The argument over whether we’re in for global warming or global cooling and whether what’s coming is natural or human-made is fun but totally irrelevant from a financial perspective. The fact is that for whatever reason and in whatever direction, the climate is getting more aggressive. Monster snowstorms and apocalyptic fires are clearly becoming more common:
Combine the rising number of bad things nature is throwing our way with the fact that millions more people are choosing to live in places with the highest propensity for those bad things, and you get yet another addition to the average family’s cost of living: soaring insurance premiums.
Phil’s Stock World recently published an analysis by University of Michigan professor Andrew Hoffman that expands on the connection between nature and insurance:
One of the great challenges of tackling climate change is making it real for people without a scientific background. That’s because the threat it poses can be so hard to see or feel.
In the wake of Hurricanes Florence and Michael, for example, one may be compelled to ask, “Was that climate change?” Many politicians and activists have indeed claimed that recent powerful storms are a result of climate change, yet it’s a tough sell.
What those who want to communicate climate risks need to do is rephrase the question around probabilities, not direct cause and effect. And for that, insurance is the proverbial “canary in the coal mine,” sensitive to the trends of climate change impacts and the costly risks they impose.
In other words, where scientists and educators have had limited success in convincing the public and politicians of the urgency of climate change, insurance companies may step into the breach.
Steroids and climate change
Dr. Jane Lubchenco, an environmental scientist who oversaw the National Oceanic and Atmospheric Administration from 2009 to 2013, offers a clever analogy to convince people of the connection between the destruction wrought by a single hurricane and climate change. It involves steroids and baseball.
Her analogy goes like this. If a baseball player takes steroids, it’s hard to connect one particular home run to his drug use. But if his total number of home runs and batting averages increase dramatically, the connection becomes apparent.
“In similar fashion, what we are seeing on Earth today is weather on steroids,” Lubchenco explains. “We are seeing more, longer lasting heat waves, more intense storms, more droughts and more floods. Those patterns are what we expect with climate change.”
And those weather patterns come with a cost.
Someone has to pay for these damages
In 2017, for example, Hurricanes Harvey, Irma and Maria and other natural disasters like Mexican earthquakes and California wildfires caused economic losses of US$330 billion, almost double the inflation-adjusted annual average of $170 billion over the prior 10 years.
Estimated costs from Hurricane Florence, which struck the Carolinas in September, range as high as $170 billion, which would make Florence the costliest storm ever to hit the U.S.
More broadly, total economic losses from wildfires in the U.S. in 2017 – the third-hottest year on record, behind 2016 and 2015 – were four times higher than the average of the preceding 16 years and losses from other severe storms were 60 percent higher.
This led me and others to realize that we should be more focused on insurance companies, society’s first line of defense in absorbing these costs, making their industry arguably the one most directly affected by climate change.
For example, the insurance industry paid out a record $135 billion from natural catastrophes in 2017, almost three times higher than the annual average of $49 billion. That’s not to mention the uninsured losses that were also incurred – uninsured losses from 2012’s Hurricane Sandy were 50 percent of the total $65 billion in losses, a staggering tab picked up by individual citizens and the taxpayer.
Insurers will eventually adjust to this emerging reality. And with it will come changes in our economy, including higher costs that will affect everyone’s pocketbook.
A whole new ballgame
The International Association of Insurance Supervisors, a respected international standard-setting body for the insurance sector, recently published a report calling climate risk a strategic threat for the insurance sector. It cautioned against relying on annual adjustments to manage climate risks as physical risks can change suddenly and in “non-linear ways.”
Recognizing this threat, many insurers are throwing out decades of outdated weather actuarial data and hiring teams of in-house climatologists, computer scientists and statisticians to redesign their risk models.
In response, insurances premiums will increase and coverage will decrease.
The take-away? It’s going to become increasingly hard for people living in disaster-prone areas to insure their stuff. And this trend might not be gradual. Note the term “non-linear” a couple of paragraphs above. This refers to the tendency of markets in times of stress to suddenly jump to dramatically higher or lower price ranges. For homeowners insurance, that could mean Floridians or Californians paying two or three times more than just a few years earlier – at a time when property taxes are also rising due to clean-up costs of past disasters.
This is the kind of inflation that people feel keenly, and it’s the kind that ultimately leads to government bailouts in the form of taxpayer-funded subsidies or even the nationalization of industries. Which makes it just one more portent of financial instability and, ultimately, an epic currency reset.