The Impact On Insurers

Natural catastrophes and climate physical risks, particularly acute hazards (hurricanes, floods, wildfires, etc.), are common threats to U.S. property and casualty (P&C) insurers. While inherently unpredictable, the frequency and severity of these events have led to some outsized financial losses and rising premiums; homeowner and commercial property insurers are among those most susceptible to physical risk claims.

S&P Global Ratings estimates that home and office insurance claims rose 5.7% year over year to $148 billion (as measured in direct premium written) in 2021. Meanwhile, average annual insured losses attributed to natural catastrophes (affecting all property-related lines) increased to approximately $52 billion in the 2017-2021 period from $21 billion in the prior five-year period, according to the Insurance Services Office (see chart 1).

The impact of physical risks on U.S. P&C insurers is complex. Insurers face increased loss volatility from climate-related physical risks, such as higher wind speed intensity, more severe precipitation, convective storms, and costlier secondary perils that result in higher insured loss damage. They also face the risk that regulators could impose restrictions on policy nonrenewals and limitations on premium increases, which may ultimately hurt their bottom line.

We believe insurers will continue to demonstrate pricing discipline and monitor growth exposure by actively controlling risk accumulations. This would help them mitigate the impact of physical risks on their credit fundamentals. However, higher premiums and policy nonrenewals could lead to affordability or other operational pressures in other asset classes, including U.S. public finance local government general obligation ratings.

Chart 1

As Premium Costs Grow, California And Florida Local Governments May Experience Economic Pressure

California and Florida face increasingly frequent physical risks. Since 2017, three hurricanes (Irma, Michael, and Sally) and three tropical storms (Eta, Elsa, and Fred) caused substantial damage in Florida leading to billions in insured losses. In 2015, California's Valley and Butte fires together resulted in the destruction of more than 1,700 homes and $1 billion in insured damages, and in October 2017 wildfires destroyed more than 14,700 homes resulting in more than $9 billion in insured damages. Although homeowners have regularly experienced insurance premium growth over time,  we believe residential premium cost increases in California and Florida could be more pronounced as insurers seek to recover losses stemming from more frequent and severe events.

Insurance companies can spread higher premiums across all customers, but rates in higher risk states are growing even faster. In charts 2 and 3, the data show projected average annual residential insurance premium increases in California and Florida to 2024. The highest projected annual increases in both states are in counties most exposed to physical risks (predominately wildfires and severe storms), like Lake and Calaveras counties in California where the Valley and Butte fires occurred and Monroe and Sarasota in Florida--counties that are exposed to acute and chronic physical risks from climate hazards.

Chart 2

Chart 3

Growth in insurance costs is evident across all types of residential dwellings. Chart 4 shows the average insurance cost per unit for military and Section 8 housing. The average insurance cost per unit in Florida is nearly 81% and 73% higher based on the most recent information available, respectively, when compared to the average cost in other states across the rental housing bond portfolio. We believe this substantial difference in cost indicates a disproportionate exposure to acute and chronic physical risks faced by entities in Florida.

Chart 4

Costs And Competition: The Role of Insurance Providers and Regulators

Each state has elected or appointed insurance commissioners, whose main responsibilities include serving as consumer protection advocates and insurance regulators that work with insurance companies and provide incentives to not leave areas for the social good. In addition, state insurance regulators can help control premium costs and may not approve higher annual premiums. However, the most recent increases requested by California insurers and the Citizens Property Insurance Co. (Citizens) in Florida for 2022 were 6.9% and 8.0%, respectively. If these increases are sustained annually, and meaningfully outpace income growth, homeowners' insurance costs could squeeze affordability and lead to economic stagnation or contraction if housing demand wanes. Furthermore, local governments dependent on tax base growth and the corresponding operating revenue generated by a larger economic base could experience revenue stagnation or declines should residential insurance premium costs lead to diminished desirability for certain communities. Particularly for those governments with robust infrastructure requirements to build resilience to the physical impacts of climate change, property tax increases required to support debt or cash investments could compound total homeowners' costs.

We also believe reduced competition among insurance providers could lead to higher costs for homeowners. Some national insurance providers have exited markets or filed for bankruptcy where physical risks have resulted in large losses. This began happening in Florida following Hurricane Andrew in 1992 and continues today. During the most recent Florida state legislative session, lawmakers considered but did not enact reforms in response to some insurance companies suspending new business, limiting coverage to certain home types, or canceling policies. The governor called a special legislative session to reconsider this issue as more homeowners pursue coverage through Citizens as private insurance options decline.

In addition, according to a 2020 report from the California Department of Insurance, obtaining homeowners' insurance has become increasingly difficult in the wildland-urban interface, an area where CALFIRE models suggest one million homes are at high or very high risk of wildfire. While state insurance vehicles can sometimes fill the coverage gap and the Federal Emergency Management Agency provides a safety net, particularly for flood insurance coverage, homeowners may forego coverage if costs are layered on top of other increasing insurance premium requirements.

Influence In Our Credit Rating Analysis For U.S. Local Governments Is Likely Longer-Term

Rising insurance costs for homeowners are unlikely to negatively affect our credit rating analysis for local governments in the short run as the visibility of the risk is not sufficiently material. However, over time, cost increases could lead to shifts in the social and economic composition of communities. S&P Global Ratings views coastal and wildfire-prone areas in Florida and California as particularly vulnerable to these transitions where already high housing costs, when compared to the U.S. as shown in table 1, could increase further as the exposure to physical risks potentially intensify, absent adaptation. Although robust economic growth and demographic trends have bolstered credit ratings in Florida and California, should fixed housing costs increase from a combination of higher insurance premiums and property tax increases required to support infrastructure investments, local governments may face revenue challenges. Ultimately, more disposable income allocated to housing could lead to the potential for less total consumer spending that, without replacement revenue, could negatively affect operating budgets.

Table 1

Long-Term Planning Can Help Mitigate Credit Deterioration In The Face Of Environmental Physical Risk Exposures

S&P Global Ratings believes that long-term planning is an important mitigant to maintenance of credit stability in the face of physical risk exposures. Furthermore, enhanced resiliency and adaptation measures could help temper the impact from more frequent and severe events on infrastructure and housing and communities that ultimately help reduce insured losses.

In table 2 we describe resiliency and adaptation measures recently implemented by Tampa, Fla. While many of the plans are in the early stages with identification of projects underway, we believe these efforts bolster our favorable view of planning by Florida local governments that we first published on Dec. 1, 2021, in "U.S. Local Government Credit Brief: Florida Counties And Municipalities."

Table 2

Related Research

• Storm Clouds Or Clear Skies Ahead: How Rising Insurance Premiums From Environmental Physical Risks Could Affect U.S. RMBS And CMBS, May 3, 2022
• Through The ESG Lens 3.0: The Intersection Of ESG Credit Factors And U.S. Public Finance Credit Factors, March 2, 2022
• U.S. Local Government Credit Brief: Florida Counties And Municipalities, Dec. 1, 2021
• Global Reinsurers Grapple With Climate Change Risks, Sept. 23, 2021
• ESG U.S. Public Finance Report Card: Florida Governments And Not-For-Profit Enterprises, Sept. 9, 2021
• The Top 10 Management Characteristics Of Highly Rated State And Local Borrowers: Through The ESG Lens, June 29, 2021
• ESG U.S. Public Finance Report Card: California Governments And Not-For-Profit Enterprises, June 16, 2021