In Property Insurance, Climate Change is Everything
The insurance industry notoriously moves slowly, but today must evolve rapidly in the face of climate change. Underwriters have long been able to rely on backward-looking datasets to assess probable risk in the future — leveraging historical data to predict the frequency and severity of loss is the heart of actuarial analysis. But as changing weather patterns impact property insurance (and our world more broadly), the industry needs to adopt new approaches for risk selection and risk management.
Climate change is demonstrably leading to more natural catastrophe events today compared to prior decades, heavily impacting insurers’ losses. Gallagher Re estimated $123B in global insured losses from natural disasters in 2023 — this represents an increase over both the 10-year average from 2012–2021 ($81B) as well as the 5-year average from 2017–2021 ($110B). Behind this trend is both an increased event frequency (the quantity of these types of events), as well as increasing loss severity from secondary perils (events like flash floods, wildfires, and convective storms that occur more frequently than primary catastrophe events like major hurricanes and named storms). Not only are there more weather-related events, but those incidents also trend more costly than in the past, in part due to recent supply chain disruptions, replacement cost inflation, increased litigation, and net migration towards regions in the South and West that are prone to floods and fires. 2023 was a relatively light year for primary catastrophe events – but still had a record number of events with loss >$1B as secondary perils contribute outsized losses.
The $160B+ premium US property insurance market is being rocked by these conditions. Carriers face shrinking/unpredictable underwriting margins and generally complex/unforgiving regulatory regimes; as a result, they are slowing or pulling back new policies in key at-risk markets like Florida and California. This includes some of the nation’s largest homeowners carriers (State Farm; Farmers; Allstate) as well as startup carriers–like Hippo, which temporarily paused all new business in 2023 in response to weather-related losses.
The shrinking supply (and worsening terms) of property insurance policies is having profound impacts in and beyond the insurance industry. Property and business owners are increasingly self-insuring or taking on higher deductibles, with premiums up by >30% in some states. And since non-renewals have spiked in at-risk regions, an increasing share of exposure is landing on the balance sheets of public insurers of last resort (a situation aptly described by a CA insurance industry body president as “an obvious slow motion train wreck.” Janet Yellen and the Dept of Treasury point to the growing insurance protection gap as a systemic risk — and we’re inclined to agree.
Managing the changing trajectory of weather-related risks is on a short list of foundational (if not existential) challenges faced by the P&C industry over the coming decade. But implementing meaningful process change is a tall order for most large multi-line carriers. Today, we’re in a market where carriers find it more palatable to exit or pause than to meaningfully change how they measure and manage risks.
Underwriting guides and workflows tend to be fairly rigid, and most new data models are insufficiently standardized to easily plug into existing processes. Whereas best-in-class models may include hyperlocal and property-specific risk factors, risk selection today is generally based on data that fails to take into account the specific parameters of the property or local surroundings beyond the zip code. For example, during our research into this space, we’ve talked to insureds who said their multi-acre commercial property was underwritten based primarily on the zip code of its mailbox. This dynamic is exacerbated in state-regulated markets, where rate filings move slowly and where forward-looking models may even be explicitly prohibited.
The problem is not just one of risk selection, but also one of incentive alignment. In theory, property owners and carriers should be aligned on resiliency, but in practice it can be challenging to put into action. It is difficult for brokers and carriers to reliably determine which property-hardening techniques are worth pursuing, and virtually impossible to assign an ROI to those improvements. But if it’s inevitable that weather risks are trending more volatile, more needs to be done to identify and implement loss-reducing mitigation opportunities.
A one-size-fits-all approach to underwriting anchored on zip codes is unlikely to lead to strong returns across highly varied perils and regions. And since weather risks over the next 30 years will look less and less like the preceding 100, then it’s clear the status-quo pricing and risk management paradigm in place today will not cut it going forward.
The intersection of weather risk and financial protection is a massive challenge for insurers to reckon with, and also a catalyst for innovation across the value chain. We are keenly focused on this problem space at Equal, and believe there is a generational opportunity for innovative startups to reshape the industry.