How to avoid insurance catastrophe – Editorial
By PATRICIA BORN
Despite this year’s calm hurricane season, the past decade of disastrous storms has made it more difficult for many homeowners to find affordable insurance. In coastal North Carolina, for example, many homeowners this year were hit with rate increases of 30 percent or more. Not surprisingly, they blamed the insurance companies. But the problem is not that simple.
Catastrophic property losses create huge problems for insurers because they affect large numbers of policyholders simultaneously and don’t occur with predictable regularity. To complicate matters more, state authorities — seeking to keep insurance available and affordable — heavily regulate the industry, limiting where and under what circumstances insurers can enter or “exit” markets, what coverage must be included in a homeowners policy, how much insurers can charge for a policy, when they can refuse to renew policies, and under what circumstances and how much they can increase rates when they feel the need to. Every decision becomes a source of political controversy.
The same is not true in the commercial insurance market. Commercial insurance is less heavily regulated — and, therefore, able to provide far more flexible coverage at far more flexible rates. This is true despite the fact that commercial property risks are greater in size than residential risks.
What sets the two types of casualty insurance apart is government regulation. In the commercial market — that is, businesses and the owners of rental properties — owners can negotiate prices and coverage terms with their insurers.
In the residential market, insurers must offer homeowners a package of coverage that typically includes the dwelling, its contents (furniture, clothing, artwork), detached outbuildings, personal liability coverage (in case somebody falls and breaks a leg on your property), and other items. While the insurance companies theoretically “set” the rates, the rates must be approved by state insurance regulators, who are reluctant to approve increases that will cause public protest.
And therein lies the problem.
Insurers that cannot remain profitable in the face of catastrophic events have an incentive to stop writing policies and even exit the market, as State Farm is doing in Florida, leaving many homeowners in a bind.
One thing government could do to make sure affordable coverage is available to homeowners in hurricane-prone coastal areas in the Gulf of Mexico, Florida, and along the Atlantic Coast — not to mention those areas of the Midwest and mid-South that are hit regularly by tornadoes, and areas of the far West that regularly are threatened by mudslides and wild fires — would be to loosen the grip of regulation and allow insurers to become more creative. We also might allow them to charge premiums that more closely reflect their actual risks — so long as there is full public disclosure of exactly what those risks are over a long period of time.
Of course, more freedom in setting rates could price some low and moderate-income homeowners in high-risk areas out of their homes. Rather than expecting them to sell their homes and move to more affordable areas, and rather than preventing needed rate increases from taking effect, a better option might be to subsidize their premiums. Such a program only would apply to existing homeowners, not to new home-buyers in high-risk areas, so that further development in risky areas is not encouraged.
For all of the controversy surrounding the cost and availability of property insurance, it’s important to remember that the private insurance market has successfully weathered catastrophic property losses without asking for bailouts.
Knee-jerk opposition to premium increases only makes it more attractive for cautious insurers to pull out of markets altogether, and leaves insurance consumers in a bind.
Born, an associate professor specializing in risk management insurance, real estate and business law at Florida State University, is co-author of the study, “Catastrophes and Performance in Property Insurance,” published by The Independent Institute, Oakland, CA.