Homeowners, lenders likely underestimating rising costs of insurance

Natural disasters and migration to higher-risk areas are pushing insurance premiums up, with investors and lenders underestimating future price hikes, according to a report from real estate services provider SitusAMC.

A rising number of claims and a dwindling amount of insurance carriers are both contributing to a jump in coverage costs, even in areas experiencing less impact from natural disasters. The combined headwinds may lead to a case of sticker shock beyond the initial year of coverage for investors, lenders and homeowners alike. Increased premiums may also lead to overvaluation of certain properties if cost increases are substantial enough, according to the report, titled “Weathering the Storm: Burgeoning Insurance Costs for Real Estate.”

“Most people may not be surprised to hear insurance rates are going up, but few understand how precarious the situation is for the insurance industry,” said Jennifer Rasmussen, PhD, vice president and head of thought leadership and publications for SitusAMC Insights, who co-authored the report.

“As the number of climate-related disasters increase, many homeowners and residential real estate investors could be in for a rude awakening in the years ahead,” she said in a press release.

According to the USI Insurance Services 2021 mid-year market update, premiums on properties outside of catastrophe-prone zones are expected to rise between 5% to 10% each year, while properties inside these zones, such as the coasts, may see costs increase from 10% to 15%. But many appraisers are only factoring in 3% annual increases for renewals after the initial year, far below what will likely be necessary based on current trends.

“Tenants and owners often do not understand or anticipate the complex factors pushing property insurance costs up so rapidly,” the report stated.

Natural disasters and other recent climate-influenced events, such as the condominium collapse in Surfside, Florida, have pointed to the exacerbated risk climate poses to insurance providers in certain parts of the country. Winter storms in Texas accounted for 40% of the U.S. property insurance market’s losses in the first half of 2021. Yet populations in areas most affected by such disasters, namely the West and Southeastern states, continue to increase rapidly, playing a large role in driving up property insurance costs.

Data from First Street Foundation found that some of the most popular destinations for new residents in 2020 are at an increased risk of flooding in the next three decades, accounting for approximately 1.2 million residential properties and 66,000 commercial units. Drought-affected regions at the risk of wildfires have also experienced an influx of recent arrivals, who have spread out far beyond urban cores, thereby increasing property damage risk.

“Experience from California suggests that as the population grows, residents will push farther and farther from the metro core in search of affordable space,” the report said. “The sprawl abuts development with vegetation and fire-prone areas, increasing the likelihood of fire. Soon, about 35 million people spread out in four states — California, Texas, Arizona and Nevada — will live in fire-prone areas from this exurban push.”

The greater risk for private providers posed in some markets have led some to exit or diminish their presence in states such as in California or Florida, decreasing the number of more affordable options and making their residents more reliant on government policies. North Carolina, Massachusetts and Kansas have also seen state insurers take an increased burden of insurance policies since 2013.

To temper much of the risk associated with catastrophe-prone areas, some property insurance providers might turn to reinsurance policies as a protective measure to mitigate potential losses from disasters. Yet the reinsurance industry has suffered losses for years as well, due in part to a greater number of natural disasters in the last half-decade, according to the report. Reinsurance providers, in turn, passed along its cost increases to insurers, hampering the ability of small insurers to serve customers.