Hurricane season a perfect storm for insurers

That's because a mixture of climate, macroeconomic and political factors have besieged this corner of the financial sector in recent years, transforming it beyond anything seen in recent memory. Expenditures are likely to rise drastically and price many out of the market altogether.

Property owners in the US are already seeing annual rate increases of 17%, according to insurer Beazley Plc. For insurers that have been exposed to natural catastrophes, the jump in the cost of covering their own exposures is as much as 50%, climbing to 75% in Australia, says reinsurer Gallagher Re.

There could be worse to come: The prices US insurers paid to reinsurers in July rose at the fastest rate since the aftermath of Hurricane Katrina in 2006, risk specialist Guy Carpenter & Co. said recently. Even those who'd escaped catastrophic disasters were having to pay 20% to 50% more than a year ago, the study found. Those costs rapidly get passed on to policyholders. In the US, the increases are so savage that some homeowners are giving up on insurance altogether, the Wall Street Journal reported this week. Less than one in five Floridians have flood protection.

To understand what's happening, it's important first to take a look at how the industry works. Insurers don't expect to be able to pay out all their claims from the cash value of the premiums they get from customers. Instead, they use their income to buy bonds and other securities, and depend on their investment returns to cover losses. A slice of their income also goes to buy their own insurance policies with reinsurers - global businesses with the enormous balance sheets necessary to spread the risk from major disasters such as cyclones and earthquakes.

Climate change throws this model into disarray. Insurers build their policies on models of urbanization and economic growth, hazard frequency and severity that traditionally grew at a fairly fixed rate - but the effects of global warming are accelerating, making it harder to price risk. The Actuaries Climate Index, which has been tracking the frequency of extreme weather in North America since the early 1960s, has showed a marked rising trend for more than 30 years. First-half economic losses from natural disasters this year were running 46% above the 10-year average, according to Swiss Re AG.

Macroeconomics compounds the problem. The one force that insurers fear even more than climate change is inflation, which erodes returns on their portfolios and cuts the value of the reserve buffers they've built up to cover payouts. During the disinflation and bond bull market of the 2010s, insurers made good money on their investments. Meanwhile, yield-hungry pension and hedge funds looking for alternative investments lifted their exposure to the industry, providing yet more capital. As a result, insurance companies could afford to be lenient in the pricing and exclusions they were offering to their customers.

With the recent climb in inflation and interest rates, that's flipped dramatically - causing what industry insiders call "hardening," and policyholders "daylight robbery." When you're hit with a premium increase in the double digits, you're unlikely to give your insurer credit for all the single-digit growth you had in prior years. If you find that a policy taken out five years ago is insufficient to cover losses now, you're likely to be apoplectic. That's the macroeconomic world we're all living in, though.

It would be good if politicians were coming up with smart policies to minimize these issues, both by reducing carbon emissions and managing the process of adaptation that vulnerable communities will need to go through.

Unfortunately, that's not happening.

Indeed, one of the main legislative drives in the US - championed by Republican primary candidates Ron DeSantis and Vivek Ramaswamy - has been to build roadblocks to prevent the financial sector considering ESG factors in their businesses.

For insurers, this move could be fatal.

You can't legislate away the risks that a warming climate will cause to vulnerable property. If insurers are forbidden by law from considering those risks - as bills passed in Texas and under consideration in South Carolina require - then they may have no option but to withdraw coverage altogether, or at least price it out of reach of most households.

Scientists and economists have warned for years that the long-term costs of climate change vastly exceed what we'll spend in the short term to prevent it. For the most part, the world has ignored those prognostications. The business of insurance, however, is to crystallize such long-term risks and reflect them in the premiums we pay in the here-and-now. At the moment, they're turning the warnings of academics into hard monetary costs that every household will pay.

Those balking at double-digit increases in their coverage costs should get used to it. As the effects of climate change spread, this inflationary trend is just getting started.

David Fickling is a Bloomberg Opinion columnist covering energy and commodities. This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.