The Relocation Two-Step

Why investors are the audience to reach

Unless there is a dramatic public sector shift in the next few years, coastal relocations caused by sea level rise will not be planned, exactly, by any public institution. Instead, the insurance and banking industries will change the picture for coastal properties, with major consequences for communities as these changes ripple outward. 

In New Zealand, Belinda Storey, Managing Director at Climate Sigma and a member of the Expert Working Group whose report I wrote about a while ago, sees this clearly.

Most of New Zealand's population centers are right on its coasts and very close to sea level, which means those populations are highly exposed to sea level rise and the much higher storm surges increases in water levels will cause. She told Bloomberg News earlier this month that her country (like ours) is already seeing an "insurance retreat" that foreshadows the "managed retreat" that will be needed decades later.

In other words, insurance retreat in NZ (as in the US) is preceding by decades the permanent inundation of properties by sea level rise. "We've identified that there's a significant number of houses that are likely to lose insurance in the next 10 to 20 years" as private insurers exit markets, Storey said. 

As in the US, New Zealand insurers have annual or three-year contracts and can without warning withdraw coverage from properties before the expected losses on those properties render the business of covering them unprofitable. Sound familiar? Storey says insurers in NZ that now provide bundled all-hazards insurance will likely unbundle, dumping flood and wind insurance. 

As the US did 50 years ago in deciding to sell unbundled public flood insurance, the public sector in NZ is stepping in to provide public insurance to coastal properties. NZ’s rationale is the same as ours: having insurance available will keep property values up, speed up recovery following disasters, and protect the most vulnerable in society from falling into poverty as a result of catastrophic weather. 

This issue is so painful and difficult: these places actually are predictably unsafe, but instead of facing that fact and enacting policies that would get money and help to people who need assistance in relocating, NZ like the US prefers to keep the status quo in place. We’re keeping insurance “affordable and available” rather than just reducing the risk.

Nominally, this is done to protect poorer people, but it also allows many other structures to continue along without adjusting. As Storey wrote last year, "The only intervention that permanently reduces risk from sea level rise is managed retreat, however managed retreat continues to face fierce public opposition." 

The trouble is, Storey points out, these risks can't be shifted off the books of the NZ government: "If there is an extension of the [NZ] public mandate to provide public insurance when private insurers pull out, it's very unlikely that reinsurers are going to be wanting to pick up that risk," she says. Why? Because it's uneconomic for reinsurers to be sharing sea-level rise risks that are so highly correlated across the globe. These houses have a time limit on them, she thinks. She is implying that someday soon the public sector will not be able to, or will not politically want to, cover the risk itself, and the houses will “go bare.”

Where will change come from? Storey thinks that NZ's planning laws will not be reformed. Instead, banks are under pressure to "get a much better understanding of their risk" by the country's Task Force on Climate Related Financial Disclosures. Restrictions on this flooding risk (meaning, changes in land use) will come "through the banking sector," Storey says. Banks won't be willing to issue mortgages in the first place on physically risky places. That will definitely change the NZ market and cause financial types to wake up, with major consequences for the financial health of the country.

A similar two-step may happen here in the US. Step One: We'll broaden our public insurance, but it will cover less and less, and someday soon the public authorities providing that insurance (Louisiana, e.g.) will simply not have the money to pay claims. Or it will become politically unsustainable to continue pretending that it makes sense for people to believe they are insured, as disasters follow disasters and the costs of covering claims becomes more than astronomical. Step Two: At the same time, we'll require the banking industry to be clear-eyed about the risks of coastal living, and that will cause a sharp decline in property values—which will trigger people leaving/moving of their own accord. If they can afford it.

Here's Step One. The federal flood insurance program, NFIP, was reauthorized at the end of September, as Congress once more kicked the can down the road for the umpteeumpth time without being willing to grapple with the details. FEMA's mapping advisory committee is recommending that the number of households required to carry federal insurance for flood be greatly expanded, and enforcement of mandatory purchase requirements be much broader. Hoped-for result: the market signal that things aren't safe here will continue to be muted, but declines in property values will be smoothed by the presence of flood insurance. And politicians will continue to be supported by their anxious constituents.

Here's Step Two. Bank risk management in the US is being shored up. 

Earlier this week, later on the same day I wrote about physical climate risks threatening the viability of smaller banks, the FDIC issued nonbinding guidance saying that banks with $100 billion or more in assets should carefully manage those same risks. (This would cover the former SVB and Signature, but not community banks.)

In particular, FDIC instructs those banks and their boards to make sure they understand and manage their physical climate risks "across various scenarios and planning horizons, which may include those that extend beyond the financial institution's typical strategic planning horizon." The FDIC continues:

Tools and approaches for measuring and monitoring exposures to climate-related financial risks include, among others, exposure analysis, heat maps, climate risk dashboards, and scenario analysis. These tools can be leveraged to assess a financial institution’s exposure to both physical and transition risks in both the shorter and longer term. Outputs should inform the risk identification process and the short- and long-term financial risks to a financial institution’s business model from climate change.

Banks will have to talk about 2070. Banks will have to talk about "intermediate-high" levels of water arriving on coastlines, the Gulf Stream slowing, and West Antarctica melting.

Those data sources will tell banks where long-term coastal risks are, and they'll need to report the implications of this data for the assets they hold (loans as well as buildings) up the chain to their boards, federal supervisors, and secondary markets. This will cause banks to tighten their mortgage standards, particularly when Fannie Mae and Freddie Mac, the GSEs who now hold 60-70 percent of mortgages, eventually say they won't ingest mortgages for properties that are likely to be chronically inundated before the debt is paid off.

The science for all of this risk is strong. There's tons of data. It's just that the public isn't getting clear communication about risks. But the financial institutions are getting their acts together.

In a sense, having property marketplaces change people's lives for them seems to provide much of the content of our "reduce the coastal risk" plan as a country. That will wake up the investing class, for sure. And David Burt of DeltaTerra thinks that the consequences of rapid property repricing in particular regions (the Gulf Coast, the Southeast coast) is the route to rapid policy change when it comes to climate issues. As he told Jason Jacobs a few years ago: 

I think it's these institutional capital moves that are the tail that wags the dog. So I think you're going to get a lot more out of waking the investing public. So the people who are actually making decisions about where these vast sums of capital get allocated. Than doing local education campaigns [about the risks to coastal property]. Not to be cynical. But just from my experience, if you really want policy to change, if you really want behaviors to change at a systemic level, you have to affect the capital.

Or we could plan, keeping in mind the public values that private markets, left to their own devices, will never prioritize. This will be a humdinger of a repricing.