Insurers Must Learn to Manage Natural Disasters’ Risky Costs

Back-to-back landfalls by Hurricanes Helene and Milton, expected to cost insurers up to $55 billion in damages, show how climate change is contributing to the intensity of natural disasters and how the damages from those disasters will continue to climb.

Insurers should take note to mitigate their risk exposures. They can do this by carefully deciding which markets to remain in, how to balance reinsurance costs on their earnings and balance sheets, and how much of these rising costs can be passed to consumers without jeopardizing their competitiveness.

Insurers are already facing increasing financing costs from reinsurance and capital regulations. Insurers rely on reinsurers—companies that forge arrangements in which insurers transfer risk to another company—as a source of capital and to diversify their insured exposures.

Rising reinsurance costs have put a strain on US property insurer earnings and balance sheets. US capital regulations have also imposed higher capital requirements for property insurers exposed to climate change risks since 2017. A study we posted this spring shows that the additional regulatory capital requirement of climate change risk is commensurate to $50 billion in 2021 and is associated with rising homeowners insurance prices.

On top of these increased financing costs, frequent major natural disasters in the past few years will likely exacerbate the property insurer risk, and the consequence would be especially dire for insurers with large insured exposure in areas affected by hurricanes. Look no further than Florida, which has experienced major hurricanes for the past three hurricane seasons.

Insurers can take one of two strategies to mitigate the risk of insolvency: Avoid high-risk markets or pass the financing costs on to consumers. When reinsurance is readily available, insurers can limit exposure to risky markets by transferring their exposures to reinsurers; this has become an expensive option due to recent increases in reinsurance costs.

Unlike other financial intermediaries, insurance is regulated at the state level. Unless a state imposes a moratorium to limit insurers pulling out of a market (such as the California homeowners insurance moratorium) an insurer can actively avoid costly markets by not issuing or not renewing policies. Such actions can help insurers stay solvent and keep their promises to existing policyholders.

But insurance consumers in risky markets would have limited choices. On one hand, it’s possible that only risky insurers would stay in the market with a state’s taxpayers ultimately funding the financial burden.

On the other hand, insurance policyholders in risky areas may be rejected by private insurers. Many states, such as Florida and Louisiana, offer state-supported insurers of last resort. But these “residual” insurance providers pass the financial burden of insuring riskier properties to the state—which passes it back to local residents through taxes, assessments, or higher premiums.

Such policies often are more expensive than the insurance policies offered in private markets. In some states, the financing costs of state-supported insurers are directly passed on to the existing insurers and their policyholders, resulting in a spiraling effect on all stakeholders in the insurance market.

If insurers don’t avoid risky markets and instead raise insurance prices, that also would lead to costly outcomes for homeowners and businesses in the US. Our study using data in Florida has shown that increasing insurance prices are costly to both homeowners and local governments. Higher insurance premiums are capitalized into property values, driving down house prices and tax revenue.

The impact isn’t limited to Florida, either. Across the US, most homeowners rely on mortgages that require insurance from a highly rated insurer, reinforcing the link between insurance costs and property values.

This leads to another big question: How much can insurers raise prices? An optimal insurance price increase should help insurers survive market competition and avoid regulatory scrutiny.

Different insurance consumers respond differently to price increases. For example, homeowners without mortgages may be more likely to drop coverage following a price increase than those with mortgages. This could lead to insurers losing market share. State regulators also monitor insurers’ excessive pricing behavior, especially for personal insurance products where consumer protection is weighed more heavily than for commercial insurance products.

When insurers juggle profit fluctuations that could lead to solvency concerns, consumers have to juggle the increased costs of owning a home or business in catastrophe-prone areas, and insurance regulators juggle the balance between affordability and availability of insurance. Ultimately, someone has to pay for property damage associated with natural disasters.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Kyeonghee Kim is an assistant professor in the Department of Risk Management/Insurance, Real Estate and Legal Studies at Florida State University’s College of Business.

Tingyu Zhou is an associate professor of real estate in the Department of Risk Management/Insurance, Real Estate and Legal Studies at Florida State University’s College of Business.

Evan M. Eastman is an associate professor of risk management and insurance in the Department of Risk Management/Insurance, Real Estate and Legal Studies at Florida State University’s College of Business.

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