Urban Insurance Issues
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THE TOPIC
NOVEMBER 2007
Underwriting, the task of deciding what risks to insure, allows insurers to discriminate between good and bad risks. Differences in prices for insurance must reflect expected differences in losses and expenses. When the risk of future losses increases or when rates are inadequate, insurers become more selective about the degree of risk they will assume in an effort to preserve their profit margin. However, redlining, defined as refusal to issue or renew, or to cancel an insurance policy based not on risk but on the geographic location of the structure or individual to be insured, is illegal in every state.
Because losses tend to be higher in urban areas, rates for auto and home insurance are often higher than average in inner cities. This has raised questions about the availability and affordability of insurance in urban communities. Responding to these concerns, insurers are redoubling their efforts to enhance the insurability of inner city properties and to push for changes in auto insurance that would enable urban drivers to have more coverage options. Some people worry that the industry’s use of credit reports in underwriting adversely affects low income households. However, the insurance industry does not collect racial or income information on applications for insurance. Government and academic studies confirm that credit scoring is not used by insurers to unfairly discriminate against any demographic group.
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RECENT DEVELOPMENTS
- California: The state’s low-cost auto insurance program will be expanded to an additional 16 counties, making it a statewide program. According to Insurance Commissioner Steve Poizner, more than 33,000 policies have been issued since the program’s inception. By law, the Insurance Commissioner must make a determination as to whether there is a need before a county can participate. The decision to include more counties must be based on the number of uninsured motorists in each county, the extent of the low income population, the availability of affordable insurance options in the voluntary market and the desire of consumers to participate as expressed at public meetings.
- The program started in 2000 in Los Angeles and San Francisco. The program was due to sunset in 2007 but in 2005 was extended to at least 2011. The insurance department estimates that there are about 160,000 uninsured motorists, many of whom cannot afford insurance. While applications to the program are increasing, the number of drivers insured under the program has been growing slowly, in part because some of the applicants fail to meet requirements. Others allow the policy to lapse. As of December 31, 2006, there were nearly 9,000 policies in force, compared with about 4,000 at the end of 2002. The state’s assigned risk plan (CAARP) runs the program while promoting it is the responsibility of the insurance department. Supporters of the program say that instead of periodic advertising blitzes, the state should establish a permanent program to explain and promote the low cost plan. Most drivers were uninsured when they applied. Los Angeles is estimated to have about 40 percent of the state’s uninsured drivers.
- To protect the public and encourage people to buy auto insurance, proof of insurance is needed to register a car. Many therefore apply for a policy through the low cost auto insurance program then drop their coverage as soon as their vehicle is registered. The Plan receives more than 38, 000 applications a year but only a fraction of these remain in force. Almost half of all policies cancelled during the last quarter of 2006–943–were in force for three months or less. A driver’s car registration can be canceled as soon as the motor vehicle department is notified by an insurer that a driver is no longer insured.
- In response to a petition filed in 2003 by a coalition of the state’s major cities and several consumer activist groups to lower auto insurance rates in inner cities, the importance of territory (where a person lives and keeps a car) as a rating factor has been diminished in California but not eliminated. The new rating law is a compromise, requiring rural and suburban drivers to subsidize urban drivers to some extent but much less than they would have if the use of territory had been completely eliminated as the groups had requested. The rates of urban drivers are subsidized in many states with large urban populations.
- Maryland: Following a series of hearings in 2005, the task force set up by former Insurance Administration Commissioner Alfred Redmer issued its recommendations on auto insurance rates in urban areas of Maryland. A number of these are included in House Bill 1600, which was signed by the Governor in May 2006. The measure requires rates filed for each rating territory or area to be actuarially justified and the commissioner to submit a report to the legislature each year on the use of territorial rating. The bill also strengthens antifraud and theft efforts. Also included were recommendations to allow insurance companies to create innovative pilot programs to rate and price auto insurance policies. Redmer was a supporter of the concept of pay-as-you-drive, which would base rates for Baltimore drivers principally on miles driven rather than location. Urban residents tend to drive fewer miles than suburban and rural drivers but because of the density of traffic they have more accidents. Also, theft, vandalism and fraud rates are generally higher in urban areas. High auto insurance rates in Baltimore have long been a source of frustration for city residents and have given birth to many innovative efforts, including the creation of an insurance company that focused largely on urban residents.
- New Jersey: A quota system set up under the state's Urban Enterprise Zone program to boost the number of insured drivers in the inner cities has been extended to 2009 to mesh with other changes designed to bring rating maps up-to-date and require insurers to accept all applicants for insurance. The law had been scheduled to sunset in 2003 and then in 2006. In the first two years, the New Jersey Department of Banking and Insurance reported a 12 percent jump in the number of vehicles insured in the state's urban areas over the two-year period, compared with a 4 percent growth rate over the same period elsewhere in the state. The 1997 law that created the program requires insurers doing business in the state to insure drivers living in Urban Enterprise Zones according to a specific formula, based in part on their share of the state’s auto insurance market. There are 27 enterprise zones in cities around the state with some 562,000 drivers out of a total of about five million.
- A new plan for rating territories has been developed by the New Jersey Department of Insurance and Banking in response to the mandates of the 1998 reform law and is being revised following public comment. The new rating plan gives insurers several choices for selecting a territorial map, including the using the common territory map, one approved by the commissioner and an individual plan based on their own data. The state’s territorial rating provisions stipulate that territories should be made up of zip codes and recognize municipal boundaries where possible. While some individuals will see premium increases or decreases, overall the new rules should not result in any revenue increase and should “have a positive social impact by preventing unfair subsidization of some insureds by others,” the insurance department says.
- Territories must not be arbitrary, unfairly discriminatory or be created for marketing purposes and they must be made up of areas that are contiguous but not gerrymandered. In addition, according to the regulation, there can be no more than 50 territories in the state and each must include at least 20,000 policyholders. The actuarial subcommittee revising the territorial map is recommending that new territories include only 10,000 policyholders to make them more homogeneous. After the new rating plan goes into effect, a cap imposed 20 years ago will be lifted. The cap, which is in place primarily in urban areas, prohibits insurance companies from charging more than 35 percent above the insurer’s statewide average. The state now has 27 territories, 10 of which are subject to the cap. Rates will not necessarily go up in urban areas once the cap is removed because the changes resulting from the state’s reform of its auto insurance system have brought more insurers to the state, creating greater competition.
- To help ensure that the changes –lifting the cap on rates in cities, requiring insurers to ”take all comers” and creating new territories – will not lead to problems in the urban auto insurance market, the insurance department is proposing a subsidy program to encourage insurers to seek out business in high loss areas. Under the program, known as the Territorial Rating Equalization Exchange, insurers that provide coverage in these areas will be compensated from a pool of money collected from all insurers writing auto insurance in the state under an agreed-upon formula.
- As of June 2006, according to the insurance commissioner, more than 40,000 New Jersey drivers had enrolled in one of two innovative auto insurance programs. As of the end of June 2006, more than 18,000 drivers had purchased the Dollar-A-Day policy, which was part of the reform legislation passed by the legislature in 2003. Over 25,000 more have purchased a Basic Policy, which provides broader coverage. Both policies were created as alternatives to the standard policy in an effort to reduce the number of uninsured drivers and make auto insurance more affordable for the state’s low-income drivers. The Dollar-A-Day policy pays up to $15,000 of most medical expenses after an accident and $10,000 in death benefits and, like the standard auto insurance policy, provides coverage for catastrophic injuries, such as severe brain damage, up to $250,000. The program is administered by the Personal Automobile Insurance Plan, the state’s assigned risk program, and covers relatives as well as the driver. Eligibility is based on standards for Medicaid. The state credits the two programs with reducing the number of uninsured drivers to about 600,000 or about 12 percent of the total.
- Michigan: Under a program sponsored by the Office of Financial and Insurance Services, the Governor’s Office and the Office of Community and Faith-based Initiatives, members of two Detroit and Flint central city organizations who have good driving and responsible homeownership records will be able to get a discount on auto and homeowners insurance policies. The program, known as the Michigan Insurance Pooling Initiative, helps create a purchasing group which can then negotiate lower rates for its member organizations. Group rates are usually lower than rates for individual policyholders because marketing costs are less and groups of responsible people generally file fewer or less costly claims.
- Loss Prevention: An analysis of the results from a loss prevention program sponsored by NeighborWorks America shows that, in general, intensive efforts to educate urban homeowners about loss prevention techniques pay off. Insurers’ overall loss experience in the target areas improved relative to the surrounding cities and states. The Insurance Alliance Loss Prevention unit, part of the Neighborhood Reinvestment Corporation developed these programs to help homeowners recognize and correct hazardous conditions in and around their homes that can lead to injuries and property damage. Known as Loss Prevention Partnerships, the programs were aimed at reducing specific hazards that have been identified as the most serious causes of loss in five targeted urban communities. Insurers provided much of the funding. The communities are Chicago and St. Louis where fire is a particular problem, Denver and Richmond, where theft is prevalent, and Staten Island, New York where water damage is prevalent. The Neighborhood Reinvestment Corporation is a Congressionally-sponsored not-for-profit organization designed to revitalize urban neighborhoods across the country.
- Over the course of the three year trial period, 2000-2003, the loss prevention pilot programs educated more than 6,000 homeowners through home safety seminars, conducted some 1,300 home safety inspections and made more than 600 loans and grants totaling $2.5 million for home improvements. The number of claims dropped in most communities and although the size or average cost increased, the increase was generally less than in other comparative communities. In addition, through their emphasis on improving the environment in the communities, the programs have opened up new opportunities for insurers, who previously may have viewed economically risky neighborhoods as poor insurance markets. The results of the study will form the basis for future programs in urban communities.
- Credit Scores: Critics of insurers’ use of credit scores often claim that insurance scoring unfairly discriminates against urban drivers. After several years of extensive research, the Federal Trade Commission (FTC) has found that auto insurers’ use of insurance credit scores leads to more accurate underwriting of auto insurance policies in that there is a correlation between insurance scores and the likelihood of filing an insurance claim. The FTC report, Credit Based Insurance Scores: Impacts on Consumers of Automobile Insurance, also states that credit scores cannot easily be used as a proxy for race and ethnic origin. In other words, credit scoring predicted risk for members of minority groups in much the same way that it predicted risk for members of nonminority groups. The Fair and Accurate Credit Transaction Act of 2003 directed the FTC to address the issue of whether the use of credit had a disparate impact on the availability and affordability of insurance for minorities.
- Based on a poll of consumers, the General Accountability Office has recommended that the Treasury and FTC take steps to improve consumers’ understanding of credit scoring and how credit histories are used, targeting in particular those with less education and less experience in obtaining credit.
- A study by the Texas Department of Insurance on the use of credit information by insurers in Texas found that there was a strong relationship between credit scores and claims experience and that insurers did not unfairly discriminate. Based on an analysis of data from two million auto and homeowners insurance policies, it found that although there was a consistent pattern of differences in credit scores among different racial/ethic groups, with blacks and Hispanics having worse scores than whites and Asians on average, the results were actuarially supported, meaning that all drivers with the same rating characteristics would be charged the same amount, regardless of race, income or ethnic background. The research, which was required by law, was conducted by the insurance department with assistance from the University of Texas and the Texas A&M University as well as the Office of Public Insurance Counsel. The findings on the relationship between credit scores and insurance claims confirm other research commissioned by the Texas legislature in 2003.
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BACKGROUND
Insurance availability and affordability in urban areas is a multifaceted problem with no easy solutions. On the property side, increasingly the issue is not so much availability as affordability. Indeed, in some parts of the country, people who live in central cities may have fewer difficulties finding insurance than rural property owners who may suffer from the same income limitations with the additional problem of inadequate fire protection.
On the auto insurance side, in several states with large urban areas, programs that offer lower priced coverage have been created. Some have been more successful than others, in part due to the type of coverage they provide. In California, where the low cost program provides liability coverage which drivers in the state must have by law, it has been expanded from the cities of Los Angeles and San Francisco, which were the first to participate in the program, to almost all counties in the state, allowing those drivers that meet eligibility requirements to comply with the law. However, experience shows that even among those who meet the qualifications, for many drivers with incomes close to the poverty line, the cost of insurance is still too high to enable them to comply with the state’s compulsory auto liability insurance law. And for those who qualify but have bought insurance through the regular market or the assigned-risk plan, the cost of the bare-bones package, which offers no first-party (policyholder) medical care, is not so low that drivers with a policy providing broader coverage are likely to switch.
In New Jersey, many previously uninsured drivers have purchased low cost policies. However, unlike the California program, New Jersey’s Dollar-A-Day program provides medical care coverage.
In the past, there was also hope that no-fault auto insurance would help solve the problem of affordability by putting more of the insurance premium in the hands of accident victims. But no-fault systems have encouraged fraud in some communities, pushing up the cost of coverage in the very areas where people can least afford it. However, increasingly in states with a large urban population, urban rates are subsidized to some degree by those living in other areas of the state.
Property Insurance
Community activists have charged that homeowners insurance is difficult to obtain in inner city communities, that it is more expensive, and that urban applicants are offered less comprehensive policies than people living elsewhere.
Studies by many different groups have shown that residents in urban communities have insurance (banks generally will not issue a mortgage without proof of insurance) and that the rates charged are in line with losses. However, because of the higher risk of loss (fire, vandalism and theft) more inner city homeowners are often insured outside the regular market, just like people who live in coastal areas exposed to hurricanes.
The prevalence of older homes in central cities also led consumer groups to charge that urban homeowners were unfairly discriminated against. Older homes present a problem in that the decorative and uniquely crafted features can push repair or replacement costs significantly above a home's market value and raise premiums to the point where insurance could become unaffordable. In the past, some insurers would not offer owners of older homes a full replacement cost policy, the most comprehensive homeowners policy that pays to rebuild the structure as it currently exists, regardless of whether they lived in an expensive Victorian mansion in suburbia or a more modest home in the inner city. Instead of a full replacement cost policy, owners of older homes purchased a policy based on the fair market value of the home with rebuilding costs based on standard building materials and techniques.
However, in response to the perception that homeowners insurance is not available in inner cities, most major insurers have changed their business practices regarding older homes, including eliminating age restrictions and minimum market value. Instead, they inspect the heating, plumbing and electrical systems and roofs more rigorously for hazards that could lead to losses and suggest repairs or replacement where necessary.
History: After the urban riots in the mid-1960s, insurers were reluctant to write policies in inner city areas because of the devastating losses they sustained. To improve economic conditions in these communities, Congress passed the Housing and Urban Development Act in 1968. This made federal riot reinsurance available to states that set up FAIR (Fair Access to Insurance Requirements) Plans, property insurance pooling mechanisms that made basic property insurance coverages available to homeowners living in urban areas where it was difficult to obtain insurance. Insurers needed federal riot reinsurance to protect them from fire and vandalism losses should riots erupt again. The private reinsurance market soon replaced the federal program but FAIR Plans and other residual market programs still exist to provide insurance where the voluntary market will not, see report on the residual markets.
The availability of insurance again became an issue in the aftermath of the Los Angeles riots in 1992. Some small businesses located in the areas destroyed by fire and looting failed to reopen, in part because they lacked the proper business insurance coverages. At the same time, community activists began to accuse the insurance industry of deliberately discriminating against inner city neighborhoods. As proof of redlining, they cited the difficulty of obtaining insurance in urban communities where the housing stock is often old and the fact that owners of older homes were offered policies that provided "actual cash value" — the depreciated value of damaged items — rather than replacement cost coverage.
Surveys by independent research groups for the insurance industry showed that most homeowners (98 percent) living in major cities had home insurance and only 3 percent of those surveyed said that they were aware of anyone in their neighborhood having difficulty obtaining homeowners insurance. Nevertheless, the charges of redlining prompted regulators and lawmakers to consider imposing expensive data collection requirements on insurers to monitor property insurance sales, marketing and cancellations. While data collection proposals failed to muster support in Congress, a program designed to encourage increased competition among large insurers in "underserved communities" is in place in California. Insurers with a significant presence in the state's urban markets or a plan to bolster inner city business are exempt from data collection requirements, see below.
Underwriting and Other Business Practices: By laws or regulation, redlining is illegal in every state and there is no evidence to suggest that insurers unfairly discriminate based on racial or ethnic differences. However, insurers do discriminate based on risk and a company's profitability is determined in large part by its ability to evaluate risk and charge a premium commensurate with the potential for loss.
To help underwriters distinguish between what the company considers good and bad risks within the confines of its marketing strategy, insurers develop underwriting guidelines. These guidelines provide a framework for underwriting decisions by identifying what factors should be considered in accepting applications for coverage. They also help ensure underwriters' selection decisions are uniform and consistent throughout the company. For example, an insurer that wants to limit its exposure to hurricane damage may decide to decline all applications for property insurance on buildings within a certain distance from the ocean. That distance may be measured in yards or by surrogates for distance such as zip codes or counties. In regions prone to hailstorms or brush fires, insurers may refuse to insure homes with certain types of roofs.
Programs to Expand Urban Property Insurance Options: The insurance industry has been working with community groups, such as the Neighborhood Housing Services, in New York, St. Louis, Philadelphia, Seattle and other major cities across the nation to increase understanding of insurance, make homes more insurable and help insurance companies better market products and services in these communities. These relationships are leading to the development of new insurance products or the modification of existing policies to better meet the insurance requirements of central city consumers and greater awareness among potential applicants of how to reduce losses. In addition, outreach programs have been established to increase the number of insurance agents in predominately low-income areas and to make it easier for them to be financially successful.
In some states, Market Assistance Programs (MAPs) have been set up to help insurance buyers and agents find insurance. Texas, for example, adopted new rules in 1997 that bar the use of age and value as the sole criteria for declining to insure a home and put into effect two programs to address urban (and rural) markets. One is a traditional market assistance program. The second offers financial incentives for insurers to offer a basic residential insurance property policy.
Insurers doing business in California must file community service statements. These anti-redlining regulations, which were originally adopted by Insurance Commissioner John Garamendi during his first term in office, require insurers to submit detailed information on business activity in all zip codes in the state, including the race and national origin of applicants for insurance. These plans are reviewed by the commissioner.
In Massachusetts, insurers receive credit against Massachusetts FAIR Plan assessments for voluntary market policies written in certain areas of the city. In addition, the state's 25 largest insurers are required to disclose their record of homeowners policy sales in these neighborhoods. Insurers are now allowed to write policies that cover the fair market value of properties rather than their replacement cost. (Formerly, insurers were required to provide replacement cost coverage which, on a large, older house with a low market value, made the cost of insurance prohibitive.)
In 1998, a group of insurers doing business in California created an investment vehicle, Impact Community Capital, to increase the industry's financial support for low-income communities. In the nine years it has been in existence, Impact has pioneered the securitization of mortgages for community housing. Securitization enables capital to be recycled into new affordable housing. In the securitization process, mortgages and other loans are pooled and sold as securities which immediately puts money back into the hands of the banks and other lenders to make more loans.
Auto Insurance
Auto insurance rates are generally higher in central cities. There are several reasons for this including the greater traffic density and pre-automobile-era design of streets in the older cities of the Northeast that increase the risk of accidents and the higher incidence of theft and vandalism.
In low-income urban communities, where the cost of insurance may force drivers to choose between insuring their vehicle and purchasing other basic necessities, many cars are uninsured. Insurers have long advocated auto insurance policies that provide basic insurance coverage as a cheaper option for low-income drivers, who have less need for liability insurance because they have no assets to protect if they are sued.
In some states with large urban populations, regulators have placed restrictions on auto insurance rates for central city drivers. These caps force non-urban residents to pay a subsidy to keep urban insurance prices more affordable, the reasoning being that the influx into central cities of drivers who work and shop there but live elsewhere is responsible in part for the greater number of traffic accidents.
Over the past decade, insurers and lawmakers have tried to enact no-fault auto insurance programs of various kinds in an effort to lower premiums. But, with the exception of Pennsylvania where a choice no-fault system has offered urban drivers a means of reducing the price they pay for auto insurance, efforts to introduce no-fault have been unsuccessful, largely due to opposition among trial lawyers and others whose income would be reduced if more claims were settled outside the court system. In addition, the high incidence of fraudulent personal injury protection claims in some urban areas of states with no-fault auto insurance laws has led some states to dismantle their no-fault systems.
Credit-Related Insurance Scoring: A growing number of insurance companies now use credit-related insurance scores to help them decide whether to accept an applicant for insurance and sometimes to set a price for coverage. Insurance scores predict the average claim behavior of a group of people— applicants for insurance with basically the same score. Studies show that as a group, people with low insurance scores tend to file more claims and people with high scores file fewer claims. Essentially, people who manage their finances well tend to manage other important aspects of their lives responsibly. The extent to which credit is used varies by state regulation and by company. In many states, insurers must file their credit scoring plan with the insurance department. See report on credit scoring for more information.
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