Goals for the Residential Insurance Market
These problems illustrate just how dysfunctional the residential insurance market has become for private insurers, policyholders, and taxpayers. Because tightly regulated residential insurers have dramatically
reduced their wind exposures in coastal areas, wind risk has shifted to state residual market entities.
The growth in these markets has transferred risk to taxpayers and to policyholders in inland areas, just as the growth in the federal flood program has transferred risk to federal taxpayers, who are subsidizing a substantial share of the residential policies in high-risk coastal areas. In addition, wind insurance coverage limits have fallen and deductibles have risen, creating greater retained risk for policyholders in high-risk areas. Adding to their burden is the need to purchase multiple policies with inherent contractual uncertainties that will likely cause another wave of litigation following the next major storm.
When considering what types of reforms might improve outcomes, policymakers and other interested parties should be guided by four basic goals for the performance of a residential insurance system:
1. Insurance premiums should create appropriate incentives to mitigate risk. As discussed above, appropriate incentives are needed to discourage homeowners from locating in risky areas and to encourage developers to build wind-resistant structures. When insurance premiums on a property are lower than the losses expected on that property, the incentive to avoid risky areas or to build windresistant structures is inadequate. Analogously,when insurance premiums are higher than expected losses, development will be unnecessarily discouraged and buildings over-engineered.
2. Decisions by households and residential developers should factor in wind and flood risk. It is not enough for insurance premiums to reflect expected losses on a property. Households and businesses must also take wind and flood risks into account when making decisions. A household that does not fully appreciate the risks in its area may not purchase wind or flood insurance, and, in consequence, losses that do occur may be borne by taxpayers, charities, or others.
3. The insurance system should pay legitimate claims efficiently and expeditiously. Claims should be paid without undue litigation and other transaction costs in order to maximize the percentage of insurer expenditures that reach those policyholders who have suffered losses. The expeditious resolution of claims aids rebuilding efforts after a disaster and helps the local economy recover.
4. The market should encourage innovation and price competition. Innovation can result in better loss-prevention programs, policy features that better serve the needs of homeowners, and faster and more efficient payments to those who sustain damages. Competition can speed innovation and reduce inefficiency.
More later from both the report and Sop.