Ideas | Our insurance system provides relocation assistance in disaster areas

The fire continues to burn across Los Angeles in what is one of the costliest disasters on American soil, with economic damage and losses estimated at up to 275 billion dollars. Thousands of residents lost their homes, often their most valuable possessions.

However, there are some signs that politicians and regulators are grappling with a decision that has brought many people into the danger zone to begin with. Their refusal to do so sets the stage for even greater, potentially deadly and costly harm.

The stock market, if left to its own devices, will force Americans to face the dire reality of our climate change and prevent them from rushing into the impossible. Human habitation will be avoided. Unfortunately, this basic system of supply and demand has been blocked by state and federal policies — policies supported by Democratic and Republican lawmakers in blue and red states that buckle under the pressure of short-term policy to keep home insurance costs low.

The result is very unfair and distorts the market. It threatens our economy by sending scarce resources into the path of natural disasters and potentially destroying more lives.

In theory, the cost of insurance determines the risk of a certain location. Of course, home insurance should be more expensive in disaster-prone areas. But in practice, states vary widely in their willingness to allow insurance premiums to rise, and some make it more difficult than others for insurers to raise prices. California has been one of the most resistant, and until recently refused to allow insurers to raise rates or reflect weather risks in their prices.

Insurers doing business in such regulated states, finding themselves unable to raise rates when necessary, pass on some of those costs to homeowners who live in the state that is more in line with the increase in premium. That is, in part, how middle-class communities, like Enid, Okla., can end up subsidizing Malibu’s million-dollar homeowners. And under our current administration, this dynamic is only expected to intensify, as climate losses continue to hit the insurance industry’s bottom line.

The voices that strongly criticize California for its strict regulation of insurance costs ignore many similar examples from other states. By 2023, after the federal flood insurance program begins adjusting rates to reflect climate realities, 10 states across the political spectrum — including Reliable red Louisiana, Florida and Texas and moderate blue Virginia – sued the program. And California isn’t the only state that has failed to raise rates to adequately fund FAIR plans, the state-sponsored insurer of last resort often relied on by those living in climate-prone areas. day; So did Florida.

Home insurance is just one way to encourage Americans to move to wind-dependent Florida or Arizona flood zones. Government giants Fannie Mae and Freddie Mac, which insure 70 percent of single-family loans, pay the same rate regardless of weather risk. No one is planning to take risks. A lot of people live in places like Texas because housing is cheaper. But that affordability is a steal: The risks of loans and their insurance are supported by everyone. This system, and the constant construction in the danger zone, reveals the constant loss.

We understand why change is difficult. Losing a home can be devastating both financially and emotionally. Rising insurance premiums can put pressure on already struggling homeowners. For households that have their entire savings tied up in their home, high interest rates combined with lower home values ​​relative to insurance costs may lead them to take out a mortgage. money.

This may explain why many households living in high-risk areas not only take on more debt to pay higher premiums, but also reduce coverage altogether, leaving them vulnerable to accidents.

Regulators can and should monitor insurers so they don’t abuse their market power by charging exorbitant rates. But we’re at the other end of the spectrum in many areas of risk: At some point, regulators must allow prices to rise so that insurers remain solvent and private insurance remains safe, even even in places most affected by climate change. The longer they delay, the bigger and more disruptive the price increases.

Foreclosure rates in Florida will nearly double from 2018 to 2023. And in times of danger, many households will move to high-risk areas, prompted by the artificially low price that covers the real price, and drains the money they earn at home. It’s a pain now compared to more pain later. But eventually, as prices reflect risk, incentives will again diminish, and people will be discouraged from migrating and building in disaster-prone areas.

For state and federal policymakers, the question they must face is not whether should move to the cost of insurance that reflects the risk, but how.

Federal flood insurance programs can point the way. From 2021 to 2023, the program moved to risk-based pricing. The new customer policy is created first. Existing customers in high-risk areas have a longer adjustment period. This gives households information and time to adjust to the new cost of living regime.

If climate change causes frequent, severe and interconnected hazards, climate change risk areas may continue to move away, even with risk-based pricing. If so, the government could step in, by creating, say, a federal reinsurance backstop. If policymakers choose to go this route, a good price is key to this coverage. If not, we may introduce other informal aid to disaster-affected areas.

We don’t have to live like this. Our policies are designed for a world where the gap between high and low is smaller and less sustainable. But those gaps widened quickly. And the longer we wait, the more we and our society will suffer.

Parinitha R. Sastry is an assistant professor of finance at Columbia Business School. Ishita Sen is an assistant professor of finance at Harvard Business School.

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