States’ insurer of last resort should not become the primary insurance market
While Californians prepare for a new normal as orders to stay home ease and businesses reopen, springtime temperatures are topping charts and fears of fire season are rising.
Insurance companies looking ahead to catastrophic events like massive wildfires are also experiencing a form of existential angst as they determine if they can survive to cover future risks with the rates they currently charge.
States have recognized this cycle and established “insurer of last resort” options – known as FAIR Plans (Fair Access to Insurance Requirements) and Beach/Wind Plans – so that homeowners aren’t abandoned if insurance companies pull back after a disaster.
The approach provides access to basic property coverage through pooled resources from the state’s insurance operators to satisfy the condition of a homeowner’s mortgage agreement. But, these safety nets were not designed to become the primary insurance market for all, or even most, homeowners. Nor should they.
We have seen this cycle play out across the nation – most recently in California. Many homeowners living in wildfire-ravaged areas were notified that their homeowners insurance policies would not be renewed. Fortunately, these homeowners could turn to California’s FAIR Plan, which writes policies other insurance companies won’t: fire coverage for dwellings in wildfire-exposed areas.
California’s Insurance Commissioner recently focused on expanding the role of the state’s FAIR Plan by ordering it to offer comprehensive homeowners coverage, mirroring policies written by the voluntary insurance market.
While these efforts were well-meaning, this is a bad idea. Insurers in California sell “Difference-in-Conditions” policies that cover a broad range of common homeowner coverages, other than fire, that can be coupled with a FAIR Plan policy. A FAIR Plan comprehensive homeowners policy would cost more than the sum of the two policies and does not solve a problem, in fact it creates one. By ordering the FAIR Plan to offer coverages that it has no infrastructure for or expertise in will only increase the rates on all existing policyholders.
Insurers of last resort are limited for sound reasons. Forcing the California FAIR Plan to expand by regulatory fiat limits the ability of the voluntary insurance marketplace to provide competitively priced coverage.
It also dis-incentivizes new entrants to the insurance market. As fewer insurers compete for business, consumer choice is limited and prices increase. The FAIR Plan’s ability to pay claims would be at risk, requiring assessments of insurance companies who would in turn pass that cost on to their customers.
South Carolina’s experience provides a better way of addressing consumers’ insurance needs when the risk of recurring disaster is high. After a series of storms, rating agency requirement changes and reinsurance cost increases, insurers there were required to improve their management of catastrophes. Rather than expand the role of its Wind/Beach Plan, South Carolina focused on promoting a competitive marketplace for consumers.
First, policymakers allowed for the use of modeling in setting rates. By using relatively stable annual average costs from the models, insurers can offer a more stable pricing methodology.
Second, the cost of reinsurance – essential to enabling insurance companies to provide coverage in catastrophe-prone areas – was permitted in ratemaking.
Third, insurers were incentivized with premium tax credits to write new policies in catastrophe-prone areas.
Fourth, tax credits for low-income families offset the expense of property insurance.
Fifth, the establishment of state tax-free savings plans allowed consumers to save for catastrophes.
Lastly, grants assisted property owners in mitigating loss to protect their homes.
As a result of these efforts in South Carolina, 62 percent of customers relying on the state’s insurer of last resort transitioned back to the voluntary market, saving homeowners money and keeping the market competitive.
FAIR Plan and Wind/Beach Plan safety nets are essential but should remain a last resort, especially when better options for consumers exist. Policymakers in California and other states prone to disaster should remain wary of changes that make their state FAIR Plan a burden all homeowners must live with.