Just how doomed is home insurance?

Insured losses from natural disasters around the world in the first half of the year have already topped $60 billion, 54 percent higher than the 10-year average. Three-quarters of insured losses were due to severe thunderstorms, flooding, and forest fires. More recent calamities like Hurricane Helene will push the toll this year much higher. Damage estimates for Helene ranged as high as $47.5 billion as of October 4.

That’s if they can find insurance at all. Hundreds of thousands of Americans have come home to a breakup letter from their private insurers, canceling their coverage. Others can’t find any company that will protect their home, leaving expensive, state-run insurers of last resort as their only option. Some private insurance companies have entirely pulled out of states like California, Florida, and Louisiana.

Insurers like State Farm point to several factors behind these trends. Inflation has made rebuilding houses much more expensive and prices for reinsurance — insurance for insurance companies — have shot up. Insurers are also bearing more catastrophic risks as more people and property take root in high-risk areas like flood zones and neighborhoods that are more wildfire-prone, so that when a blaze ignites or a storm passes over, the losses are greater. And because of climate change, many types of natural disasters are packing more of a punch.

The turmoil in the insurance industry has major implications for the economy and for politics. Most banks will not offer a mortgage without homeowners insurance, and letting a policy lapse can lead to foreclosure. In the wake of a hurricane or wildfire, insurance payouts are critical for rebuilding lost homes or relocating to somewhere safer.

Insurance is also where the risks of tomorrow manifest today, and with rising average temperatures, many buildings will face bigger threats. That means homeowners will have to pay more for insurance, go without, or move to a place with lower rates.

Right now, that leaves a trio of unpleasant options. Insurers can raise their rates in line with the risks they face, pricing more people out of coverage and leaving them to fend for themselves. Regulators can limit rate hikes and enforce coverage minimums, which can drive private insurers into bankruptcy or out of the market altogether. Or the government can subsidize or offer its own coverage, which would leave taxpayers holding the bag for mounting losses.

So it’s a great time to be selling insurance, but not to buy it. Insurers have shown they can thrive even in a warmer world with more costly disasters; the challenge is getting their products to the people who need them. Doing so will require changes to how states regulate insurance, how companies model catastrophes, and new insurance products.

But insurance is ultimately about risk, and over the long term, there’s no substitute for reducing the overall risks stemming from climate change.

Like most businesses, a simple calculation lies at the core of the insurance sector: A company has to make more money in premiums than it pays out in damages. However, figuring out where to set premiums and how much damage to expect gets extraordinarily complicated. The most common form of property insurance is indemnity, which grants a payout based on the amount of damage.

The formula for the losses that an insurer can expect has three key components. The first is the hazard, such as the probability of a severe storm occurring. The next is exposure, which is the value of the insured property in the path of danger. And the third is vulnerability, or how well a property can stand up to a given extreme weather scenario — whether it readily floods, burns, collapses, or survives the disaster intact.

Insurers then have to distribute these costs across their customers. Companies are competing with one another, so they can’t set their rates too high, and in many states, they face further limits on their pricing and must meet minimum coverage requirements. There’s a whole subfield of mathematics dedicated to this practice.

Insurers themselves cover their risks with reinsurers. When a major earthquake, hurricane, or wildfire demands more payouts than a company can afford at once, insurers can file a claim with their reinsurer, which in turn is balancing disaster threats among insurance companies all over the world.

If you can balance these risks properly, insurance can be a lucrative line of business, as we’ve seen over the past year. But if they tip too far in any direction, it can lead to a financial collapse. After Hurricane Andrew rammed into the tip of Florida at Category 5 strength in 1992, causing $25 billion in insured losses (1992 dollars), at least 16 insurance companies became insolvent.

The storm was a major turning point for the insurance sector. It showed that the old formulas for calculating risk underestimated how much destruction could end up on an insurer’s books. After the waters receded, companies began to adopt catastrophe models, computer programs that use the physical traits of extreme weather events in a given area to estimate how much an insurer might have to pay out. This raised rates for many homeowners, but also led insurers to advocate for stronger building codes and defensive infrastructure like sea walls.

Now even catastrophe models are starting to show their weaknesses. These simulations are typically built on historical severe weather patterns, but because average temperatures are rising, the past is no longer prologue.

Integrating climate change into catastrophe models and then into insurance premiums is its own technical challenge. Scientists are still trying to suss out exactly how much warming is in store given that the biggest factor is how aggressively the world will act to limit greenhouse gas emissions.

But even within physical models of the Earth, there is still a wide range of uncertainty in how these gasses will alter weather. Insurers then have to gauge just how bad of a disaster they have to plan for, by what time frame, and then how to distribute those costs to policyholders in the present.

At the same time, the number of people is increasing in areas that are vulnerable to disasters worsened by climate change. Roughly 40 percent of the US lives in a coastal county, for example, and in states like Florida, the waterfront has experienced some of the highest levels of population growth. Just how many more people will build bungalows, condos, and office parks in places likely to burn or flood will shape payouts in the future — and thus premiums today.

Incorporating climate change into their business may be a more recent development for retail insurers, but reinsurance companies have long kept tabs on warming. While the fundamentals of risk management are similar, reinsurance companies and retail insurance firms operate under different constraints.

Frontline insurance companies tend to focus on specific regions and operate under local regulations, while the reinsurance business spans the globe in a freewheeling market. That gives reinsurers a more diverse risk portfolio and more flexibility in managing it, but they also must examine these risks on a global scale over decades.

Munich Re, the world’s largest reinsurance company, has studied climate change for 50 years, and their chief climate scientist, Ernst Rauch, has been working on this since for more than half of that time. While climate change is altering the risks on their balance sheets, Rauch said understanding the fundamental physics behind it has helped the company game out what to expect and adjust accordingly. With climate science, what was once a blank, uncertain view of the future is now coming into focus.

“We feel very well prepared to cope with the challenges of climate change,” Rauch said. “And with this understanding we want to not only continue with this business, but depending on the terms and conditions, also grow our business model.”

This knowledge also lays a course for reducing the financial and physical threats from warming, for companies and for policymakers. Looking at the three-pronged formula for insurance risk — hazard, exposure, and vulnerability — climate change mainly comes into play with the hazard component since rising average temperatures increase the chances of weather events causing more destruction. That provides the impetus for halting the rise in greenhouse gasses in the atmosphere from burning fossil fuels.

Exposure is largely governed by inflation. For a house built decades ago, simply buying the lumber, shingles, and concrete for repairs after a storm is much more expensive now than it was when that house was built. Residential reconstruction costs have risen almost 5 percent in just the past year. Add to that the higher cost of labor and rising property values, which makes losses more expensive, and insurance costs go up independent of climate change.

Reducing vulnerability to disasters is one of the most immediate things people can do to keep threats in check. “This is where we as consumers, as policyholders, have the biggest influence on the risk,” Rauch said.

Tactics like preventing flooding by restoring natural watersheds and controlled burns to reduce the odds of a deadly wildfire can blunt the impact of a disaster. Adapting to climate perils like sea level rise with tactics like seawalls or using fire-resistant building materials in wildfire-prone forests can allow properties to endure a catastrophe. But to drive down insurance premiums with these measures, insurers have to first recognize and reward the homeowners and property managers that undertake them, and they don’t always do that.

“The computer models that insurers use to decide whether to renew or write insurance for homes and condominiums don’t always account for those investments in mitigation by homeowners,” said Dave Jones, who runs the Climate Risk Initiative at the University of California Berkeley and served as California’s insurance commissioner from 2011 until 2018.

Reinsurance companies also connect the impacts of disasters around the world. Their international portfolios allow them to withstand billions of dollars in insured losses. But that also means that a gargantuan disaster can create financial burdens even for people far removed from the destruction. If a massive typhoon hits Taiwan and causes extensive insured losses, reinsurers may have to raise their premiums for retail insurers, who would then raise their prices for policies in Florida.

Many insurance companies say climate change is a key driver of long-term risk. Right now though, only 1 percent of the overall annual increase in insured losses seen so far is due to actual changes in the climate, according to Verisk, a risk analytics firm. The larger force to date is growing exposure due to inflation.

Verisk’s Rob Newbold, who studies extreme events, noted that many of the disasters that insurers are worried about do stem from the climate, but they’re already built into insurance rates (or they should be). And the specific role of rising average temperatures exacerbating these catastrophes so far hasn’t shown up in a big way in the data. The trend right now seems to be “ordinary” extreme weather falling on more expensive homes and businesses.

“I don’t want to try to suggest that climate change isn’t happening. The climate is changing. But climate itself has been a factor in insurance losses forever,” Newbold said. “We’re seeing this overall level of insured losses [rising], but from our perspective, the industry should not be surprised by this because the tools exist to quantify that risk.”

In addition to inflation, there are other local factors that have driven up the costs of insurance in some states. Last year, major insurance firms like State Farm and Allstate announced they would not sign new property insurance policies in California because the losses they were facing from perils like wildfires were too much to bear at the rates they were allowed to charge (State Farm and Allstate did not respond to requests for comment). Other insurers dropped thousands of Californians from their existing policies. Similarly, Florida has also seen private insurers leave the state and drop customers in recent years.

Jerry Theodorou, who leads insurance research at the R Street Institute, a free market think tank, noted that insurers in California face regulations that limit their ability to increase rates and for a long time blocked them from using forward-looking catastrophe models to set their prices.

“California was a special case largely for regulatory reasons,” Theodorou said. “The main driver of the high premiums in Florida was plaintiff attorney firms run amok.”

So while climate change is increasing hazards over the long term, right now policy choices, economic trends, and market forces are driving most of the disruption in property insurance.

That depends on who you ask.

And some insurers are responding. Earlier this year, Allstate said it would come back to California under one condition: It gets to raise home insurance rates by an average of 34 percent. In North Carolina, insurers are asking state regulators to raise rates by an average of 42 percent.

Despite these challenges, the insurance industry is still profitable, investors continue to demonstrate an appetite for risk, and insurance requirements to get a home loan haven’t changed, so it’s not going to fade away anytime soon. At the right price, there is theoretically an insurance policy that can cover even the most precarious home. “Technically everything could be insurable for the right amount of protection and the right amount of mitigation,” Newbold said. “There’s no such property you can’t put coverage on.”

But there’s no guarantee that anyone would be able to buy such a policy. Some insurers offer alternatives and complements to conventional indemnity insurance. Parametric insurance, which pays a fixed amount based on the strength of a disaster rather than the extent of the damage, is one approach.

Jones echoed that a government-run insurer wouldn’t solve the underlying disruption in the insurance sector and agreed that inflation and greater exposure are the major factors driving price hikes right now. “However, none of those two factors would matter near as much if there weren’t more severe and frequent weather events due to climate change,” Jones said.

He added that even though Florida fulfilled much of the insurance industry’s wishlist, such as protection from lawsuits and state-funded reinsurance, companies like Farmers Insurance are still exiting the state. “Florida may well be proof that we’re not going to rate our way out of this problem,” Jones said.

It’s also important to remember that insured losses are only the starting point for grappling with a disaster. According to Munich Re, more than half of natural disaster losses were not insured. Many of the people facing the greatest dangers from weather extremes are also the least equipped to deal with them and most likely to suffer in the aftermath. The dollar values don’t convey the entire social cost of a calamity.

Without halting greenhouse gas emissions, these problems are only going to get harder. According to Jones, the rising risks from unchecked warming is going to make it practically impossible for insurers to stay in the game over the long term. “Insurers are not magicians; they can’t wave a wand and make the risk go away,” Jones said. “Ultimately, it all goes back to the climate crisis.”