Will mortgages be underwater before houses are?
When he testified to Congress last month, the Chairman of the Federal Reserve, Jerome Powell, stated, “...climate change poses risks over the long term.” The reference to the “long-term” was surprising in light of the present insurance crisis plaguing many people across the US. Climate change could affect the economy sooner than the Fed expects.
Drastic increases in home insurance premiums is a problem of the present, not the future, and climate-fueled extreme weather is one of the culprits. Higher insurance costs create an impending threat of runaway inflation, collapsing home prices, and financial failures.
Floridians are on the frontlines of this insurance crisis. The average home insurance premium on a $300,000 house in the state of Florida is $5,770 - but even that high rate underestimates the true cost and the recent inflation of property insurance. As insurers have exited the market, many homeowners have lost their private insurance coverage, and had to buy subsidized policies through Citizens Property Insurance Corp., Florida’s state-run insurer for the uninsurable.
Citizen’s below-market rates hide the true cost, typical for such government schemes. Even Governor DeSantis acknowledges that Citizens could blow up in the event of a disaster. The likely bailout is expected to include a special assessment imposed on both Citizen’s and private insurance clients. Being the backup insurer for the subsidized is not what those policyholders had in mind when they bought their policies. Nonetheless, these policy holders may have to pay for the bailout exactly when they themselves have to repair weather-related damage to their homes. A de facto retroactive price adjustment for private insurance policies is needed to account for the hidden cost of being given the role of a reinsurer.
Additionally, insurance companies increasingly require mitigation policies, such as roof upgrades, that are often enforced by drones and effectively raise the price of insurance. New regulations to protect insurance companies from litigation lower expected claims payouts. While these regulations hopefully limit fraud, collateral damage will reduce legitimate claims. Taken together, inflation in insurance premiums—when properly adjusted for quality—is even higher than reported in the media.
Home insurance costs do not factor into the calculation of CPI, therefore the impact of climate change on inflation is excluded from the measure. If home insurance costs were included, the CPI would be higher than what the BLS reports. This exclusion is particularly strange since home insurance is required by mortgage lenders—and thus is an unavoidable cost.
Climate-related impacts are not limited to home insurance. Car insurance premiums have also soared. Moreover, policyholders are also likely to incur higher uninsured losses, in addition to insured losses. Policyholders have reacted to higher premiums by upping their deductibles and declining to submit claims for the fear of being dropped. Lower-quality insurance policies increase the affordability of home insurance, but could impact the ability to repair or rebuild if disaster strikes. Another way to lower premiums is to forgo flood insurance—87% of Florida homeowners do not have flood coverage. However, that also limits their ability to repair or rebuild in the case of an event such as a hurricane or tropical storm.
The median household income in Florida is around $65,000. Combined with the average $5,770 price tag on a $300,000 coverage, 9% of Floridians income could go to home insurance. Insurance prices in Florida have increased between 30% and 40% in each of the past few years. A dire, but plausible, scenario is that premiums continue increasing at a similar rate due to climate-driven factors. This is likely to happen—at least next year—if the current hurricane season predictions of 170% above-average activity prove accurate.
If wages increase at the Fed’s 2% inflation target, a 30% annual increase in the insurance cost would mean that home insurance will consume 11% of the average household income in 2025; this could increase to 14% in 2026, and all the way up to 38% by 2030. At this rate, home ownership will soon become unaffordable for many, with many homeowners racing for the exits before a plunge in value. Dip buyers would not step in to save the market because savvy individuals and corporations will crunch the numbers and stay away.
The Fed should keep a close watch on home insurance costs. Insurance inflation needs to come down, or the American Dream could become only a memory.
Joel Lander is the co-founder and head of strategy at Tatari.
Anna Scherbina is a Nonresident Senior Fellow at the American Enterprise Institute.
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