Don’t Get Blown Away By Climate Change

Heading Into The Storm

Interestingly, the U.S. is experiencing counterintuitive migration patterns with people continuing to move toward areas at higher risk of natural disasters, said Federal Housing Finance Agency (FHFA) Senior Policy Analyst Joe Weisbord. Homebuilders responding to that demand are increasing the number of homes in higher-risk areas.

Meanwhile, regulatory-driven consumer protections have led to reduced insurance availability. If insurers can’t price the risk in an actuarily fair way, they’ll exit, Greenland explained.

Taken together, these factors have all led to rising natural disaster costs, which in turn have caused insurance companies to raise premiums, pull out of markets, or implement coverage exclusions.

Increases in climate risks put lenders and servicers at risk in several ways. Originators can no longer assume borrowers will have modest homeowner’s insurance payments, while servicers may find borrowers unable to afford rising premiums. Natural disasters can lead to increased modification requests. A lack of insurance availability has overburdened state insurance funds of last resort, the panelists observed.

At the same time risks are increasing, lenders and servicers may soon be required to disclose more about catastrophe risks of the assets they hold.

“The United States has imported the European regulatory structure, [Task Force on Climate-related Financial Disclosures] TCFD, which more or less requires financial institutions to measure and disclose their climate risk, which in residential real estate is natural catastrophe risk,” Greenland said. “Expect to have to measure this through a catastrophe model and disclose it to auditors or the public market, if you’re a publicly traded entity.” 

An FHFA working paper released last month examined research on the interplay between climate change and residential real estate highlighting key research findings, Weisbord explained. 

There’s a lot of uncertainty right now. Information asymmetries, differences in state insurance regulations, and federal disaster assistance all influence how consumers perceive risk and the value of insurance, as well as how the market prices insurance, he explained.

“For example, research suggests many people may overvalue the amenities of being in a coastal area versus the risk of a hurricane or flooding,” Weisbord said. “Climate risks are an agencywide concern and a top priority for [FHFA] Director [Sandra] Thompson.”

Monitoring Mods

Panelist Christopher Joles, senior vice president of enterprise and credit risk at Planet Home Lending, said his company closely monitors modification rates following natural disasters both in its own servicing portfolio, as well as for the loans it sub-services and assets it manages. While there’s often a post-disaster spike caused by homeowners waiting for insurance reimbursement or having difficulty finding a contractor to complete repairs, the increase should resolve. If it doesn’t, that’s a risk red flag.

Joles also predicted that we’re on the leading edge of having homeowners in high-risk areas facing large premium increases as they go through the annual insurance renewal process. “Premium sticker shock is going to come out of that,” he predicted.

As insurance companies pull out due to increased risk, an unexpectedly high number of people are being pushed to state insurers of last resort, including Citizens Property in Florida and the California FAIR Plan.

“Those companies are having to absorb unexpectedly high inflow of policyholders,” said moderator Andrew Hellard, vice president of product management, Matic Insurance. “Because those are taxpayer-backed companies, now you’re turning what was a market problem into a political problem. So, we’re going to see a lot of action in state houses in the next few months,” he predicted.

Servicers On The Frontline

At a time when relatively high interest rates and low housing inventory put affordability under tremendous pressure, adding rising insurance costs makes homeownership harder to achieve for first-time homebuyers, especially low- and moderate-income buyers, Hellard said.

The same risks are driving homeowner’s insurance policy exclusions. That’s an issue the industry will need to watch carefully to ensure the policies selected by homeowners continue to meet agency and government lending guidelines, he added.

“Servicers are on the front line of this issue,” Hellard said. “They’re responsible for monitoring that coverages are in place and working with homeowners who are unable to find coverage. We’re starting to see exclusions in homeowner policies. Those can be in direct odds with Fannie and Freddie requirements. It’s very easy to get out of compliance.”

Insurance company downgrades due to losses, while not related directly to climate, also have the potential to be disruptive.

In the final analysis, climate risk is likely to continue changing the real estate insurance environment drastically and swiftly. Lenders can best manage risk by staying abreast of key impacts such as the rising cost of coverage, changing risk profiles, increased frequency and intensity of natural disasters, availability of coverage, and adaptation of mitigation efforts to reduce exposure to climate risk. 

Dona DeZube is vice president, communications for Planet Home Lending.