NAR Insurance Task Force Final Report/Recommendations - Findings

Findings

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Hit by a number of forces over the course of the past few years, the insurance industry in 2002 was in the midst of a particularly difficult period as insurers experienced a surge in the number and size of property casualty claims. Wildfire, flood, storm-related damage, lead paint, mold and terrorism claims all contributed to generate a negative net income after taxes for property casualty companies.

According to the Insurance Services Office, Inc. (ISO) and the National Association of Independent Insurers (NAII), the property/casualty insurance industry posted a $7.9 billion net loss in 2001, its first-ever net loss with a statutory rate of return of negative 2.7, down 6.5 percent from the year 2000. In the first quarter of 2002, the rate of return was 6.9, down from 7.4 during the first quarter of 2001. Net written premium rose 10.3 percent. Net income after taxes dropped 7.3 percent to $5.1 billion in the first quarter from $5.5 billion in the first quarter 2001.

In addition to rising claims, industry performance was jeopardized by recent large court judgments against insurers. Recognizing the opportunity that the latest household hazard - invasive mold - offered for lucrative lawsuits, the trial bar had begun to file and win mold lawsuits. One well-publicized Texas lawsuit, for example, resulted in a $32.1 million judgment. While this judgment was subsequently reduced, most legal experts expect mold judgments to continue as mold cases are introduced in more states.

The events of September 11th also impacted the financial state of the insurance industry. The Insurance Information Institute estimated September 11th-related claims would total $40.2 billion. Other estimates range as high as $70 billion. These claims have taxed insurance company reserves and the level of demand for and cost of future reinsurance coverage.

Finally, the impact of the decline in the stock market cannot be ignored. Historically low interest rates took their toll on investment income, which fell 5.5 percent. On an annualized basis, insurance industry investment income was estimated at $35.8 billion in 2002, down $1.3 billion from $37.1 billion in 2001.

For much of the 1990's, insurance companies competed for market share as a way to grow more profitable. The primary means of competition used was price. Consequently, homeowner premiums had not kept pace with the risk companies assumed along with this growth. Record stock gains on investment portfolios had been used to make up any losses with investment income. With the decline in the financial markets, this source of revenue no longer exists and premiums increased.

Putting all of these factors together - increasing claims, large judgments, terrorism and the meltdown in the stock – the insurance industry faced the "perfect storm".

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Insurance Industry Reactions

In reaction to rising claims and losses, insurers took somewhat predictable steps to limit their risk. These steps included limiting the number of new policies written, increasing premiums, instituting new policy exclusions for some hazard claims and tightening their underwriting criteria for both borrowers and properties.

Limitations on new policies. The most common reaction has been to limit the number of new policies written. One of the largest property casualty companies, State Farm, initially declined to write policies for new customers in 30 states nationwide. Late last year, Farmers Insurance announced that the company would not renew any homeowners' policies in the state of Texas once coverages in effect expired. This action could have forced approximately 700,000 homeowners to find a new insurance company to provide their insurance coverages. Luckily, this possibility was adverted as the result of discussions between the Texas insurance commissioner and Farmers.

Premium increases. Annual premium increases averaged 8 percent in 2002 while a 9 percent average increase is expected for 2003, according to the Insurance Information Institute. In some areas, the increases have been higher. The North Carolina Department of Insurance, for example, approved higher homeowners insurance premiums, effective Aug. 15, 2002. Rates there increased an average of 5 percent statewide, with the increase in coastal areas averaging 30 percent.

Tighter underwriting. In addition to raising premiums, insurers also tightened their underwriting criteria for both potential policyholders and the homes themselves. A homeowner who files "too many" claims can find himself or herself notified that their insurer will not renew their coverage for the coming year.
Potential policyholders are now underwritten for risk through the use of insurance risk scores - a hybrid of the credit scoring methodology used by lenders to evaluate credit risk. According to the developers of the methodology - Fair, Issac and Company - while they have not shown a causal relationship between insurance claims and an insurance score based on credit history, there is a correlation between the two. One common explanation of the relationship between credit history and the likelihood that an individual will file insurance claims is that individuals who are not careful about paying their bills on time and managing their credit are likely to be similarly careless when it comes to dealing with routine maintenance or how they use their property and, therefore, will generate excessive claims.

In terms of underwriting the physical structures, insurers have slowly tightened underwriting requirements for structures. Bans on wood shake roofs, requirements for circuit breakers rather than fuses, field inspections, and mandatory repair requirements are examples of insurers’ increased attention to property condition.

These has also been an increase in the use and sharing of databases among the industry, like the Comprehensive Loss Underwriting Exchange (CLUE) database, that record 90 percent of all insurance claims made in the U.S. The CLUE database is a service of the Choice Point. ChoicePoint is part of the Equifax credit-reporting agency. The database contains name, address, telephone number, credit report, claims history and motor vehicle report. The company uses the information for credit scoring, claims history reporting and driving-record reporting.

Increased exclusions. Mold claims and judgments have lead many insurers to seek exclusions for mold coverage from the basic homeowners policy terms mandated by state insurance commissioners. To date, 20 state legislatures have authorized policy exclusions for mold problems.

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Impact on Real Estate

The availability and affordability of property casualty insurance is critical to well being of homeownership efforts in this country and the real estate industry – the one sector of the economy that has continued to perform well in recent weeks and which is commonly cited as keeping the economy afloat.

Insurance is a necessary component in securing a mortgage. Ongoing insurance coverage is a necessary condition for meeting the terms of most mortgages. Increases in premiums can prohibit the marginal homebuyer from being able to afford homeownership and can severely strain the ability of existing homeowners on fixed incomes to continue to meet the ongoing costs of homeownership. Housing affordability is already a problem in many parts of the nation – escalating insurance premium costs only exacerbate the problem.

Insurance affects affordability in more ways, though, than just increased premium costs. Multifamily practitioners report that insurance costs are increasing also due to lender demands for additional insurance coverages over and above what has traditionally been required for mortgage underwriting purposes.

On a micro-level, NAR has done survey work to gauge the impact that these events have had on transactions. In general, the member reports received indicate that transactions are oftentimes problematic, often delayed and some are falling through due to insurance availability or affordability problems. In some cases, inspections by insurers are resulting in repair requirements as a condition of insurance that also adds to the cost of a transaction.

Typically, though, buyers have gotten coverage, albeit at higher rates. In order to reduce premiums, some buyers and owners are increasing deductibles from the $100-$500 range that has been most commonly used to $1000 or more as higher deductibles can lower premiums.

Prior water damage claims have stigmatized properties resulted in some refusals to write coverage. Additionally, poor credit has priced some individuals out of the insurance marketplace. In these cases and some extreme markets, consumers have had to turn to surplus line carriers like a Lloyd's of London who are not regulated by the insurance commissioner rate-setting process and are able to offer coverage at rates that are higher and, therefore, acceptable to the insurer or to state-managed FAIR Plans.

Perhaps the most troubling reports uncovered by the survey work are those that indicate that new homeowners are being informed after the close of escrow but prior to the end of the time period for which a binder is effective that the insurer will not offer the coverage indicated in the binder. This obviously is troublesome and, at best, leaves new homebuyers without recourse to negotiate with the seller over any newly required repairs that may be a mandate for any insurance coverage and, at worst, forces a new homeowner to find coverage at any cost and therefore shoulder insurance cost far beyond what was anticipated.

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