Higher Housing And Insurance Costs Could Constrain Economic Growth And Weigh On Government Credit

Why it matters:  By 2022, more than 55% of households earning the median income or lower were spending over 30% of disposal income on housing costs (also known as housing burdened), according to the U.S. Census Bureau's American Community Survey data. Existing affordability challenges are amplified when combined with costs from increasingly frequent and damaging storms and flooding. And weaker economic growth and property value decreases could occur in the long term without offsetting tax-base growth. This confluence of events could lead to a downward credit trend for some U.S. governments.

What we think and why:   When higher insurance premiums compound existing housing affordability problems, it can affect location and purchase decisions for homebuyers and employers. If these conditions persist, it could lead to lower taxable property values, affecting local government revenues and long-term growth. Playing catch-up to replace losses keeps governments from pursuing new economic growth and can affect long-term financial stability.

Insurers' Cost Recovery Typically Results In Higher Underwriting Actions

The rising trend of global economic losses from climate hazards averaged almost $333 billion annually from 2013 to 2023 (see chart 1).   Insurers' relatively high credit quality is supported by decisions to limit losses and exit unprofitable businesses in response to extreme weather-related events. Economic and population growth, as well as claims inflation, are the main drivers of this trend, while climate change contributes to the volatility of both event frequency and severity. (See "Insurers Focus On Underwriting To Tackle Climate Risk," published Sept. 10, 2024, on RatingsDirect.)

Reinsurance costs for insurers also contribute to higher premiums.   During the Jan. 1 to July 1, 2023, renewal period, property catastrophe reinsurers raised rates in the U.S. by 20%-50%, according to reinsurance broker Guy Carpenter & Co. Since insurers pass these costs along to policyholders (to the extent allowed by state regulators), premiums continue to rise. As insured losses mount, rising homeowner premiums cause housing affordability to fall.

Chart 1

Existing Home Affordability Challenges Are Exacerbated By Costlier Insurance

Housing affordability is decreasing in many places in the U.S., even before accounting for the cost of insurance.   The median U.S. home price reached 5.5x the median household income in 2022--the highest level since the 1960s. Since 2022, affordability has eased slightly in some places, but the long-term trend points to a growing challenge for state and local governments. A prolonged trend could affect revenue-generating capacity and economic growth, both key factors for government creditworthiness.

The affordability challenge is particularly visible in urban counties and coastal areas, where the proportion of households spending more than 30% of their income on housing can exceed 50% (see chart 2). Some of these areas overlap with states where homeowners' insurance premiums have increased the fastest in the past year, including Arizona, Illinois, Texas, and Utah.

Chart 2

Rising insurance premiums can also create a long-term drag on home prices.   In the near term, higher premiums can make it more difficult for middle- and lower-income households to afford housing, particularly in already high-priced areas. (See "The Impact Of Rising Insurance Premiums On U.S. Housing," published April 22, 2024.)

Chart 3

In some states, average homeowners' premiums written by the top 10 insurers increased by more than 50% between 2019 and 2024 (see chart 4).   In states where insurance rates are increasing rapidly and median home price-to-income ratios are well above the national average, we could begin seeing affordability constrain growth in property values and affect households' choices about where and what to buy. Furthermore, a lack of affordable housing can affect employers' ability to attract and retain workers, and local governments' ability to sustain economic activity and increase their populations over time.

Chart 4

U.S. States May Fill The Gap Left By Private Insurance

As insurers change coverage and availability, the financial implications for states who support residents through insurance-of-last-resort programs are growing.

States can implement support mechanisms, including reinsurance programs or state-sponsored insurers of last resort, to support homeowners unable to obtain insurance.   As part of the 1968 Civil Rights Act, Congress created the Fair Access to Insurance Requirements (FAIR) program to provide a vehicle for homeowners experiencing discrimination or living in high-crime areas to purchase insurance. Initially 26 states adopted such programs and, in the decades since, other states have joined (see chart 5). Furthermore, many states expanded coverage to help homeowners and corporations get insurance even in high-risk areas exposed to physical risks from hurricanes, wildfires, or tornadoes.

Chart 5

Credit risk to U.S. states is twofold if insurers exposed to costly claims from residents and businesses raise premiums or cease operations in high-risk areas.   Recovering from a disaster, or replenishing reserves for insurance programs of last resort, can take resources and funds away from other priorities, such as pensions, Medicaid programs, and infrastructure investment. Frequent and recurring exposure to storm events, coupled with rising insurance rates, could cause economic growth to stagnate or decline, particularly if insurance premiums become a heavy burden on taxpayers, or if states have to increase assessments to fund statewide insurance. Slowing demographic growth could lead to limited economic expansion and dampen revenue trends or reduce revenue-raising options. Although these trends might not immediately affect U.S. state credit quality, in the long term, it could be an indirect driver of lower ratings.

Affordability Considerations Can Influence Our Credit Analysis

It can be difficult to predict how, where, and when affordability considerations might develop, the severity and distribution of their effects, or how and when creditworthiness might be affected. However, several aspects of our analysis can affect our view of the financial health and stability of U.S. governments' annual expenditures and balance sheets (see chart 6).

To effectively incorporate these factors, our analysis considers the additional costs and liabilities to offer insurance of last resort where private insurance is costly or unavailable for residents. Our view of debt and liabilities can also be informed by investments in adaptation and resilient infrastructure to manage vulnerability to physical climate risks, resulting in a higher debt load over time. Finally, our forward-looking view of gross state or gross county product could reflect dampening tax-base or population trends.

Chart 6

Proactive Preparation And Climate Adaptation Investments Could Keep Insurance Premiums In Check

Highly experienced management teams across the U.S. typically use a variety of techniques to reduce the potential for operational, economic, and financial impacts of acute physical risk events.   If an issuer's strategy to manage physical risk exposure succeeds in reducing insured losses following a disaster, it could help to stem future increases in insurance premiums.

Consistent with our criteria for analyzing U.S. governments and not-for-profit enterprises, we consider how issuers' risk-management practices might offset exposure to physical risks. In our view, robust disclosure of evolving risks and integration of climate and physical risks into financial and capital planning could reduce governments' vulnerability to those risks. This could take the form of investments in infrastructure hardening, integrating climate resilience into building and development codes, emergency plans that consider a forward-looking view of hazards rather than just focusing on historical events, and bolstering reserves to cover initial costs following an acute weather event.

Chart 7

Rising Insurance Costs Can Weigh On Home Values And Dampen Long-Term Growth

In recent years, the ability to own a home has become increasingly out of reach for many Americans, given rapidly rising prices and higher mortgage rates.   The ongoing growth in insurance premiums only exacerbates the problem for local governments, because without tax-base expansion resulting from a strong housing and commercial property market, economic growth prospects could be limited and revenue generated by property taxes is constrained.

Homeowners' insurance premiums will continue increasing, particularly in places where insurers are grappling with escalating losses from severe weather events.   In states where insurers are unable to achieve underwriting profitability, homeowners could have difficulty securing private coverage altogether (see "Record Weather-Related Losses Hit U.S. Homeowners Insurers And Pose Challenges In Estimating Catastrophe Risk Charges," published Sept. 3, 2024). Rising rates of participation in state-sponsored FAIR plans in states like California and Florida indicate this is already occurring. For some U.S. states, if they are the last insurer standing, they may face a choice between maintaining their own balance sheets or ensuring the financial and economic stability of their residents and local governments.

Olivia Fellbaum, James Patterson, and Robbie Whelan contributed research for this report.

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• Sustainability Insights: Insurers Focus On Underwriting To Tackle Climate Change, Sept. 10, 2024
• Sustainability Insights Research: No Quick Fix For the U.S. Affordable Housing Shortage, Aug. 21, 2024
• Sustainbility Insights Research: Navigating Uncertainty: U.S. Governments And Physical Climate Risks, April 23, 2024
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