Insurers didn’t learn from the financial crisis

BY MARK GONGLOFF "You might not believe in climate change, but your insurance company does" is a common joke about climate change. Because obviously the companies that pay claims after weather disasters are well aware the planet has grown hotter and more chaotic. Sadly, knowledge isn’t the same thing as wisdom.

In the past few weeks, a chorus of industry insiders has gathered to warn that insurers can be just as myopic about the long-term consequences of global heating as the most oblivious denier. For short-term profits, insurance companies are sacrificing the future well-being of their customers, the planet and ultimately themselves, these whistleblowers warn, with behavior echoing that of mortgage lenders before the 2008 financial crisis. Though this won’t simultaneously set all of the money on fire again, the repercussions can still be dire.

"This may be a successful short-term financial play for insurers, but it’s not sustainable," former California Insurance Commissioner Dave Jones told me. "For the real economy and the financial sector, it’s a disaster."

The chorus warmed up on Oct. 14, when a risk assessor for a "major insurer" wrote an anonymous op-ed for the Guardian that said, "I am coming under pressure to cut my forecasts for the losses that disasters will cause in order to make insurance more affordable — and get my employer more business." The writer added, "If this is happening at my firm, which is struggling to compete with rivals’ prices, it’s happening elsewhere."

That same day, dozens of high-level insurance executives from Europe and the UK warned in a report published by the nonprofit group Inside Track that "natural catastrophe modelers and actuaries are being asked to give a ‘haircut’ to future projections or ‘manage down the numbers’ in order to avoid causing alarm and to keep getting deals done."

They told of insurers taking an all-or-nothing approach to climate risks, ignoring them when convenient to attract business but using them as an excuse to raise premiums or retreat from markets when the losses start to bite. In the process, they’re leaving customers, investors and governments ill-informed about and ill-prepared for those risks. They’re also widening the gap between insurance coverage and the catastrophic damage to come.

Then, last week, the Financial Times interviewed five insurance insiders who confirmed these warnings, saying they’re often forced to fudge numbers in their models to keep premiums low. "There are some people who think the models are silly," an unidentified "senior professional" at "top-five" insurance broker told the paper, and potential disasters are "not going to happen." "It’s a one-in-250-year event, so let’s get the deal done. Let’s hit the short-term targets."

If this sounds a bit like the "fog a mirror, get a mortgage" days of the housing bubble, when chronic short-termism set the world up for a brutal crash followed by nearly a decade of economic misery, well, there’s good reason.

"Without intervention these physical risks will translate into major economic risk," the Inside Track authors wrote. "The undermining of the mortgage market drove the Global Financial Crisis — we are worried a major increase in uninsured, high-risk properties could manifest in a similar way as climate impacts intensify."

These insiders were mostly describing conditions in Europe and the UK, but there’s no reason to doubt the issue is global, Kenneth Klein, a professor at California Western School of Law who has studied insurer behavior for many years, told me. "Nobody is adjusting their coverage predictions up. Everyone of them is doing the same thing."

One dangerous result of this behavior is that millions of homes across the US lack adequate insurance against potential climate disasters. Investor Dave Burt, who made his reputation during the mortgage crisis, has estimated the insurance gap for wildfires and floods alone could be as wide as $2.7 trillion. That doesn’t include potential losses from severe convective storms, aka thunderstorms, which climate change has put on steroids, making them the biggest source of insured losses in the country for the past three years, according to the Insurance Information Institute.

In a recent paper in the Lewis & Clark Law Review, Klein crunched California wildfire-loss data and found that 78% of homes in the state could be underinsured in the event of a disaster, by an average of 25% of the home’s replacement cost. Somebody trying to rebuild an $800,000 California home with insurance money could well find themselves $200,000 in the hole, in other words.

Klein also found that insurer models and behavior were the primary drivers of this underinsurance. And if it’s happening in California, then it’s happening everywhere. Indeed, Klein’s previous research has suggested 80% of American homes may be underinsured. That percentage of a $55 trillion housing market gives you crisis-level potential.

The good news for financial markets is that not all of these homeowners will recognize their insurance shortfall at once. This unpleasant discovery usually comes in relatively small batches around catastrophes such as wildfires and hurricanes. That’s when homeowners find out their insurance won’t cover the full replacement cost of their house, leaving them either homeless or on the hook for the rest.

This typically works out pretty great for insurance companies, which enjoy a 40% acceptance rate for lowball estimates, according to a 2023 Philadelphia Federal Reserve study of California wildfires. It’s not so great for the lowballed homeowners, who ended up $200,000 to $300,000 short of the value of their homes. It’s also not great for mortgage lenders, who saw 4% higher delinquencies and 16% higher mortgage prepayments (costing them future interest income) on fire-damaged properties, according to the study.

Homeowners who sue insurers usually settle for less than they demand. And the relative few who go to trial won’t always win in courts, which tend to hold them responsible for not having enough coverage. Meanwhile, insurers and sympathetic politicians in Florida and elsewhere keep trying to make it harder for homeowners to sue.

At the other extreme, even as they’re allegedly lowballing catastrophe models, insurers are also jacking up premiums across the country, straining housing affordability, particularly in riskier locales, or abandoning those places altogether. These two seemingly contradictory behaviors can coexist partly because insurance contracts last only a year. Insurers are under political and business pressure to quash premiums and keep customers renewing as long as possible, but in any given year they can decide the risk has become too great and play the disaster card. Again, homeowners and governments pay the ultimate price in a classic example of privatizing profits and socializing losses, another housing-bubble echo.

In fact, despite rising disaster costs, the insurance industry has consistently managed to rack up big profits. Even when underwriting losses have bitten hard in some years, investment returns have still more than offset them, boosting net income to record levels. US property and casualty insurers alone netted $111.6 billion from investments last year, according to National Association of Insurance Commissioners data.

Some of those investments include the very fossil-fuel companies that are primarily responsible for the climate change destroying insured properties at a quickening pace. Dumping these investments, along with any business underwriting oil and gas extraction, would be a good start toward fixing the growing insurance crisis. Instead of writing amicus briefs to the Supreme Court defending Big Oil against climate lawsuits, insurers should be suing those companies to recoup disaster losses.

Insurers would also help themselves, homeowners and the economy by investing in hardening homes against disasters. North Carolina’s insurer of last resort sets a good example by dedicating some of its earnings to fortifying roofs, Jones noted. Meanwhile, the problem of insurers’ black-box models being fudged wouldn’t be a problem if those models were public, something California has started trying to make happen.

The underinsurance problem could be addressed by mandating extended-coverage options, as Colorado has done recently. And, in a hypothetical future world where the US government believes in and cares about rising climate damage, Fannie Mae and Freddie Mac could refuse to back mortgages on properties that didn’t have enough coverage.

The hard truth is that, in many places, insurance will just keep getting more expensive the hotter the planet gets. Even some industry executives have warned that the traditional framework of for-profit insurance companies mitigating climate risks may no longer be fit for purpose. Replacing it won’t be easy or cheap. But there’s wisdom in trading short-term pain for long-term gain.

Mark Gongloff is a Bloomberg Opinion editor and columnist covering climate change. He previously worked for Fortune.com, the Huffington Post and the Wall Street Journal. The opinions expressed by columnists do not necessarily reflect the view of Vermont News & Media.

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