What's Behind the Rising Cost of Auto and Homeowners Insurance?
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Dr. Robert P. Hartwig, Ph.D.,
Vice President & Chief Economist
Many policyholders have seen the price they pay for auto and homeowners insurance increase over the past year. In 2003, the cost of insuring both cars and homes is expected to rise by 9 percent. The increases may have taken some policyholders by surprise given that they came after several years of relatively flat to decreasing prices. While these increases translate into a relatively modest $40 for the average homeowner and $60 per vehicle, many policyholders are understandably concerned about higher insurance costs and have been left wondering why their premium rose and what they can do to keep costs down in the future. This article will address the major cost drivers in auto and homeowners insurance today and offer customers money saving tips that can help them offset these costs.
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Why Are Auto Insurance Rates Rising?
Vehicle owners understand that their personal driving record, the type of vehicle they drive and how much they drive influence the cost of auto insurance. Yet rising medical costs, sharply higher vehicle repair costs and soaring jury awards in vehicular liability cases are the principle drivers behind higher auto insurance rates today. In several states, fraud and abuse is pushing up the cost of auto insurance.
Medical costs are an important factor in the cost of auto insurance. Each year there are more than two million car accidents involving injuries. Several people are often injured in the same accident. Typical costs for treating an auto accident victim range from $6,000 to $9,000 but can easily run into the tens of thousands of dollars. The cost of auto injury claims is rising by as much as 30 percent in some states.
The $15 billion to $20 billion that auto insurers pay in medical claims each year are a very significant component of auto insurance costs and the upward trend in claims costs is an important cost driver in auto insurance today. Higher costs for hospitalization and pharmaceuticals, state regulations permitting a wide range of dubious treatments and associated legal costs are largely to blame.
Higher repair costs are another significant cost driver today. A recent court decision essentially forced many insurers to suspend their use of aftermarket (generic) crash parts in automobile repairs, giving manufacturers of name-brand parts a virtual monopoly in this multi-billion dollar market. In the year following that decision, the pace of increase in the cost of motor vehicle body nearly tripled. The effective prohibition on the use of generic parts—which are of like kind and quality to name brand parts—in the repair of damaged vehicles is a factor that could ultimately add $4 to $5 billion annually to the cost of automobile insurance. Name brand parts often cost 30% to 70% more than their generic equivalent.
Another court in late 2001 reached an equally unfriendly consumer decision that could have the effect of reaching deep into the pockets of drivers. The Georgia Supreme Court ruled that insurers must compensate drivers for the so-called diminished value that occurs when a car is involved in an accident, even if the car is completely repaired and functions normally. The theory is that a car involved in an accident is always worth less than one that has not, even if repaired to its pre-loss condition. Auto dealers claim that diminished value for cars involved in accidents is typically 10% to 15% of the vehicle’s resale value. If insurers must pay out an additional 10% to 15% on each claim, then clearly the cost of insurance must reflect that fact.
Sharply higher jury awards in vehicular liability cases are putting additional upward pressure on auto insurance rates. The average jury award in auto liability cases rose from $187,000 in 1994 to $269,000 in 2000—an increase of 44%. Auto liability issues are much more important than people realize. About 60% of auto premiums paid in 2000—nearly $70 billion—were for liability coverages.
Fraud and abuse are major problems in some states, such as New York, Florida and Massachusetts. Loopholes in New York’s no-fault insurance statutes, for example, are costing the state’s drivers nearly $2 million per day.
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AVERAGE EXPENDITURES ON AUTO INSURANCE
* III Estimates
Source: NAIC, Insurance Information Institute.
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Why is the Cost of Homeowners Insurance Increasing?
Homeowners know that the price they pay for insurance depends on factors like type of construction, age of the home and the quality of local fire protection services. Nevertheless, it is the extraordinary number of catastrophes, the high cost of home repairs, the aging of the U.S. housing stock and the emergence of mold claims (yes, I said mold) that are pushing homeowners insurance rates upward. Mold claims—which were virtually unheard of just a few years ago—cost homeowners insurers more than $1 billion dollars last year, approximately five times the cost in 2000.
During the 1990s, the frequency and severity of catastrophes began to increase dramatically. Over the past 12 years, insurers paid out more than $100 billion in catastrophe-related losses—about $700 million per month—many times more than in previous decades.(1) Catastrophes include well-known events such as Hurricane Andrew and the Northridge earthquake, but also hundreds of smaller disasters associated with tropical storms, tornados, wildfires, hail, ice and snow.(2) Homeowners insurance rates in many parts of the country continue to rise because of the extraordinary costs associated with paying these claims. In fact, virtually every part of the country is now at risk for billion dollar disasters.
In dollar terms the numbers are sobering. Homeowners insurers over the past decade paid out $1.18 in losses and expenses for every $1 they earned in premiums. In 2001 alone, homeowners insurers paid out $8.9 billion more in losses and expenses than they received in premiums, the second worst year on record (1992, the year of Hurricane Andrew, produced losses of $11.5 billion). Losses in the homeowners insurance line over the past three years (2000 through 2002) are estimated at $19 billion, rivaling the $20.3 billion in insured property losses from the September 11 terrorist attack.
Every homeowner knows that home repairs don’t come cheap and that home repair and rebuilding costs continue to rise. This phenomenon is a major driver of behind rising homeowners insurance rates today.
Mold has recently emerged as the dominant cost driver in some states. Mold is certainly not new—it’s been around for hundreds of millions of years—but the sharp rise in mold claims is definitely a 21st -century phenomenon. Multi-million dollar jury awards, sensationalized reporting in the media and profiteering by some individuals have led to an explosion in mold claims and costs.
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AVERAGE EXPENDITURE ON HOMEOWNERS INSURANCE
* III Estimates
Source: NAIC, Insurance Information Institute.
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In Texas, for example, mold claims in 2001 cost insurers more than $850 million compared to virtually nothing just a few years earlier. The number of mold claims in the state increased by 1,300% between the first quarter of 2000 and the fourth quarter of 2001 while insurer payouts through the third quarter of last year increased 1,200%. Runaway costs associated with mold claims are having an adverse affect on the availability and affordability of homeowners insurance in Texas, and increasingly in other states. California, for example, has seen a large spike in water damage claims—which often give rise to mold claims. Water claims accounted for 32% of all claims in 2001, up from 24% in 1997. Over the same period, the average cost of these claims surged by 86% from, $2,537 to $4,730.
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Saving Money
Although the cost of insuring cars and homes is rising, there are many ways that policyholders can hold down and even lower what they pay for insurance. First, make sure that you take advantage of every discount that you are eligible for. Insurance companies offer many discounts, including discounts for good drivers, good students, loyal customers and to customers who insure multiple cars or their home and vehicles with us. Discounts on your auto policy are also available if you’ve taken a defensive driving class or if your car is equipped with certain safety equipment and anti-theft devices. Homeowners can save money if your residence is equipped with smoke detectors and by installing certain home security devices. Raising your deductible is another way to save money. Higher deductibles on your car and home could produce savings of 15% to 30% or more. Maintaining good credit will also help you save on auto and home insurance.
Knowing how to save money can go a long way toward offsetting higher insurance costs. For more information, visit the Insurance Information Institute’s web at www.iii.org or call your agent or insurance company.
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(1) Excludes the impact of the September 11, 2001 terrorist attacks.
(2) Insurers define a catastrophe as any single event that produces insured losses of $25 million or more.
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