Toxic “Consumer-Friendly” Insurance Laws More Bane than Boon to Homeowners
This commentary originally appeared in the Heartland Institute on October 22, 2014.
Reflexively responding to the 2008 financial crisis, many government regulators moved to reduce the burden of toxic assets in the financial market, after widespread speculation instigated a credit crunch and contributed to the economic slowdown.
Yet, despite the consensus that it was these firms’ inability to shed these assets which instigated their failure, many state governments continue to use “consumer interests” as a justification to forcing other industries — in this case, home insurance companies — to shoulder more toxic assets. Perhaps surprisingly, Texas is one of those states forcing businesses to make bad investments
Under the Texas Insurance Code, home insurance companies are not allowed to decline to renew a homeowner’s insurance contract once it expires, unless the policyholder has submitted three or more claims. The ban excludes any claim resulting from natural causes, and it applies even when the policyholder overused or abused the claims process.
A Bane upon Consumers, But Not a Boon
Due to these narrow parameters, it has become nearly impossible for insurers to reach the state’s statutory threshold, obliging them to maintain policies that pocket more money than their premiums cover — in other words, a toxic asset.
Although this restriction may seem like a boon to homeowners, since it shields them from the loss of their insurance, non-renewal laws inflate insurance premiums for most consumers by forcing insurers, and therefore their customer base, to bear the costs of certain high-risk policies.
But, isn’t that how insurance works, smoothing over high risks clients by submerging them within a pool of safer policies? Not precisely.
While it’s true that insurers rely on “the law of large numbers” to diffuse their clients’ risk, there is logic behind insurance companies management of that risk, and calculation of customers’ monthly premiums.
Theoretically speaking, a home insurer pools together customers with similarly situated risks and properties. This not only allows the company to calculate its population-to-risk ratio more accurately, but also helps ensure that homeowners pay only for the risks that they themselves incur, keeping their premiums low.
Market Distortion Field
Non-renewal laws disrupt this ideal actuarial practice by preventing the insurers from self-correcting their risk pools, when a policy proves more expensive than originally anticipated.
This inability to self-correct puts both insurers and their customers in an awkward position. Insurance companies have a legal obligation to stay solvent. At the same time, non-renewal laws bar them from dropping unsound policies. Since lowering their risk exposure is not an option, the only way left for them to balance their books is to increase their cash flow — in practical terms, across-the-board premium increases — or lowering their business costs by providing fewer services to customers.
This is where we see parallels to last decade’s credit crunch. The overabundance of toxic assets in a market crowds out the availability of a product or service. Companies become so overexposed that they do not have the resources to invest in new customers, even when there is little likelihood of losing money.
In retrospect, that’s why the collapse of subprime mortgages caused a sudden credit shortage. The mortgages lost so much value that the banks could not afford to broaden their loan exposure, regardless of someone’s good credit. Instead, consumers had to accept higher interest rates and stricter terms in order for the banks to extend credit.
Differing in degree but not kind, non-renewal laws mimic the subprime mortgage failure. The toxic policies crowd out the availability of cheap insurance and clog up what otherwise would be a flexible market.
Insurance companies are not immune to the laws of economics, as overburdening an industry with toxic assets hurts consumers, who ultimately bear the costs of the added vulnerability. The situation in which Texas insurance companies are placed is no different, as the regulations are directed this time at how consumers protect their homes, and not how they finance it.
Kathleen Hunker ([email protected]) is a policy analyst with the Texas Public Policy Foundation’s Center for Economic Freedom.
“Non-Renewal of Policies in Texas’ Homeowners Insurance Market,” Kathleen Hunker, Texas Public Policy Foundation, http://www.heartland.org/policy-documents/non-renewal-policies-texas-homeowners-insurance-market
October 24, 2014