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Article 1 of 2 in Insurers of Last Resort |
Freeadvice investigates homeowner's insurers of last resort |
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Homeowners in many coastal states have been asking: “Why is my insurance company dropping my homeowner’s policy?” Others are questioning why their rates are rapidly going up or they are being subjected to surcharges.
The answers lie in past losses and fear of future losses by the insurance companies and a related move by states to provide coverage, often at rates that are too low for the risks involved. The result is to drive people increasingly to state operated plans. These state plans operate like insurance companies, but have different objectives. They often do not have adequate reserve funds set aside for unexpectedly high losses, and sometimes have less expertise in setting rates, settling claims and dealing with customers.
Because states require the private companies to contribute to losses by the state plans and because ultimately the taxpayers will be responsible, fears are growing that risk is being shifting from the private insurers to the state plans. This shift makes policyholders, even in areas not affected by the risk, and state taxpayers bear some of the risk of losses. Furthermore, as the concentration of risk in these state plans grows, it poses the possibility of large losses in the wake of future storms – risks that might have been borne largely by private insurance company previously.
The problem has developed as insurers, have been cancelling homeowner’s policies, in areas that might be at risk – primarily shore areas. Increasingly, the companies are worried about the possibility of large losses from hurricanes and other severe storms and concerned that regulators will not allow them to raise rates enough to cover potential losses. While no one can predict how many storms there will be or how much damage they might cause, insurers know that states from Texas along the Gulf of Mexico and up the Atlantic coast to Massachusetts could be subject to crippling financial losses if a major storm such as Andrew or Katrina were to strike an area where they have many policyholders. Katrina payments by insurers have totaled more than $40 billion to 1.7 million U.S. policyholders in 6 states.
In addition, continued development in at risk areas has placed even more properties and higher property values at risk. For example, more than 2,100 new condominium units are scheduled for completion in South Miami Beach by the end of 2009. Other rapidly developing coastal areas include Galveston Island, Texas, Hilton Head and Myrtle Beach, South Carolina, the Maryland shore, eastern Long Island and Cape Cod. As the private insurers retrench to cut their risk, the states have attempted to fill the market need with “insurers of last resort.” In a June 7, 2007 article, The Wall Street Journal reported that such insurers in 16 states have seen a rapid growth in the number of policies and potential liability for damages since 2001. The plans could have serious losses that require bailouts by taxpayers or force policyholders who are not in the affected areas to backstop the losses.
The state plans have tended to change from providers of insurance coverage to those with no other possible carrier to major providers of insurance in high risk coastal areas. This shift of high risk exposure away from private property insurers is placing an enormous financial burden on state-run insurance plans and leaving them operating at substantial deficits while shifting the long-term risk of hurricane related losses to policyholders and taxpayers who do not live near the coast according to Dr. Robert P. Hartwig, president and chief economist of the Insurance Information Institute. Others see it as representing a shift away from the prevailing federal government’s efforts to make individuals assume more risk in areas such as retirement and health care.
Just as investors must be wary of having “all their eggs in one basket” insurance companies that insure too many properties in one geographic area are subject to the danger of concentrated losses. The concern that climate change may exacerbate the severity of the storms only increases the possibility of severe losses in coastal areas. As a result private insurers have moved to limit the number of policies they have in threatened areas and “insurers of last resort” have picked up the business of many of those they dropped. More than 30 “insurers of last resort” are operating in the United States. Some cover other risks such as earthquakes or wildfires and some provide insurance in inner cities where poverty and high crime rates mean that private insurance is not available.
States need to assure that coverage is available in order to continue economic growth in their territory, hence the need for “insurers of last resort.” In addition, there is often political pressure to keep rates for the plans lower than actuarial realities might call for. In some areas, the state plans have been directly competing with private plans and exacerbating the shift away from private insurance. The rapid growth of the plans since 2001 means that potential liability for claims has tripled to over $650 billion.
Florida is the state most vulnerable to coastal storms. It has 27% of all hurricane exposed property in the U.S. and is expected to gain almost 13 million new residents by 2030 according to the U.S. Census Bureau. Coastal exposure in Florida is estimated at more than $2 trillion. New York (primarily Long Island) has almost as much exposure, but the probability of a major hurricane hitting its properties is lower.
In addition to these state plans, the Federal Flood insurance plans liability has grown by two-thirds since 2001 to over $1 trillion.
A prime example of the problems:
Florida operates one of the largest of these coastal “insurers of last resort.” Its problems illustrate the problems faced by such organizations. Citizens Property Insurance Corp. started in 2002 with the idea that it would cover only those who could not find coverage elsewhere and would ultimately shrink and perhaps disappear as the need for it declined. But as market realities and nature intervened to require higher premiums private companies dropped policies or moved out of state. State politicians have reacted by allowing Floridians to opt for coverage by Citizens if private coverage would be significantly higher than what Citizens would charge and offering guarantees of rate stability for several years.
As Citizens is currently the largest homeowner’s insurer in Florida, critics say a major hurricane could cost other Florida policy holders and ultimately Florida taxpayers. Floridians are already paying surcharges on their property insurance bills to pay off deficits from 2004 ($516 million) and 2005 ($1.7 billion). If Citizens charges rates that are insufficient to cover future claims because of political considerations or misjudgments of future losses, there could be large future deficits to cover.
Critics fear that Citizens will get the highest risk customers at unrealistically low rates, thus competing with private companies that might want to insure Florida homes and moving the storm risk to the state plan and away from private carriers. Problems with service to customers and administrative problems have also elicited many criticisms about the organization’s capabilities.
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