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Dan Loney: Well, as the battle against the
California wildfires continues, the question of rebuilding all
of those lost homes and
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buildings will become a very
important one. And part of that issue ahead involves the
insurance industry. Some
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companies had canceled policies
due to the threat of natural disaster, and there's also a
greater concern about further
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pull outs in the state. Now it
won't happen, at least in the short term, because the state's
Insurance Commissioner put in
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place a one year moratorium from
pulling out of the state. Nonetheless, still lots of
questions involving the
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insurance industry in the state
of California. Ben Keys is a Professor of Real Estate here at
the Wharton School, and he joins
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me right now. Ben, great to talk
to you again. How are you? Ben Keys: I'm doing well. Dan, thank you
so much for having me. And I
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want to say right at the outset,
my thoughts and condolences are with everyone in Southern
California dealing with the
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incredible challenges from these
wildfires. And obviously the component of
what's been going on in and around
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the insurance industry becomes
very, very much a huge talking point, especially when you think
about what could potentially be
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the rebuild of this area in the
future. Well, that's right. The backdrop for
these wildfires is an insurance
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market that was already in
turmoil. This is a market that has seen an enormous amount of
distress over the last few
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years, with— with climate change
inducing ever more frequent and severe disasters. Dealing with
issues around inflation, rising
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cost of materials and labor. And
then rising cost of capital. Going from a low interest rate
world to a not low interest rate
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world has shaken up these types
of insurance and reinsurance companies. And so we've seen
insurers sharply increase their
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premiums in risky areas, and my
research has been focused on that. And now the question
becomes, okay, after a sizable
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disaster like this one, what is the path of
recovery going to look like? All right, so let me ask you
that question. What is the
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potential path of recovery at
this point? Well, I think there are a lot of
incentives that drive local
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policymakers to attempt to
rebuild in the same location. There's a desire among local
municipal governments to rebuild
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their tax base. And there's sort
of the— the warm and fuzzy feelings that we get in saying
that we've rebuilt bigger—
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bigger and better in the same
location. But we know that that's not often the right
strategy, and it's likely that
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we'll rebuild with higher
quality materials and more durable materials. But, you know,
I think in terms of wildfires,
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there's a playbook in terms of
wildfire prevention. And one of the key elements of that
playbook is keeping a buffer
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zone between that wild land-
urban interface. And so, you know, I think there are going to
be a lot of local pressures to
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want to rebuild in the exact
same locations. But I think we can learn some lessons from it
and rebuild in a smarter way
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that increases density in some
of the safer locations and create some buffer zones elsewhere.
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I guess it's interesting,
because when you think about the state of California, I guess we
saw this a little bit with the
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wildfires in the northern part
of the state the last couple of years— is that it just has been
a sprawl. It's been a spread out
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of how builders have thought
about and where they have thought about putting homes in
the state of California.
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That's right, it's all connected.
When we think about land use policies over the last few
decades, those policies have
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encouraged building in the
suburbs and in the exurbs. We've seen cities blocking increased
densification. We've seen inner
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ring suburbs deciding,
"Hey, we're all full up." We've imposed strict lot size
requirements and things like
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that. And what that does is, it
pushes developers further and further away from the city
centers and into the areas that
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are most wildfire prone. And so
this is— a big challenge going forward is, you know, in an
environment where we're going to
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see more frequent fires, how can
we encourage development in those denser, safer locations,
and try to steer clear of some
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of the riskiest spots? So you also, I guess, when you're
thinking about policy, and you
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think about housing policy,
don't you also have to look at the types of homes that may be
built or how they are
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constructed as you move forward?
Obviously, some of the homes, especially the ones along the
water, are basically one level.
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You know, do you— you know, from
what I understand, the policy has been to build out and not
up. And so maybe that changes in
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the mindset of how you think
about building as well. Yeah. And it's hard, sort
of in the— in the immediacy of
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these fires, to just kind of
think through what some of these neighborhoods could look like
going forward. But what I think
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part of this is— again, being
strategic about, you know, where should we build in a way that's
more dense, and that allows people
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to return to their communities,
broadly defined, and where can we avoid some of the
riskiest things? But there's
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also another layer of wildfire
prevention that I think is that sort of last mile of prevention
that it is hard to do when it
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comes to removing all the
landscaping around properties. People need to give up their
yard. Roads and shrubbery need
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to be, you know, cleared in a
way that's just not very appealing to the eye. And so
there is a sense in which there
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is something we're going to have
to give up going forward if we want to really harden
communities against wildfires.
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So let's look at this from from
first the consumers' perspective, the homeowners' perspective. How,
then, should they think about the
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idea of insurance, especially if
they are in an area that is susceptible to these types of
events?
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Yeah, I think this is
the tension that— that these markets are facing right now,
which is that insurance
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companies are recognizing the
risks. They've been very clear- eyed about climate change for a
long time, and the effect that
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that has on their balance sheet.
And so that is going to lead to higher premiums in risky areas.
And that's what my research has
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borne out. Over these last few
years, insurers have sharply increased the ways in which they
price disaster risk, and so
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living in a risky area has
gotten much more expensive. We should expect that it will
continue to get more expensive
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as the path of climate change
continues. And so I think this is going to be the challenge for
households. It's going to be one
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of affordability struggles. Is
it affordable to purchase insurance to live in these
areas? Now, on the flip side, we
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should anticipate that insurance
premiums will be capitalized into house prices. So
ultimately, the value of the
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asset should decline, to sort
of, quote, unquote, "compensate" for— for those rising costs. But
regardless, the position that
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homeowners are going to be in is
one of substantially higher premium. What needs to be done then from
the regulatory side to kind of
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bring both the homeowner and the
insurance industry to a point where both sides can feel it to
be palatable?
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And this is the tension for
state regulators. Insurance is regulated at the state level,
and so we have 50 different
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regulatory entities that
regulate this market across this country. And they're all
grappling with this issue at the
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moment, this tension between
access and affordability. For the states where they've been
more tightly regulated in the
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past, giving insurers less
discretion in setting premiums, insurers have simply left.
They've said, "We don't want to
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operate in these locations." And
insurers are extremely mobile and— and they write annual
contracts. And so they can
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readjust their risk profile
quite quickly. But we should recognize that homeowners and
and policymakers are operating
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on a very different time scale.
They're thinking about living in their house for the rest of
their lives, essentially. - Yeah.
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So there's a real tension there,
and I think this is going to be where policymakers will— will
have to collaborate with the
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industry and with researchers to
think about both considering ways to both keep sending price
signals to markets saying, "This
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is a risky place to live and a
risky place to develop," but also find ways to support the lowest
income homeowners in our
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communities who might not have
that flexibility if the premiums rise. When you have a disaster this
size— and obviously we've had a
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couple very large ones in the— in
the last several months, when you think about the hurricanes
that came through and obviously
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impacted portions of North
Carolina, what does that mean for insurance prices in general?
Because these— you're talking
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about companies that are
obviously in so many of these states that I would assume there
has to be a downstream impact on
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insurance prices in general, as
well as the region where the disaster occurred. It's especially hard because
2025 was anticipated to be a
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year where insurance markets
were going to normalize a bit, where we weren't going to see
the sharp increases that we've
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seen in the last few years. And
instead, these waves of disasters, hurricanes Helene and
Milton and now these awful
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wildfires, are driving up the
costs for the insurance and reinsurance industries, and
they're going to have to take
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that into consideration as they
go forward. To your point, there's an open question as to
how much of these costs are
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being spread more broadly across
the country. So imagine a national insurer who operates
across a lot of different
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states. They might see these
losses in California. Can they pass those costs on to the rest
of the country? I think it's a
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little bit unclear. We know that
more regulated states are generally more affordable than
than less regulated states, but
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in terms of, you know, a direct
mechanism across those states, it's challenging. You do have
local providers in most states
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who potentially can— can
undercut in terms of the pricing. So if a national
insurer said, "Hey. You know,
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we know that you're in Iowa, but
these wildfires in California have— have increased our costs.
So we want to drive up your
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premium," you could go find a
local operator who doesn't have that exposure and shop around.
So I think you know, teasing—
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teasing out exactly that
mechanism is challenging. How does this also potentially
impact the business side? I
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mean, so many businesses in this
region as well, who have their businesses insured,
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obviously will feel an
impact from this as well. The business side is— is, I
think, the under-studied and
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underappreciated aspect of this.
Insuring commercial property, the market is— is quite a bit less
liquid. There are fewer players
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in that space, and there's been
less regulatory support. There's been less effort among
policymakers to make, you know,
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the lives of the business
community easier when it comes to finding affordable insurance.
Whereas, you know, for
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homeowners, these state insurers
of last resort have been more— more generous and more
accessible. So I think on the
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business side, there's a real
challenge there. And certainly we're hearing about this in the
context of housing
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affordability, because this is
going to drive up the cost of developing new apartment
buildings, for instance. And
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we've heard stories of
multifamily developers saying, "We couldn't get this project going
because we couldn't find
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affordable insurance for it." And
so all of these— these issues become interconnected in the
same way. We have the climate
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crisis interactive with an
affordability crisis. What do you take from this
unfortunate instance, in terms of
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where we are, but where we need
to go in terms of our thought process around insurance?
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I think it's a great question.
There's no doubt that— that policymakers and— and homeowners
more generally, are— are way
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behind relative to how quickly
the climate is changing, how rapidly we're seeing more severe
disasters, and just how
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seriously we need to take these
changes going forward, if they continue on the trajectory
that's forecast. I think of
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insurance as being very— very
clear-eyed when it comes to these risks. And we should be
all taking signals from the
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market, that they're telling us
that these are riskier places to live in. And that means that we
should— we should react
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accordingly. That means that we
should invest in being more resilient, home hardening
efforts and community hardening
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efforts, whether that's for
floods or wildfires or otherwise. It means we should
rethink where we're developing,
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to your point earlier. Where are
we putting the new buildings that are going to be there for
50 or— or 75 years? And we should
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be thinking about the most
vulnerable communities and thinking about ways to bring
together, I would say,
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policymakers and the industry
and researchers to shed more light on these risks and give
people some sort of toolkit in
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order to defray some of these
challenges and help them re-optimize. Ben, great to talk to you, and
thanks again for your insight.
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All the best.
- Yeah, thanks so much for having me, Dan.
- Thank you. Ben Keys, who's a Professor
of Real Estate here at
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the Wharton School.