September 2, 2009
OAKLAND, Calif., September 2, 2009As Hurricane Jimena makes landfall in Mexico, signaling the advent of hurricane season, a new analysis of property insurance trends sheds light on the effects of regulation in the aftermath of natural disasters.
In Catastrophes and Performance in Property Insurance (September 2009) an Independent Policy Report from the Independent Institute, economists Patricia H. Born (Florida State University) and Barbara Klimaszewski-Blettner (Ludwig-Maximilians-Universität Munich) reveal that post-disaster property insurance regulation actually drives up the prices it purports to control. Drawing data from the National Association of Insurance Commissioners, as well as catastrophic event figures from Swiss Re Sigma reports, the two scholars argue that strict regulatory environments induce higher losses from unexpected catastrophes, as firms are unable to adjust prices in light of changing conditions. Notably, commercial insurers experience less loss following catastrophes than the homeowners insurance market due to greater flexibility and fewer constraints.
The authors demonstrate that in states such as Florida, regulations that include premium limitations or exit restrictions can cause severe market distortions that may result in an inadequate supply of insurance coverage. When restrictions on premium adjustments are enforced, insurers may choose to exit the market if rates are not adequate to maintain solvency. This, in turn, prompts regulators to impose exit restrictions or cancellation bans. Addressing wide variations in state-level regulation, Born and Klimaszewski-Blettner dissect the phenomenon of regulatory chain reactions, in which one intervention seems to establish the necessity for more government action. This snowball effect actually exposes taxpayers and consumers to greater risk when disaster hits.
Considering the staggering losses by insurers in 2005$45 billion for Hurricane Katrina alonethe authors propose a number of reform measures to protect both insurers and policyholders. They propose deregulating prices and a reform of residual market solutions with emphasis on allowing market forces to operate more freely in responding to the insurance needs. In considering low-income people in affected areas who are unable to move or afford coverage, they suggest that even direct state subsidization of premiums is preferable (but hardly ideal) to keeping premiums artificially low, while cautioning that incentive-incompatible subsidization of premiumsfor example, for new buildings in high risk areasmust be avoided.
According to empirical analysis, the natural disasters of 2005 cannot be seen as unusual outliers, but reflect the continuing trend of increasingly frequent and severe natural disasters. Given this trend, the conclusions and recommendations in Catastrophes and Performance in Property Insurance arrive at just the right time.