Homeowners’ insurance markets are undergoing significant transformations, presenting challenges for both insurers and consumers. Average premiums across the country have surged by over 30% between 2020 and 2023 (13% adjusted for inflation), according to available data. Some insurance companies have withdrawn from certain areas, and more homeowners are turning to ‘last resort’ insurance plans – designed as temporary solutions – because they can’t find coverage in the private market. The number of policyholders in these last-resort plans doubled in Florida, California, and Louisiana from 2018 to 2023, with Florida’s last-resort insurer becoming one of the largest homeowner insurers in the state in 2023.
These developments warrant serious attention, and concern. Homeowners’ insurance is generally a prerequisite for a mortgage, obligating most American homeowners to maintain coverage throughout their loan terms. As premiums increase, homeowners face no choice but to pay these higher costs. Rising premiums and limited availability of insurance can trigger ripple effects throughout the housing market, potentially decreasing demand and depressing home values, particularly in high-risk areas. Given the wide-reaching impacts of an unstable property insurance market, there’s a sense of urgency to develop a policy response. There is also public pressure to implement policies that ensure insurance remains affordable and accessible for everyone.
However, artificially suppressing property insurance costs in risk-exposed areas would leave property and financial markets increasingly vulnerable to climate-related risks. This explainer delves into the reasons behind escalating homeowners’ insurance premiums, the role of climate change, and potential policy solutions.
What’s Driving the Increase in Homeowners’ Insurance Premiums?
The primary drivers of rising home insurance premiums are increasing associated costs for insurers. The costs of construction materials and labor have increased in recent years, alongside interest rates. The Insurance Information Institute, a trade organization of insurance companies, estimates that cumulative replacement costs for home repair increased 55% between 2020 and 2022, significantly outpacing the general rate of inflation over this time period. These cost increases are being passed through to homeowners in the form of higher premiums.
Climate change is also a major factor, putting upward pressure on insurance premiums through several avenues. First, insured losses, and therefore insurance claims, resulting from climate-related disasters are increasing. This is partly due to significant increases in building and development in high-risk areas and the increasing frequency and intensity of natural disasters as the climate shifts. Wind and hail, water damage and freezing, and fire and lightning have long been leading causes of property damage – which helps to explain why Florida, Louisiana, Oklahoma, and Texas consistently have the highest homeowner’s insurance premiums, according to the Insurance Information Institute. The rise in wildfire losses in Western states has also started to put pressure on insurance premiums.
Second, more frequent and more damaging catastrophic weather events are becoming more common, because of climate change. Insurers must increase their capital reserves and or purchase more reinsurance to ensure they can pay out claims in these worst-case scenarios and safeguard their solvency. These strategies for managing risk increase insurers’ costs and, consequently, the insurance premiums they charge.
Third, as the damage caused by extreme weather events becomes more pronounced, insurers are actively investing in enhanced climate risk modeling. The risk of damage from hurricanes or wildfires is more challenging to assess compared to other insurable risks, such as health outcomes or car accidents. Insurance companies use historical data to assess and manage risks, but the rarity of these catastrophic events means there is limited historical data available to support traditional actuarial analysis. Moreover, a shifting climate can lead to historical data underestimating future climate risk exposure. Catastrophe models, which simulate plausible catastrophic event scenarios, are evolving the way insurance companies assess and price natural disaster risks. If insurers discover through more sophisticated risk modeling that they have been underestimating climate risk exposure, this will cause them to increase prices.
Finally, newly developed risk modeling tools can support more granular pricing of climate risk, aligning customer premiums more closely with a more precise assessment of their individual risk. This more customized pricing will imply higher premiums for those homeowners who were previously pooled with low-risk homes at a lower price.
Climate Change and Insurance Market Regulation
Homeowners insurance is regulated at the state level in the United States. While regulatory regimes vary across different states, all are guided by the objectives of rate adequacy (insurers should charge prices high enough to remain solvent) and fairness (prices should not generate exorbitant profits). Insurance affordability, availability, and rate transparency are other regulatory imperatives guiding regulations in many states. In pursuit of these objectives, state regulators have adopted various methods of regulating insurance rates. In “prior approval” states, regulators review insurance prices before they are offered in the market. Other states rely on market forces, with some regulatory oversight, to keep insurance rates in line with costs. Regulations designed to limit insurance price increases can have unintended consequences on insurance market outcomes. Limiting insurers’ ability to charge prices commensurate with costs can reduce insurers’ willingness to write policies in high-cost areas, which is intuitive. As costs increase, regulators face difficulties in balancing competing policy objectives of insurer solvency, availability of insurance, and fair insurance pricing.
Looking Ahead: Policy Interventions
As private insurers retreat from high-risk areas, the temptation may be to have state and federal insurance entities assume more of the climate risks going forward. However, greater reliance on publicly funded climate risk insurance doesn’t address the fundamental issues destabilizing private property insurance markets. Public insurers would encounter many of the same challenges as the private market in terms of managing rising costs and increasing climate risk exposure, plus the added complexity of political pressure to maintain artificially low premiums. Subsidizing insurance in high-risk areas would burden households in less risky areas and diminish the price signals potential homebuyers should receive about the true cost of living in areas exposed to harm.
Instead, state regulators can take initiative and encourage private insurers to write policies in high-risk areas. This includes programs that provide insurers with access to more sophisticated catastrophe modeling tools and re-insurance. Technologies, such as virtual home inspection tools and fire safety certification programs, could give insurers opportunities to offer premium discounts for more resilient properties and lower monitoring and verification costs.
Beyond insurance price regulation, federal and state governments can implement policies to promote investments that reduce risk more effectively. There’s mounting evidence that investments like wind-resistant roofing, fire-resistant siding, hail-resistant shingles, and more can reduce losses at a reasonable cost during extreme weather events. Adoption of effective risk mitigation investments could help limit increases in insurance premiums by decreasing vulnerability to climate catastrophes. Carefully designed building code mandates, like California’s wildfire building codes or Florida’s hurricane wind codes, have been effective in lowering premiums for homes built more recently.
While regulatory reforms, risk modeling innovations, and building codes are promising in their own respect, it is a fact that property insurance premiums will need to increase in high hazard areas to reflect climate risk exposure. Property insurance markets are crucial in providing financial assistance to households and their communities when disaster strikes. To fulfill this role, insurance prices must increase to adequately reflect the real and rising costs of climate change.
