The Risks of State Property Insurance
GOVERNMENT IS SHIFTING THE COST OF COASTAL LIVING
On October 30th a legislative subcommittee will meet to discuss the issue of the availability and cost of coastal property insurance.
South Carolina coastal residents have been fortunate this year in that South Carolina, as well as other coastal states, has enjoyed a relatively mild hurricane season. Thanks to the government, inland residents should also be thankful (financially speaking) for this year’s lack of major storms, since inland residents subsidize coastal property insurance under the Residual Market Property Insurance Plan established in South Carolina.
Residual Market Plans were originally established to provide property insurance to individuals (often coastal residents) who tried and failed to find reasonably affordable property insurance on the private market. In recent years, however, these plans have seen large expansions in both number of policies held, and in the value of property insured as individuals have increasingly looked to these plans early rather than as last resorts for insurance.
In South Carolina, the state-created Residual Market Plan is known as the South Carolina Wind and Hail Underwriting Association (SCWHUA). The SCWHUA is operated by a board of directors who have the power to issue insurance policies to South Carolina residents who reside in the legislatively defined coastal area and apply for such coverage. More interestingly, with few exceptions, all insurers authorized to sell property insurance in the state are legally defined as members of the SCWHUA and “shall participate in its writings, expenses, profits, and losses.” What this means is that whenever the SCWHUA experiences a loss it may levy “assessments” on private insurers requiring them to help make up these deficits through payments. Naturally, it would be expected that private insurers would pass some, if not all, of the cost of these state assessments on to their inland resident customers.
Aside from being essentially a redistribution of wealth program, the SCWHUA is problematic both for its natural tendency toward growth and its related increasing risk to taxpayers.
The SCWHUA provides incentives to both other insurers and individuals that ensure it will continue to grow. The SCWHUA is supposed to be an insurer of last resort, but its subsidized low premiums provide an incentive for residents to treat it as a first choice. A 2010 report by the Government Accounting Office found that SCWHUA premium rates don’t fully reflect the risk of loss and are lower than private market rates.
The effects of these low subsidized rates are threefold:
- First, private insurance companies unable to compete with the subsidized premiums of state insurance gradually offer less and less property insurance plans in coastal regions. As is often the case when the government decides to get involved in an industry through either subsidies or direct provision of the industry’s service, the effect is to drive out market based competition.
- Second, state residents who normally couldn’t afford the associated cost of living on the coast will relocate to the coast as the decision to do so has been made less costly. This second effect serves to strengthen an existing phenomenon: South Carolina’s costal population increased by 125 percent between 1960 and 2010, or to use a more recent benchmark, it increased by 33 percent between 1980 and 2003.
- Third, more policies protecting a greater total value of property will continually be issued by the state insurance provider. At the end of 2005 the SCWHUA had some 22,068 property insurance policies in effect, by the end of 2012 that number had increased to 45,855 policies, an increase of 108 percent.
The increase in the number of policies issued by the SCWHUA comes with an increased total value of property insured, and as a result an increased potential for state losses. Contemporaneous with the large policy expansion described above, the SCWHUA’s total in force liability increased from $6.6 billion in 2005 to $15.7 billion in 2012 or by 138 percent.
This expansion of state insurance liabilities and general increase in the value of property on the coast relative to the rest of the state is a trend with a strong possible backlash both for state finances and the South Carolina economy. Were there to be a major storm that produced damage even equivalent to around a sixteenth ($1 billion) of the SCWHUA’s total liability, it could put a major strain on the finances of a state with a $24 billion budget. The state would have to make up these losses either through cuts (possibly to actual core services, as government officials have historically often cut core services first as a protest to spending cuts) or, more likely, through heavy assessments to private insurance firms, which would largely pass on these costs to consumers. USA Today reports that state property insurance plans in the Southeast and Gulf Coast have already collected $7.4 billion in taxpayer funds and insurance surcharges since the 2005 hurricane season, and that typical insurance surcharges to support state-offered insurance can equal up to 15 percent of an insurance premium. The loss of valuable property (increasingly on the coast) would also be damaging to the general productive ability of the South Carolina economy.
Due to the chances of financial losses to both the state and South Carolina residents, reducing the state’s role in property insurance is not something that can be affordably put off, especially since the potential losses are constantly growing. Unfortunately, the legislature has been exacerbating the problem in recent years with bills like the 2007 Omnibus Coastal Insurance Property Reform Act which actually increased the land area from which residents can apply for SCWHUA insurance. Lawmakers also introduced a bill in 2013 (covered in this year’s Best and Worst of the General Assembly) which would increase tax revenues to the hurricane damage mitigation program and reward private insurers who concentrated risk in the coastal region with tax credits.
The attempt to coerce private insurance companies to provide more policies in coastal regions shows that lawmakers are asking all the wrong questions. The question isn’t, “How can we get more private insurers to provide property insurance on the coast?” The question they should be asking is, “What drove private insurers out of the market to begin with?” If they asked themselves the latter question they might realize that a government program was responsible for the initial exodus of private companies, and further, that market-distorting government programs aren’t the way to get private companies back.
Rather than expanding programs with perverse incentives, the state should be seeking to rein them in. The state should cease issuing new policies from SCWHUA and should begin retiring existing policies when they come due for renewal. Once all existing policies have expired, the program should be eliminated and the private market should be allowed to communicate price signals free of distorting subsidies from this or any other program.