In this episode of The REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi discuss the dynamics fueling the dramatic increase in homeowner’s and property insurance, and what it means for the housing market.

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Listen to the REconomy Podcast™ Episode 107:

“Even in lower risk states, rising costs for materials and labor are pushing premiums higher. What's more, some buyers are opting out of insurance, altogether. 12 percent of homeowners in the U.S. don't purchase homeowner's insurance, and about half of them have household incomes of less than $40,000, according to a 2023 study by Insurance Information Institute. While that may seem like a cost savings, it poses long-term financial risks and could impact market stability.” – Odeta Kushi, deputy chief economist at First American

Transcript:

Odeta Kushi - We’re starting out today’s episode, which focuses on the economics of homeowner’s insurance, a little differently. We actually recorded the episode before the recent devastating fires in Los Angeles began, so we wanted to take a moment and express our support for everyone affected by this awful tragedy. 

We’re inspired by the heroism of first responders, the resilience of the impacted communities and the outpouring of support from across the country. And we’re taking action too. First American has committed $25,000 to the Los Angeles Fire Department Foundation and our fellow employees have rallied to collectively donate more than $15,000 to the American Red Cross via a fundraising drive.

We hope today’s discussion on homeowner’s insurance provides valuable insights into how insurance works and its role in such challenging times. And now on with episode 107.

Odeta Kushi - Hello and welcome to episode 107 of The REconomy Podcast, where we discuss economic issues that impact real estate, housing and affordability. I am Odeta Kushi, deputy chief economist at First American, and here with me is Mark Fleming, chief economist at First American. Hey, Mark. I am currently recording this episode from Western New York in my hometown of Rochester. It is very, very cold here. I think living in Washington, D.C. for about a decade has made me a little less resilient to this type of climate.

Mark Fleming - Hi, Odeta, well, it's not as cold here in the DMV, but it's only mid-January, and I'm already wishing for some warmer weather myself.

Odeta Kushi - You and me both. Now, speaking of climate, today's topic is all about property insurance premiums, and as many of you know, they have been rising steadily in the U.S. According to an analysis from the Harvard Joint Center for Housing Studies, from the Great Recession to present, homeowners insurance prices have increased 74%. Real premiums have risen approximately 20% between 2020 and 2023 alone, and this is for both homeowner’s insurance which covers common risks, including fire, and hazard-specific insurance for earthquakes, floods and other climate-related exposures. 

Mark Fleming - According to this analysis, the average annual homeowner's insurance premium in 2024 was $1,984 and that compares to $1,528 a decade ago. So almost $500 difference. 

Odeta Kushi - But, why are we even discussing this topic? Why is property-related insurance important for the real estate market? 

Mark Fleming - You mean other than the obvious fact that your lender probably insists on you having it? 

Odeta Kushi - Well, yeah, there is that. Generally speaking, property-related insurance plays a pretty critical role in the housing market and personal financial stability. First, it facilitates access to mortgage credit. Lenders require insurance because it protects the underlying asset, the home, of course, that serves as collateral for the loan. Without insurance, the risk to lenders would be way too high, which could mean fewer people qualifying for mortgages.

Mark Fleming - And that means fewer buyers, which we know isn't great for anyone.

Odeta Kushi -Exactly, but insurance isn't just about meeting lender requirements. It also smooths financial shocks when disaster strikes. Whether it's a flood, wildfire or a hurricane, insurance helps homeowners cover repair costs without having to drain their savings or take on significant debt. 

Mark Fleming - And let's not forget the rebuild factor. Rebuilding after damage is one of the most expensive and stressful things that a homeowner can face, and without insurance, a lot of people would be left with no way to repair or replace that damaged home, leaving their biggest asset, often also their life savings, at risk. 

Odeta Kushi -That's right, protecting the equity in one's home is another big reason why insurance matters for most Americans, their home is their largest source of wealth. According to our analysis of 2022 Survey of Consumer Finances data, housing is the single largest component of net worth for most households. The lower the income of a home-owning household, the greater the share of its wealth that comes from homeownership. This pattern has actually remained very consistent over the last three decades. In 2022, home equity accounted for approximately 84% of the total net worth of the lowest income households.

Mark Fleming - Yeah, 84%. That is a very significant share of one's wealth. So, when you think about it, insurance isn't just a safety net, it's a bridge that helps the people recover, rebuild and move forward after life's unexpected disasters. And that's why rising premiums are such a big deal at the moment.

Odeta Kushi - Right. When premiums rise, it doesn't just increase costs. It can affect access to housing and financial stability. So let's talk a little bit about what's driving these rising premiums. So broadly, we'll look at three major factors, climate risk, rising rebuilding costs, and dynamics in the insurance market.

Mark Fleming - Translation, aka Mother Nature, inflation and Adam Smith's invisible hand.

Odeta Kushi -Something like that. A report from First Street Foundation highlights that as climate risks like flooding, wildfires and hurricanes intensify, insurers are recalibrating premiums to reflect these rising risks, with climate change driving more frequent and severe natural disasters, annual losses in the U.S. have surged past $120 billion. This has created significant challenges for the homeowner’s insurance market, which is now facing unprecedented pressures. For example, average homeowner premiums in Florida surged nearly 60% between 2019 and 2023 in part due to hurricane exposure and escalating reinsurance costs. 

Mark Fleming - I think there's really only one appropriate word for a 60% increase over four years, and that is yikes. Luckily, neither of us live in Florida. So it's not just about paying more for current losses. It's about the risk of potential future losses, which are also increasing, or there's a recognition that they will be likely increasing.

Odeta Kushi - Correct. And it's not just catastrophic events. Rising labor and material costs mean even small claims, like roof repairs or water damage, are more expensive. We know that construction costs have increased 38% since 2020.

Mark Fleming - Yes, and let's not forget the elephant in the room, rising reinsurance rates. Recall that reinsurance involves insurance companies passing on some of their risks to another company, known as the reinsurer. This helps primary insurers mitigate the impact of significant or extreme losses, allowing them to provide coverage to customers while insuring their own financial health. The reinsurers see the increased risk of higher losses in the future too. And, according to a 2024 report from Fitch Ratings, in the mid-2024 renewal period the rates for reinsurance increased by up to 15% for accounts that had experienced losses and up to 10% for accounts that hadn't experienced losses. The report also noted that reinsurers are likely to push for double-digit increases in U.S. casualty premium rates when policies come up for renewal now in January of 2025 to keep up with the higher loss costs.

Odeta Kushi - That's actually a good segue into the third factor, which is profitability. As insurers face rising claims and operational costs, they're adjusting their pricing models, so some states like California are even seeing private insurers pull out entirely, creating affordability and availability challenges for prospective home buyers and the risk of breaching mortgage contracts for existing homeowners.

Mark Fleming - That's a good point. Now I'm wondering how these rising costs affect home prices. I don't think that the relationship is straightforward, but there is an FHFA paper that summarizes these price effects. We're linking to all the sources that we reference in the transcript of this episode, of course, for all for all of our listeners.

Odeta Kushi - Now that's a really great paper, so I'll just summarize a couple of their findings when it comes to prices. So, when it comes to flood risk, homes in high-risk flood zones often see price discounts, especially immediately after a flood event. These discounts can vary based on location, type of home and timing of the disaster, but coastal amenities can sometimes offset the negative impact of flood risk. In other words, it's a desirable area, so despite the fact that it might be at high risk of a flood, you still just really want to live there, because it's highly desirable. 


Odeta Kushi - Now, when it comes to wildfire risk, wildfires cause temporary price drops, with prices usually recovering within a few years. The impact is more significant for homes in very high-risk areas. Another note that I found very interesting in the paper is that there's a role for beliefs and perceptions. In other words, the perception of risk plays a crucial role in how property prices are affected. Information about recent damages or flood risk disclosures can lead to price adjustments, but how you react to this can wane over time. 

Mark Fleming - It's interesting. That last part about awareness and timing reminds me of another study analyzing Christ Church, that is Christ Church in New Zealand, and a housing market there, post-earthquake. It found that buyer’s valuation of earthquake risk diminished as time passed since the event. Sort of that anchor bias, I guess, isn't that strong when it comes to these disasters. They found that after the earthquakes, a significant price discount, around 2% emerged for properties in the highest seismicity areas with liquefaction risk. I got that right. This discount, though dissipated quickly, within just three years. 

Odeta Kushi - Well done with those technical terms that are outside our usual realm of real estate, but that's really interesting, and it suggests a strong behavioral response, where the salience of the risk diminishes over time. Now, I know our research has somehow taken us to New Zealand, but let's bring it back to the U.S. There's significant geographic differences when it comes to hazard risk and which areas are experiencing the steepest insurance hikes. According to an analysis from the Bipartisan Policy Center, states like Florida, Colorado and Texas have experienced some of the steepest insurance premium hikes.

Even in lower risk states, rising costs for materials and labor are pushing premiums higher. What's more, some buyers are opting out of insurance, altogether. 12% of homeowners in the U.S. don't purchase homeowner's insurance, and about half of them have household incomes of less than $40,000, according to a 2023 study by Insurance Information Institute, while that may seem like a cost savings, it poses long-term financial risks and could impact market stability.

Mark Fleming - That's right, they're doing it because higher insurance premiums increase your monthly cost of owning a home and to the point where you can potentially not be able to afford to own that home. But the possibility of being financially snowed under by one bad climate event is certainly a risky proposition.

Odeta Kushi - Indeed. Rising premiums can reduce affordability for potential home buyers or price them out altogether, but might also make a house unaffordable for an existing homeowner. As you just mentioned, according to a Wall Street Journal article, some borrowers who are delinquent on mortgage payments are actually blaming their late or missed payments on unexpected increases in their insurance premiums. So it's really a double whammy for both existing owners and potential home buyers. 

Mark Fleming - Yeah, the research also shows that rising insurance premiums can negatively impact transaction volumes, as higher costs associated with property ownership can deter or dissuade potential buyers, leading to fewer transactions overall. This is especially true when dealing with high-risk properties or areas with frequent claims, making buyers more hesitant to commit due to the increased financial burden of insurance costs. 

Odeta Kushi - So, I'm curious, because we've talked about potential buyers and existing homeowners, but we can't forget about multi-family. Multi-family housing developers and providers, operators, for example, are facing higher operating costs, but may be limited in how much they can increase rents to offset these rising costs.

Mark Fleming - That's a great point. Now institutional investors and REITs, they may be better positioned to absorb these costs or negotiate better rates through their economies of scale. They own so much of that multi-family housing. But, for small landlords, especially those with just a few properties in a high-risk area, rising insurance costs mean tough decisions, like possibly selling the property or reducing maintenance spend in the short run.

Odeta Kushi - And that could create a ripple effect in the rental market, perhaps driving up rents or reducing the quality of available housing. According to a 2023 study, more than 90% of affordable housing providers indicated they would need to adjust their operations to manage rising insurance costs, with more than half saying they would decrease or postpone investments in existing housing stock and new housing projects.

It's important to highlight that changes are being made to address these challenges. In response to challenges in high-risk areas, certain regions are implementing regulatory measures to ensure homeowners have access to necessary insurance coverage. For example, California has introduced rules requiring insurers to increase coverage in wildfire prone zones, aiming to protect homeowners from escalating risks. While these measures may lead to adjustments in premiums, they are designed to enhance the availability and reliability of insurance for those in vulnerable areas.

Mark Fleming - That's interesting, and I'm sure that there will be much more to come on the policy front in the next year or two, I think. The recent years have shown, as there's been a real recognition that the risks have increased, and it's clear that rising homeowner’s insurance costs are a very significant contributor to the housing affordability crisis. Policy makers face the challenge of mitigating these rising costs, while insuring that insurance coverage remains widespread and adequate, a tough one. 

Odeta Kushi - And on a cautiously optimistic note, a recent report from Matic, which is a digital Insurtech platform, reveals that premium growth slowed in the latter half of 2024, with new policies seeing average rate increases of 6.6% compared to 10.7% in the first half of the year. They owe the stabilization to the easing of inflation, which we've talked about a lot on this podcast, and approvals for rate increases, which has helped carriers align premiums with current costs and a return to profitability. So, according to the report, this shift has actually prompted large national carriers to re-enter previously restricted states.

Mark Fleming - That's really good news. 

Odeta Kushi - Always, nice to end the episode on a more positive note. Thank you for joining us on this episode of The REconomy Podcast. If you have an economics-related question you'd like us to feature in the future, you can email us at economics@firstam.com. And, as always, if you can't wait for the next episode, you can follow us on X. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.

Thank you for listening, and we hope you enjoyed this episode of The REconomy Podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2024 by First American Financial Corporation. All rights reserved.

This transcript has been edited for clarity.