RiskProf

The One about "Research"

Florida Insurance Commissioner Kevin McCarty talks about "research" ...

It is always interesting, and frequently amusing, to read various “research” pieces on the Florida property insurance market. While I, like every other insurance regulator, industry professional and observer in the world, agree that the Florida property insurance market provides a challenging, to say the least, economic environment, I must also finally break down and respond to some of the more recent articles.

Here is an abstract and a link to a recent and hopefully amusing article on Florida written by a couple of real comedians (at least our friends think so).  Actually, I am not sure if he is even responding to our riotous prose because Mr. McCarty does not refer to any particular piece of research and does not cite any studies or commentary in his protest regarding the amusing research.  As the "regulator" he should point fingers and cite his sources of amusement for the rest of us aspiring humorists. 

Here is a direct but extremely short rebuttal from the CEI. I didn't notice any belly busters or guffaw worthy bon mots in the CEI's response, but I did note (with a couple of well placed chuckles) that the CEI recently ranked Florida regulators at the bottom of a 50 state list.  I suppose it probably was not for the lack of a sense of humor.

 

ABSTRACT (gated link, but appears to be free for now)

The Perfect Storm: Hurricanes, Insurance, and Regulation

by Martin Grace and Robert Klein

The intense hurricane seasons of 2004 and 2005 caused considerable instability in property insurance markets in coastal states with the greatest problems occurring in Florida and the Southeast. Insurers have substantially raised rates and decreased their exposures. While no severe hurricanes struck the United States in 2006 and 2007, market pressures remain strong given the high risk still facing coastal states. These developments generate considerable concern and controversy among various stakeholder groups. Government responses have varied. In Florida, political pressures prompted a wave of legislation and regulations to expand government underwriting and subsidization of hurricane risk and constrain insurers' rates and market adjustments. Other states' actions seem more moderate. In this context, it is important to understand how property insurance markets have been changing and governments have been responding to increased catastrophe risk. This article examines important market developments and evaluates associated government policies. We comment on how regulation is affecting the equilibration of insurance markets and offer opinions on policies that are helpful and harmful.

RiskProf takes the dare

I could be wrong about a number of things, but I try --in this forum --to be correct in applying economics to situations involving risk and insurance.  My opinions are based upon economic theory which includes the theory of how insurance is priced.  In a comment to a previous post on free insurance someone said,

"No one is asking for free insurance. Compare the expected losses to the premiums. I dare you."

So, I take up the dare.  Except I punt a little.  I do not have access to expected losses.  So I looked at past performance.  

One of the problems with this incredibly simplistic assertion is that it is based on the assumption that everything works with in a one year period.  Firm's are in business for the long run, thus they expect to make profits in the long run.  In fact, they do not have to make a profit every year, just in the long run.  Otherwise they will leave the market.

In the figure below I plot the loss ratio (losses incurred in a given year to premiums earned).  Thus this is actual losses rather than expected.  Florida has the big swing in 2004 and 2005 due to the hurricanes in those years.  If we look at the average of these ratios over time Florida's is 72.77.  That means that for every dollar of insurance premium paid, the state's customers received 72.77 cents in loss payments.  Kansas (one of those middle states without any hurricane risk) has a relatively stable loss ratio and an average ratio of 62.64.  That means for each dollar of premium paid, the state's customers received 62.24 cents back in loss payments.  Finally, in the U.S. overall, the average loss rat is just a bit above Kansas'.

So, Florida's customers already get a better deal than the average customer in the U.S. given that they receive more back in terms of loss payments.  They would like an even better deal (as would I).  To get this better deal, they would like Kansas and the other states to chip in. 

The data come from the NAIC and are available from them if the commentator wants to check my work.  To be fair, maybe no one wants free insurance.  Maybe they just want less expensive insurance.  Either way, someone else who doesn't share that risk has got to chip in to make it so.

Insurance is not socialized risk sharing.  It is sharing of risks where everyone pays their risk based price. And for the record, I was (and still am) against federal programs like TRIA.  I also believe that the private market could cover flood insurance.

(Note this post was updated slightly from the previous version because I meant to save it and I inadvertatnly published it before it was finished).