Related Links

• Housing and Housing Finance

Transcript

Tim Sablik: My guest today is Sierra Stoney, a senior research analyst at the Richmond Fed. Sierra, welcome back to the show.

Sierra Stoney: Happy to be back.

Sablik: A lot of your research focuses on housing and housing affordability, which is a topic of growing importance to the communities that we serve in our District and, of course, across the country.

One component of the cost of housing that is starting to affect affordability in some markets is home insurance. Can you talk a little bit about what's been happening in the home insurance market recently?

Stoney: The big news is related to major insurers pulling out of markets in California as well as Florida. Companies are stopping issuing new policies in some parts of those states or they don't renew existing policies. That effectively constrains the number of insurers available to homeowners in those places.

One of the reasons why we've been seeing this happening in California and Florida is because of the growing prevalence and severity of natural disasters in those spaces. We've seen a lot of wildfires happening in California. Florida is more prone to being hit by hurricanes.

We've also heard from insurers that state regulation has been a factor in their decision. Some states such as California and Florida regulate how much insurers can increase their prices annually. Insurers have argued that this prevents them from setting premiums at levels that would account for their growing costs. In some of these states, public insurance has been provided to homeowners as an option of last resort.

At the same time, we've also seen insurance costs growing nationally. A Policygenius report from 2023 — Policygenius is an insurance broker — estimates that premiums grew by an average of 21 percent nationally between 2022 and 2023. This is compared to 12 percent between 2021 and 2022. At a state level, that average premium increase has varied. Vermont had the lowest average premium rate increase at about 10 percent. Florida had the highest at about 35 percent.

Sablik: In general, what are some of the things that seem to be driving all the recent changes in prices and availability of insurance that we're seeing?

Stoney: Natural disasters is absolutely one of the things that insurers have largely been pointing to as a reason why they have increased premiums as much as they have. Insurers have been incorporating catastrophic disasters into their premium pricing for quite some time. Along the Atlantic and Gulf Coast states, hurricanes are really what they're looking towards. Wildfires in California, and states in the West more broadly, are going to be the things that they're paying attention to. Severe storms are much more prevalent across a broader geography. That includes storms that include hail, tornadoes, high winds that aren't necessarily a tornado. Those happen every year and they affect more geographic regions than some of those more localized events.

Inflation is another one of the things that insurers have talked about quite a bit in terms of why they've increased premiums. If you have a claim, then the insurance company is going to have to pay more in both labor and materials to either repair your home or replace your home if it is a total loss. Also, inflation has affected operational and business expenses. The cost of creating the premiums and administering them has gone up as well.

Insurers have also indicated that there have been growing instances of fraudulent claims. So, this is like filing a claim for roof damage when the damage was actually caused by wear and tear or deferred maintenance. Just having to navigate those situations is costly. Also, insurers have indicated that legal fees associated with litigation have been increasing.

All of these things are going to contribute to growing premium prices. That can, in turn, affect availability if the insurers determine that profitable and actuarially reasonable prices would exceed homeowners' willingness to pay. So basically, they would decide, "You know what, it's not worth it to continue providing coverage to this community because no one's going to buy insurance anyway."

Sablik: As I mentioned at the outset, home affordability is a topic that our Bank has been looking into and researching. Do we have any idea yet how these changes in insurance prices are impacting home affordability?

Stoney: When first-time homebuyers are buying their home, most of the time they're going to want to pay with a mortgage and most mortgage brokers are going to require homeowners insurance. So, this is going to be a cost that every person who's financing their home with a mortgage is going to face in most circumstances.

What we've heard here [has] mostly been anecdotal evidence, so we haven't really seen a lot of research in this space of the effect of insurance on affordability. What we've been hearing is that for new homebuyers, homes might not be affordable based both on current price and mortgage rate conditions. High monthly insurance payments could push housing expenses over that 30 percent threshold that we look to when we think about homeownership affordability.

Sablik: Thirty percent of income, right?

Stoney: Exactly, yes. Households spending 30 percent of their income towards their housing expenses — which is inclusive of their principal and interest payment on their mortgage as well as their insurance payments and property taxes — [are] going to be considered housing cost burdened, which is going to put constraints on other parts of their life in terms of their finances.

With insurance rates rising measurably, homebuyers are going to need to take that into account if they're going to stay in a situation where their housing payments are going to be considered affordable. What they'll need to do is lower their price ceiling to accommodate that added insurance cost if they want to remain within their budget.

For existing homeowners, monthly mortgage payments do tend to be consistent over the duration of their mortgage, unless they refinance. Insurance premium pricing can change on a yearly basis, though. Every time the premium is renewed it can be adjusted, depending on changing situations that the insurer is seeing. Significant increases there can increase the share of household income spent on housing, which again could push a household that otherwise would have been able to afford their home into a state where their housing is no longer considered affordable.

This is more of a concern among low- and moderate-income homeowners as well as homeowners on a fixed income. They are at greatest risk of having an increase in their premium cause their homes to become unaffordable.

Another thing that homeowners can do to mitigate this expense is to choose to forego insurance altogether, which puts themselves at greater financial risk. This is particularly an issue if a catastrophic event or some kind of major damage does occur. The homeowner, in that circumstance, is on the hook for the entire expense of those repairs, whereas if they had bought into an insurance policy, they would only be on the hook for their deductible and the insurance policy would cover the remainder of the cost.

Sablik: Yeah, it seems like one of the key takeaways here is that these changes in insurance prices are a little bit unpredictable compared to the mortgage costs, which is often fixed at the time that you take out a mortgage.

Stoney: Right, right. Exactly.

Sablik: Have you looked at what the insurance market and pricing looks like in our Fifth District, which includes Maryland, West Virginia, Virginia and the Carolinas?

Stoney: I have, just a bit. In terms of pricing, most estimates of average insurance premiums by state show that D.C., Maryland, Virginia and West Virginia are falling below the national average. This is when we're looking at policies that are just comparing prices for $300,000 dwelling coverage.

North Carolina and South Carolina have average premiums that tend to be higher than the national average, but not dramatically so. One of the reasons for this has to do with risk exposure to natural disasters. FEMA ranks risk exposure related to natural disasters on the National Risk Index on a scale of very low, relatively low, moderate, relatively high, and high. Several coastal counties have relatively high overall FEMA National Risk Index ratings in the Carolinas. Nearly all of those coastal counties have relatively high or very high risks of hurricane damage and most have relatively high expected annual losses, which also take into account things like social vulnerability and community resilience measures.

Notably, Charleston, S.C., has very high expected annual losses. That's despite having moderate social vulnerability and very high community resilience.

According to a study that I saw based on 2022 American Community Survey data, West Virginia and South Carolina homeowners are more likely to be uninsured than the national average — 12.3 percent of West Virginia homeowners are uninsured relative to 9.8 percent of South Carolina homeowners. So, that's another thing that I'm paying attention to when we're thinking about exposure to risk as well as costs associated with insurance. That same study did find that D.C. has the lowest share of uninsured homeowners relative to all the states in the United States. Only about 3.3 percent of D.C. homeowners are uninsured.

Sablik: Turning to researchers' favorite question on the show, which is forecasting about the future. Thinking ahead, what are some of the potential long-term implications of these trends when it comes to housing affordability?

Stoney: Increasing insurance premium prices might make homeownership an unaffordable option.

Established homeowners can respond to those increasing prices in a few ways. One of the ways is to adjust their policy terms. They can choose to reduce their coverage, so the number of events that are going to be covered if they happen. Or they can increase their deductible, so they have a higher out-of-pocket expense if something happens but they still have full coverage of the event. This does increase the homeowner's risk exposure, but it's also going to decrease that homeowner's monthly payment.

Homeowners can also invest in home features that improve security or prevent damage — in hurricane-prone places, this is hurricane-resistant doors and windows. Home security systems are also the sort of thing that are going to reduce premium prices. But that does require homeowners to have the capital available up front to pay for those improvements.

Another option can be downsizing or moving to a new home with fewer risks. Again, this is not a costless option. Moving, in and of itself, is expensive and there might not be such a place available where the person wants to live. There might not be a home that's at a lower risk point or there might not be a home that's smaller.

Another thing that I'm going to want to be paying attention to is how housing prices adjust in response to limited insurer options. In places that have fewer insurance options, we might see people taking note of that and adjusting their demand for those kinds of communities. That's going to put downward pressure on prices. In addition to being a source of lowering prices, which is a benefit to the homeowner, that does also reduce the value of homeowner's equity in their homes and it limits those homeowners' resources that they have available for purchasing a different home if they did want to take the option of downsizing or moving to a different area.

Overall, monthly housing costs might also exceed what first-time homebuyers can afford. We've talked about this a little bit. As a result of that, people are going to want to stay renting for a while. So, the other thing to consider with rising homeowners insurance prices is that it's not just homeowners insurance. It's property insurance more broadly, and so both multifamily and landlord property taxes are going to also be increasing over this time. For market rate units, those increased insurance costs might be passed on to renters in terms of price increases, so renters might still see price increases even if they can't directly tie it to increasing insurance costs.

Affordable property owners have shared that insurance increases have made operating expenses sometimes exceed their revenue, even with the subsidies that they have in place. In some cases, we've heard of properties that are going to be sold off, and that will reduce the number of dedicated affordable housing units in a certain market. We've also heard that affordable developers have been having a harder time making the development finance math work. Projects are either being delayed or they're being scrapped altogether before they even get off the ground.

Sablik: For policymakers who are concerned about home affordability or rental affordability, does the research suggest particular things they should be thinking about or paying attention to when it comes to home insurance?

Stoney: There are going to be costs and benefits associated with any type of regulation.

From an insurance pricing perspective, increased regulation does seem to detract insurers from operating in an area. That's one of the things that insurers have been saying as a reason why they're pulling out of certain markets. At the same time, that regulation is put in place for a reason. It has been put in place to make sure that insurers don't increase prices at a level that people can't afford. Also, it's there to protect people from potentially not having coverage or not having transparency on what their policy provides.

One thing that several states have been doing — Florida has been doing some research on this in their own market — is looking at how they can revise their policies to attract more private insurers. There has been research that's found that growing competition in insurance markets dilutes the market power of individual insurers. That's going to give insurers less ability to set prices at higher levels. It's going to force that competitive pricing, that's going to keep downward pressure on premium pricing overall.

Some of the ways that states have been doing this have been to adjust building codes to require damage mitigation features so that new properties that are built are going to automatically have those benefits in place, so insurers know that they're less risky going in. Another way that some policymakers are trying to attract insurers is to invest in local infrastructure to prevent damage, so updating the building codes so that the homes themselves are more damage resistance as well as investing in infrastructure that makes it so that damage doesn't get to the homes in the first place. Those are going to be things like flood mitigation measures so that flooding doesn't actually get to the homes themselves.

Another thing to look at in terms of policy solutions is related to public insurance. Public insurance has served as a stopgap for homeowners who are unable to procure private insurance. That model might potentially be financially unsustainable in the long term, [which] is one of the concerns. Public insurers still have to have their actuarial math make sense. They have to be able to have enough revenue from premiums and other sources to cover the losses that they have to cover.

The other piece of that is that public insurers tend to take on homeowners who are considered especially risky. That actuarial math is even more challenging for public insurers relative to private insurers in those spaces. One of the ways that they're responding is by sometimes not offering as comprehensive of coverage as private insurers.

Another way that policymakers can respond is by providing funding and financing for things like home repair [and] damage mitigation. Home repair programs provide maintenance that's going to not be supported by coverage. That's going to prevent some of those fraudulent claims and also make sure that homes do remain safe and comfortable for the people living in them.

It's important to note that investing in measures to reduce risk exposures can sometimes be costly. So, providing affordable financing for homeowners without the resources to pay up front is going to give them the opportunity to improve their property in a way that will make them eligible for those insurance premium discounts.

Those are kind of some of the things that I like to keep in mind. Just to make it clear, there's no straight direction on what should be done. There are a lot of different interests and needs to balance.

Sablik: Yeah, a lot to think about there and a lot of things to watch on this issue.

Sierra, thanks so much for joining me today to quickly give us an overview on this topic.

Stoney: Happy to talk about it, Tim. Thanks for having me.