rebuild a secondary home and for personal property (the NFIP pays only the replacement cost of a primary residence and the depreciated value for personal property). They may even pay for detached structures and additional living expenses.

NFIP and private flood policies usually cap coverage at $250,000 for the house and $100,000 for personal property.⁵ Whatever type of primary flood insurance you have, if you have a high-value home, you may find that the maximums of your policy aren’t sufficient to meet your needs.

In this case, adding excess flood insurance to your primary insurance is worth considering. An excess flood policy sits on top of your primary flood policy, and it begins to pay when the dwelling or personal property limits are reached on that policy, and it can pay up to the actual cost to replace your dwelling and personal property. Some excess flood policies will broaden coverage, such as paying for the replacement cost of second homes and personal property or for additional living expenses.

Premiums vary depending upon the flood risk and from provider to provider, but these policies can be expensive, so it’s important to set your coverage amounts correctly to avoid paying for too much coverage. At Bessemer, we employ sophisticated storm surge modeling that compares storm surge data to the elevation and appraised value for each part of the house to right size policies and control costs.

Adding valuable articles insurance to protect your fine art or antiques from flood or wind damage can also be helpful in reducing costs. These policies can be reasonably priced, usually don’t include any hurricane or other deductible, and can pay the full value for any art or antiques. (NFIP primary flood policies, for instance, will only pay up to $2,500 for fine art and the functional value of antiques).

How Bessemer Can Help

If you live in an area at high risk of extreme weather events, your homeowners policy is increasingly likely to offer less coverage and cost more than it has in the past. You may even find that your carrier drops your coverage entirely. As the effects of climate change on our environment are expected to worsen in coming years, and traditionally low-risk areas come to be considered high risk, these trends aren’t likely to end any time soon.

Solutions may be available, but the complexities of structuring an insurance program that meets homeowners’ needs when they live in a high-risk area are many: understanding the large print and the fine print in policies; finding the most suitable policy or combination of policies; balancing coverage needs with generally higher premiums, higher deductibles, and lower payout caps of high-risk coverage; and more.

Bessemer’s experienced insurance advisors can help you uncover and evaluate the available options, minimize the chances for unpleasant surprises, and help ensure that you assemble an insurance program that meets your coverage needs.

If you’re interested in discussing these issues in the context of your own insurance needs, please reach out to your client advisor.