As concerns about the price and availability of insurance premiums grow, and as the cost of new construction continues to increase, what can be done to mitigate and improve the current construction climate?
Costs surrounding affordable housing development and management are spiking at an alarming rate throughout the United States. This growing crisis is fueled by a myriad of factors, ranging from a seemingly unchecked rise in insurance premiums to rapidly ballooning costs of building materials. Climate change-related disasters, the COVID-19 pandemic, and the increased use of “crime scores” by insurance companies are all contributors to these growing issues.
While each aspect taken individually would constitute a major issue on its own, they have combined to form a perfect storm of staggering increases in insurance premiums that are straining the limits of what affordable housing developers can tackle in existing and new projects given budget constraints, limits on income generation, and insurance mandates.
Insurers Are Pulling Out of Entire Regions, and Climate Change Isn’t the Only Reason Why
Climate change-related disasters have been making headlines at an increasing rate. What used to be considered once-in-a-generation storms or natural events are now cropping up seemingly every year, testing the limits of existing infrastructure and what insurers are willing to cover. The noted increase in extreme weather like hurricanes, floods, and fires, and their subsequent damage has led to insurers raising rates in vulnerable areas, and in some cases, simply pulling coverage entirely. Florida and California, two states facing notable affordable housing crises, are currently among the most affected — Hurricane Milton was projected to cost insurers as much as $100 billion, and even fire stations in California are struggling to find coverage.
In one recent analysis, an estimated 25% of all real estate in the United States is being saddled with increasing insurance rates and reduced coverage due to climate risks. In high-risk states with strict regulations on insurance rates like California — Proposition 103 requires a public hearing if an insurer requests an increase in rates above 6.9% for personal coverage — insurers are pulling out entirely. In other high-risk states like Florida, property owners face the highest annual premiums in the entire country.
For affordable housing developers, climate change-related cost increases are only part of the puzzle. An increasing number of insurers are now using “crime scores” to rate properties based on the number of crimes that occur in a given area, but exactly how this score is calculated remains a bit of a mystery and has already raised some potential discrimination red flags.
“We saw some of our premiums double in just one year,” said Cathy Coler, Chief Operating Officer at MRK Partners. “In the past, we could budget a 5% increase a year but for the last four years even budgeting a 20% increase each year is often not enough. Our income potential through rents is capped based on the government based income formulas , but even if it wasn’t, our renters would not be able to afford an increase like that so we often absorb that differential.”
The theoretical idea behind this metric is to protect insurers from potential lawsuits. If an assault takes place on an insured property, the insurer could potentially be responsible for paying the damages caused. Crime scores are an attempt to predict what properties are most likely to face these sorts of liabilities. However, its implementation has raised concerns, especially in the areas most heavily penalized by this new metric.
In a 2020 study titled “How Insurance Carriers Use Crime Scores to Assess Risk in the Affordable Housing Industry” by Jeffrey Robert, an Assistant Professor of Real Estate at Virginia Tech highlighted 10 key reasons why the use of crime scores fails to accurately depict the actual risk of certain areas, including the fact that these crime scores treat every crime with the same level of severity and fail to take into account the actual risk of liability. On top of that, crime scores for an area are calculated en masse — a crime anywhere within a given area increases the crime score for the entire area, no matter how far it occurred from a given property or how unique or targeted the crime may have been.
The use of crime scores has been compared to redlining, the discriminatory practice of denying access to goods and services to areas with a high percentage of minorities, most notably affecting Black communities in the United States. Not only have there been ethical questions raised about the use of crime scores to facilitate increases in insurance premiums, but there are also practical ones. Many of these areas with a “high crime score” are those most in need of affordable housing. Time, and time, and time again, studies have shown that increased access to housing reduces crime rates in a given area.
Increase in the Cost of Building Materials
Rising insurance premiums are a major issue, but are far from the only financial burden facing property owners and developers. In addition to maintaining insurance policies to create a safety net in case of a disaster, it’s becoming increasingly expensive to both fix problems and build new structures as the cost of building materials continues to rise. Price increases throughout COVID lockdowns are a major driving factor From 2013 through 2020, the average inflation for residential construction costs sat around 5%, but in 2021 it rose to 14% and then jumped again to 15.7%, the highest increase on record according to economic analysis.
“In addition to our expenses going up from insurance, they are also increasing for our regular repairs and maintenance,” said Coler. “Increasing rent to cover this is just not an option in the affordable housing industry and if we do not have the cash flow then we have to find some other way to finance it or continue to cover the deficit with additional capital.”
As supply lines slowly return to some semblance of what they were before the global pandemic, the costs of some building materials are dipping slightly, and some are even reaching levels that could be considered normal. “The only major building material to see price recovery is lumber,” said Jesse Wade, National Association of Home Builders (NAHB) director of tax and trade policy analysis. “At the end of 2023, lumber was trading about 20% higher than in 2019, but with further price declines in 2024, the price is roughly back to normal. This is after surges in 2020-21 that saw lumber prices rise more than 300%.”
Even with other building materials showing some signs of trending toward price normalization — steel products and diesel fuel also saw price decreases over the past two years — other materials like concrete, copper, and brass continue to see price increases. Rising costs of these materials, as well as questions around supply lines and potential tariffs on imported materials, are just part of the larger issue of a scarcity of housing in the country.
“Regulations in the affordable housing industry restrict what can be charged, and they have not been going up proportionally with rising costs,” said Kyle Webster, General Counsel at MRK Partners. “This is a unique area where extensive government regulations around subsidized housing actually exacerbate the issue.”
Affordable housing remains a vital part of tackling one of the largest growing needs in the country. As the housing shortage in America continues to demand answers, the roadblocks in the way of these developments — skyrocketing insurance premiums, opaque and deeply questionable risk assessments, the continued rise in the costs of building materials — need to be answered as well. Without an effective solution, large-scale affordable housing could become increasingly financially unfeasible. Like most issues that affect people from all walks of life, the housing crisis is a complex, multi-faceted problem that demands a coordinated, well-planned approach to achieve sustainable solutions.
Possible Solutions to These Growing Issues
As the industry continues to change and grow to meet this moment of extreme demand, there needs to be corresponding effort made by elected and appointed representatives to ensure that these projects can remain both affordable and insurable. This may require regulatory oversight that mandates insurance coverage at a certain rate for subsidized housing projects or slows the ability to increase premiums.
Balancing this oversight with the inevitable pushback from insurance providers is key to ensuring that entire regions don’t lose access to coverage. Some potential options include an incentive-based approach, either in the form of a CRA (Community Reinvestment Act) requirement for the insurance industry or tax credits or other financial offsets that encourage insurers to want to provide lower costs to affordable housing.
Another option could be implementing some form of a public option that covers the public policy demand for affordable housing, something that is already being explored in various places around the country but has not yet been implemented anywhere. Because insurance is mostly regulated at the state level, there is a higher potential to investigate exactly what methods work best for different parts of the country — the same policy that thrives in California may not work to the same degree in Florida, but foundational elements of what works in Virginia could potentially be adapted and applied to policies in Oregon.
No matter what the end solution may end up being, it’s clear that some form of collaboration between the insurance industry, affordable housing developers, and policy makers is vital in the coming years to solve this crisis and ensure everyone has a safe place they can call home.
