The WSJ did a story last week on the explosive growth of state-owned insurers of last resort. This is a fine story that makes an important point: the public has quietly been taking on massive liabilities, particularly since the 2004 and 2005 hurricane seasons— more than $600-billion from more than two million policies in 2006, up from $200 billion and less than one million policies in 2001—because private insurers increasingly won’t sell policies along the coast.
Fair Access to Insurance Requirements, or FAIR, plans cover people who can’t get homeowners insurance anywhere else, usually because they live in a place deemed risky. FAIR plan policies are usually more limited and—by law—more expensive than any competing private carrier in order not to undermine the private market, if there is one.
In insurance-industry paralance FAIR plans are known as the “residual market,” i.e., the crap.
These don’t operate like most insurance companies. They don’t build up reserves to pay claims. If the money runs out, they assess other policyholders in the state, either directly or indirectly through insurers, who pass along the costs.
The story quotes the articulate and knowledgeable Robert Hartwig, the executive director of the Insurance Information Institute, the industry’s research and public relations arm, who says:
The system “shifts the risk literally from those who are most at risk … to individuals who are at less risk or even at no risk.”
The problem—and yes, I’m very hard to please on the subject of insurance, particularly hurricane coverage—is that it misses the big picture.
The Journal misses the story, really.
Hartwig frames the story in a way that pits one group of insureds against another. It is the fault, in other words, of irresponsible people who insist on living near water. And while that’s his job, he’s basically wrong, and the Journal should stop falling for it.
What “the system shifts the risk from” is not coastal dwellers to inlanders, but from insurers to everybody else. And when it comes to paying for things the insurance industry doesn’t want to pay for, there are only two other candidates: taxpayers and policyholders. There is no third choice.
Think about it. If Allstate Insurance Co. and State Farm Insurance Co. are canceling or not writing policies south of Interstate 10 in Louisiana, which cuts through New Orleans, that leaves them with the profitable business—the not-risky homes inland and the incredibly lucrative auto business—and dumps the bad risks in the state’s lap.
Meanwhile, the state doesn’t get the benefit of the low-risk policies to pay for the risk on the coast.
Is this complicated?
This insurance “system” defeats the point of insurance, which is to spread risk as widely and efficiently as possibly. Not for nothing is insurance known to operate by the “the law of large numbers.” The more premiums you collect from the more people, the cheaper the whole system becomes. The more you chop up risk—separating sick people from healthy ones, for instance, or Louisiana homeowners from Mississippi homeowners from New York homeowners in a utterly stupid state-based system—the more expensive it becomes to cover the risky, the more lucrative to cover the unrisky and the more costly it becomes to administer all the separating that’s required. Saying “No” costs money.
And the premise underlying the story, that the private U.S. insurance system must leave the coast because it can’t handle another Katrina, is laughable. As I said in a previous post, the worst-ever insurance-loss year—2005—was the best-ever profit year in the history of insurance, $48 billion net income. On top of that, the industry added—not subtracted—added to its surplus that year, by $35 billion, pushing it to $495 billion, a record.
And that was a bad year.
How do they do it? Audit Readers, the U.S. pays $430 billion a year in property/casualty premiums every year. Forget health and life. That’s just auto, home, etc. That’s $1 trillion in less than three years. You don’t think we can handle a lousy hurricane, even a $45-billion one, every once in a while?
And while I’m at it, you probably think these government-owned companies are inefficient because they’re the government, right? You are wrong, seiche breath.