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Saturday, September 23, 2006

How Should the Risks of Natural Disasters Be Distributed?

The increase in home insurance costs in areas where risks of natural disasters are high is affecting housing affordability for low-income groups. Should low-risk areas cross-subsidize high-risk areas to help with this problem?:

Soaring Insurance Costs Make Housing Less Affordable, by Ana Cruz-Taura, Atlanta Fed: Across the country low interest rates have masked the effect of rising taxes and insurance costs on monthly housing payments. But as the real estate market cools down, interest rates continue to rise, and catastrophic losses reveal the exposure of vulnerable geographies, attention is shifting to the volatility of insurance underwriting and pricing.

Affordable insurance is critical Many remedies have been proposed to address insurance concerns. The disproportionate impact of Hurricane Katrina on the poor and the uninsured has prompted community groups in hurricane and flood zones to increase outreach and education regarding the availability and benefit of both hazard and flood insurance. ...

Access to affordable insurance will ultimately determine the success of community-based outreach to protect homeowner assets. Those already insured will have to keep up with the mounting expense of insurance and rising deductibles... For the uninsured, establishing coverage can be difficult without prior insurance history. Personal credit scores are now used across the industry to approve and price insurance, and this practice may adversely affect low-income homeowners.

Insurance tab drives housing costs upward In higher-risk markets such as California, Texas, Florida and New York, coverage has become more restrictive and deductibles have risen. In some areas the number of companies underwriting insurance is dwindling. In Florida, for example, some insurance companies have been allowed to leave the state and others have become insolvent, so there are fewer providers. Lack of competition combined with the increased market risk is fueling double-digit increases in premiums there.

Housing advocates, who have been battling soaring home prices with elaborate layers of financing to make ownership affordable for low- and moderate-income families, are now confronted with the severe impact of insurance premiums on the monthly mortgage payment. While a few thousand dollars difference in the price of a home can determine whether a family will qualify for the mortgage, a few hundred dollars’ in insurance cost can have the same effect. Moreover, while a fixed-rate mortgage will maintain the same principal and interest payment over the life of the loan, insurance premiums change annually and therefore can unexpectedly jeopardize the family’s ability to stay in their home...

To further complicate the issue, government has been attempting to work with the insurance industry in high-risk and high-cost markets to keep homeowner insurance accessible and affordable. These measures have traditionally focused on state-based negotiations with insurance providers, but support is growing for a federal response similar to the 1968 National Flood Insurance Program...

Insurers seek new solutions Another proposal would create a federal insurance fund to help companies pay claims resulting from catastrophic events that meet certain damage or market thresholds. However, a federal pool of funds would distribute insurance cost nationally, as does the market-based risk mitigation strategy for traditional insurance models.

Distribution of costs raises one of the most contentious points of dispute in the insurance debate, namely whether low-risk markets should be required to help fund losses in higher risk markets. While this idea has been broached across the country since Hurricane Andrew in 1992, the insurance industry has responded to Katrina with the decision that premiums will go up nationally to help cover losses sustained in the 2005 hurricane season.

Many living outside high-risk markets—especially those outside hurricane-prone markets—understandably oppose an industry-based risk sharing model preferring instead a market-specific risk pricing model. However, changes in the exposure to risk and in the types of risk have compelled the industry to find alternatives for meeting demand while protecting profits and solvency.

The state-based focus on regulation and pricing has kept larger insurance companies from adequately spreading costs and risks throughout their market areas, creating instead concentrations of risk in vulnerable geographies. This dynamic is especially important for large insurance companies that are not able to reinsure their exposure effectively. Through reinsurance smaller companies are able to buy their own insurance policies to protect funding of their claims in the event of significant covered losses. But larger companies, and more importantly those with dense concentrations in high-risk markets, are not able to access reinsurance at all or cannot do it profitably...

Emphasizing the importance of insurance Market penetration is another issue for the insurance industry as homeowners and renters opt to “self-insure,” that is, to cover their own losses rather than include insurance cost in a tightening household budget. Education and counseling may help many homeowners, especially low- and moderate-income families or those with otherwise limited savings, to consider the advantages of obtaining some level of insurance.

The proportion of homeowners without flood insurance in New Orleans surprised many. On average, insurance covers more than 60 percent of losses after a natural disaster; in New Orleans, it is expected to cover less than half. Lack of flood coverage will make the New Orleans recovery that much more costly. For lower income families without any insurance, the prospect of rebuilding may seem hopelessly challenging...

The potential for natural and man-made disasters is expected to remain high for the next 20 years. Community organizations must continue to educate and inform the uninsured about the benefits of insurance, the importance of building a cash reserve for disaster recovery, and the availability of community loan programs to mitigate potential losses by repairing homes, trimming trees and installing safeguards. At the same time, discussion must move forward about how to control the rise in insurance premiums for the average homeowner while keeping high-risk markets reasonably profitable for insurance companies.

    Posted by on Saturday, September 23, 2006 at 02:40 PM in Economics, Politics, Regulation | Permalink  TrackBack (0)  Comments (20)


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