Monday, July 03, 2006
Question for our readers: Climate change and the insurance of coastal real estate
I have a couple of beliefs -- I say "beliefs" because I cannot prove them -- that I am having a hard time reconciling. I could use some help, especially from environmentalists who understand casualty insurance and financial markets.
My first belief is that financial markets (including the market for insurance, which is really a form of financial instrument) do an excellent job of assigning values to contingent risks. The collective wisdom of thousands of pricing decisions seems to produce better predictions than any one person or panel of experts. The principle is so sound that it can be extended to risks that are not financial in the least. This is the logic behind the Iowa Electronic Markets, which support the trading of "futures contracts" to predict election results.
My second belief is that there is at least some risk that we are on the verge of a significant change in the global climate that may result in, among other consequences, a material increase in sea level. To be clear, I am not persuaded that sea levels are destined to rise dramatically, but I it is hard to argue that there is no chance that they will.
Now, apart from the obvious burdens (think of all the "Altitude" signs that will have to be revised by a couple of feet), rising sea levels will disrupt modern patterns of human settlement with potentially catastrophic human suffering in poor countries in particular. In rich countries, a lot of beachfront property will disappear or become too dangerous to be used for residences.
With all of this nonsense swirling around in my head, I found myself shooting the breeze with a veteran banker at a cocktail party last night. We got to talking about the ready availability of 30-year mortgages to finance the purchase of coastal property. I wondered why such mortgages did not come at a higher cost to reflect the risk that the security for the loan would be wiped out. The banker observed that the property needs to be insured to secure a mortgage loan, so the mortgagee is not bearing any incremental risk. Also, the originator of the mortgage packages it up and sells it off, and the resulting pool is also insured. So if sea levels rise and property gets wiped out, neither loan originators nor the owners of mortgage-backed securities will take the hit.
Insurance companies and their reinsurers, however, will take a bath. As it were.
The first question is, is there anything wrong with this reasoning? The second question is, does anybody out there know whether insurance companies are actually pricing the risk of rising sea levels into their long-tail property insurance policies?
Speculation alert: The left is increasingly using the mechanisms of corporate governance to make political statements (see, for instance, the absurd and disingenuous "stockholders proposals" offered at the annual meetings of the largest public companies). How long do you think it will take before climate change activists agitate for property and casualty companies to disclose the actuarial assumptions behind underwriting liability they have assumed for coastal real estate? When they do, how will those companies respond?
Fire away.
17 Comments:
By 
, at
Mon Jul 03, 07:22:00 AM:
Does normal mortgage insurance cover eroding land or encroaching sea water.
By 
Gordon Smith, at
Mon Jul 03, 08:25:00 AM:
First of all, it's funny that you have to add a disclaimer to your post (I am not persuaded that sea levels are destined to rise dramatically) to assuage the anti-science readers in your fold. Anyone who's not preparing for global climate change is a fool. If it doesn't happen, then no one will be the worse for preparing.
Insurance companies will simply refuse to pay massive numbers of claims. They will declare bankruptcy and leave those homeowners without Al Gore's foresight to commune with the fishes.
By , at
Mon Jul 03, 10:31:00 AM:
We got to talking about the ready availability of 30-year mortgages to finance the purchase of coastal property. I wondered why such mortgages did not come at a higher cost to reflect the risk that the security for the loan would be wiped out. The banker observed that the property needs to be insured to secure a mortgage loan, so the mortgagee is not bearing any incremental risk.
It's always bothered me that lenders do not share in the casualty risk on any given property. The borrower and insurer end up holding the bag. My lender doesn't care that the nearest fire house is 5 miles away and that there are no hydrants. My insurer assured me that my rate assumes that the volunteer fire company will arrive in time to cool the ashes.
However, for the most part, the system seems to work. Hold on to a property long enough and the lender falls out of the equation. Now, it's just you and the insurer.
As for rising water levels, don't forget that is a flood and is not covered by homeowners insurance. Federally backed flood insurance, if purchased, covers that. Looking at all the properties destroyed and rebuilt in the same place, leads me to conclude that the NFIP isn't cognizant of climatic or oceangraphic change. At least the new places are better built.
Someday we'll learn not to built on shifting sands. But as long as their is incentive to do so, nothing will change.
By Dylan, at
Mon Jul 03, 10:36:00 AM:
Private insurers will not raise prices for global warming risk for several reasons.
1. Many coastal areas already cannot be insured at "acceptable" market rates just because of hurricane risk. The government steps in with subsidized coverage. If insurers tried to price in rising sea levels, people would bitch and get a government guarantee for their property.
2. Insurers to the best of my knowledge NEVER offer flood insurance. It's too unpredictable and the losses when it happens are just too huge. All flood insurance is federal. Note that virtually all hurricane coverage will mention this in some way, that private insurers will only pay for wind damage that results from a hurricane, not flooding that is solely a result of storm surge or heavy rain.
3. Even if they ever insured this type of damage, I don't think anyone is proposing a 1 foot increase in sea levels in 6 months. Anything less than that is nothing for insurers to worry about, because policies run for a year and can be cancelled if the sea level is obviously rising. It rose half an inch in 2007, three quarters in 2008, and one and a quarter in 2009? Then there will be no (mythical) flood insurance to be had at any price in 2010.
By , at
Mon Jul 03, 11:19:00 AM:
Bingo. The answer is that flood insurance is underwritten by the government. So we're all going to pay for it.
For more of this fun, see here
By , at
Mon Jul 03, 12:22:00 PM:
First, being an "environmentalist" is not someone well versed in earth sciences. Environmentalism is a cult.
Second, lenders will lend whenever their interests can be protected adequately with insurance (property insurance, default insurance, title insurance, etc.)
Third, the insurers try to take as objective a look at the risks involved, but there still is some subjectivity to the process. Insurance contracts that protect against weather phenomena are based on past experience, i.e., "experience rated." So, if insurers have paid out higher than expected claims on losses you can expect future premium rates to rise. BTW, "higher than expected losses" means that the insurers underestimated the premium in the previous insuring period.
Fourth, not all risks are insurable by PRIVATE insurers; in property insurance, uninsurable risks include war,flood, nuclear energy release, and the acts of governments, just to name a few.
Fifth,some uninsurable risks can be underwritten if all players, i.e., the tax payers, are required to participate. Flood is one of those risks, nuclear energy release is another. The Social Security System embodies yet another set of risks in which all players (or almost all) are required to play -- and pay.
So, Tiger, the insurance markets have some long experience in the kinds of risks you concern yourself with. What happens next will depend on what new information becomes available, but don't expect environmentalists to make much of a contribution.
By GreenmanTim, at
Mon Jul 03, 02:50:00 PM:
Conservationists have been planning for sea level rise, including the inland migration of coastal wetlands. An armored coastline, while delaying the loss of private property, not only is a hard barrier to such inland migration but also wipes out the public's rights of beach access (in most states) below mean high water. It is for this latter reason that Texas, a state not generally regarded as in the progressive forefront of the conservation movement, adopted the concept of a rolling easement that is triggered by a set rise in sea level and after which private property owners cannot hold back the sea. There is a fellow at EPA named James Titus who is an asoundingly entertaining public speaker as well as an expert on this subject. You can find more information at
http://yosemite.epa.gov/oar/globalwarming.nsf/content/ResourceCenterPublicationsSLRTakings.html
By , at
Mon Jul 03, 04:09:00 PM:
I just went out and checked the beach. Yup! Sea level has risen at least four feet over the past several hours. Things are looking very ominous here on the coast. Come to think of it, sea levels rose about the same amount yesterday over a period of hours.
This is turning into a frinking disaster! Wait a minute. Sea levels went down again by about the same amount after several hours more. Kind of cyclic like. Kind of like the seasons, or how climate naturally changes from cooling to warming to cooling again. Gosh, no wonder insurance companies aren't panicking like some bloggers I know.
By Lanky_Bastard, at
Mon Jul 03, 07:24:00 PM:
We use a lot of energy on this planet, but it's nothing compared to what the sun gives us. The global energy usage of 2005 amounts to what we get from 42 minutes of sunshine. The sun is enormously powerful.
But we have 30,000 cubic kilometers of ice on this planet, and in energy terms, that adds up too. It would take about 20 months of the sun's dedicated energy to melt the ice, and even in the worse case scenario only a small fraction of the sun's energy will go into melting ice. Most energy will still be radiated back out to space and even the accumulation terms will be slowed by increases in the sensible heat, of the land and ocean.
The point is, it takes a long time for an Ice Age to come or go, even with atmospheric changes, 30 years might not be the right time scale. It takes a long time for a watched pot to boil (though scientifically, the answer is not "never"). When the pot is the size of the entire Earth, effects take a long, long time. If geological effects are ever reduced from a geological timescale to a human lifespan, it's probably way too late to do anything about it anyway.
By , at
Mon Jul 03, 07:28:00 PM:
Are you all blind? This is a calculated move of the Bush administration. Bush is causing global warming. When coastal areas flood, Halliburton will get no bit contracts to build sea walls. Follow the money!
By Assistant Village Idiot, at
Mon Jul 03, 07:28:00 PM:
But Maggie! Last winter wasn't like any winter before! And the one before that was also unusual! And the one before that, unusual in a different way!
It's this darn global warming. Hot in the summer, cold in the winter, and who knows what to expect in the spring and fall...
By Gordon Smith, at
Mon Jul 03, 08:50:00 PM:
It's astonishing to hear people (some of the commenters here) tut-tutting the idea that sea levels are on the rise due to global warming. Are these the same people who are willing to stake our Constitution on defeating a few thousand guys called terrorists?
You're willing to dismiss what thousands of scientists agree upon despite the notion that, if those thousands of peer-reviewed scientists are correct, we're going to undergo a series of calamities to make 9/11 look like a bad day at the rodeo. Conservative how? I must be missing something.
----------
GreenmanTim, thanks for the info about Texas. That's some very informative stuff. It's good to know that some legislators are acting responsibly to deal with the gathering danger.
By GreenmanTim, at
Mon Jul 03, 11:08:00 PM:
TH kindly linked to two posts of mine around Memorial Day in which I discussed the challenges of keeping an extraordinary Massachusetts waterfront property in the family. The conservation easement of which we are negotiating the sale to enable the family to keep the land intact for future generations also takes sea level rise into account. There is a floating building envelope proposed for the easement in which the old Victorian house near the bluff could be relocated, or the barn back in the woods renovated as the primary residence, should increased hurricane activity, erosion and sea level rise alter the status quo. Otherwise, we could have unwittingly locked up the development rights without leaving an escape route to higher ground...
By TigerHawk, at
Tue Jul 04, 07:31:00 AM:
GT, that's pretty interesting. Smart stuff, too. Is that a common tactic?
By GreenmanTim, at
Tue Jul 04, 01:47:00 PM:
I suspect it will become more so, but most landowners contemplating placing a conservation easement on their land do not have the benefit of a conservation professional working on their behalf, such as I am for my family.
I know of one huge land deal the Nature Conservancy negotiated in California n the 1990s where the landowner turned the tables on the conservationists. It was ahuge ranch, and the owner negotiated a clause in the easement that if global climate change should alter the vegetation of his property such that its original, narrowly defined conservation purpose to protect the present day natural communities on the property no longer applied, then the easement would be extinguished. TNC, much to its subsequent regret, aggreed to the terms. We all know better now and the conservation purpose section of conservation easements is now routinely crafted in very general terms so that whatever natural communities exist on the land following climate change, they will be valid conservation targets.
By TigerHawk, at
Tue Jul 04, 02:22:00 PM:
Fascinating. I wonder whether the landowner reflected the diminished value of his contribution (by virtue of the weakened conservation easement) in the taking of his tax deduction. I'm guessing that he did not.
By Unknown, at
Tue Dec 04, 04:28:00 PM:
Speculation, in the narrow sense of using it as financial speculation, involves the buying, holding, selling, and short-selling of stocks, bonds, commodities, currencies, collectibles, sportsbook, real estate, derivatives, or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. Speculation or agiotage represents one of four market roles in Western financial markets, distinct from hedging, long- or short-term investing, and arbitrage. http://www.enterbet.com
