Homeowners' Insurance: A New Crisis in Availability And Pricing

There is a "crisis" in the affordability and availability of homeowners' insurance, a crisis which was so unexpected and sudden that it has caused the Governor of Texas, Rick Perry, to call the top three writers in his state (Allstate, Farmers and State Farm) "an insurance cartel" taking action "to bring the state to its knees."

There is a sudden surge in homeowners’ insurance prices in many states around the country.

At the same time, remarkably tough underwriting restrictions have been imposed, particularly on renewal business. State Farm is refusing new business in several states and imposing uniquely restrictive rules at renewal, causing a jump in non-renewals.

The 2002 "crisis" in homeowners' insurance follows several years of ample profits — averaging 4.6 percent over the past 5 years — and reasonable rate increases.

According to a 2001 survey of insurance departments by the Consumer Federation of America, to which 40 departments responded that in 1999, the average rate increase in the 20 states reporting numbers was 2.6%. In 2000, the average increase in the 25 states reporting a figure, was 3.1%. On an annualized basis, the increase in 2001 figured to be about 6.5%. While the 2001 change was larger than in recent years, the increase appeared to be reasonable.

States that commented on the cause of any 2001 increase credit lower investment income in 2001 and higher claims costs recently, the latter often related to catastrophes.

Some states said homeowners' insurance had been a "loss leader" or "accommodation" line used to get auto and other sorts of policies on the books while auto and these other policies were extremely profitable. Now that these lines have returned to normal profitability, the homeowner’s line must be increased to carry its own claims expectations.

One of the causes for the current "crisis" appears to be the business practices of the leading writer of homeowners’ insurance, State Farm, which is not writing new business in several states and has adopted draconian underwriting rules for renewal business.

About a year ago, in his annual letter to shareholders, Warren Buffett complained that State Farm was inappropriately holding prices below cost in an attempt to maintain market share against the onslaught of the more efficient (direct writing) insurance companies. Buffett’s warning came home to roost this year as State Farm reported a large underwriting loss of $9.3 billion, causing Standard &Poors to cut the insurer’s rating to AA+ from AAA (not because of the surplus, which remains excessive, but because of the bad one-year result).

Given State Farm’s immense size (over 25% of the market in most states), massive price increases may result for at least two key reasons:
  • Other insurers will feel free to move as the market leader leads the pack upwards in price – indeed, many tie their rating strategy directly to State Farm.
  • The refusal to write new business and the jump in State Farm non-renewals will add pressure to the demand and prices will be raised as a result.

States need to more strongly regulate insurance companies to prevent these kinds of shock price increases and insecurity on policyholders. For example, state insurance commissioners should prevent insurers, like State Farm, from overreacting by not writing new business in some states and by adopting draconian underwriting rules for renewal business.

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