Millions of homes across the United States are at risk of catastrophic damage due to climate-fueled disasters, and their insurance premiums do not adequately reflect this growing threat. The potential financial impact could be devastating, with underinsured properties posing a significant risk to homeowners and the broader housing market.

The Warning

David Burt, a notable figure who foresaw the subprime mortgage crisis and was featured in Michael Lewis’s “The Big Short,” now warns of a new crisis emerging from climate change. Burt, now heading DeltaTerra Capital, emphasizes the underestimation of wildfire and flood risks in the U.S. housing market. In a recent webinar, he revealed that U.S. homeowners are underinsured by approximately $28.7 billion annually for these risks. This underinsurance affects more than 17 million homes, representing nearly 19% of the total U.S. home value, and could result in a staggering $1.2 trillion in value destruction.

“This isn’t a ‘global financial crisis’ type of event,” Burt noted, acknowledging the $45 trillion valuation of the total housing market. “However, in the communities affected, it will feel like the Great Recession.”

Burt’s estimates might actually be conservative. The First Street Foundation, a climate-risk research firm, estimated last year that 39 million U.S. homes—almost half of all single-family homes—are underinsured against natural disasters. This includes 6.8 million homes relying on state-backed insurers of last resort.

The Insurance Dilemma

The core issue is that insurance premiums in many U.S. regions do not adequately reflect the increasing risks of climate-driven disasters. As the planet warms, these risks are escalating. In 2023, the U.S. experienced a record 28 weather disasters, each causing $1 billion or more in damages, according to the National Oceanic and Atmospheric Administration (NOAA). This year is on track to match or exceed that record, with 15 such events already recorded, not counting the potentially $30 billion in damages from Hurricane Beryl.

Globally, natural disasters have caused over $120 billion in damages this year, according to Munich Re, a leading reinsurer. Only $62 billion of this total was covered by insurance, a figure 70% higher than the long-term average. Most of this damage occurred in the U.S., impacting homeowners significantly.

In response to these increasing catastrophes and the rising costs of rebuilding, insurers have been hiking premiums. In 2023, homeowners’ insurance premiums in the U.S. rose by an average of 11%, according to S&P Global Market Intelligence. Over the past five years, these premiums have increased by more than a third. States like California, Florida, and Texas, which are on the front lines of climate change, have seen even higher increases.

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Market Pressures and Political Challenges

Despite these hikes, premiums are still not sufficient. Homeowners dislike paying high insurance rates and often vote against politicians who allow substantial increases. Higher premiums can also decrease property values, affecting tax revenues. This has led to market interventions, such as California’s Proposition 103, which limits how much insurers can raise premiums. Even if insurers had more freedom to increase rates, they might hesitate to do so due to the potential loss of customers, especially given laws and regulations that discourage homeowners from suing insurers for uncovered damages.

“Every part of our financial and legal system at this point is singularly devoted to maintaining the status quo,” said Susan Crawford, a Harvard Law School professor, during the webinar. “Adapting to these changes will be challenging.”

To illustrate the disparity in insurance costs, First Street used a hypothetical scenario involving a California home. Suppose the homeowners paid $2,000 annually in insurance premiums in 2010. If this premium increased by the maximum allowable 7% annually—a highly unlikely scenario—the premium would have risen to $4,820 by 2023. Despite this significant increase, it would still fall $2,900 short of what would be needed to accurately reflect the risk, considering factors like climate change, inflation, and reinsurance costs.

The Exodus of Insurers

This discrepancy has led to insurance companies withdrawing from high-risk areas like California and Florida, leaving homeowners to depend on state insurers of last resort. These policies are often costly and inadequate, with providers at constant risk of insolvency. For instance, California’s FAIR plan faced potential losses of $311 billion, while Florida’s Citizens Property Insurance Corp. could see losses up to $525 billion. The federal National Flood Insurance Program, the largest flood insurer in the U.S., consistently operates at a loss. The question arises: who will back these plans if they fail? The answer points to taxpayers.

Finding a Solution

The logical solution is to accurately price climate risk, as the NFIP has started doing by updating its flood maps. This would prevent the subsidization of building in high-risk areas. However, such a move would lead to sudden and significant adjustments in the housing market, potentially making Burt’s $1.2 trillion loss estimate a reality.

A balanced approach is necessary, one that discourages development in high-risk areas while avoiding economic disaster. However, as many homeowners in California and Florida have experienced, disasters often strike without warning, leaving them unprepared.

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Conclusion

The underinsurance of millions of U.S. homes poses a significant risk to the housing market and the broader economy. Addressing this issue requires a comprehensive approach that accurately reflects climate risks, encourages responsible development, and ensures the stability of insurance systems.

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