S5E2: Think climate change is a hoax? Ask the insurance industry

The Insurance Information Institute's Chief Economist, Michel Leonard, discusses how the insurance industry is contending with increasingly intense and more frequent extreme weather events that are driving up insurance costs for consumers. While there are a number of factors driving cost increases for insurance, such as inflation, there's no doubt that extreme events driven by human-caused climate disruption is a principal factor, Leonard says.

Climate is the one of most critical issues affecting the insurance industry, he says. "It's the make or break of our industry."

Transcript

EMP S5E2: Michel Leonard, chief economist with the Insurance Information Institute

BL: Welcome to the Energy Markets Podcast. I'm your host, Bryan Lee, and our guest today is Michel Leonard, chief economist and data scientist with the Insurance Information Institute. Michel, thanks for joining us today. 

ML: My pleasure. 

BL: So, I've been wanting to do an episode with the insurance industry for a long time now. You know, when you deal with most of the industries in my field, the energy industry,  they tend to either reject the idea of climate change or they poo poo it. It's not going to be that big of a deal. But yet it seems to me that your industry might have a different point of view. Would you want to elaborate on that?

ML: Of course. By the way, part of my insurance career was working with a lot of energy companies, so it's a field I know well. You know, our approach, well, thank you, by the way, thank you so much for having me. Our approach in the industry is to look, we track the losses. And attribution of those losses, causes, and so forth, is not our major concern. Now, carriers, especially reinsurers that are global, have been very active in climate change, in issues of global warming, and so forth, and then other carriers spend less time on it, but certainly it's something that we look at. And then, of course, we go into the losses, as I said, and then we look at severity and frequency, and that's really what, what is the major issue, you know, the increase in frequency and severity in extreme weather events, which range from everything from wildfires to hail, much more of a problem now, and so forth. There is no debate whatsoever in our industry that those increases in both frequency and severity are the major issues of our time.

BL: You agree that there is an increasing frequency and intensity of these sorts of events that cause your members losses, and it seems that this has now gotten to a crisis point. There are insurers leaving the market in California and in Florida. I'm looking at a Levy Economics Institute Bard College policy note from April saying "climate change is rapidly destabilizing the U.S. homeowners' insurance system, creating major challenges for policymakers concerned with housing affordability and financial stability. All of the disasters - hurricanes, floods, wildfires, tornadoes, severe hail, and other climate disasters - are wreaking havoc on U.S. residential properties." And it goes on to talk about the price of homeowners insurance, averaged about $3,200 in 2024. "Homeowners in the United States are overburdened and struggling to keep up with the cost of coverage."

ML: There's no denial that climate is the, or one of the, I would suggest, the most critical issue of insurance these days, for the reasons you've mentioned. It's the make or break of our industry. And why is that? It's that because it challenges, makes it much more difficult to operate the way we do. What is that? We operate by consolidating risk, syndicating risk. At the end of the day, we share risk, that's the underlying point there. That means that we have to ensure those risks that are in the margin, you know, folks come together, that's the heart of where we come from as an insurance industry, Benjamin Franklin, and so forth, communities coming together and set by mutuals, and we diversify, now, diversify by risk, diversify by seasons, diversify by types of peril, diversify by geographies, etc. It's difficult to diversify property in that cat right now when there's greater correlation between those risks, when there's greater severity and frequency. You know, hail, for example, now is one of our main concerns. Used to be that it was, we would think about hurricanes, now we think, of course, of wildfires. Now we also have to think about that. So, and it covers the full year round. We've had freezes in the winter, of course, in Texas a while back, so that's why it is our biggest issue. And then we have legal system abuse, and so forth, which are also critical, but that's the one that threatens the core of the industry. And then we can get that's the frame there, and you know, when it comes to replacement costs and so forth, that's we can live with that, we have, you know, right, working with regulators, we can get challenging. It means that we can, we have to absorb some of those costs. Everyone that's in business wants to offer their most competitive product, and then we have to share and pass on some of those costs. And if we're looking during Covid, for example, at one point we did some numbers in III, the average replacement costs had gone up here over three years, almost 55%. So, but replacement costs, those can be passed on, some of those costs can be passed on. But what's different about extreme weather events that it challenges the core risk diversification, their model that we've had for a very long time.

BL: Well, your own internal data shows that there's increasing severity and frequency of these events, whether or not you're willing to say climate change is real and is happening now. 

ML: Okay, I'm going to stop you right away, that you know, you know, Bryan stop you right away. Definitely no longer come across as a, as a climate denier, that's not who I am as a person, and I don't think that's what we are as an industry. What I said specifically is that as an industry, our business is to focus on delivering an affordable and available and sustainable product to our insured, our policyholders, and we don't see a debate around climate change. What we see is how it impacts our bottom line, and I added to that just again, just to add, if you're looking at some of the global actors and the national actors in shaping the conversation around climate change, you have at the table, financial services and stakeholders from all of that are global reinsurers, for there are several of them are hundreds of III and very active, and the UN initiative and the other initiatives, and so forth. So again, then want to be clear on that.

BL: What is the industry doing in terms of policy to address these issues, what are they doing to address standards, building standards? What are they doing to advocate against redeveloping in risk-prone areas? That sort of thing.

ML: Yeah, it's super important, but I want to make sure I address, you mentioned Florida and California, so I want to make sure that I address that for your audience. There are two different cases: Florida is exposure, and California is a bit more a mix of everything - exposure, of course, the wildfires, but also a regulatory environment. One of the challenges that sometimes we face as an industry, and as challenge to communicate, is that in order to be fair, we have to price, and that's our regulator's requirements in a way that reflects historical risk, and we can't come up with saying, and that limits our ability to use forward-looking models, and that's out of fairness, we don't want all our insurance companies out there saying, oh, you know, I think of this risk, and might be a risk, and we're going to start pricing more, and that's in the context that we have to be solvent purely on the basis of our underwriting profits. So, quite often the margins are very small. We have something called a combined ratio, so the combined ratio is above 100 it means we're paying more, if it's under 100 it means we're paying less than what we collect, and traditionally it's a few percent up and down, so our profit also is regulated. So a lot of these issues of surrounding climate change and extreme weather events have to do with dynamic models, and without getting too technical, I don't know how you like to talk about that stuff with your audience, but that needs intersection, for example, of less, less rain, and and droughts, and and population, so that's that's California, so we can't necessarily price that right now, which means that if there is a big loss, and so forth, then in the immediate aftermath, there needs to be significant increase, and that's what we've experienced. What I want to mention, though, is that in Calif, in Florida, there was also regulatory reform that led to a lot of those carriers to come back, because for many years, almost a decade, no carrier had been able to make money in Florida, and then a lot of carriers have come back and capacity has increased as well. In California it's a bit of a different story. There is an issue about how do we work with regulators with this modeling. So you're asking me about solutions before we get to even the product, and I'll definitely get to that in a sec, but before we get to those products, we have to understand a little bit of the economics of this, and our flexibility, or our lack of flexibility. Does that make sense for you? Am I expressing this in the right way for your audience?

BL: Yeah, carry on.

ML: There's no doubt insurance is more expensive, and it was in the same way as I've mentioned that extreme weather events, climate change is transforming, challenging us as an industry. The reality of that and the cost of insurance is challenging how we as individuals can manage us. You know, I'm calling you from looking outside here, from upstate New York, Hudson Valley, beginning of Hudson Valley, not totally upstate, and I'm in the flood zone, and I had to get out of there, and you know, look, if I could get ditches built, and all of that, and get trees down, and so forth. My insurance carrier didn't require me to do that. We don't do that as an industry, but it sure allowed me to have more availability. There were probably some carriers who would not have quoted. I had a tree fall outside my house, and I removed it, and it's not cheap to remove trees, especially if they're big. My carrier didn't require me to do that. I did it, but I didn't want those losses to keep accumulating which would have made it more difficult. So that's when we get to those building codes, for example, that you're talking about, I didn't know this until I joined the institute, but a roof, just most like a residential house, the roof sits and stays on the frame of the house by its own weight, which makes it very vulnerable. I had no idea, you don't think about these things, and which means that it makes it very vulnerable to hurricane, the roof literally fly off, and so forth. We kind of get into the Wizard of Oz here, Dorothy's house, and so forth. But our sister organization, the IBHS (Insurance Institute for Business & Home Safety), the insurance contributor to encouraging and getting better codes out there, better building codes, came up with hurricane ties they're a simple tie, that literally will attach the beam of the house of the ceiling, the roof, sorry, beams to the structure, the frame of the house makes an incredible difference. I know, I don't want it's more than half in terms of reduction, but it might be closer to 75 I need to check on that number, but huge difference, so billing codes matter. Also where we move, and I think you mentioned that where we move, we move to harm's way more and more, there's more and more people, and but can't tell people not to move, I got into a flood zone here because it's more affordable, because sometimes the location has different taxes, and so forth. So, before we even get to those insurance solutions, there's a lot that we as individuals have to manage the same way as we manage other costs, and everything is going up. We know inflation has been significant across the board. Okay, now the next part of your answer what are there products? I think more specifically that we can do. Yes, the industry is providing significant, significant array of products that are aimed at availability, easing availability, making availability more easier, more widespread, and addressing costs. So, how can we.. what are some of these products? Some of them will deal with first the policies themselves, and most folks know that, but our parents certainly, most of the time, tell us that if not, we learn it ourselves, that you can increase a deductible that speaks to what I mentioned about going outside, getting ways to manage water, getting ways to create buffer zones for wildfires, and so forth, we can look at the limits, very important to look at the limits. You can increase the base of deductible, you can look at your limit. These are ways to self-insure or retain more of the risk. And then there are the type of coverages, one can narrow the coverage, so if you're looking at something very narrow, if an area that has that's more exposed to hurricanes, but less so to a type of flood, etc. So, within existing products, there's great, great flexibility, and these are the decisions that we all, as policyholders, have to come up with. None of these are fun, and no one wants to have to reduce coverage, but it's something that, and then finally I think we have to be more proactive when we purchase homes, in terms of it is a fact that insurance is more important in the calculus of buying a home or an apartment. And then last point, you know, when we talk about affordability, we always focus on homes and those who are owners, property owners, it's part of the American Dream, the American economic ladder. One is enriched because they own property, but you already own property. I always want to mention renters insurance. Renters insurance is a very good product. It is very affordable. It is easily available, a lot of it online instantly, and that really provides protection for those who are most disenfranchised.

BL: You talked about when you were buying your house, you, despite your knowledge base, you chose a house in a floodplain. My wife and I just moved last year, and the first thing we looked at was the flood risk in buying our house, and yes, we're seeing that impact in Miami. Folks are, you're seeing it in the real estate values? If they're prone to flooding, the real estate in Miami is not as attractive and is priced less, and if it's on higher ground, it demands a premium price.

ML: You know. I did, because of what I knew. I knew that I would be able to personally, it was way cheaper, and I did assess it, and I was able to say, okay, but I have to have these ditches done and all that. So I did the economics of it. The problem, and you and your wife want to keep monitoring that, that flood zones move, they move both in terms of what's official, so where you're required to have that for your mortgage, you have a mortgage, if you don't, you still want to have it, but also they themselves move. And you know, Florida, Miami is a great example, there was a lot of hardening, that's the term we use, but of building and all of that to to make sure that the coastline itself was better protected, water moves, it just went inland, so as, as, as the, as the, you know, it's frontline nights coming into Miami Harbor, in those areas, and doing much more inland than it used to be.

BL: So I've about exhausted my notes here, and I just wanted to open the floor to you.

ML: What I would like to maybe to end with is we're all paying more for so much because of inflation, and as an industry, just saying we're paying more, all of us doesn't answer whether they are solutions, and communities are coming together, but most importantly, since we started by talking about climate change, global warming, and so forth, and the impact on our industry. What's important here is to monitor those and to get adequate coverage, and there are solutions for that, to those changing risks. And you know, folks should not be worried, we're going to, we are prudent as an industry, we have good surpluses when necessary to pay, and we see ourselves, and you use that, I think, in some of your notes when you're reaching out to me, you know, we think of ourselves as first economic responders. We pay, and we're here for our communities, and a lot of other self-legal system reviews, and so forth, very important, you know, but, but I wanted to focus on this, and, and the energy component is a, is a somewhat of a separate conversation, but I think, you know, you were mentioning we both share some time in the energy sphere, I read the other day that 50% of that alternative energy as a whole now produces as much as gas around the world in terms of BTU output. Energy companies are very much embracing alternative energy. We have a lot of our members who focus on that, so hopefully there's change there, Bryan, across the board.

BL: Well, thank you for that. There's certainly a lot to be done in all areas and in all industries, and certainly on the policy level. But I think in today's political climate, any hope for a global policy approach to climate change is pretty fraught, I think that's, I think that's an understatement, but yeah, and I just, if I were to retrofit my house on the shore, like a friend of mine had a friend who bought a house on the shore in Rhode Island, and the beach was just littered with rocks and whatnot to break the waves, and they spent a million dollars on the house, and I said, “My gosh, what a poor investment that was.” But say, you know, as an example, they were to raise it up on stilts, they were to do other things that would make it more resilient, would that count towards an insurer being, (a) willing to insure that property and (b) willing to insure it at a lower rate?

ML: I'm going to be very blunt here, and no disrespect to your friends or those who've worked hard to be able to afford those homes, but we're talking about affordability and availability here for people who may not have a million bucks to spend on a house on the shore and a million bucks on top of it. And so that's the first thing. And I don't think folks who are struggling with affordability and availability should be paying for the homes of folks who can afford that much, and you know, we all want to work hard, we all want to make money. There's nothing wrong with that, but I think that speaks of moving into harm's way in a more generic way. And some move into harm's way because it's beautiful, the setting, they can afford it, and more power to them. Some move into harm's way because of economic reasons, they don't have a choice. Disenfranchised communities that have traditionally been throughout the U.S. and Texas and southern communities in Philadelphia, for example, you know, in the older parts of town, which are more prone to that. And when I have a conversation like this one, which I really appreciate about affordability, that's about increases in premium, that's where I want to focus. That said, yeah, if you're moving into harm's way, insurance works for risks that are that can be distributed, and when you move into harm's way to that point, it's just not a possibility for the risk management model to work. But there are carriers, because that was your question, that specialize in high-end property that offer great products, so for example, instead of having a certain limit to replacement costs, it's as is. Historical homes and beams, and so forth. You want to keep that. We saw that in California, some of the higher-end properties, coastal properties, they're now there's now specialty insurance that will focus on those, and some of them will require the kind of hardening that you said, but you know, if I had a beautiful house, whether it's small or big, I don't want to have to rely on the insurance.

BL: What do we do to keep people from moving back into a disaster zone after an event? You know, we should, my point of view is we should not be building more houses on Ocracoke Island, for example, and yet the first things the politicians say after an event like this is, we're going to, we're going to rebuild just like I was before, yada yada yada. How do we change that mindset? How do we get acceptance of the need to abandon these high-risk disaster-prone areas?

ML: Well, first people can rebuild, but they still carry the scars, so the human cost there never goes away, human pain, sober, and loss. So, let's just acknowledge that up front. That's not an insurance question to answer, that's a social, that's why we have governments, that's why we live in a democracy, and we can convey a lot of communities are starting not to rebuild the same way, there were a lot of coastal communities, I've been reading about one particular where they have the same issue about erosion. There are parts here in New York, Fire Island, and so forth, where there's been a significant amount of erosion, and that's been going on for 20, 30, 40, 50 years. And after Harvey, most of the beach was gone, and they decided a community to come together and to very much on the larger scale do what your friends did, and the community paints a wealthy community in that part of Fire Island, and that's what they did. They rebuild the beach. Other parts of Ireland aren't as wealthy, and they didn't do it. So, I think communities individually can take the lead in saying the kind of risk they want. If you move into harm's way, then you really want to think about the community you have in the community, whether it's a large condo association, depending on how it's structured, whether it's a town, so forth. I think that's where the solution to that is. Now, I'm not going to avoid the question. I agree with you, people shouldn't move into harm's way. At the same time, you know, I want to say some people don't have a choice, and we need to be mindful of that.

BL: Michel Leonard, chief economist with the Insurance Information Institute. Thank you so much,

ML: My pleasure.

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