In recent years, wildfires, floods, and other extreme weather events have not only caused billions of dollars’ worth of damage to property and infrastructure, but also resulted in massive losses for insurance companies. In addition, they have significantly bumped up insurance premiums in many vulnerable areas. As real estate owners and investors look for strategies to understand and prepare for climate-change-related risks, insurers are studying ways to encourage policyholders to implement resilience measures to reduce risk. The solutions are complex and involve cooperation at both the public and private level.
ULI has partnered with the global real estate investment management firm Heitman, to research the relationships between climate risk and real estate. Two resulting reports, Climate Risk and Real Estate Investment Decision-Making and Climate Risk and Real Estate: Emerging Practices for Market Assessment, discuss ways that real estate investors are incorporating climate risks in their investment decision-making processes at the asset level and the market level, respectively.
“Investors want to know if the current level of investment in resilient infrastructure and current strategies within a building offer enough protection from climate risk,” says Lindsay Brugger, ULI vice president of urban resilience. “And they want to know, what is the ability of those structures to perform under future climate-change scenarios? That anticipated level of performance may forecast future insurance premiums.”
Insurers are increasing their premiums or pulling coverage from geographic areas that are particularly vulnerable to extreme weather events, increasing reliance on public insurance options, says Natalie Ambrosio Preudhomme, associate director at Moody’s Analytics CRE. State and federal backed insurance programs provide policies to many high-risk regions, often at a lower price than private insurers can offer. “This shifts the risk to the government and to taxpayers,” she adds. “Should taxpayers be funding the insurance of people or developers who decide to build in high-risk areas? There are a lot of conversations going on in the industry about this, and there are significant implications for long-term development and the viability of communities.”
Higher insurance premiums in areas subject to extreme weather can lower property values, Ambrosio Preudhomme notes, with a cascading effect: “Reduced property values can decrease mortgage values, and greater financial strain from premiums or disaster damage can increase risk of defaults on mortgages, which further threatens the market. Everyone counts on insurance as a financial safeguard, thinking ‘I have insurance, so I’m fine.’ But one lender I talked to mentioned that his company hardly considers insurance as a risk mitigant anymore. They’re trying to work resilience measures into the loan terms instead.”
All of these factors underline how important it is for the real estate industry to prepare for climate hazards, she adds. A study undertaken by the Federal Emergency Management Agency estimated that properties conforming to the International Codes, which include hazard-resistant design measures, avoided average annualized losses of $1.6 billion for post-2000 construction nationwide.
A developer or property owner may not be willing to invest in resilience strategies if they believe that a hazard event won’t occur during their holding period, Brugger notes, but “developers might be more willing to invest in resilience strategies if they know that they can keep their premiums at a certain rate by doing so, or they maintain availability of insurance, or at least avoid substantial spikes in premiums.” At least one insurer, FM Global, is providing a five percent reduction in its annual premium to encourage policyholders to implement resilience strategies.
More and more real estate investors are factoring climate risks into their decision-making process, she adds. “That said, the insurance industry and the real estate industry need to work together to shift from awareness to action and move the market.”
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