While most people know that carrying homeowners’ insurance is critical, few are aware of the extent to which climate change influences policies – after all, no two properties are created equal. Similarly, investors are often in the dark when it comes to the effects of changing weather patterns on pieces of property. To help lessen the confusion on this subject, the U.S. government is working to require publicly traded companies to put specific guidelines in their disclosures, so that investors will have more insight into weather events that might potentially negatively impact a portfolio of properties.

In this episode, host Maiclaire Bolton Smith sits down with George Gallagher, who is a principal account executive at CoreLogic, to discuss how climate change impacts the risk factors against which homes are insured. Additionally, the pair discuss recently released SEC guidance that is intended to enhance and standardize climate-related disclosures for properties.

Follow along at HazardHQ.com for an up-to-date analysis of climate-related catastrophes.

Maiclaire Bolton Smith:

Welcome back to Core Conversations: A CoreLogic Podcast, where we dive into the heart of what makes the property market tick. I’m Maiclaire Bolton Smith, your host and curious observer of all things related to property — from affordable housing to market trends and the impacts of natural disasters to climate change — I want to converse about it all. The language of insurance is a complicated one. So is understanding the risk of weather hazards. Understandably, this can make it a challenge for the average person —or even a company — to determine whether that property investment is a sound decision. For example, if a hotel in Miami Beach expects an increase in flood issues due to a rise in sea level, is that increased flood risk material to the viability of the hotel's insurability?

George Gallagher:

Thanks, Maiclaire. If I could just throw a few more letters at you. One of the things I forgot to mention is I am the co-educational chair for the MISMO, the Mortgage Industry Standards Maintenance Organization, MISMO. The co-education chair for MISMO's ESG Community of Practice. So it's MISMO ESG COP. And really what that means is that this is a segment of the market that's gaining rapid attention. So the Mortgage Bankers Association (the MBA) through MISMO, is taking this as a very serious issue. And it's getting a lot of exposure to create both guardrails and guidelines for not only our industry but all the affected industries.

MBS:

That A, is a lot of letters, George, but that is super interesting. And I think that really sets the stage about why we want to talk about this today. And you and I are going to take a bit of a different perspective on weather hazards and understanding weather risk that we've not really talked about before on this podcast. So, how did you get to be involved in this hazard weather space?

GG:

How did I get into the weather and the climate change part of that? I think it's an interesting story, but let me start with a couple of definitions. You asked about environmental, social and governance, ESG. That is a framework around disclosing things such as climate change impacts, carbon emissions, energy efficiency when it comes to environmental issues. From a social standpoint, things like customer satisfaction, data protection and privacy, gender and diversity, community relations. And then from a governance standpoint, board diversity, business ethics, lobbying, whistleblower programs. Those all fit under the broad definitions of ESG, or environmental, social and governance. Again, it's a way of giving investors more transparency into the companies that they invest in.

MBS:

Okay, that was a really great introduction, and really the reason we want to talk with you today. And really, I love that because that's how you and I got to know each other so well through the event response side of our business and what you and I have worked very closely on. So we're going to dive into that a little bit today. So we've talked time and time again on this podcast about how climate change just has such widespread effects on the property market and from all different perspectives. Earlier this season, in Episode 32, we dove into how flood risk is changing and then we talked about hazard insurance. So, if you haven't listened to those episodes, I do encourage everyone to go back and listen. But just in case our listeners haven't listened, can you talk a little bit about the types of weather risk that homeowners need to be aware of?

GG:

Absolutely. And it's a great question because now you're talking about scope, scale and the security of information. A person in Portland, Oregon, needs to have as much awareness and understanding of the environmental impacts to their properties, whether they are insured, a borrower, a lender, or an insurer, as a person in Portland, Maine. Identifying the localized perils and the potential impact of those localized perils as a data provider is something that CoreLogic is really striving to achieve. So again, use an example of Portland, Oregon, versus Portland, Maine, understanding the perils that could exist and do exist in those areas, what impact they can have upon a borrower, a policyholder or the company that's underwriting borrowers or policies, is key to understanding the impacts of climate change. So broadly, what we're looking at is an understanding of awareness, disclosure and the financial materiality of the natural environment, the environment's impact on an individual or a collection of properties.

MBS:

Okay. That is so great and so helpful. So, I think if we dive into this a little bit more, we all know that forecasting changing weather patterns is not simple. I want to talk a little bit about how data specifically can be segmented to offer different insights into natural hazard risk. I think people think, "Oh, storm is coming. Let's talk about a hurricane, let's talk about a tornado, let's talk about hail. We can forecast that, we know it's happened. It's happened, we've looked at it." What you do is something very different than just, "Let's look at what's about to happen." So, can you talk a little bit about segmenting data into different parts of natural hazard risk?

GG:

That's a great question, I appreciate your teeing that up. Yes, it's interesting. Trying to understand what the future impacts could be opens up a lot of horizons for us. But before we start talking about the future, let's talk about how we look at the future and how we build the building blocks or the ladder steps, if you will, to get to what the future looks like. And it deals with the concept of rationality. So, what I want to get at is, how well do you understand the current environment and then what the influences could be on the future environment. And let's really break that up a little bit. When we talk about it, I mentioned it before scope, scale and security, how much information do you have about an individual property? At CoreLogic, we have property level detail based on the footprint of an individual property. That's very unique in the fact that there are a lot of estimates of climate impact that start at the zip code level, or the county level, or the state level or even at the country level. Great information and awareness is important.

So, if you're in a country or a state or a city that potentially has wildfire or storm surge issues, that's important to know. But when we really start to make this information actionable is when we can tie it to the individual property at a very granular level.

MBS:

Okay.

GG:

So, in order to be rational in the future, you have to have a complete dataset of information about the present. How big are the buildings? How many buildings are there? What type of use is that building? What does the reconstruction cost value of that building? What's the first-floor height of that individual building? Those are the component elements that enable a rational decision process into the future. So we take that base-level information, incorporate catastrophe modeling. Catastrophe modeling is a proven financial vehicle that can talk about outcomes from simulated events, and then we educate those models by exposing them to climate change data for the future. We use the Intergovernmental Panel on Climate Change science. It's an internationally-recognized standard, the IPCC. And we incorporate different representative concentration pathways. So if you think of things as current state, potential future state, worst case future state, those are the different pathways that are presented through that science.

MBS:

Right.

GG:

So having a very robust and comprehensive set of models for all the perils, not just flood, not just wildfire, but things like severe convective storm, inland flooding versus storm surge flooding, and having both of those, severe winter storms, which are going to be or could be considered elements of future climate change, severe convective storms, your hail patterns, your tornadic and straight-line winds. All of those are different models that need to be used to understand what the future state of a property is. Again, going back to my analogy of Portland, Oregon, versus Portland, Maine. Different geographies, different impacts from perils, but understanding consistently across the country, across every property — large or small, or groupings of properties, what the individual characteristics and the impacts of those properties are —gives us that rational view into what the future will look like. I'm trying to make a very difficult science sound simple, but if you think about it, the component parts are interesting and simple.

If you don't have a lot of granular data, you're not going to be able to make rational opinions towards what the future impact could be, and that's really what we're trying to achieve.

MBS:

Right, absolutely. And it is that granular data that gives you that better estimate. So you talked a lot about how giving... So we're looking at these properties, we have all this individual data for each of them, whether it be the first-floor height or the footprint of the building, the reconstruction cost of the building. Now, what do we do with all of that? What can we do with all of that information?

GG:

Similarly, mitigation against a known hazard near your property could help lower the score, the risk profile of your particular property, as well as at a community level. If community safeguards and mitigations are brought into play, that can additionally bring down those scores. So our composite risk score and other solutions and power that risk-informed decision making that FEMA is focused upon.

MBS:

Okay, this is super interesting. So now I want to talk a little bit more about this composite risk score and really the idea of having a single risk score based on a number of different factors, a number of different data points. How do we think that can be useful, let's look at it from the perspective of banks. How can they help homeowners protect themselves? Just can you dive into a little bit more of the value and the use cases that could come from using data like this?

GG:

So a composite risk score, by its nature, is intended to have a holistic view of risk at an individual property level. So to make it consumable, you have to simplify at least the front end of it. The simplification comes in a composite risk score that takes a number of different perils — and we have seven different perils that we can get into some of the details about — but we base our 1 to 100 scores on the average annual loss, or AAL. So, on a 1 to 100 basis, we can stack rank what the risk is on our expected average annual loss.

Why is that important? Because where I live in Southern California, I have earthquake risk and I have wildfire risk as natural disasters that impact me. Both of those, fortunately for me, are very low, but as I'm looking at my property in Southern California and comparing it to another property in another part of the country, I have the same guidelines I can use the same rating system for...again, we talked about Portland, Oregon, versus Portland, Maine. In Portland, Oregon, I might have earthquake and wildfire risk, while in Portland, Maine, I might have storm surge and severe winter storm impacts.

MBS:

Right.

GG:

If I'm in Portland, Maine, I want to understand what those perils are. So I can make sure, at a minimum, that I have the appropriate amount of insurance for those. Similarly in Portland, Oregon, wildfire is typically an insured loss, but earthquake may not be. So understanding what my unique perils are, in the context of an overall peril, helps me make a decision about pursuing that property as well as making informed decisions towards ensuring and using other mitigation efforts to make sure that I have a long-term use of that property.

MBS:

Okay. I think this is super interesting because this is something that I think a lot of people will see huge value in because we're essentially looking at something, the analogy we commonly talk about is it's like a FICO Score for your natural hazard. And a lot of people, you want to know what your credit score is, you have this score, it's based on a bunch of different data points. No one knows the data points it's based on, but they know that they get this score and it means something. And I think that's really the direction that we're trying to go in with this composite risk score. So I want to dive a little bit into that, but really from the perspective of mortgage-backed securities, this is something that you work really closely with George. And can you just really talk about the value of this to mortgage-backed securities? And then I want to get into the Securities and Exchange Commission, but let's hold off on that. First, can you talk just a little bit about mortgage-backed securities and the value of this, George?

GG:

Sure. So mortgage-backed securities, right now, are graded and presented based on their credit risk profile. So there's a very clear understanding of what — again, we called it earlier, the Fair Isaac Corporation, the FICO Score — what the creditworthiness is of that portfolio of properties. In fact, I would say that the industry has nearly perfected credit risk rating. What they haven't perfected, however, is the hazard impacts against a portfolio. That's what we're trying to achieve. So in the future world of mortgage-backed securities, the intent is to incorporate not only the credit risk rating that's currently in place but also an understanding of what the potential impacts from climate disasters could be, both near term and based on climate change impacts. So the questions are: Will this impact the pricing of a portfolio? That's yet to be determined, everyone has an opinion, and some have very strong opinions.

It's likely that the future iteration of portfolios have your least-risky from a hazard standpoint grouped together and your most-risky from a hazard standpoint grouped together or some sort of formula where they offset one another. Again, the overall pricing concerns are obviously important to the marketplace, but they've yet to be clearly articulated and defined.

MBS:

Okay, this is really interesting. And this whole topic of mortgage-backed securities, I think, is a really interesting subject and something that we've not really talked about before. So I'm glad that we're getting into this because I think it's a really interesting part of the industry that people maybe don't necessarily realize is happening. It also leads to something else I want to talk about that I just briefly mentioned before, and it is the U.S. Securities and Exchange Commission, or the U.S. SEC. They've recently, in the last couple of months, had some guidance that was released. Can you talk a little bit about what this guidance was about, how it's relevant to this topic, and what people may expect to see? I think this is a good place...just as something to finish today. Can you talk a little bit about this?

GG:

MBS:

Okay.

GG:

What this means is all publicly traded companies will be required to have specific guidelines for their disclosures. Now, in the context of the SEC, a lot of it was focused on greenhouse gas emissions, Scope 1, Scope 2 and Scope 3 categories, which we don't really need to get into here. But from a climate change standpoint, there is some governance around what needs to be disclosed and how it should be disclosed. And a great way to think about this, and what to look for in the near future, is how much the SEC is speaking to leveraging the existing infrastructure. Right now, for example, in loan origination, if a property is in a Special Flood Hazard Area, as defined by FEMA, so a 100-year flood zone, specifically known as a Special Flood Hazard Area. If a property is in a Special Flood Hazard Area, it's required to have flood insurance if it has a federally-backed loan. So it's a very binary decision. You're either in or out of a Special Flood Hazard Area. If you're in, it requires a process to acquire flood insurance. If you're out, that requirement does not exist.

Here's the issue, however. Because of what we've seen, starting many, many years ago, but probably most profoundly through Hurricane Harvey. There was such a high percentage of impacted properties that were outside the Special Flood Hazard Area, that the concept of a graduated risk, risk outside the Special Flood Hazard Area, has really caught hold and captured the attention of investors, as well as lenders and insurers. So what the SEC is looking for, and intending to provide, is guidance that leverages currently the binary system of in or out of a Special Flood Hazard Area and giving more rational decisions about what should be disclosed outside, and then taking that layer and applying it to other risks.

MBS:

Okay.

GG:

That's our anticipation from what's going to come from the SEC, yet to be released, so we don't know that that's accurate. But in all the conversations we've had with other government agencies, that's what they're hoping to see in terms of guidance, that can then be consumed and adopted by other agencies.

MBS:

And that's great because I mean, that really is a progression from something we've talked a lot about on this podcast, of that we've made several references to Hurricane Harvey and flood risk in particular and how historically it was in or out of a flood zone, and this graduated risk of looking at risk outside of designated flood zone areas and really what that means for natural hazards across the board as climate change continues to impact the frequency and severity of weather hazards. So, I think a lot is yet to come in terms of what we see from the SEC, a lot is yet to come in terms of what we see with the development of science and solutions that go along with it to help people, as we like to say, "Know your risk, to help accelerate your recovery," and I think ultimately understanding what the risk is. The consequences are going to blow you away. So we just need to wait and see what's going to happen. So George, thank you so much for joining us today on Core Conversations: A CoreLogic Podcast.

GG:

Absolute pleasure. Thank you, Maiclaire. I hope we get to do this again as an update.

MBS:

Absolutely, we'd love to have you back, George.

And thank you for listening. I hope you've enjoyed our latest episode. Please remember to leave us a review, let us know your thoughts and subscribe wherever you get your podcasts to be notified when new episodes are released.

And thanks to the team for helping bring this podcast to life. Producer Jessi Devenyns, editor and sound engineer, Romie Aromin, and social media duo of Sarah Buck and Makaila Brooks. Tune in next time for another Core Conversation.