Insurance: the confluence of climate crisis

Earlier this year, The Groundwire Group published its first report - Macro Meets Micro: Deciphering Renewable Energy Trends in 2024.

The report identified three key themes: Water and Commerce; Interest Rates and Unemployment, Trust and Verification. We've since been monitoring and building a database of relevant news stories according to these themes. Among the hundreds of stories we've catalogued, a new trend began to emerge: an increasing number of stories have been cross-tagged between one of these themes and two other tags: "insurance" and "polycrisis". In the last few weeks alone, we've logged state-specific insurance stories ranging from the usual suspects, like Florida and California, to less obvious states like Iowa, Minnesota, and New Jersey. All of them intersect in one or more ways with the three key themes in our report, and the way insurance is regulated in the U.S. is surprisingly similar to elements of ratemaking for electricity.

Allow me to explain.

Water and Commerce

When the flood arrives, as it has in states throughout the Midwest and California in the past year, it sweeps away everything in its path. The losses are enormous, and play a significant role in crumbling home insurance markets across the United States. Disasters like flooding and other water-based extreme weather reduce the overall housing stock when they destroy homes, contributing to the shortages driving higher costs, and recent limitations on canal transit have driven up the cost to transport materials to build new homes. Housing costs are a major contributor to our stubborn inflation trend.

Interest Rates and Unemployment

Insurance rates are largely based on the cost to replace an asset and the likelihood of needing to repair or replace the asset. High inflation means the cost of replacing an asset has likely increased, and insurance premiums will need to increase accordingly.

While inflation is having a significant impact on insurance rates, the Federal Reserve doesn't place much weight on these cost increases when they evaluate the degree of inflation in the economy. We pointed out in our report that the data used by The Fed to calibrate interest rates, and the impact that rates have on taming inflation, may no longer be correlated in the way economists have traditionally believed. Based on recent reports showing continued strong job growth and sticky inflation, it looks like we were right. Stay tuned for drama coming out of The Fed's meeting on Wednesday this week.

Trust and Verification

Insurance rates and coverage are regulated at the state level in the U.S., much like electricity rates, and some states limit the amount of increase an insurance company can pass on to consumers in a given year. Odd Lots did a fantastic podcast episode in the spring that details the nuances of insurance regulation and ratemaking in states like Florida and California that is worth a listen - it's quite illuminating. California is one of the only states that does not permit forward-looking modeling to be used when insurers set rates, meaning they can only price their policies based on historic losses and can't incorporate the expected impacts of climate change. This podcast episode from Climate Rising breaks down how Insurers and reinsurers build their own models to evaluate future climate risk. Meanwhile, an episode of Climate One discusses the availability of information about climate risks for homeowners, and the positive impact that disclosure of risks can have on buyer behavior. How accurate are our models? Can we trust their predictions as climate change drives increasingly-extreme weather?

All these trends add up to insurance markets that are increasingly-fragile and under strain. Middle class homeowners suffer - in the U.S. you can't get a mortgage if you don't have homeowner's insurance, and home values are the cornerstone of generational wealth for families. Perhaps we've identified a major contributor to the disconnect between an economy that wonks deem "quite good" and the bleak consumer outlook on that same economy. The fear of loss is palpable, and so are the risks.