May 4, 2009

Why are my insurance rates going up?

Now that hurricane victims are collecting insurance claims, Wasudeo in Texas wants to know: how come insurance companies raise their rates after a disaster?

Why do insurance companies increase the rates after a disaster; while all the other times they earn all the money and hardly pay a dime to their customers?
Wasudeo P. -- Plano, TX

In simplest terms, they raise rates because they didn’t collect enough money in the first place to cover all the claims against losses.

At its most basic, insurance seems like a fairly simple business. Companies that write life insurance, for example, can predict fairly accurately -- thanks to a branch of statistics called actuarial science -- how much to collect. Based on decades of mortality data, they can calculate your life expectancy, based on age and other circumstances.

Women, for example, who on average live a bit longer, pay a little less. Smokers, who tend to die younger, pay more. And for every person who dies sooner and collects after paying less than their "share" of premiums, there will be someone else paying “extra” premiums well into their 90s. By keeping the pool large enough, and continually crunching the numbers, actuaries have a pretty good handle on how much to charge each policyholder.

But how do you predict how many more Katrina’s will hit in future hurricane seasons? Worse, how can you predict where they’ll hit: in the heart of a major city built below sea level or a little ways down the coast where there are just a few condos on the beach? A few miles can make a multi-billion-dollar difference.

When an insurance company gets hit with claims, it has to replenish the capital reserves it used paid out those claims, and then stash away more reserves to pay future claims. If it didn’t keep those reserves topped off, it would be selling you on a promise it couldn’t keep.

This year, the drain on reserves was a whopper. Though the total losses are still being tallied, 2005 will go on the record books as the worst year ever for insured catastrophic losses, more than twice the record set in 2004, according to the Insurance Information Institute. A report earlier this month pegged the loss at nearly $57 billion, but that’s just an estimate. And this was just the was the latest in a string of huge losses – including hurricanes Ivan and Charley in 2004, and the Sept. 11, 2001 attacks. Five of the 11 most expensive disasters in history have hit in the past four years, according to the III.

You could argue that insurance companies “blew it” by not charging enough before Katrina hit. But charging premiums for such a worst-case catastrophe would have meant the insurance industry was overcollecting over long periods that were relatively free from disaster.

There's no question the insurance industry was making a bundle before the hurricane season hit. Property casualty insurers posted a profit of nearly $31 billion for the first half of 2005 -- for a return of more than 15 percent. But the average return for the 15 years before that was 8.8 percent -- compared with 13 percent for the Fortune 500, according to the III. You may think insurance industry profits are "too high." But if investors can get more money elsewhere, insurance companies can't raise capital -- and you can't get insurance.

And even if it wanted to, your insurance company can’t just charge whatever its want. For one thing, it has to submit rates for approval by state regulators. While those regulators usually go along with rate increases, they don’t have to. State Farm recently got approval for an average 8.6 percent increase in homeowners insurance in Florida. Allstate, on the other hand, is appealing a decision by Florida regulators turning down its request for an 18 percent rate hike.

When claims get too big, some insurers simply refuse to cover certain types of disasters – like earthquakes or floods. After Katrina struck, some adjusters reportedly tried to deny claims by saying that damage was caused by flooding (which wasn’t covered) rather than the hurricane (which was.) Bring on the lawyers.

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