I have been pondering this topic since seeing a story in Forbes about insurers leaving the Florida market.
Understanding the factors driving skyrocketing premiums or complete market exits on the part of insurers requires going back to basics and modeling the basic behavior of an insurance market which combines all of these factors
- a quantifiable risk of some event triggering an outsized cost
- a risk which is NOT likely to occur simultaneously over multiple customers
- a consumer who CANNOT afford that cost if it occurs as one instant charge but CAN afford it if costs are spread out over a sufficiently long enough period
- a company which CAN afford individual payouts by collecting premiums from thousands of customers and spreading the risk, handling claims and collecting some arbitrary cut as a profit for absorbing the temporal risk and handling claims
If the average house in Florida costs $377,000 to rebuild and analysis indicates the odds of an event requiring a complete rebuild are 1/100 years, then selling homeowners insurance for $3800/year is a break even proposition (ignoring discounted cashflows…) (Spoiler… The average cost of a home in Florida is about $377,000 and the average cost of insurance for that much home looks to be about $4700/year. That’s a margin of about $93,000 for the insurer over 100 years or $930/year.
If the average house in Florida is WORTH $380,000 but would actually COST $570,000 to rebuild if lost in a hurricane because that single event triggered losses on 5000 other homes simultaneously, causing materials shortages and price spikes, any firm holding policies for homeowners insurance for only $4700 is looking at a loss.
If the average house in Florida is WORTH $380,000 but climatologists now believe the chance of a Category 5 hurricane hitting the area are now 1/20 years and even if the hurricane doesn’t destroy the house, tornados triggered by associated thunderstorms are now 4x more likely, now the risk of a total loss might be 1/15 years. That would require $25,333 in yearly premiums.
At that point, if you WANT to live in Florida with those risks and can either SAVE $25,333 per year and self-insure or you’re willing to pay $25,333 in premiums for an insurance company to handle the money for you, by all means… go ahead. If enough like minded people hang around, an insurance company might write those policies and everyone stays and everyone’s happy. If on the other hand, if you cannot afford a mortgage and that insurance cost, YOU CANNOT AFFORD TO LIVE IN FLORIDA. Nothing in the “market” is going to fix that problem.
THAT is the dynamic at work in places like Florida (hurricanes, sea levels), California (fires, now maybe floods) and other areas.
I’ve been experimenting in my spare time to develop a visual animation (like those in 3Blue1Brown videos) to illustrate the sensitivity of insurance profitability to changes in likelihood of catastrophic losses. I don’t have the models working yet but I suspect they will show markets in these states are already at a break even point. I further suspect actuaries at these firms are SCREAMING in their board meetings that they will become insolvent at current premium levels in the next 3-5 years as disasters continue spiking.
Primarily because these disasters are more frequent, more intense, and more correlated to each other. More Cat 5 hurricanes doesn’t just mean more homes lost to the eye of the hurricane but an ever wider circle of destruction from storm surge, secondary tornadoes and heavy rains covering multiple states. And raising premiums won’t help because consumers in these markets CANNOT AFFORD to live there if they had to pay the implied costs for future (inevitable) losses stemming from these disasters.
All of which points to a larger macro-economic and yes – political – meltdown to come to decide how the country as a whole absorbs these losses when private markets fail and insurers file for bankruptcy. Do we as a country tell people they cannot live in a fire / hurricane / flood zone? Do we tell them they’re free to live in a disaster waiting to happen but they will be on their own? If we TELL them that, will we actually stick to it when disaster strikes to ensure people get the message or will we “cave” and make people whole while incenting the problem?
WTH
