On today's episode of the 5 Things podcast: Historic fires and floods are wreaking havoc in insurance markets

In the course of just one month, deadly wildfires in Hawaii and an historic hurricane in Florida caused billions of dollars of damage, bringing an awareness of insurance risks to the forefront of homeowners’ concerns. As insurers reassess their risk exposure due to worsening climate events, some are choosing to leave certain markets altogether, making insurance affordability a very serious issue. What’s the solution? Ed Richards, a law professor at Louisiana State University who specializes in Administrative Law, joins 5 Things to discuss how the federal and commercial insurance industries are evolving to adapt to new risks.

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Hit play on the player above to hear the podcast and follow along with the transcript below. This transcript was automatically generated, and then edited for clarity in its current form. There may be some differences between the audio and the text.

Dana Taylor:

Hello, and welcome to 5 Things. I'm Dana Taylor. Today is Sunday, September 10th, 2023.

The historic and deadly wildfires in Hawaii have brought an awareness of insurance risks to the forefront of homeowners' concerns. Maui's risk had previously been deemed low and that it kept premiums imminently affordable. Now, not so much. The flood insurance industry faces a similar set of problems as risks in coastal states continues to skyrocket. Affordability is now a very serious issue, and without fire or flood insurance, the real estate market would be paralyzed. What's the solution? I'm joined by Ed Richards, a law professor at Louisiana State University who specializes in administrative law, which covers both the federal and commercial insurance industry.

Ed, thanks for joining me.

Ed Richards:

Pleasure to be here.

Dana Taylor:

So I want to start with the fires in Maui and how the insurance industry is responding there. To date, damages are estimated to be over $3 billion and still rising. Homeowners in Lahaina are saying they want to rebuild. How are insurers responding and will there be money for people to do that?

Ed Richards:

Well, the insurers will need to pay the claims on the policies that are in existence. And the real problem with these is after this disaster is paid off, will they want to stay in the market? Will they withdraw? Will rates go up dramatically? What we've seen in other areas is that the insurers sort of lag the risk. It takes one big disaster, and then they realize their exposure and suddenly rates go up. We've seen that with California wildfires. We've seen that with hurricanes in the Gulf and Atlantic coasts. So they'll pay to this year's policies.

Now, a hard question will be whether, with the inflated cost of rebuilding after a storm, whether people will get enough money to rebuild. But then they'll face the perhaps explosive cost of insurance, or what is happening in Florida; and other markets, the insurers will leave the market and leave the problem to the state.

Dana Taylor:

Reassessing the fire risk In a place like Maui, is that going to be key to shoring up the industry? How easy or complicated will that be?

Ed Richards:

Well, the insurance industry is pretty much all state regulated, particularly the property owners' insurance for fire and casualty. Flood insurance is a different question. That's a federal program. The question is always the balance between how high the state regulators will allow the rates to go, and whether the insurance industry believes that's high enough to cover the risk.

It's a constant tension. Rate regulators are under enormous political pressure to keep rates low, and in the states where we've seen a lot of loss of coverage, Louisiana, Florida, some others, the problem of course is that the Rate Commission doesn't want to allow the companies to charge a high enough rate, they leave the state. At the right price, there's certainly insurance available.

Dana Taylor:

So that really is the affordability question, the big question. Will homeowners be able to afford these higher premiums?

Ed Richards:

Absolutely. The cost of rebuilding will be high. We've had some inflation. Whenever you have a mass disaster, you have a small number of craftsmen available to rebuild. Everyone's competing for them. Hawaii is extremely expensive to move building materials into, and you'll quickly deplete the on-island supplies. So it's going to be very expensive to rebuild. It may exceed the policies. When the insurers come back in, they're going to see the houses as worth a lot more than perhaps the residents thought at the time. They'll be correcting for the fire risk, but also for the increased value of the property.

Dana Taylor:

Some storms in both California and Florida resulted in multiple flood warnings from the National Weather Service. Louisiana, as you mentioned, another state that faces increasing risks of flooding. Those insurance markets are in crisis now, with skyrocketing rates. So let's start with the commercial insurance industry along those coasts. How are insurers dealing with the increased risks?

Ed Richards:

Well, you have to separate out the damage from hurricane winds, from the flood damage. There's effectively very little commercial insurance for flood, and almost none for homeowners. It's theoretically available, but it's usually priced at a very high cost compared to the federally subsidized National Flood Insurance Program.

Historically, the National Flood Insurance Program has not collected enough money to even run the program. Whenever they have a big loss, like after a hurricane, Congress has to put money into the program and then forgive the debt of the Flood Insurance Program for paying that money back. Suddenly we're having a huge affordability crisis for homeowners who have been receiving insurance that might cost 10% or less what they'd have to pay to a commercial carrier.

Dana Taylor:

So that's the National Flood Insurance Plan or the NFIP. How has that changed over the last couple of years, and how is this different than fire insurance?

Ed Richards:

The National Flood Insurance Program was started by the federal government in the late '60s. Its original intent was to sort of be a deal with the states and the localities. If they would stop building new homes in high risk flood areas, the government would provide subsidized insurance for the houses that were already there. The problem is that, of course, the feds provided the subsidization, but the states never stopped building high risk properties.

And so over the years, the program has expanded, and has been providing subsidized insurance for homeowners in river valleys, homeowners subject to flash flooding in the West, and particularly homeowners along the Atlantic and Gulf coasts. Congress has told the Flood Insurance Program that it wants it to charge fair rates, so it doesn't have to prop it up. But at the same time, Congress also doesn't want them to charge rates that cause their constituents to yell at the congressman.

The Flood Insurance Program is on a temporary renewal. That renewal expires in September, and then we'll go through the cycle where Congress will again try to decide does it want to subsidize the rates and put money into the program? Does it want the program to operate like a business? What about all the poor and middle income people that depend on the subsidy?

So it's two and a half years ago, the National Flood started increasing rates as if they were a private company. Now the rates are capped at 18% a year increase. So what a homeowner might get is a bill saying, "Your rate is up 18%. Maybe your rate was a thousand dollars a year. It's now gone up to $1200, but we're going to keep raising it at 18%, and maybe it'll ultimately be $8,000 a year." For a wealthy property owner, that's just a fair cost for insurance. For a middle or lower income homeowner, that may be a large percentage of their mortgage price, and they may actually have to sell their homes. Or if they're not required to have flood insurance, they will drop their policies.

Congress has to wrestle with, if it wants the company to charge fair rates, maybe it needs to provide a subsidy program for low income homeowners or base rates on an income factor, the way they did with parts of Medicare.

Dana Taylor:

The national plan called Risk 2.0 has been rolling out, as you mentioned, for many months now. But a few states, in fact, nine states, recently filed a motion to roll back these changes. Why was that?

Ed Richards:

Well, because politicians never want to have their constituents have to pay money for anything. The Attorney General of Louisiana is leading this charge, and he's fought every regulation of the federal government. Their argument is, "Gee, we've always had rates and we rely on them, and you can't raise them." Legally, that's not a very strong argument. If they were actually successful, what they might in fact end up doing is stopping the feds from writing any flood insurance at all, which would be a very paradoxical result.

Dana Taylor:

Well, how has the Biden administration responded?

Ed Richards:

Their lawyers have filed a good response explaining that there's really no legal basis for this injunction. They've explained how the Risk 2.0 works, the extensive conversations they've had with state and local officials as they've shaped the rate structure. So they've built a strong legal and factual case. Now, you never know what will happen these days, but I don't think this has much of a chance of going forward.

Dana Taylor:

So what's been the impact of Risk 2.0 on the real estate and mortgage industries in places like Florida?

Ed Richards:

It's just beginning to be felt, because when you're selling existing housing, if the policy has been in effect, it can transfer to the new owner. So the new owner would inherit the older rate, which might eventually go up significantly, but it'll only go up 18% a year.

If it's a new construction, they'd pay the new rate immediately. If you look at the general U.S. housing market, there's not a lot of new construction. It's a real problem for new construction, but as long as we're transferring policies, it sort of takes a while for the market to incorporate that information.

And then areas like Florida, after the hurricanes, one of the great ironies is that people who watch these areas being flooded and they just feel like they have to go down and buy a home there. So there's in fact, investors delighted to come in and buy up those properties.

Dana Taylor:

So can you talk a little bit about the reinsurance industry? What are reinsurers and what's happening with them?

Ed Richards:

Well, insurance companies can't really predict these big risks like a hurricane or an unprecedented wildfire in Maui. So they maintain enough investment money to pay the sort of ordinary, predictable claims. A few house fires in a neighborhood, some break-ins, things like that.

They buy insurance from what are called reinsurers, which are insurers for insurance companies. These are large international companies with very deep pockets. They work because they don't insure just in one place or just one thing. So a reinsurance like Renaissance Re out of Bermuda, or Swiss Re out of Switzerland, they will insure some companies in Florida for wind risk. They'll insure some companies for fire risk in California. They'll insure companies in other parts of the world for other types of risks.

So even a big disaster is only a small part of their portfolio, whereas it may completely wipe out a local insurance company, say, in Hawaii. So the locals spread this to these big international companies. They are entirely private market vehicles. They are not regulated by the states or the federal government. They charge based on the risk. They've been real leaders in pricing climate risk.

Dana Taylor:

So Ed, what's the solution? Should people who live in these high risk flood zones just move? Abandon their homes? Start over? What should they do?

Ed Richards:

It's hard for most of the individuals to do that. Higher income individuals are less sensitive to flood risk, but lower and middle income don't have the capital. We should be investing money to move people out of these zones, not wasting money to try to protect them in the short run when we know we can't protect them in the long run.

We should be using the flood insurance money and subsidies to really help people move out and close these areas down. But that's politically impossible because no politician likes to lose voters. There's no way to solve it through the insurance context, because when you subsidize their insurance, they don't see the risk they're living in, and they will live in dangerous places because they think it's a low risk, because insurance is inexpensive.

Dana Taylor:

Ed, thank you so much for your time.

Ed Richards:

Thank you.

Dana Taylor:

Thanks to Cherie Saunders for production assistance. Our senior producer is Shannon Rae Green, and our executive producer is Laura Beatty. Let us know what you think of this episode by sending a note to [email protected].

Thanks for listening. I'm Dana Taylor. Taylor Wilson Will be back tomorrow morning with another episode of 5 Things.