Navigating the Maze of Homeowner Insurance

Approximately 40% of the US population lives in a coastal county, and that percentage is expected to continue to increase over the next decade.  Their homes are often high value and face greater risks than properties further inland. According to the recent Storm Surge Report by CoreLogic, over 6.5 million homes along the Atlantic and Gulf coasts are at risk of storm-surge inundation.  AIR Worldwide estimates the insured value of coastal property exceeded $10 trillion in 2012.  Given the significant exposure, how does the consumer properly protect one of their most valuable assets?

The Homeowners insurance policy does a good job of insuring against the more routine perils like fire, theft and vandalism.  However there are significant exclusions and coverage limitations for catastrophic perils such as windstorm, hail, flood and earthquake.  These gaps lead to the current piecemeal approach to insuring catastrophic perils through a combination of endorsements, state residual markets, specialty insurers, and federal insurance programs.  This is a disjointed, complicated system that has developed over time.  Given our state based regulation model, there is a great deal of variability in the insurance programs.

If our leaders were to design a new model from scratch, they would likely create a single, truly comprehensive residential insurance policy that covers all perils.  Coverage would be consistent nationally and spread the risk around all fifty states.  Unfortunately, we have a convoluted system that has been created in reaction to market crises with attempts to provide a source of coverage when private insurers pull back.

Insurance companies may choose not to provide coverage for certain perils due to catastrophic risk, and rate suppression.  These two factors are intertwined.  The frequency and severity of losses caused by catastrophic perils are difficult to predict.  Insurers need accurate predictions to develop an accurate premium.  Due to the uncertainty and high level of potential losses, insurers may choose to exclude the peril, or only provide coverage in exchange for a substantial premium.  Given that the perils are so potentially destructive, insurers are reluctant to risk potential bankruptcy at rates approved by regulators.

Rate suppression occurs when regulators and/or legislators attempt to keep insurance coverage affordable and impose price controls.  Given that the regulators and legislators face substantial political pressure to hold down insurance rates, this is an issue in nearly every coastal state. If insurers are unable to charge premiums based on their calculation of the risk however, they will not provide the coverage.  The result is a Homeowners insurance policy with numerous exclusions, and attempts by state and federal governments to create a source of coverage.

Let’s use an example of a property owner living in in Charleston, SC to illustrate.  Assume the home valued at $400,000, not unrealistic given the location.  The property owner should purchase a Homeowners insurance policy, but the insurer is likely to exclude wind, hail, flood and earth movement.  The property owner is hopefully directed by their agent to the state residual market (South Carolina Wind and Hail Underwriting Association) to purchase the Standard Wind and Hail Dwelling Policy.  The property owner will also want flood insurance, so they will need to purchase a Standard Flood Insurance Policy from the Federal Emergency Management Agency (FEMA).  The maximum amount of building coverage from FEMA is only $250,000, so the property owner will need to also purchase an Excess Flood Insurance Policy to be fully insured for the remaining $150,000 in value.  The Excess Flood Insurance Policy will be purchased from an insurance company, though not necessarily the same one they purchased their Homeowners coverage.  Since Charleston has a significant exposure to earthquake damage, the property owner should attempt to purchase an earthquake endorsement from the Homeowners insurer (assuming they are willing to provide it). That is four separate policies and a special endorsement, with different policy language on deductibles, conditions and limitations.

The current situation is clearly very challenging for a consumer.  A good insurance agent can certainly help, but even in the best case there are still multiple policies to purchase and understand.  When consumers are uninsured, or underinsured, it makes it much more difficult for the community to rebuild and recover.  It also creates a greater reliance on federal intervention and disaster relief.  Ideally, the private sector will eventually move towards providing a more comprehensive coverage policy. Although the trend over the last two decades has been to restrict coverage, there are recent signs of change.

Private insurers in Florida have recently begun experimenting with offering flood insurance.  The South Carolina Wind and Hail Underwriting Association has seen a moderate decline in the number of policies. Reinsurance rates have fallen again this year and there is an unprecedented level of financial capacity to provide additional protection.

These positive signs are encouraging, but in order for the private sector to move forward though, the state governments will need to allow greater price flexibility and less rate suppression.  Certainly not what an elected official wants to do in an election year.  Another possible solution is for the federal government to step in and create an expanded, multiple catastrophe peril insurance program.  This approach has been proposed numerous times over the last decade without much progress and is unlikely in the foreseeable future.

Dr. David Marlett is a professor and the Chair of the Department of Finance, Banking and Insurance at Appalachian State University, and he is also a senior fellow for the American Consumer Institute Center for Citizen Research.

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