As California recovers from its most recent and bruising round of extreme weather, which saw plunging temperatures and snow followed by flash flooding and landslides throughout the state, its residents must contend with another chilling reality.
Home insurance companies are scaling back the coverage they offer residents, leaving many facing the prospect of taking more expensive insurance - known as the insurer of last resort.
Years of worsening wildfires, flooding and drought have dulled the Golden State’s image as a place for insurers to make a buck. In California, private insurers have threatened to leave and various reports have noted that some have left.
It’s the same in other disaster-prone states, including Hurricane-ravaged Louisiana and Florida.
“The insurance companies have had to basically recalibrate their economic models, realizing that hurricanes and other disasters they cover are worse than expected,” said David Marlett, the Managing Director of the Brantley Risk & Insurance Center at Appalachian State University in Boone, North Carolina. “The risk is too high and the reward too little.”
In just the last three months alone, California has gone from severe drought to flash floods and record-breaking snow. Just before Christmas, the atmospheric rivers that hit the state dropped 32 trillion gallons in three weeks. It was welcome and replenished many of the state’s desperately low reservoirs.
However, an environmental anomaly conspired against residents to create epic flash floods and mudslides that swept away people, cars and homes. Severe drought causes the ground to become hydrophobic, which means that rather than absorbing water, it repels it. In addition, wildfires kill trees and their roots, meaning the soil is looser. Under the right conditions, the loose ground can become a mudslide.
The dry conditions have also caused record-breaking wildfire seasons. Over 4 million acres burned, with the loss of around 11,000 buildings in 2020. In addition, the average number of large U.S. wildfires has risen by 30% over the past 15 years and by nearly a fifth in just the last five, according to Lloyd’s of London insurer Chaucer.
Florida and Louisiana experienced a majority of the record-breaking storm season in 2020. There were 30 named storms, including 12 that made landfall.
Hurricane Laura caused $16 billion in damage, while Hurricane Delta caused $4 billion. The warming climate means that hurricanes are generally becoming stronger and more frequent. And erosion on Louisiana’s coastline, which has lost over 2000 square miles of land since 1932, means hurricanes are able to supercharge in the warm shallow waters and inch closer to large cities like New Orleans and Baton Rouge.
Boom or bust
Part of the reason insurance companies are leaving, according to Marlett, is that in heavily regulated states like Florida and California, the insurance companies need approval before raising rates. That creates a political complications in states where insurance commissioners are elected and appointed.
“There’s a lot of pressure to keep rates low and affordable,” he said.
In some cases, the rates are low to stop the insurance companies from earning excessive profits from constituents. But when the economic pendulum swings the other way, insurance companies plead that they can’t stay in the state if the rates don’t increase.
“It creates a game of chicken,” said Marlett. “The regulators don’t want to increase rates to create profit, but they also don’t want to chase insurers out of the state or see them go insolvent. It’s whoever blinks first.”
But in many cases, regulators haven’t blinked at all.
Michael Soller, deputy commissioner of media and communications in California’s northern branch of the department of insurance, said in an email to Reckon that there was “no change in the number of insurance companies writing residential and commercial coverage between 2019 and 2022.”
He added that the changes in coverage offered by Chubb and AIG “affected a very small number of California’s 8.7 million insured policyholders” and that his department’s experts “look at the data, not insurance companies’ false narratives, to make sure consumers get the best value and don’t pay more they have to.”
Across the country, small insurers have filed for bankruptcy after being unable to pay out insurance claims in the millions and often billions in the aftermath of major natural disasters. Larger insurers that have weathered the bankruptcy storm have pulled out or dropped policyholders.
Over the last two years, 20 insurance companies have left Louisiana or filed for bankruptcy.
That leaves fewer choices for homeowners and, in a riskier environment, means there’s a higher likelihood of rejection from the remaining private insurers.
Residents are then faced with the option of taking state-sanctioned home insurance, which is the insurance of last resort and is legally required to be more expensive than private insurance.
If they don’t take that, then things get complicated. If the person has a mortgage on their home, the lender will likely take out insurance on their behalf, which is known as forced-place insurance. That can be double or triple the cost of private insurance and is added to the mortgage.
“Those people are mostly made up of working poor, as they’re often described,” said Jim Donelon, Commissioner of the Lousiana Department of Insurance. “Those with less resources have to go to the most expensive places to get their coverage. I do think we’ll see thousands of people lose their homes over this.”
Donelon said that he reluctantly approved a 63% rate hike last year on the state-sanctioned insurance, knowns as Citizens. In response, he visited the Bahamas to woo back private insurance companies to the state.
It’s the same for nine companies in Florida, resulting in the loss of coverage for hundreds of thousands of policyholders. Florida only accounts for 9% of the home insurance market but 79% of litigation against insurers, according to Bankrate. Many of the lawsuits are fraudulent and partly why insurers have gone cold on the sunshine state.
That has meant that Florida insurance companies have seen two consecutive years of $1 billion in losses.
In California, insurers such as Chubb, Liberty Mutual and AIG are changing the coverage they offer residents as climate change creates greater risk.
That loss has created a problematic situation for insurance regulators in the golden state. When insurance companies flee the market, residents are often forced to turn to a more expensive option: homeowners’ insurance of last resort. And those policies can be expensive and don’t cover all eventualities.
California’s Fair Plan, for example, only covers fires. That was created after riots and particularly bad brush fires in the 1960s. It’s the insurer of last resort, but increasingly more residents have to rely on it as traditional insurers bail.
The state’s FAIR Plan covers less than 3% of the state’s homeowners. It was far less before insurers increased non-renewal notices in 2019. FAIR Plan policies increased from 140,447 in 2018 to 241,466 in 2020, according to the latest data available from the California Department of Insurance.
Florida has a similar system created after Hurricane Andrew caused $26.5 billion worth of damage in 1992. It bankrupted 11 private insurance companies.
Getting covered for the most likely eventualities can often result in a patchwork quilt of policies.
But flood insurance is rarely offered by insurance companies. In short, floods are too expensive to insure and would result in incredibly high premiums.
Feds to the rescue
However, flood insurance can be obtained from the federal government if the homeowner lives within one of the 23,000 communities participating in the National Flood Insurance Program. The federal government has a reasonably low bar regarding flood risk.
Any place with a 1% chance or higher chance of experiencing a flood each year is considered to have an increased risk. Those areas have at least a one-in-four chance of flooding during a 30-year mortgage.
The federal government recently changed the program to be more equitable.
The new program, known as Risk Rating 2.0, addresses rating disparities by incorporating more flood risk variables like flood frequency, multiple flood types — river overflow, storm surge, coastal erosion, and heavy rainfall — and distance to a water source, as well as property characteristics such as elevation and the cost to rebuild, according to FEMA.
The basic idea is that NFIP will be cheaper for low-income people and more expensive for better-off people. The cost savings for low-income people will also open the door to people who have perhaps been priced out of the flood insurance market in the past.
The other hope for the federal government is that the program can balance the books. Since Hurricane Katrina hit the Gulf of Mexico in 2005, the program has accumulated over $20 billion in debt. The interest on that debt in 2022 alone was $280 million.
But there are other reasons why insurance companies don’t offer flooding insurance and have fled certain states.
Insurance companies have complicated economic models that are influenced by events worldwide. For example, once-in-a-century floods in Australia or Germany will increase insurance costs for homeowners in the United States. That’s not because State Farm and other insurance companies operate in those countries; it’s because of a thing called reinsurance.
It’s like insurance for insurance companies. Those organizations are primarily based in Europe or Bermuda but operate worldwide.
Insurance companies in the U.S. can counteract the increased risk of natural disasters in the U.S. by getting a good deal from the reinsurers. However, as climate change creates a greater risk of natural disasters worldwide, those good deals are harder to come by.
“They are basically getting squeezed from both sides,” said Marlett of U.S.-based insurance companies.
State regulators are hesitant to let insurers raise rates, while reinsurance firms are raising their rates to account for the greater risk globally.
And it’s that greater risk that will continue to complicate insurance for homeowners. If climate change continues to cause unpredictable and destructive weather patterns, something fundamental has to change. What that change will be is still up for debate.
“State and local governments are already taking steps to discourage people from living in vulnerable areas,” said Donelon. “But we have demonstrated repeatedly that if you build high enough and strong enough, then homes can withstand tidal surges associated with hurricanes as Katrina brought to my state. Risk can be mitigated if we are willing to be more resilient.”