NEW YORK, Dec. 30, 1996 — Broadening homeowners coverages, and not just worsening catastrophe losses, are behind the recent poor performance of the industry's third largest line of business, according to Insurance Services Office, Inc. (ISO).
A new ISO study concludes enhancements that insurers have made to their homeowners policies to satisfy growing customer needs, increase market share and meet competition also have increased costs and produced a drag on the line's financial performance.
The ISO study, "Homeowners Insurance: Threat from Without, Weakness Within," also points to catastrophes as a reason for poor profitability in homeowners insurance. From 1989 to 1995, the homeowners operating ratio averaged 115.6. The ratio peaked at 151.9 in 1992, the year of Hurricane Andrew, and has not fallen below 107 since 1988. An operating ratio is the combined ratio minus the net investment ratio — the ratio of net investment gains, including net investment income and realized capital gains — to earned premium.
The losses insured under typical policies have outstripped premium growth,ISO found.
The ISO analysis finds that homeowners premiums grew an average of 5.1 percent per year between 1977 and 1995, while loss costs grew an average of 6.7 percent per year. When the experience of the worst catastrophe years — 1985, 1989, 1991, 1992 and 1994 — is removed, loss costs still grew5.7 percent per year, more than one-half percentage point higher than the average premium growth of 5.1 percent.
The overall revenue shortfall of 12 percent — the annual shortfall compounded from 1977 to 1995 — indicates that catastrophes alone do not fully explain poor homeowners underwriting results since the late 1970s, according to the study.
Many coverage enhancements provide "questionable advantages" for insurers by adding complexity and cost to the product.
Examples of recent coverage enhancements include coverage for hidden leaks; removal of fallen trees; some limited coverage for business property; and extended limits for items such as money, jewelry and silverware. Also, many insurers have added enhanced loss-settlement options, such as "guaranteed replacement cost" to their homeowners programs.
Further, the enhancements may have added to policyholders' anticipation that homeowners insurance covers every possible loss, the study observes. "As insureds file more and more claims, the administrative costs of settling claims rises, whether or not the companies pay those claims,"the ISO study says.
As insurers commonly use five years of experience in homeowners ratemaking, it may take many years for rates to fully reflect the cost of an individual enhancement, the study notes. "A series of continuing enhancements can have a continuing and cumulative effect, with rate levels constantly playing 'catch-up' with the forces driving cost," says the report.
The study points out that over time, through the use of insurers' loss and premium experience in ratemaking, homeowners rates recognize these costs. "But it may take years for the ratemaking data, and eventually rates, to reflect fully the costs of a single enhancement."
The study also reviews current issues in homeowners insurance, including availability and affordability problems in Florida, California and Hawaii;catastrophe modeling; the accumulation of tax-free catastrophe reserves;capital-market alternatives for managing the catastrophe risk; urban property risks; environmental issues such as lead paint; and the use of credit information in underwriting.
For copies of "Homeowners Insurance:Threats from Without, Weakness Within," call: ISO Customer Service at 1-800-888-4476.