The rise in natural disasters has led to immense losses of over $600 billion in the United States over the last two decades. Accordingly, the cost of real estate insurance has seen significant increases. However, even assets that are not exposed to increased climate risk still face significant risk of increased insurance costs due to varying levels of regulation in different states.

Insurers in more regulated states adjust rates less frequently and by a lower magnitude after experiencing climate losses. They overcome these rate-setting frictions by increasing rates in less regulated states. These behaviors lead to a decoupling of rates from risks, implying distortions in risk sharing across states.

The Research

Increases in real estate insurance premia are likely to be seen even in states without significant climate risk. Why? Due to varying levels of regulation between states, insurers are cross-subsidizing climate risk across states. Some states heavily regulate the ability of insurance companies to raise premia, while other states do not have such regulations. In states with both high restrictions on raising insurance premia (in other words, high “friction”) and high climate risk, insurers cannot adjust premia appropriately to account for climate losses. To compensate for this distortion, insurers look elsewhere for ways to reduce risk. In a recent paper presented at the Inaugural Georgetown-Clark Symposium on Global Real Estate, the authors show that insurance companies raised premia in low regulation (low “friction”) states to reduce losses from high-risk, high-friction states. Thus, even states without increased climate risk may face increased insurance premia risk.

For example, take an insurer that operates in California and Virginia. Because of more frequent and high-damage wildfires, the insurer faces losses in California, but because California is highly regulated, they cannot increase premia there. Instead, the insurer will increase premia in Virginia, a low-regulation state, even though Virginia’s real estate is not facing additional climate risk. Ultimately, Virginians pay higher insurance premia to cover the higher climate losses of Californian real estate assets.

Figure 1 shows the climate losses and level of friction for individual states. States that have the lowest levels of friction are expected to have a high risk of rising insurance premia. States with low levels of friction and low levels of climate risk are expected to have the highest risk of “unfairly” having to pay increased insurance despite low levels of climate risk.

Figure 1. Regulation friction and climate losses

The plot below shows the relationship between regulation (friction) and climate losses for each U.S. state.

What do we conclude from this research?

• Real estate insurance premia are rising due to increased climate risk even in states without significant climate risk;
• States with low friction will likely experience higher risk of rising insurance costs; 
• Real assets in high-friction states will likely experience the following outcomes:
  • Insurance costs may increase more slowly than in low-friction states;
  • Insurers may pull out of high-risk markets completely, leaving owners without viable insurance options;

• Assets in low-friction states will likely experience the following outcomes:
  • Insurance costs may increase, even if there are no significant climate risks in the area.