Climate change is dramatically driving up the cost of homeowner’s insurance in the United States as insurers pay out billions for weather-related losses, and Wharton real estate professor Benjamin Keys believes the financial risk is only going to get worse in the years to come.

“It’s hard to make decisions based on things we haven’t experienced. But by ignoring the growing consequences of climate change, we are investing too much in potentially hazardous areas in a way that’s hard to unwind,” Keys wrote in an opinion piece for The New York Times. “The financial consequences of these choices will be enormous, causing ripple effects through insurance markets and ultimately undermining home values.”

Keys joined Wharton Business Daily on SiriusXM to talk about his op-ed. In his piece, he noted that climate risk has led to an estimated 12% increase in homeowner premiums from 2021 to 2022, with the average cost of a yearly policy now at $1,900. That price goes up to $5,000 in cities with greater exposure to weather disasters, such as New Orleans and Miami.

Keys said private insurance companies are hiking premiums because they carry risk more than any other player in the risk-transfer chain. Some companies have gone bankrupt or pulled out of high-risk areas, while others are undercapitalized for the worsening weather. Even homeowners who don’t live in disaster-prone areas are paying more as insurers try to balance their losses.

“By ignoring the growing consequences of climate change, we are investing too much in potentially hazardous areas in a way that’s hard to unwind.”— Benjamin Keys

“Insurers are often taking some of the very first losses after a disaster, so they are really sensitive to these concerns, and we’re seeing them respond in some pretty aggressive ways,” he said. “We’re seeing them raise their premiums. We’re seeing them cut back on their coverage. And we’re seeing them leave some markets entirely.” State Farm, the largest insurer of homes in California, announced last month that it would no longer sell policies in that state, citing “rapidly growing catastrophe exposure,” among other issues.

The professor warned that homeowners and potential home buyers are largely unaware of how much higher their insurance costs will go because the inflated housing market is masking the effect. Since 2020, housing prices have soared more than 35% on average and more in desirable retirement areas like Florida, Arizona, and the coastal Carolinas. Coincidentally, those areas are also bearing the brunt of climate change through increased storm activity and brutally hot temperatures. One study determined six Arizona counties will become uninhabitable in the next 20 to 40 years because of heat.

Under normal market forces, housing prices should fall as insurance premiums rise and buyers turn away, worried about their homes falling into the sea or being destroyed by a tornado. But Keys said that’s not happening.

“We’re just not seeing either of those channels leading to lower prices. If anything, it’s the opposite,” he said. “I think this is a critical time to try to understand exactly what’s going on in these insurance markets a little bit below the surface. This isn’t necessarily being made aware to everyone as they are buying these homes, and I think people are making some decisions that may prove costly in the long run.”

Should the Government Get Involved?

Insurance is regulated mostly by state governments. But Keys said it may be time for the federal government to step into the market, much like it did when it created the National Flood Insurance Program (NFIP) in the 1960s because there was no private flood insurance. He said he wouldn’t be surprised to see a national program for wildfire insurance, especially because California has been ravaged by fire in the last decade. One of the largest was the 2018 Camp Fire, which destroyed more than 18,000 structures and cost more than $10 billion.

“I think this is a critical time to try to understand exactly what’s going on in these insurance markets a little bit below the surface.”— Benjamin Keys

Keys said he also expects that more states will begin offering specialized or affordable homeowner’s insurance policies as private insurers back out of their markets or adjust premiums so high that they are prohibitive for the average homeowners. Citizens Property Insurance Corporation is an example. Established by the Florida Legislature in 2002, it is a nonprofit that provides property insurance to eligible Floridians who can’t find it in the private market. The program is funded through premiums, but the state can levy assessments on all Florida policyholders if there is a deficit in the program.

“I don’t think the rest of the country wants to insure the Florida housing market, but guess what? We already do,” he said, referring to federal taxpayer money that supports the NFIP, Fannie Mae, Freddie Mac, the Federal Emergency Management Agency, the Small Business Administration, and other entities that provide loans and disaster relief.

Keys said regulation and newer pricing models could force homeowners in high climate-risk areas like Florida and Arizona to begin paying the actual cost of their insurance.

“There’s a number of ways in which we already subsidize housing along Florida’s coastline, and I think the question is do we formalize these subsidies in more direct ways, or do we pull back some of these subsidies and push the owners and say the cost of owning in these areas should reflect the risk in a more direct way.”

Whatever the future holds, it’s clear to Keys that homes will continue to be built in desirable areas that are most at risk from climate change, including beaches, ocean fronts, and the Southwestern desert. Those homes require long-term financial investments in roads, electricity, and other infrastructure that is costly to build and maintain.

“The choices we make now are very difficult to shift away from,” he said. “I think there is potentially a role for the government to come in and make the prices more aligned with the true risk, and recognize that some of these areas are going to be extremely risky in the coming 20, 30, 50 years.”