October 10, 2024 | We are in Washington, DC, this week for mortgage industry meetings, but watching events in Florida has dominated many discussions. For the housing sector in Florida, Hurricane Milton simply adds to a situation where insurance rates are either soaring or coverage is unavailable at any price. Washington is engaged on the issue of flood insurance, but the larger need is to focus on providing basic property casualty coverage for homeowners.
"This is a monster mess in Florida," says David Kotok, Chief Investment officer of Cumberland Advisors in Sarasota. "I am getting constant calls from clients about losses in Florida. This is a multi, multi billion dollar loss event. I have never seen a loss event this big in Florida. The risk and potential losses to banks and other financial institutions is massive."
Jonathan Miller of Miller Samuel made three key points about this latest storm event in a comment yesterday:
2024 Is Shaping Up To Be The Most Expensive Year For US Disaster Clean-Up
The Frequency and Intensity Of Natural Disasters Is Ramping Up
The Cost and Availability Of Insurance Will Have A Profound Impact on Housing
Jon's last bullet is already a big problem for residential real estate in Florida and other flood-prone states. Many homes in Florida no longer have adequate home owners insurance much less federal flood insurance. Many homes in Florida not in "flood prone areas" had no floor insurance.
The State of Florida, through the Citizens Property Insurance Corp., is the largest insurance company in Florida. Styled as an "insurer of last resort," Citizens has an 18.5% market share and appears insolvent due to hundreds of thousands of policies in the area of the state most exposed to the latest storm.
“The state-backed entity is now so large that it stands in the way of a healthy and effective insurance marketplace,” notes Jonathan Levin of Bloomberg. “It issues policies at below the actuarially appropriate rates, thus curbing private insurers’ ability to properly price risk. It also introduces moral hazard by allowing homeowners to assume too much risk, potentially putting more people in harm’s way than there otherwise would be.”
As the state-owned insurer Citizens has been taking up market share at below-market rates, private carriers are fleeing the state. The Citizens situation is a major problem for Florida Governor Ron DeSantis, who like lawmakers in Washington pondering increased fiscal support for flood insurance is unwilling to cut-off homeowners in Florida from home insurance. Meanwhile, desperate subprime and even prime insurance carriers, seeing a wall of claims and litigation in Florida, have been denying claims, even where policies should cover storm-related damage.
“Homeowners insurance is labeled as one of the hidden costs for property owners, and their escalating prices could have an impact on the secondary and capital markets, in terms of loan salability and performance,” reports Brad Finkelstein of National Mortgage News. But what happens to the value of the home on Florida if the homeowner cannot get insurance at a reasonable price? We believe that Florida Governor DeSantis will be looking for a bailout from Washington to prevent the collapse of the state home insurance carrier.
Loans in conventional and government insured mortgage securities must have home owners insurance. Back in May, Fannie Mae and Freddie Mac jointly created a blog post on explaining their home insurance requirements, which call for a replacement cost value policy, rather than the alternative, for actual cash value. The requirement for replacement cost protection covers the value of the securities that finance the mortgage, securities guaranteed by the GSEs. What is fascinating about “replacement cost” is that inflation in the cost of labor and materials over the past decade has greatly increased the replacement value of homes and commercial properties.
In order for lenders to meet the replacement cost value criteria of Fannie Mae and Freddie Mac, or private investors, means getting insurance coverage that may no longer exist in the Florida market. As appraised values of homes have risen due to inflation, the willingness of insurers to cover replacement value has waned because of the elevated risk of storm damage. Commercial insurance costs for Florida condominiums, for example, have been rising faster than inflation for a decade.
Many attribute the rising scale of hurricane damage to global warming. But the more immediate and obvious explanation is the vast increase in population in coastal areas of the Southeastern US. When a hurricane hits Tampa or the Carolinas or coastal New York, the number of people and households effected is far greater than a century ago. The density of coastal communities and the rising cost of homes and replacing damaged structures is a huge issue for the housing industry. And federal flood insurance, which is eagerly supported by home builders, encourages further home building in flood prone areas.
Meanwhile, even as the impact of climate change and the increased loss severity from storms on residential housing holds the public’s attention, the impact of changing use patterns and also weather events is causing perverse and dangerous changes in insurance coverage for commercial properties. Falling property values, for example, are causing insurers to reduce coverage on buildings based upon current market value vs replacement value. And the loans that finance these buildings are often found in commercial mortgage backed securities (CMBS).
“There is a non-climate reason for insurers to reduce commercial property coverage, especially for major-city office buildings,” opines Nom de Plumber. “As office properties continue to drop in value for non-climate reasons (amid higher interest rates and operating costs, plus post-Covid tenant vacancies and lower rents), insurers are considering material reductions in coverage amounts, potentially leaving the outstanding property loans insufficiently covered for casualty loss. That itself is an initial risk.”
Falling valuations for commercial properties based upon local conditions are only the start of a frightening feedback loop of deflation, NDP worries:
“We could see as a compound risk, office properties may hence become extra-exposed to climate physical losses, adversely impacting the interest-only, premium-coupon, or subordinate CMBS bond tranches which contain them, especially in Single-Borrower/Single-Asset CMBS. Insurance coverage reduction has feedback loop to valuations,” he adds. “Hard to reverse the loop direction.”
Bottom line for investors and policy makers is that severe weather events and other factors such as declining utilization of commercial properties are creating big risks for public and private investors. The federal flood insurance scheme is already insolvent and must be bailed-out by Congress. But the bigger issue is that risks to residential and commercial property owners in states like Florida may not be commercially viable as insurance.
“Floridian homeowners with property insurance claims were over than nine times more likely to sue their insurance companies than elsewhere in the country,” wrote John Dizard in Substack last year. “Were Florida insurance companies nine times more tight-fisted and evil than other insurance companies in the U.S.?” He continues in a prescient article:
“A fair number of homeowners will have extreme difficulty finding affordable property insurance. No home-owners insurance means no access to mortgage financing supported by the US government’s housing agencies. This is a real wake-up from the Florida Dream. Reasonable people might say this set of problems was not created by Governor DeSantis, but he happens to be Governor right now, this year and next year, when the reckoning is coming due.”
The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.
Comments