If climate change intensifies, there’s a trend that is going to solidify and gain strength; insurance premiums are rising to cover the increasing costs of natural disasters. Many homeowners are underinsured, and state-backed insurers are struggling to meet the growing demand. The market is grappling with adapting to these changes, and accurately pricing climate risk is essential.

According to the NOAA, National Oceanic and Atmospheric Administration, a record 28 weather disasters in the US last year caused $1 billion or more in damage. This year, the country is on track to match or exceed this number, with 15 such events already recorded, not including Hurricane Beryl, which may have caused $30 billion in damage. Globally, the cost of natural disasters has surpassed $120 billion this year, with only $62 billion covered by insurance, a figure 70% higher than the long-term average. Most of this damage occurred in the US and was borne by homeowners.

In response to these catastrophes, insurers have been raising premiums to cover the rising costs of rebuilding and purchasing their own insurance through companies like Munich Re. Homeowners insurance premiums in the US rose by 11% on average in 2023, according to S&P Global Market Intelligence, and have increased by more than a third in the past five years. In states at the forefront of climate change, such as California, Florida, and Texas, these increases have been even more significant.

However, premiums still do not adequately reflect the risk of climate-fueled disasters, which is increasing as the planet warms. The climate-risk research firm First Street Foundation estimated that nearly half of all single-family homes in the US are underinsured against natural disasters, including 6.8 million relying on state-backed insurers of last resort.

Using a hypothetical California home, First Street demonstrated that insurance costs can be significantly divorced from reality. If a homeowner started with a $2,000 annual premium in 2010 and it increased by 7% annually—the maximum allowed by the state—the premium would have reached $4,820 in 2023. Yet, this would still be $2,900 less than what the price should be to accurately reflect the risk, considering factors such as climate change, inflation, and reinsurance.

It is no wonder that insurance companies are increasingly withdrawing from high-risk areas like California, Florida, and others, leaving homeowners to rely on state insurers of last resort. These policies are often expensive and inadequate, with providers at risk of insolvency. For example, California’s FAIR plan faced potential losses of $311 billion, and Florida’s Citizens Property Insurance Corp. faced a possible $525 billion hit. The federal National Flood Insurance Program, the largest flood insurer in the US, consistently loses money.

To address this issue, it is crucial to accurately price climate risk, as the NFIP has begun to do by moving away from outdated flood maps. This would prevent the subsidization of building and rebuilding in areas most vulnerable to extreme weather. However, implementing this change all at once could lead to sudden and significant price discovery in the housing market, potentially resulting in losses of $1.2 trillion as predicted by Burt.

Finding a balanced approach is essential, discouraging settlement in high-risk areas while avoiding economic disaster. As homeowners in California and Florida can attest, disasters often strike when least expected, with unexpected magnitude.