The big hurricanes have passed for now, but the battle over insurance rates and coverage is just beginning.
Insurance industry executives and regulators are warning of significant premium hikes for homeowners' insurance nationwide -- including double-digit-percentage increases in the Gulf states -- that could also spill over into other types of insurance.
After a catastrophic event causes widespread property loss, insurers by law must move money from their capital base, known as the policyholders' surplus, to a reserve account large enough to pay expected claims. Typically, they then seek price increases to replenish capital and guard against future claims. Insurers also usually pass along to all customers their own increased costs for backup insurance, known as reinsurance.
In remarks echoed elsewhere in the industry, Evan Greenberg, chief executive of Ace Ltd., a large Bermuda-based commercial insurer, recently said Hurricane Katrina was a "market-changing event" that would require price hikes in sectors beyond property insurance. He said rates for covering the marine and energy industries were already rising. "Ultimately, the effect of these events will be felt worldwide."
The expected price hikes would hit consumers in a marketplace where prices already were climbing at more than twice the rate of inflation. Average annual homeowners' premiums have risen 62 percent since 1995, to $677 -- an industry estimate that does not include the effects of the summer's catastrophes. In part, the rapid cost escalation is a result of higher home prices, which force consumers to buy more insurance at higher premiums.
The record-setting season of hurricanes Katrina, Rita and Wilma and its industry-shaking consequences offer a window on the murky world of insurance pricing -- where regulation, markets, litigation and politics all play a hand in a process that occurs out of sight of most consumers.
By law, prices are set by state insurance commissioners, who must approve insurers' rates. Under the rules, price increases aren't allowed for past losses -- only future risks -- but insurers plug big losses in their actuarial models to make the case that the world is becoming riskier. Generally, price increases are likely to be smaller farther away from hard-hit areas, but with the current focus on hurricane risks, coastal areas in Virginia, Maryland and Delaware also may be hit with higher premium costs, according to industry executives.
As a practical matter, rates for businesses are set between buyer and seller and can fluctuate sharply. Commercial property rates, for instance, jumped about 71 percent from the end of 2000 to mid-2003 before easing recently, according to Advisen Ltd., a New York-based insurance consulting company.
Homeowners' and auto policy rates are considered more politically sensitive and are typically given more scrutiny, though consumer advocates complain that state regulators are too quick to accede to industry demands, which also include attempts to cut off coverage to risky areas to reduce costs.
State regulators say this summer's hurricanes gave insurers ample motive to consider cutting back on coverage. "When you get hit buy a car in the middle of the street, you start looking both ways," said J. Robert Wooley, Louisiana's insurance commissioner.
Allstate Corp., for instance, has both trimmed exposure and sought rate hikes. Just last month, two units of the Northbrook, Ill., company asked Florida regulators for rate increases averaging more than 25 percent. Florida allowed 8 percent, ruling that the companies failed to provide adequate support for the request. Allstate earlier this year also transferred 95,000 Florida homeowners' policies to another company, Universal Group Inc., based in Puerto Rico.
"There's obviously a need for us to better address and assess the risk we are assuming along the Gulf coast," an Allstate spokesman, Bill Mellander, said.
To bolster their case for higher rates, insurers point to National Oceanic and Atmospheric Administration pronouncements that the global climate is about 10 years into a 20 to 30-year cycle of increased hurricane activity. And recent events provide strong support for the claim that insurer are experiencing extraordinary losses.
The Insurance Information Institute, a Washington-based trade group, says insured catastrophe losses in 2005, estimated at $56.8 billion, are the largest ever, twice as big the losses created by four hurricanes in Florida last year, which was itself a record. Seven of the 10 biggest-loss-creating hurricanes in history occurred in the past two summers. And this month's Wilma, costing an estimated $7.2 billion or more, could end up being history's fifth-most-destructive hurricane.
"There's no way an insurer can operate in an environment like that and assume it's business as usual," said Robert Hartwig, an economist with the Insurance Information Institute.
But consumer advocates say insurers perennially use high-profile losses to campaign for higher rates and make enormous profits as a result. The industry has recorded profits of more than $100 billion since the terrorist attacks of 2001, and last year, it recorded profits of $38.7 billion, even after the $27.5 billion loss suffered from the four Florida hurricanes.
Hartwig argues, however, that the key financial measure isn't total profit but the industry's profit as a percentage of its equity, the surplus available to shareholders, which he said lags behind major industries. Amy Bach, executive director of United Policyholders, a San Francisco-based consumer group, also says insurers often reserve large losses for accounting purposes, but then, as claims are settled, pay far less.
"I don't think their exposure on the residential side is going to be nearly what they're saying," she said. "They can reserve until the cows come home, but then they never actually pay."
Insurers are facing their own price hikes from reinsurers, which are expected to pick up at least 40 percent of Katrina-related losses. The reinsurance industry is mostly based offshore and largely unregulated, its prices subject to secretive negotiations with insurance companies. Losses drain the supply of reinsurance available globally, making it more expensive.
Hartwig of the Insurance Information Institute says reinsurers are expected to raise premiums as much as 100 percent on coverage of the highest-risk zones.
Mario P. Vitale, chief executive of the North American unit of Willis Group Holdings Ltd., a large commercial insurance broker based in New York and London, says that in the wake of the hurricane losses, global insurance investors will demand a higher rate of return for the perceived increased risks. That's how property losses on the Gulf can pressure rates across all types of insurance.
"That's real money being paid by real companies to third parties," Vitale said. "The industry needs to right the ship."