Why Are Homeowners Insurance Rates Rising?
June 7, 2012
Some U.S. states are seeing an increase in their homeowners insurance rates. There are a number of reasons for this trend.
The rates have been inadequate for many years, with insurers paying out more in claims than they received in premiums, after accounting for the expenses insurers incur when running their businesses on a daily basis. In fact, from 2005-2008, U.S. homeowners insurance premiums grew more slowly than the rate of inflation. And in 2011, some insurers began filing for rate increases in a few states to get their homeowners rates back to levels that would provide the company with the capacity to pay future claims while also maintaining their long-term solvency.
Rising homeowners rates also reflect the growing frequency and severity of natural catastrophes. In 2010 the federal government provided disaster relief for 81 natural disasters—a record number at the time. This record was broken in 2011, when there were 99 federal disaster declarations. To put this in historical perspective, in the 14 years prior to 2010, the number of disaster declarations made by the U.S. federal government ranged from 44 to 75, averaging 57 a year.
2011 was one of the most expensive years for insurers in global history, as well as in the United States. Furthermore, some of the areas hit hard by big storms in 2011 are not areas of the U.S. that insurance companies expected to have a great deal of risk. The extraordinary spring tornado season in the U.S. in 2011, along with severe winter weather and the $5.5 billion in claims payouts arising out of Hurricane Irene in August, reduced the property/casualty insurance industry’s cumulative policyholders’ surplus—the amount of money remaining after an insurer’s liabilities are subtracted from its assets—to $550.3 billion as of December 31, 2011, from $559.2 billion at December 31, 2010, a nearly 2 percent drop.
More troubling, however, from the industry’s perspective, was the 3.5 percent rate of return the industry realized on its policyholders’ surplus in 2011. It was the eighth lowest full-year rate of return since ISO started chronicling this number in 1959. These low interest rates have negatively impacted insurers’ investment portfolios. Investment income is a source of revenue for insurers that can be used to pay claims and expenses. When it drops, insurers must rely more heavily of premiums.
Like homeowners insurance companies are vulnerable to facing large, immediate needs for funds. In the case of insurers, these needs arise mainly when natural disasters occur and buying insurance can help avert financial trouble. For insurance companies, such protection is called reinsurance—essentially insurance for insurance companies. And just as with homeowners and other types of property insurance, the same pressures drive up the rates for reinsurance, which in turn, increases the costs the insurers bear.
Finally, homeowners insurance rates have been affected by construction costs. The cost of building a home rose by 45 percent from the start of 2001 through the end of 2011. The annual construction price (e.g., the cost of materials and labor) change in 2002 was -0.4 percent higher than the previous year. In 2011, it was +5.9 percent above where it stood in 2010.
To summarize, the prolonged low-interest rate environment, which has hurt insurers’ investment portfolios, coupled with the rising price of reinsurance and construction, and the aftermath of the record catastrophe activity in 2011, are all factors influencing many insurers’ decisions on homeowners rates in 2012.