Weathering Hurricane Season Without Devastating Property Insurance

 

Friday, Sep 04,2009, 9:27:31 AM   Click:

Jimena Hurricane landfall in Mexico, signaling the advent of hurricane season, a new analysis of property insurance highlights the effects of regulation in the wake of natural disasters.

In "Disasters and performance in property insurance," a policy report of the Independent Institute, economists Patricia H. Born and Barbara Klimaszewski, Blettner reveal that post-catastrophe property regulation of insurance actually drives up the price it seeks to control. Drawing data from the National Association of Insurance Commissions, and Swiss Re Sigma reports, the scholars argue that strict regulatory environments induce higher losses from unforeseen disasters, as enterprises are unable to adjust prices in according to changing conditions. Notably, the commercial insurers experience loss following disasters market homeowners insurance because of greater flexibility and fewer constraints.

The authors demonstrate that in states such as Florida, regulations that include premium limitations or exit restrictions can cause severe market distortions that may result in "an inadequate supply of insurance coverage." When restrictions on premium adjustments are enforced, insurers "may choose to exit the market if rates are not adequate to maintain solvency. This, in turn, prompts regulators to impose exit restrictions or cancellation bans." Addressing wide variations in state-level regulation, Born and Klimaszewski-Blettner dissect the phenomenon of "regulatory chain reactions," in which one intervention seems to establish the "necessity" for more government action. This snowball effect actually exposes taxpayers and consumers to greater risk when disaster hits.

Considering the staggering losses by insurers in 2005 -- $45 billion for Hurricane Katrina alone -- the authors propose several reform measures to protect both insurers and policyholders. They propose deregulating prices and a reform of residual market solutions "with emphasis on allowing market forces to operate more freely in responding to the insurance needs." In considering low-income people in affected areas who are unable to move or afford coverage, they suggest that even direct state subsidization of premiums is preferable (but hardly ideal) to keeping premiums artificially low, while cautioning that "incentive-incompatible subsidization of premiums -- for example, for new buildings in high risk areas" -- must be avoided.

According to empirical analysis, "the natural disasters of 2005 cannot be seen as unusual outliers, but reflect the continuing trend" of increasingly frequent and severe natural disasters. Given this trend, the conclusions and recommendations in "Catastrophes and Performance in Property Insurance" arrive at just the right time.

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Contact: Wendy Honett 510-632-1366 whonett@independent.org