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A $1 Trillion “Hidden” Liability? How Climate Risk is Reshaping Home Insurance and Lending

  • State-run “last resort” insurance programs are now bearing over $1 trillion in liabilities, with Florida and California facing staggering potential losses. 
  • Home insurance costs have surged 55% since 2019 - over twice the rate of inflation - creating significant challenges for housing and lending markets nationwide.

What you need to know: As wildfires intensify, more homeowners are turning to state-run 'last resort' insurance programs - doubling participation since 2018 - while skyrocketing premiums and insurer withdrawals leave these programs with over $1 trillion in liabilities. Florida and California face the biggest risks with natural disasters, with potential losses of $525 billion and $290 billion (up six-fold since 2018).  

Why it matters: Homeowners are feeling the pinch as home insurance costs continue to soar. Prices jumped 19% in 2023 and are up 55% since 2019 - far outpacing the 24% rise in the CPI during the same period. Experts blame rising rates on inflation in building material costs and an increase in climate-related disasters. 

Now the Dunham Deep Dive: With wildfires raging through Los Angeles, it’s time to spotlight a growing crisis nationwide.

Long story short, homeowners are being squeezed as rising climate risks and higher building costs drive up premiums or push private insurers to abandon these “high-risk” areas altogether.

In fact, many insurance carriers have been paying out more in claims than they collect in premiums - a trend that has persisted for four straight years.

To highlight this - according to S&P Global - U.S. homeowner insurers faced net losses of $101.29 billion in 2023 - a 21.3% increase from the previous year. while net premiums grew only 10.8% to $119.89 billion. Put simply, losses are rising faster than premiums.

Meanwhile, this growing gap doesn’t just affect homeowners - it’s reshaping the lending market too.

Long-term loans - like the 30-year fixed mortgage most families rely on - depend on insurance to mitigate risk (obviously since that’s what insurance does). But the traditional model of rebuilding homes on damaged land is useless when climate change renders that land permanently altered, uninhabitable, or uninsurable. Experts say this could cripple lending in higher risk areas.

As a result, states are stepping in to absorb the risk and keep the housing market afloat.

The U.S. home lending system is already largely nationalized. The FHFA oversees Fannie Mae and Freddie Mac, which back 58% of home loans, while another 22% are supported by agencies like the FHA, Rural Housing Authority, and VA. So, is another government step into the housing market through the insurance sector really that surprising.

But even as they take on more responsibility, a critical question remains: How will they cover claims? Taxes? Debt?

Just shoving it onto the government’s plate doesn’t mean it’s free - nothing is.  

Thus, expect this problem to only worsen, with repercussions for home prices, insurance premiums, homebuilders, state budgets, and the insurance industry itself.

This is a big topic, so I’ll dive deeper into it in an upcoming Morning Pour.

Figure 1: Bloomberg, December 2024

 

Surging Corporate Bankruptcies and Tight Credit Spreads: A Market Paradox Worth Watching 

  • Corporate bankruptcies hit a 14-year high in 2024, yet bond spreads remain unusually tight, signaling investor confidence despite rising risks. 
  • Businesses are grappling with record debt, weak interest coverage, and stretched consumers as high interest rates and sticky inflation take a toll.

What you need to know: Corporate bankruptcies hit a 14-year high in 2024, reaching levels not seen since the aftermath of the Great Financial Crisis, according to S&P Global data. 

Why it matters: Last year, 694 U.S. companies filed for bankruptcy, the highest since 2010, when 828 firms went under. Bankruptcies rose 9% from 2023 and a staggering 86% from 2022, as higher interest rates and inflation squeezed corporations (most filings came from the consumer discretionary sector). 

Now the Dunham Deep Dive: It’s intriguing that corporate bond spreads – aka the gap between junk bonds and investment-grade bonds - remain very tight, even as bankruptcies hit a 14-year high.

  • Remember: when spreads are tight, it signals that investors feel good about the economy and trust companies to repay their debts. They don’t demand much extra reward for buying riskier bonds over safer ones like U.S. Treasuries. It’s essentially saying, “Things look stable - let’s chase better returns in the junk market.”

In fact, looking at the data, bond spreads are at their tightest since 2007–08 - right before the financial crisis sent them skyrocketing. Now, this doesn’t mean another 2008 is around the corner. But the market’s confidence - despite surging corporate bankruptcies - makes me scratch my head.

So, why are they struggling? Well, businesses are squeezed between high interest rates - with debt among credit-rated U.S. nonfinancial companies hitting a record $8.453 trillion and weak interest coverage in Q3 – and an increasingly stretched consumer (even though retail sales data has held up).

The Fed’s September rate cuts provided some relief, but with inflation staying sticky, further easing may slow in 2025.

Thus, either bond spreads are underestimating risks. Or something else is keeping investors overly optimistic. Time will tell. 

Figure 2: S&P Global Intelligence, January 2025

 

China’s Bond Market Signals a Looming “Japanification” Moment 

  • Chinese 10-year bond yields have fallen below Japan’s, signaling fears of prolonged stagnation and deflation reminiscent of Japan’s 1990s economic slump. 
  • Despite new stimulus efforts, China’s economy faces mounting debt, record capital outflows, and demographic challenges that mirror Japan’s post-bubble struggles.

What you need to know: China’s $11 trillion government bond market is gripped by gloom. Investors fear a deflationary spiral, drawing comparisons to Japan’s 1990s economic slump. 

Why this matters: Chinese 10-year bond yields have hit record lows, now roughly 300 basis points below U.S. levels, despite new stimulus from President Xi’s government. The drop, deeper than during the 2008 crisis or the COVID pandemic, reflects fears that China may face decades of economic stagnation – like Japan post-1991 in its great malaise. 

Now the Dunham Deep DiveRemember the term “Japanification”? It’s the nickname for what happened to Japan after the 1990s when its asset bubble burst, leading to decades of stagnation.

Now, it seems China is following a similar path. Or at least that’s what bond markets are signaling. . .

And if the bond market’s right, the stakes are enormous. Why? Because deflation could cripple the world’s second-largest economy -stirring social instability and driving even more capital outflows. This would be a big issue as last year, those outflows already hit record levels as investors fled China amid slowing growth and mounting debt.

On the back of all this, Chinese 10-year bond yields have dropped below Japan’s, marking a pivotal moment.

  • Remember: bond yields drop when an economy is weak, and prices aren’t rising much. This suggests governments can’t spur growth, and the private sector isn’t seeking new loans. Put simply, interest rates will keep going down because fewer people want loans. Meanwhile, the economy's weighed down by too much debt, further reinforcing yields lower.

In fact, if you take a step back and look at it, the parallels between Japan and China are glaring.

For instance, Japan was the world’s fastest-growing economy until its bubble burst in 1991 (just like China has been post-2008). Both nations also heavily relied on exports. And both face grim demographic trends (rapidly aging population and collapsing birth rates) that threaten long-term growth.

Chinese leaders have tried to stimulate the economy to reverse these trends, but so far, nothing has stuck - just as Japan struggled to do decades ago. Actually, many believe China missed its chance by not acting more aggressively earlier.

But this highlights just how hard it is to stop a structural economic spiral once it begins.

This is a critical macro-trend to watch, and I’ll keep you updated on this pivotal story. 

Figure 3:  Bloomberg, November 2024 

Anyway, who knows what will happen?

This is Just some food for thought as we watch how these trends develop.

As always, we’ll be keeping a close eye on things. Enjoy the rest of your weekend.

Sources:

  1. US Home Insurance, Real Estate Markets Teeter on Financial Crisis
  2. US homeowners insurers' net combined ratio surges past 110% | S&P Global Market Intelligence
  3. The 30-Year Home Mortgage Isn’t Designed for Climate Chaos
  4. US corporate bankruptcies soar to 14-year high in 2024; 61 filings in December | S&P Global Market Intelligence
  5. ICE BofA US High Yield Index Option-Adjusted Spread (BAMLH0A0HYM2) | FRED | St. Louis Fed
  6. China Investors Sound Alarm Over Japan-Style Deflation as Yields Hit Record Low - Bloomberg
  7. The Japanese Economic Miracle – Berkeley Economic Review

Disclosures:

This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance. All examples are hypothetical and are for illustrative purposes only.

Information contained in the materials included is believed to be from reliable sources, but no representations or guarantees are made as to the accuracy or completeness of information. This document is provided for information purposes only and should not be considered as investment advice.

Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/Dealer. Member FINRA/SIPC. Advisory services and securities offered through Dunham & Associates Investment Counsel, Inc.

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