Underwriting leakage for natural catastrophes becomes obvious after a bunch of claims are paid: prices go up within a year or two. While these premium increases are considered a necessity by insurers, it is a source of frustration to consumers and anxiety to regulators. Consumers don’t like premium rises, and regulators don’t like unpredictable pricing because they don’t like unhappy consumers (i.e. voters).
This “catching up” by insurers happens across all natural perils after an event, and the response is predictable:
Three perils, in three different regions, united by a common outcry: insurance rates are rising after an event.
These increases need to be defended by the insurers to consumers and regulators. To justify increases to the regulators, insurers supply recent claims history and a summary of future exposure – both are reasonable requests, and the process is understood on both sides. Meanwhile, justifying rate hikes to customers is not so easy because the pricing of insurance policies is opaque. It is safe to say the average policy holder does not understand how risk is priced, and it is difficult to explain a price increase when the original price is only a number, and is not attached to anything of tangible value. I want to be careful and clear here, though: the security offered by insurance is absolutely valuable; however, that value is abstract, unlike other stuff a couple thousand dollars can buy. A typical property insurance shopper buys the lowest priced policy, without any further consideration.
The need to raise rates comes from a combination of not having collected enough premium over the years and inadequate risk diversification to handle a big event. To glimpse a simple and perfect world, the rates charged for the coverage would have matched the cost of the claims paid (plus the overhead, profit, etc. needed to run a business). In this perfect world with no underwriting leakage, there would be no future premium increases to justify, no regulators to satisfy, and no customers to placate. Such price stability would be value that policy holders could covet, and insurers who use better risk assessment analytics to stabilize their pricing could differentiate themselves on something other than price.
Later this week, we’ll explore the coverage gap found in nat cat coverage everywhere around the world. It, too, is a result of underwriting leakage (along with a bunch of other factors).