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Record number of policies sold through insurers of last resort

In a new report, the Insurance Information Institute (III) says that nearly 3 million residential and commercial policies were in force nationally through state-run property insurers in 2010. That’s a record number.

Property owners turn to state-run programs when they’re unable to acquire insurance in the standard market. There has been explosive growth among these “last-resort” insurers over the past decade. Annual growth has averaged around 18 percent. In the event of a catastrophic storm, this could have financial  repercussions for all property owners in the states where such programs operate, the III report says.

The biggest players

The biggest insurers of last resort in the marketplace today are Fair Access to Insurance Requirements (FAIR), Beach and Windstorm Plans and Florida Citizens Property Insurance. (See more about FAIR plans here.)  Residual plans were established in the 1960s to ensure that owners had property insurance in urban areas where it might be hard to find private market policies.

Over the last four decades, however, these plans increasingly have been used in coastal areas. The total loss exposure in these plans increased from $54 billion in 1990 to $757 billion in 2010.

There are a number of reasons for this growth. A major factor is insurance rates. "In most states there is a subsidy, so rates from state-run insurers are lower when compared to private insurers," says Claire Wilkinson, co-author of the III report.

Concerns about fair competition

Rates charged by state-run insurance companies are set by state regulators and legislators. Critics say this often means that political factors influence pricing. When these state-run insurance companies  were originally set up, they were required to charge higher rates than the private market. However, many state legislatures have removed the provisions that prevented state-run insurance companies from competing with private home insurance companies on price, according to III, an industry trade group.

As lawmakers have become involved, insurance rates have dropped, making it difficult for private insurers to compete on price, critics hold. As a result, private insurers often drop out of a market. In 2010, a Government Accountability Office (GAO) study found that the majority of rates charged by residual programs are not actuarially sound. This can lead to significant problems when a big storm hits and claims pour in.

Applicants in residual markets must prove they are unable to find insurance in the private markets. Due to regulatory suppression of rates, private insurers say they are unable to fairly price a policy, so they reject applicants and these potential customers end up in residual policies.

A concentration of risk

As residual plans have expanded, they have taken on a huge concentration of risk, says Wilkinson. This can prove to be extremely dangerous in years where large storms cause billions of dollars worth of damage. As an example, in 2005 the FAIR plans combined suffered a deficit of $2.8 billion, according to III.

When these plans run a deficit, they are required to pass this cost to all participating insurers in the state. This means that any insurer that writes policies in the state, regardless of coastal exposure, will be assessed. In most states the insurers are allowed to recoup the assessments via surcharges on their policyholders. In Florida, a 2007 reform expanded the base of assessments beyond property insurers to auto, liability and other lines of insurance.

According to Wilkinson, "This legislation will put the burden of paying for the next big storm in Florida on all Floridians, even those with no exposure to hurricane losses."

She says this means that consumers who live nowhere near the coast could find a surcharge on their auto and homeowners insurance if a catastrophic hurricane hits the area, to compensate state-run plans for the deficits they have sustained.


More from Mark Vallet here

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