When insurers can no longer afford the risk

In 2023, two major insurers joined a growing list of companies that will no longer offer new home insurance policies in California. In Florida, the situation is worse, with more than a dozen large home insurance companies retreating from the state. Both states have seen devastating property losses due to extreme forest fires and hurricanes - risks that are only increasing due to the changing climate.

But why can’t the insurance companies simply adjust premiums to reflect the changing risk that climate change is bringing, rather than leaving a market entirely? Because like many economic models, insurance risk is assessed based on historical data (in some cases, by law), which is not particularly reflective of future (or even present) risk. 

Dr. Spencer Glendon, Founder of Probable Futures and former Head of Research at the investment firm Wellington Management, returns to Climate Now to examine how much our historical experiences can be used to inform how we should respond to our rapidly changing world, and how the roles of quantitative data, empirical analysis, and storytelling may need to shift for us to make the most of our collective wisdom in preparing for challenges of the future.

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Transcript

James Lawler: [00:00:00] Welcome to Climate Now, a podcast that explores and explains the ideas, technologies, and the solutions that we'll need to address the climate emergency. I'm your host, James Lawler. In this episode of the podcast, as in every other episode, we often will quote research reports and articles. You can find the links to these articles and other reference links in the transcripts associated with these episodes on the Climate Now website, if you'd like to dig deeper or see where we're getting our facts. So to do so, you go to climatenow.com, go to podcasts, and look for this episode. Here we go. 

Climate change impacts every sector of the economy. While governments, scientists, and businesses work on finding solutions to mitigate emissions and adapt, one industry in particular is tasked with footing the bill for many of the destructive storms, wildfires, and other disasters that are growing in frequency and severity: the insurance industry.

Here are some numbers. In 2022, extreme weather [00:01:00] damages totaled over $165 billion, according to a report by the National Oceanic and Atmospheric Administration's National Centers for Environmental Information, that report also looked at global insured losses from wildfire damage. So, losses eligible for insurance coverage between 1980 and 2018, so a period of nearly 40 years.

70 percent of that damage occurred in just the last two years of that period. In the United States, NOAA reports wildfires caused $81.6 billion in damage in the four years from 2017 to 2021. That is nearly 10 times more damage than the preceding four year period. Faced with increasing costs due to more frequent claims, insurers are responding by either hiking up their rates or refusing to offer insurance at all in certain locations.

For example, in California, ever-worsening wildfires have caused insurers to reassess the cost benefit analyses of insuring homes there, according [00:02:00] to a 2023 Fortune article. According to the California Department of Insurance, since 2015, quote, “California wildfires have contributed to more than $8.5 billion in insurance rate increases requested by companies”.

And in October 2023, Fortune reported that six insurers, including insurance giants State Farm and Allstate, actually stopped issuing new homeowner policies in that state. The insurance industry is also suffering in Florida, where Hurricane Ian caused over $112 billion in damages in 2022, according to NOAA. And homeowners pay insurance rates nearly four times the national average, as CNN reported this past summer.

My guest today has spent a lot of time thinking about how climate change is wreaking havoc on the insurance industry. Spencer Glendon is the founder of Probable Futures, a platform that offers maps, science, and stories to help people understand what our climate futures might look like. We were joined by Spencer in June of this year, and we're very happy to welcome him back to the show today.[00:03:00] 

Spencer publishes seasonal essays, one on each equinox and solstice, on topics related to the changing world and global economy amid the climate crisis. Spencer's latest letter, Equinox greetings: the way we live now, discusses how climate change has pulled the rug out from under the insurance industry.

He describes how property owners and large-scale developers have taken access to insurance for granted, and that in a changing climate, this may no longer be realistic. He asks, how do our usual strategies and financial mechanisms of managing risk hold up in places where hurricanes and wildfires are not questions of if, but when and how bad?

What happens when the storms and the wildfires one insures against are no longer freak occurrences, but regular? Our discussion today draws from economics, science, and even literature to answer some of these questions. Spencer Glendon, welcome to Climate Now. Great to have you on again. 

Spencer Glendon: Thanks, it's a treat to be back.

James Lawler: Today we're talking about your most recent letter, and the unifying theme for me was this [00:04:00] idea that examining the degree to which the fact of a stable climate has informed everything from our institutions and the language we use to describe the world around us in this very, very sort of profound way, and then taking that, you examine how these things are coming apart in the context of one particular industry, which is the insurance industry.

How important is the insurance industry to our way of life today and to the institutions that we depend on? 

Spencer Glendon: One of the ambitions in the letter is to make the world more interesting to people, make people actually more aware of how kind of fabulous- and I mean both senses of the word- our civilization is.

What I realized is that insurance plays a very interesting role in modern society. And it has explicitly to do with climate. So a [00:05:00] local climate, I live in Boston now. I grew up in Michigan. I have lived in Russia and in Germany and in some other places, in Chicago. And in each of those places, those places are described not by being the same temperature every day, but by a range.

And there are warmer years and cooler years, wetter years and drier years. And what's happened with insurance, and in this case we're going to talk explicitly about property insurance, is that insurance in some sense truncated those ranges. And what do I mean by that? Well, take the house I live in. It's built to withstand a certain amount of rain.

And beyond that amount of rain would be very expensive to build the house, be expensive to have the house be sort of an impenetrable fortress. So what became practice in my house and in all the houses around the developed world is you say well we build the house up to a certain standard and then outside of that standard, if we get something that's [00:06:00] more extreme than the range the house is built for, we will buy insurance for that.

And so what insurance is actually there to do is to offset if you get an out of the normal run of the mill experience. And so somebody on the other side of this contract would sell me insurance. And what that means is that if this unusual, very unusual event happens, they would pay me. In the absence of the very unusual thing, I pay them.

So I pay most years a small amount, they get that amount predictably, and the trade off is that occasionally, very occasionally, I would call on this contract to say, “hey, something unusual happened here, I get paid”. Well, for that market to exist, actually both parties need to understand just how unlikely it is.

So you don't buy insurance for, you're in a grumpy mood, or you have a bad day, something that happens [00:07:00] frequently, you can't buy insurance for. It's only for the very infrequent, and that's infrequent enough that you would not build for it, not per- not insulate yourself for it by insuring yourself by building the stronger building or whatever. But it's frequent enough that it's worth buying a contract to protect yourself because over the course for example of a 30 year mortgage, it's got like a 25 percent chance of happening and that's a pretty big number. You say “all right, I should do something about that, but not too much”. But both parties need to understand just how likely that is, and so insurance became this way that we limited the future we planned for explicitly, but shared the risk that unusual things happened with lots of people.

James Lawler: Right.

Let's talk about the structure of the residential insurance market. If you could just talk us through the structure of this [00:08:00] market. 

Spencer Glendon: Sure. So insurance is a very interesting market as it turns out, because it's an unusual market. It has lots of norms and standards around it. So on the face of it, insurance is a financial contract.

One person pays another person and under certain circumstances, or one person pays an institution and under given circumstances, that institution will pay the person back, so it has the structure of, uh, of a very specific financial contract. But insurance doesn't act like a financial market. So what do I mean by that?

Well, one of the things about it is that you can only buy insurance one year at a time. There's this norm that insurance gets renewed annually. Consumers treat this like something, like a commodity that will always be around. And so maybe next year I'll get a better deal. And then the company likes to issue one year at a time because the company is thus not taking any time-based risk.

But there's a fourth party, which [00:09:00] is the regulator. And the regulator is, in the United States, there's a different regulator for every single state. And those regulators are organized, not necessarily for the market to work, but to protect the consumer. Now on top of that, you start realizing that insurance is a price of entry, is like a, an ante you need to offer to be a homeowner.

Well, homeownership is treated in many countries, especially in the United States, as being a sort of right that you have. So now the regulator is invested in making sure that you, James, can't lose your insurance, that you get a good deal on insurance, that it's always available to you. And so what that has meant is that the regulation of insurance does very interesting and strange things.

So, for example, in California and in many other states, only past data can be used by the insurance company to determine pricing for [00:10:00] next year. So if you want to know how much to charge James for his insurance for next year, the only information you're allowed to use by law, are premia and costs, so basically how much money went into the insurance companies and how much came out over the previous 20 years. You can use no other information. 

Secondly, if you decide that James's new insurance policy should be more costly, that the risk has gone up, there's actually a cap on how much you can raise the new fees, the new charge. So the companies are actually unable to reprice and they're unable to use new information like climate models.

As a result, it means that the insurance business can't really push back on the market and signal “hey, this policy is no longer right”, that the past is no longer a good model for the future that the past is now in fact biased data. [00:11:00] It's, it's not the right set of inputs to determine the risk going forward, but it's been so regulated to insist on the status quo, that you can't do this.

James Lawler: I've read a couple of articles about Florida in the wake of, of the hurricanes they've had. And the, these particular articles have noted that actually developers have come into these areas that have been devastated and have bought land and have, and are actually pouring money in to build new structures to build new resorts and and all of these things. How does that square with, with what you're describing now?

About you know, the insurability and the livability of areas like Florida, for example.

Spencer Glendon: In the case of Florida, the Floridian government has stepped in and created a new insurance company. In fact, they've created, also, a reinsurance company. And so if you [00:12:00] have a home in a vulnerable place in Florida, the market is unlikely to offer you insurance, actually.

But the state of Florida now will offer you subsidized insurance. And so there isn't yet the signal that you can't get insurance in places where the market has gone away, because the state has stepped in and actually treats it like a right. And so this risk that you will be uninsured, thus far, hasn't manifest because the government has stepped in where the market has stepped out and insisted that, “oh no, there still is an insurance market here”.

James Lawler: Right. The Florida government created Citizens Property Insurance Corporation. And you pull a wonderful quote from their mission statement, and I'm wondering if you could unpack this for us. And this is in your most recent letter, their mission, the Citizens Property Insurance Corporation's mission is to, quote, “efficiently provide property insurance protection in Florida to those who are”, [00:13:00] comma, “in good faith”, comma, “entitled to obtain coverage through the private market, but are unable to do so, period”, emphasis is my own. I'm wondering if you could reflect on, on some of the turns of phrase here. So the first being “in good faith”, citizens property insurance corporation exists to “efficiently provide” it- property insurance protection- in Florida to those who are “in good faith entitled”.

They're in good faith entitled, what does that mean? But they're unable to obtain coverage. So this- millions of questions, questions abound, enlighten us, Spencer, what does this mean? 

Spencer Glendon: I shared it in the letter because It does represent the ambivalence that even a supposedly conservative government has towards the market, which is that if the market [00:14:00] deems a place no longer viable, what do you do about that?

It's such a violent idea that where you live has now been voted against by the market as being a viable place to live. It's a- it is an act. Part of the reason I included it was exactly that language. The “in good faith”, you start realizing that this is a- this isn't really a market. This is being treated as a right.

In fact, they even say that you have the right to coverage that the market is not covering and the California FAIR Plan has a very similar turn of phrase and so this idea of that, that you know, it's nobody's fault that they can't get private get insurance And we don't want markets to judge places in this negative way and it is, I think, accurately captured by that quote from the insurance company.

We will do whatever it takes to maintain confidence that Florida is, and what I find also amazing is they often use [00:15:00] this slogan, “open for business”, so long as the business doesn't say that Florida is risky. 

James Lawler: I want to talk about California because, as you note in this letter, California is on the other end of the American political spectrum.

And I want to quote from your letter. “California's version of citizens is called FAIR”, capital F-A-I-R, “which was established ‘to meet the needs of California homeowners unable’”, again, the word is unable, “‘to find insurance in the traditional marketplace’. FAIR is funded by a tax on all insurance companies that offer property insurance in the state”.

Essentially, any Californian who has insurance from a company like State Farm or Farmers is paying a subsidy to those who don't. This may help explain why, instead of just retreating from specific risky locations in California, State Farm stopped offering policies to anyone in the state. 

Now you pull this really cool quote from the About page on FAIR's website, which you note is in a smaller, paler font than the rest of the site. What [00:16:00] does this, this sort of slightly paler font say on the website? 

Spencer Glendon: “In the last decade, more Californians have turned to the FAIR plan as wildfires have devastated California, and some insurers have pulled back from these markets. While we will support homeowners regardless of a property's fire risk, unlike traditional insurers, our goal is attrition. For most homeowners, the FAIR plan is a temporary safety net, here to support them until coverage offered by a traditional carrier becomes available. We lead with our customers' interests at heart and reach success when we are no longer needed”.

James Lawler: Hmm. Okay. So, There are all kinds of wonderful clues in this paragraph about what is actually going on with wildfire insurance in California. Spencer, can you do a close reading of this for us? 

Spencer Glendon: So, we start with the, The first part. “In the last [00:17:00] decade, more Californians have turned to the FAIR plan as wildfires have devastated California”.

That's important because what's happened with losses, both in California and in Florida, is that, remember the idea of insurance was when you have a bad outcome, you will fix the building that was damaged. This is property insurance. You'll fix the building. But what's actually happened is not only that the probability of a fire or a flood has gone up, but the devastation has gone up.

And so instead of just being, “well, we need to fix some things because there was a fire”, it's the neighborhood has been completely flattened and then the claim to the insurer is to rebuild the entire thing. So the frequency has changed, but also, now we're talking about devastation, and that's really not what insurance was built for.

Insurance was built to shore things up when there was an exceptional outcome, but not start from scratch. 

James Lawler: So this language seems both clever and also a bit [00:18:00] absurd, right? They say they'll support homeowners, not insure them. They're not saying they will actually offer insurance. It's like they're trying to rethread this rhetorical needle where they understand the pitfalls of offering insurance in California, where the chances of your home burning down are high, but at the same time, they'll want to appear to be on the side of homeowners saying they'll, they'll be there for them if insurers decide to pull out, you know, without actually committing to insuring.

Spencer Glendon: There are a couple of interesting things about it. One is I really like the way it, it really makes practical that the climate has changed, but the institutions that were built on the stable climate are finding it hard to change. 

James Lawler: Right. 

And grasping, grasping- 

Spencer Glendon: They're grasping, that's exactly right. 

James Lawler: As though, they're, they're just, they're trying to hold on.

They're, they're making this impossible connection, like you can feel the strain. 

Spencer Glendon:  That's right. 

James Lawler: As they, as they struggle to hold on to language on the one side, and reality on the other. And pull, keep these things joined, but they don't join anymore. They, they don't connect anymore, do they? 

Spencer Glendon: That's exactly right.

Maybe that's a good transition [00:19:00] to the novel. 

James Lawler: Yes. So, your essay is titled, The Way We Live Now, which is a reference to a 19th century novel of the same name by author Anthony Trollope. Happens to be one of my favorite books. 

So, Anthony Trollope, novelist, born in the early 1800s, so lived until the late 1800s, wrote a very large number of novels. I think close to perhaps around 50 novels, many other things. He had a career in the postal service at the same time, came from a very interesting background. I was doing a little bit of reading about him. 

You know, he had a very challenging upbringing and had to sort of wrestle with a lot of, sort of, dissonance in his childhood and in his life, which I think is highly relevant to the books that he wrote and also to our conversation today. Actually, you know, he came from noble lineage, noble lineage in a titular sense, but without the economic means. And so he grew up with this tension between, you know, outward appearance, and a lot of his work reflected that, including perhaps most [00:20:00] brilliantly, the book that's widely acknowledged as his masterpiece, which is entitled The Way We Live Now.

And it's one of my favorite books. And I think it's a way to understand the times we live in today, as much as what things were like in the 1800s. So Spencer, why did you choose to reference this book in this letter? How does The Way We Live Now, a novel written in the 1800s, connect to this story about insurance and climate and all of that?

Spencer Glendon: So the story of The Way We Live Now interests me for a couple reasons.

One is, actually just very literally, you've probably heard about one degree of warming, or one and a half degree of warming, or two degrees of warming and climate change. That's on a baseline called the pre-industrial baseline. So the pre-industrial period is this period of the late 18th century, 1850 to 1900.

Is considered the- before we screwed up the climate, before we really started mucking up the climate- This was the period of time we treat as a baseline. And this is the period of time that's right [00:21:00] at the cusp of when Trollope is writing what's happening, around the time of this letter is the birth of modernity.

So this is when economics is just getting going and you have the roots of sociology and anthropology around this time. We're trying to learn truths about the human, human nature that would be themselves also enduring. If only we could unlock this. And the last part is that we're starting to conquer the physical world in the industrial world.

The industrial world is starting to conquer the natural world. 

James Lawler: Right. It's a wonderful portrayal of a scandal based on the machinations of a charlatan. So there's the, the, the main antagonist in this story is Melmotte, who's this financier who sort of waltzes into town with a beautiful daughter who, you know, one of the one of the characters becomes sort of smitten with and anyway, you know, you see all of the characters around, you know, in, in, in the novel become sort of [00:22:00] ensnared in, in the myth of these rail, railroad shares.

And you could really draw a line between all of the characters in that book and name the scandal today, whether it's Elizabeth Holmes, whether it's FTX. Human nature in that sense, you know, in that particular reading of the title doesn't change. The way we live now, the way we are now, is the way we, we have been, are, and ever shall be. 

Spencer Glendon: I think that's right. Although what I would also say about it is there are times when, when people are much more open to charlatanism. And I do think that that's what, what is specific temporally about that, which is that Melmotte is not a particularly good charlatan. It's just everybody so desperately wants to believe.

Or there may not even need to be an actual charlatan. People buy into a myth because it, it is so much more convenient to embrace the myth. And so, you know, to compare it to where- The Way We Live Now, the idea that the Californian [00:23:00] government is this, you know, is is in the way like Melmotte is sort of a conniving charlatan, no, they're actually responding to a strong desire that is actually irreconcilable with the truth to have the past come back for them, to have the past still be true.

And so people can delude themselves into demanding a charlatan effectively prop them up at the beginning of industrialization to say, well, we're very late into the consequences of industrialization and now pretending that industrialization didn't have moral consequences and doesn't have financial consequences is turning us into a group of people using very strange words on very strange websites for state-owned insurance companies that say “we are here when the market irrationally or unfairly chooses not to offer insurance”.

And in all of these conversations, what I'm hopeful is that people will see problems far enough in the [00:24:00] future that they won't just be saddled onto the, the people who right now either don't live in Florida and are expected to come by and bail everybody out or the young people for whom when these distributions move, what was rare becomes common.

And so understanding how the rare becomes common, how the assumptions of the old are sort of foisted onto the young is a kind of a transition that we're all engaged in. And the more we can make people aware of that transition now, the more we can get people to think about the future in a constructive way, the less damage there's going to be along the way.

And so that's the hope of the entire endeavor. 

James Lawler: Well, thank you for joining today. It was a fascinating conversation and really appreciate your time. 

Spencer Glendon: You're welcome.

James Lawler: That's all for this episode of Climate Now. If you'd like to check out Spencer Glendon's Equinox Greetings, a link to that letter is in our show notes. You can also hear [00:25:00] our previous conversation with Spencer on climatenow.com, along with many other conversations. 

And if you'd like to get in touch with us, you can email us at contact@climatenow.com. We love to hear from our listeners. We hope you'll join us for our next conversation. Thank you.

Climate Now is made possible in part by our science partners like the Livermore Lab Foundation. The Livermore Lab Foundation supports climate research and carbon cleanup initiatives at the Lawrence Livermore National Lab, which is a Department of Energy applied science and research facility. More information on the Foundation's climate work can be found at livermorelabfoundation.org.