How to react without being reactive: when insurance no longer presents the same level of assurance

As emerging risks play out, what can financial institutions do to help protect their borrowers and themselves?

by Elisabeth A. Wilson

Concerns about the potential efficacy of insurance as a controlling stopgap have increased over the last few years. While smaller insurance companies have been quietly exiting or folding in markets more prone to climate change-related events, insurance still features prominently as part of the typical financial institution’s strategy to minimize risk to commercial and consumer real estate collateral.

Now, faith that insurance will save the day — and the balance sheet — is shaken as larger insurance companies have begun to pull out of fire-ravaged California and hurricane-ridden Florida. Insurers are rationalizing their decisions to exit these regions due to catastrophic weather events in addition to inflation, economic challenges, reconstruction costs and an increasingly expensive reinsurance market (and, in the case of Florida, soaring insurance litigation costs).

These exits have been both subtle and swift. In January 2022, AIG withdrew from California, announcing it would not issue or renew loan home policies followed by State Farm and Farmers in the first half of 2023. Allstate also paused homeowner, condo and commercial policies in California in November 2022, but did not make a formal exit until May of this year — a concerning lag for homeowners searching for coverage. Then July ushered in Farmers’ retreat from Florida.

Florida: worst-case-scenario example

None of this is necessarily new to Florida, which has also seen Bankers Insurance, Centauri Insurance and Lexington Insurance (a subsidiary of AIG) abandon the state since 2022, while 14 other insurance companies are in receivership. In response, Florida residents increasingly are turning to Citizens Property Insurance Corporation, Florida’s insurer of last resort. But as a result, Citizens’ insurance is now becoming more difficult for homeowners to obtain. And as Citizens takes on a larger percentage of the market, there are concerns in the market that it may be overextended — which may in turn present broader implications in the face of the ever-more virulent hurricane activity Florida faces. On average, Florida homeowners are now paying $4,200 in insurance premiums.

Farmers’ exit highlights what has been the subtly-evolving plight of Florida residents — heightened risk of damage and loss due to climate change-intensified storms, suspended or unrenewable insurance coverage, desperate searches for new insurers and substantially hiked premiums. All of these threaten the average borrower’s ability to repay.

Just wait and see — the government will fix it?

Florida has taken steps to curb previous legislation that exacerbated losses for insurance companies. Gov. Ron DeSantis’s office announced in April 2022, that while Florida represents only nine percent of homeowners’ insurance claims across the United States, it constitutes 79 percent of homeowners’ insurance lawsuits. This has been due to a perfect storm of roofing insurance scams paired with a Florida law that allows assignment of benefits from homeowners to construction companies. Construction companies present inflated insurance claims to insurers, who naturally reject the claims — and are then taken to court by the construction companies. One-way attorney fees in Florida attribute costs to the losing party, leaving insurers in the damned-if you-do/damned-if-you-don’t scenario of potentially assuming all litigation fees or settling out of court.

In response, Florida enacted new legislation in December 2022 to revoke assignment of benefits, institute a $1 billion reinsurance fund and limit one-way attorney fees going forward. To try to balance market share, the Florida legislature will also require homeowners to seek other private insurance (even at a higher cost) outside of Citizens. However, legislation did not go into effect until October, emphasizing the amount of time generally required for congressional bodies to identify and attempt to solve for a problem — if they can actually gain a consensus to do so. This should be a sobering thought for those stating that the insurer market exit trend will eventually be curbed by federal or state intervention.

Florida’s efforts to address the rampant challenges insurers face can be demonstrated as somewhat successful based on local reports that AAA, although refusing to renew policies in some riskier parts of the state, announced it will continue to underwrite new policies, citing recent legislation.

What does this mean for financial institutions?

Organizations with limited or no market presence, or collateral, in California and Florida may be tempted to keep on moving without a second thought. However, it may be prudent for these institutions to keep their ear to the ground for both local news and anecdotal reports of homeowners who are experiencing challenges in obtaining policies (as was seen post-Farmers exit from Florida when Virginia residents complained that Nationwide was refusing to renew policies in coastal regions). The Wall Street Journal also reported in June that sources are indicating AIG (which led the prominent insurer exit in California) also may be planning to pull back on insurance sales across broader regions more prone to flooding or wildfires, such as New York, Delaware, Florida, Colorado, Montana, Idaho and Wyoming. As climate change-exacerbated events spread across the U.S., insurers may be finding more and more legitimate reasons to cut their losses and move on.

As this emerging risk plays out, what can financial institutions do to help protect their borrowers and themselves?

Luckily, flood insurance is de rigueur in the financial industry, but it may benefit organizations to ensure their blanket mortgage hazard insurance policies are in place. For institutions that are not formally tracking to ensure borrowers maintain personal hazard insurance, they may want to start instituting this requirement — after weighing the time and resources required to do this against the fact that it is may not be industry standard. (On the flip side, this may help to reduce an organization’s own insurance premiums.) Institutions without resources at hand to support such an effort may be able to lean on third parties who can.

Analyzing portfolios via scenario analysis or catastrophic event modeling to identify areas of greater risk concentration, and then subsequently force placing insurance on collateral in those regions, is potentially another option. This will also help institutions align with evolving federal and SEC climate-related external disclosure regulatory guidelines, which are continuously pushing for scenario analysis. Organizations may also choose to adjust credit pricing in higher-exposure regions/markets, a standard methodology to safeguard any institution, though, alternately, they should be cautious to assess any resultant fair lending concerns.

With lag times as some insurance companies like Allstate (and now possibly Nationwide and AIG) quietly withdraw their presence prior to formally announcing their intent to exit specific markets or regions, it is still a bit of a guessing game where and how we may witness the next significant insurer pull out. Any location more subject to wildfires and hurricanes is a good first guess, and financial institutions can leverage this assessment to begin developing response strategies to defend against the loss of their original first defense, insurance.

In the meantime

Many bankers are skeptical about the merits of unwarranted government involvement in market decisions. The fact that many market participants believe future federal and state intervention could avert a potential insurance market crisis indicates how dire the situation may be in certain markets. As demonstrated by Florida, government intercession requires time — time homeowners may not have if insurer exits increase in momentum. While the rest of the country may not see the same level of vulnerability as Florida and California, both from climate and insurance market perspectives, the state may forecast a more widespread reality as a greater number of homeowners become financially exposed to hazards — as will the financial institutions that lend to them.

In the face of an uncertain economy, interest rate unrest, residual supply chain complications stemming from the pandemic and potentially burdensome climate change-related regulatory requirements, insurer market exits present financial institutions with just one more challenge on the multi-front war they call doing daily business. It may not be time to panic yet, but financial institutions — no matter their location — should prepare to add the lack of assurance in insurance to their growing catalogue of emerging risks.

Elisabeth A. Wilson, operational risk manager, leads the environmental, social, and governance risk framework at Atlantic Union Bank, a $20 billion regional bank based in Richmond, Virginia. She has contributed to The RMA Journal, Risk Management Magazine and American Banker. All views expressed in this article are her own and do not represent the opinions of any entity that she may be associated with.