Category: Business

Property insurance rates have been soaring in the U.S. for years, and a number of factors are contributing to the problem, including inflation, building expansion into high-risk areas, and record natural disaster losses.

The devastation from ongoing wildfires in California and last year’s hurricanes in the Southeast are fueling fears that the enormous hit insurance companies will take in those states will be recouped – at least in part – by national carriers jacking up rates in other states that were not impacted.

One source supporting this concern comes from a 2022 study from Harvard Business School, titled “Pricing of Climate Risk Insurance: Regulation and Cross-Subsidies,” that concluded “households in low friction [risk] states are disproportionately bearing the risks of households in high friction states.”

The insurance industry says that is not true.

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Robert Gordon, SVP of policy research at the American Property Casualty Insurance Association (APCIA), says he does not challenge some of the data the study uses, but argues its conclusion is wrong.

He explained in an interview that insurance is state-regulated, and every state prohibits rates that are discriminatory or excessive. So, regulators don’t allow companies to arbitrarily charge excessive rates. 

Beyond such regulations, insurance is one of the most competitive industries, he noted. There are thousands of insurance companies, with hundreds in every state, and many of those are not national companies, but rather, state-only companies or regional insurers.

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“So, if a national insurer is losing money in California, that doesn’t mean it can increase its rate in Iowa or Vermont or any other state, because it’s competing with all these carriers, many of whom aren’t even doing business in California, so they’re not raising their rates because of California losses,” Gordon told FOX Business.

He compared the situation to gas stations. Where, if Chevron, for instance, had losses in California, the company wouldn’t raise prices by 50% in Oklahoma, because everyone in The Sooner State would then go to a different gas station. 

Any time insurance rates increase significantly, companies see a surge of policyholders shopping around and switching companies. That is what the industry is seeing right now. 

While the Harvard study’s authors and the insurance industry disagree on the study’s conclusion, they do agree on multiple points, including what is happening in California, which has sent insurers fleeing in recent years because regulators will not allow carriers to raise rates to meet the market.

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“What we see in a lot of states with rate suppression is that you have these exploding residual markets – essentially government-run insurance programs,” Gordon said. “And those government insurance programs subsidize rates, particularly the highest risk properties – which ironically, then eliminates the very socially important environmental risk signals like: don’t build in the forested areas or don’t build in the hurricane prone areas, and if you do, make sure there’s appropriate risk mitigation, [like] better building codes and so forth.”

He added that when states suppress insurance rates and subsidize building in disaster-prone areas with government insurance programs like California’s FAIR Plan, it appears as though such programs are lowering rates in the market. But all that really does is mask those signals.

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The Harvard authors, Sangmin Oh, Ishita Sen, and Ana-Maria Tenekedjieva, wrote in their conclusion that, “When rates no longer reflect risks, the informational role of insurance rates breaks down.”

They added, “[O]ver the long-run, rate-setting frictions could make insurers less prepared to deal with large losses and insurers may respond by exiting markets altogether or dropping important product features.”