How extreme weather risk is creating a real estate insurance disaster

As additional rainfall and new stormwater surges from Hurricane Harvey hit Texas, the country continues to rally around hard-hit communities just beginning to comprehend the impact of the unprecedented flood. Cities will rebuild and return, promise local and national leaders.

But as Harvey’s full significance comes into focus over the next weeks and months, flood insurance, one of the pillars of local rebuilding efforts, will be in the spotlight. Early estimates suggest the losses may hit $10 billion to $20 billion, making it one of the 10 costliest hurricanes in U.S. history.

By September 30, Congress must reauthorize the National Flood Insurance Program (NFIP), a crucial government program that helps pay for and provide policies for millions of properties in at-risk areas across the country. The impact of Harvey on the NFIP is yet unknown, but is clearly expected to be sizable; in Harris County, Texas, the flood program holds more than 240,000 policies, representing more than $60 billion in coverage, according to AIR Worldwide.

In other words, just as the nation begins to figure out how to pay for one of the costliest natural disasters in its history, the insurance program that functions as a backstop for hundreds of thousands of affected properties will be up for debate and renewal.

Battered by recent disasters, hurricanes, and floods, the NFIP is currently $24.6 billion in debt to the U.S. Treasury. That means Harvey may well push the flood program up against its borrowing limit of $30 billion and require further action from Congress to reform the program.

If it’s allowed to lapse, according to a spokesperson from the Federal Emergency Management Agency (FEMA), which oversees the NFIP, it won’t be allowed to sell or renew flood insurance policies, pay existing claims, or start any mapping or management activities to create accurate assessments of risk.

At a time of increased political polarization—especially around the question of climate change and its relationship to the kind of inclement weather events that trigger billion-dollar payments from the NFIP—a chance to reconsider how we develop, build, and plan our communities—and make them more resilient—may be lost to more immediate financial and political needs.

Luckily, issues of flooding, natural disasters, and protecting real estate investments tend to cross party lines. Senator John Kennedy, a Louisiana Republican, told Politico that the program is an absolute necessity.

“America, the American economy, Louisiana and the Louisiana economy cannot operate without the National Flood Insurance Program,” he said. “Write that down. Take it home to mama. It's the truth.”

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The risk before the storm

In many worst-case scenarios spun about climate change, coasts flood, wildfires burn, and property gets ruined. But the increasing number of extreme weather events will impact real estate risk assessments well before an actual hurricane or flash flood touches anyone’s real estate.

The insurance market will react to the potential for damage well before the actual damage happens; pricing out risk, in other words, may place homes “underwater” in mortgage terms. And as seas rise, and sprawl and development push further and further into rural areas with increased wildfire risk, insurance markets will feel the impact of increased risks and, potentially, more frequent payouts.

Last year, the chief economist for Freddie Mac, a government enterprise that supports the mortgage market, wrote that increased coastal flooding and storm surges will eventually get so bad that homeowners, unable to sell waterlogged property, will ditch their homes and mortgages, triggering a housing crisis.

The last decade has seen natural disasters occur at a rate that’s beginning to strain the government’s ability to pay for them. According to Insurance Journal, the government has spent $357 billion on disaster recovery in the last 10 years, and the number of billion-dollar disasters in 2016 was the second-highest on record. That’s why the U.S. Government Accountability Office rates climate change as one of the greatest financial risks facing the federal government.

With the government intimately tied to the home insurance market via NFIP, the costs continue to rise with the tides. In just the last dozen years, the NFIP faced the triple threat of Hurricanes Katrina, Wilma, and Rita in 2005, forcing it to borrow $17.3 billion from the Treasury, and Sandy in 2013, requiring another $6.25 billion loan. According to Risky Business, a 2014 analysis of the economic impact of climate change on the U.S. that was commissioned by nonprofits like the Bloomberg Foundation, the next 15 years could see higher sea levels and storm surges that would increase the annual cost of coastal storms along the Eastern Seaboard and Gulf of Mexico by up to $35 billion.

Flooding has long been the most common and most expensive type of natural disaster in the U.S., which is why the NFIP was created in the 1960s. Private insurers didn’t want to take on the risk, so the government stepped in to offer coverage, some of it subsidized, which forced those in at-risk areas to buy plans and provided grants for programs that mitigated damage, such as efforts to elevate homes or buy out owners of flood-prone homes.

Carlos Gutierrez, the principal realtor at Miami Beach, Florida’s Gutierrez Group, says the NFIP program is “a key part of the equation in Florida real estate,” as it is in many coastal regions and areas at risk of flooding. The vast majority of buildings in Miami Beach—93 percent—are located in a Special Flood Hazard Areas (SFHA) as mapped by FEMA, and require flood insurance for federally backed mortgages.

“We’re depending on the NFIP program,” he says. “It could really hurt our industry if it isn’t renewed, and could cause thousands of home sales not to happen.”

Gutierrez says that climate change has become part of the conversation around real estate and property in Miami, but it’s not slowing down the overall market. (A report by Attom Data Solutions, covered in the New York Times, did, however, show that flood-prone neighborhoods were growing 25 percent slower than counties without as much risk.) Sales volume and prices overall have been trending upward, and the biggest concentration of new construction in town is in downtown coastal areas.

“The way I see it is, climate change and sea-level rise is a long-term discussion,” he says. “Flooding and how to deal with it is a short-term discussion. But Miami Beach is doing things to stay ahead of it.”

He points to the fact that Miami Beach is spending $400 million on water pumps and working to preserve and protect natural resources like corals and dunes, raise streets, and improve infrastructure. Miami is on the cutting edge, which is reflected in its building codes. If insurance gets too expensive, it’ll be a major deterrent: Gutierrez wants to see more private insurers enter the flood-insurance market to increase competition and lower premiums.

“I think some discussions of climate change can be alarmist,” he says. “The future isn’t written, in that respect.”

The true price of risky property

But as extreme weather events increase, the NFIP finds itself paying out more and more to very at-risk properties, raising the question of whether limits should be placed on putting the government on the hook for high-risk regions. A FEMA spokesperson said that currently, insured properties categorized as “repetitive loss” and “severe repetitive loss” number approximately 90,000 and have accounted for $9 billion in claims over the history of the program (or 16 percent of total claims). Since the NFIP started, 30 percent of its total claims have been for these types of properties.

While NFIP was set up to cover all sorts of flood risks, especially along inland rivers and waterways, repairing damage along continually developing coastal areas has taken up the bulk of the program’s resources. NFIP data shows that $38 billion of the $52 billion paid out since 1978 have been for hurricanes and nor'easters. And other point to the ways the NFIP incentivizes homeowners, including wealthy ones, to build in dangerous, flood-prone areas. A recent Politico report found that 80 percent of NFIP households are in counties that rank in the top income quartile, and a 1998 report called Higher Ground highlighted how the system pays for unstable development. One home in Houston, valued at $115,000, flooded 16 times in 18 years, netting its owners more than $800,000.

But flooding isn’t the only weather-related reason for increased insurance risk. As cities and metro areas continue to sprawl and expand, wildfire risk has also become a larger issue. According to Dr. Tom Jeffery, a senior hazard scientist at CoreLogic, a business intelligence and consulting firm that focuses in part on real estate, new residential construction, especially in the western states, tends to be on the higher side of the risk scale.

CoreLogic data released last fall put this risk into perspective. More than 1.8 million single-family homes across 13 western states, representing a reconstruction cost value of nearly $500 billion, are categorized as being at extreme or high risk of wildfire damage. If communities refuse to build upward and densify, there really isn’t any other place to grow. And that’s placing new homes in the path of wildfires. Scott A. McLean, deputy chief of CAL FIRE, the state’s forestry and fire protection service, says that so far this year to date, 224,000 acres have burned. At this time last year, that rate was 198,000 acres.

“The difference between now and, say, the ’50s and ’60s is that we’re getting into even more riskier areas, pushing farther and farther out,” says Jeffrey. “It’s pushing out into areas of dense brush and growth. Think about recreation and vacation properties; those by definition are in the most beautiful places, and near the most potential fuel.”

According to an analysis by Montana-based Headwaters Economics, 60 percent of the new homes in the U.S. built since 1990 have gone up in what’s called the “Wildland-Urban Interface area,” a term for the in-between area that marks the division between unoccupied land and human development.

In much the same way that insurance coverage works for flooding, wildfire risk results in part from local land-use decisions, but is then paid for in part by the federal government. Headwaters has found that more homes are hit by fire every year, meaning insurance losses have increased and the U.S. Forest Service has to spend more of its budget of firefighting (from 13 percent in 1995 to 50 percent in 2015). Growth is only forecast to continue: 84 percent of the Wildland-Urban Interface remains undeveloped.

According to the Risky Business analysis, forests in the Pacific Northwest and Rocky Mountains may see a 78 percent and 175 percent increase in annual burn area due to rising temperatures caused by climate change. Jeffery says that CoreLogic is seeing an increase in the number of properties at risk. Even the end of the recent western megadrought has been a problem; new rain led to a bumper crop of brush and grass, a match that can spark more fires.

Real estate agents in the Rocky Mountain region say that fires do impact local sales, but only in the immediate aftermath of the blaze. Mike Budd, who works in Vail, Colorado, says that he sees increased insurance costs when wildfires are in the news, but people still generally think of them as a deterrent only when they’ve happened recently.

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Kelly Moye, president of the Boulder Area Realtor Association, says buyers’ memories can be short-lived, but there are still significant environmental challenges after a blaze that impacts the insurance picture (the mud and mess leftover after fires actually create a flood insurance problem).

Insurance issues can lead to lost sales, says Moye. In some states, big players such as Allstate temporarily stopped writing policies altogether due to wildfires. Boulder mandates that sellers prove that homes can get insurance, which slows down transactions, and perform mitigation work around their home, such as cutting down trees within a certain distance of around their residence. But that hasn’t stopped area real estate from doing well; prices have been trending upward over the last decade, she says.

“Unless it’s a massive fire that gets massive attention, you don’t see it affect the market in a big way in terms of big numbers,” she says. “Very quickly, people forget. There’s the draw and lure of the outdoors. That’s the Colorado experience. It’s like having beachfront property.”

How to make insurance more resilient

Going forward, increasing insurance costs tied to extreme weather and coastal flooding would mean changing how we value and share risk. Some legislators have suggested raising rates for properties that flood multiple times, and current FEMA Administrator Brock Long has said he wants to reduce the federal government’s involvement—and risk—in this particular insurance market, hoping that by getting more private insurers involved, risk would be priced more accurately, without a federal guarantee, and discourage building in high-risk areas.

“I don’t think the taxpayer should reward risk going forward,” Long told Bloomberg. “We have to find ways to comprehensively become more resilient.”

One of the ideas being proposed is the “disaster deductible,” which would require states to pay some of the cost of recovery up front, before the federal government makes public assistance payments to rebuild public infrastructure. The idea, proposed by Obama administration officials in January just before they left office (and resisted by state and local officials), would theoretically force local government to impose tougher, more resilient building codes, which might carry over to the private market. Long, who has concerns about the program, has said that the proposal “has merit.”

Others have suggested focusing more on relocation. The Natural Resource Defense Council’s recent report, Seeking Higher Ground, advocates shifting part of the focus, and resources, toward moving homeowners to safer, higher ground. For every $100 the nation spends to rebuild homes with national flood insurance funds, FEMA spends just $1.72 to better protect people by moving them to safer, less flood-prone land.

Clearly, there is dire need for the NFIP in the wake of Hurricane Harvey. But as the deadline gets closer, and because it is set to come during a time when other big issues, such as tax reform and the overall federal budget, take up the time of legislators, will we lose a chance to reform the program to make it more effective and less costly to taxpayers? Trump administration budget proposals released earlier this year state that part of the funding for the NFIP’s Flood Insurance map program, which updates out-of-date risk assessments in the wake of climate change and rising sea levels, would get the axe, potentially weakening the program’s overall effectiveness.

According to FEMA, Congress and the agency “will need to find the appropriate balance between reducing risk to the taxpayer through a greater private sector role, and maintaining a fiscally sustainable federal program.” Insurance is a bedrock of real estate investment and ownership. As representatives debate the future of this program, will the greatest risk be not agreeing on the risk of climate change?