Partners (Number 2, 2006)

Vol. 16, No. 2, 2006


Can Housing Be Green and Affordable?

Technical Education: a Remedy for Poverty?

Soaring Insurance Costs Make Housing Less Affordable

CRA Revisions: Flexibility and New Choices

Reverse Mortgages Provide Answers for Some (but Not All) Seniors

Recruiting Retirees Calls for Careful Planning

Atlanta Fed Hosts Last in Series of Asset-Building Forums

Spotlight on the District—Georgia and Eastern Tennessee



  Soaring Insurance Costs Make Housing Less Affordable

Today’s discussions of affordable housing are likely to turn to the topic of insurance. In some hot real estate markets like south Florida, escalating home prices over the past four years have overshadowed the role of taxes and insurance in eroding home affordability.

house squeeze

Across the country low interest rates have masked the effect of rising taxes and insurance costs on monthly housing payments. But as the real estate market cools down, interest rates continue to rise, and catastrophic losses reveal the exposure of vulnerable geographies, attention is shifting to the volatility of insurance underwriting and pricing.

Affordable insurance is critical
Many remedies have been proposed to address insurance concerns. The disproportionate impact of Hurricane Katrina on the poor and the uninsured has prompted community groups in hurricane and flood zones to increase outreach and education regarding the availability and benefit of both hazard and flood insurance. Educational efforts and financial assistance also aim to mitigate damage through repairs that will protect properties from future storms and keep them from deteriorating further. Unfortunately, in Florida and along the Gulf Coast many homeowners are facing the 2006 hurricane season without having completed repairs to damage from storms in 2005.

Access to affordable insurance will ultimately determine the success of community-based outreach to protect homeowner assets. Those already insured will have to keep up with the mounting expense of insurance and rising deductibles brought on by shocks to the industry that have resulted in special assessments and significant hikes in premiums. For the uninsured, establishing coverage can be difficult without prior insurance history. Personal credit scores are now used across the industry to approve and price insurance, and this practice may adversely affect low-income homeowners.

Insurance tab drives housing costs upward
In higher-risk markets such as California, Texas, Florida and New York, coverage has become more restrictive and deductibles have risen. In some areas the number of companies underwriting insurance is dwindling. In Florida, for example, some insurance companies have been allowed to leave the state and others have become insolvent, so there are fewer providers. Lack of competition combined with the increased market risk is fueling double-digit increases in premiums there.

Housing advocates, who have been battling soaring home prices with elaborate layers of financing to make ownership affordable for low- and moderate-income families, are now confronted with the severe impact of insurance premiums on the monthly mortgage payment. While a few thousand dollars difference in the price of a home can determine whether a family will qualify for the mortgage, a few hundred dollars’ in insurance cost can have the same effect. Moreover, while a fixed-rate mortgage will maintain the same principal and interest payment over the life of the loan, insurance premiums change annually and therefore can unexpectedly jeopardize the family’s ability to stay in their home.

The insurance dilemma has even more far-reaching implications. While homeowner insurance supports mortgage underwriting by protecting the property’s collateral value, insurance company investments in both bonds and mortgage-backed securities maintain the liquidity of the mortgage lending industry. Insurance companies sell a variety of products with variable risks and payouts. The premiums they collect are split between building up reserves to meet short-term payout demands and generating investment income with funds dedicated to long-range returns. Thus the solvency and profitability of the insurance industry—whether considered nationally or in specific markets—directly influences the mortgage industry and affects the availability of residential and commercial real estate financing.

To further complicate the issue, government has been attempting to work with the insurance industry in high-risk and high-cost markets to keep homeowner insurance accessible and affordable. These measures have traditionally focused on state-based negotiations with insurance providers, but support is growing for a federal response similar to the 1968 National Flood Insurance Program. Insurers are requesting that legislators allow claims to be funded with pre-tax rather than post-tax reserve dollars.

Insurers seek new solutions
Another proposal would create a federal insurance fund to help companies pay claims resulting from catastrophic events that meet certain damage or market thresholds. However, a federal pool of funds would distribute insurance cost nationally, as does the market-based risk mitigation strategy for traditional insurance models.

Distribution of costs raises one of the most contentious points of dispute in the insurance debate, namely whether low-risk markets should be required to help fund losses in higher risk markets. While this idea has been broached across the country since Hurricane Andrew in 1992, the insurance industry has responded to Katrina with the decision that premiums will go up nationally to help cover losses sustained in the 2005 hurricane season.

Many living outside high-risk markets—especially those outside hurricane-prone markets—understandably oppose an industry-based risk sharing model preferring instead a market-specific risk pricing model. However, changes in the exposure to risk and in the types of risk have compelled the industry to find alternatives for meeting demand while protecting profits and solvency.

The state-based focus on regulation and pricing has kept larger insurance companies from adequately spreading costs and risks throughout their market areas, creating instead concentrations of risk in vulnerable geographies. This dynamic is especially important for large insurance companies that are not able to reinsure their exposure effectively. Through reinsurance smaller companies are able to buy their own insurance policies to protect funding of their claims in the event of significant covered losses. But larger companies, and more importantly those with dense concentrations in high-risk markets, are not able to access reinsurance at all or cannot do it profitably.

The Florida legislature created a state insurance pool to provide coverage to homeowners as insurers fled the state following Hurricane Andrew. Citizens Property Insurance has always operated on tight margins and has periodically faced significant shortfalls to cover claims, most recently after the active 2005 hurricane season. Although access to the state insurance is limited to those who cannot obtain private coverage, that list is growing as more insurance companies become insolvent, opt to limit coverage geographies, or leave the state altogether. As a result, the latest session of the Florida legislature had to approve a state-funded bailout of the pool, which resulted in premium hikes for the insured.

Governor Jeb Bush is now asking the lawmakers to consider creation of a second insurance pool to help small businesses as commercial windstorm insurance has become prohibitively expensive or completely unavailable.

Emphasizing the importance of insurance
Market penetration is another issue for the insurance industry as homeowners and renters opt to “self-insure,” that is, to cover their own losses rather than include insurance cost in a tightening household budget. Education and counseling may help many homeowners, especially low- and moderate-income families or those with otherwise limited savings, to consider the advantages of obtaining some level of insurance.

Flood Insurance Coverage
Owner-occupied homes with severe flood damage as a result of Hurricanes Katrina and Rita
flood insurance chart
Source: Federal Emergency Management Agency and Department of Housing and Urban Development

The proportion of homeowners without flood insurance in New Orleans surprised many. On average, insurance covers more than 60 percent of losses after a natural disaster; in New Orleans, it is expected to cover less than half. Lack of flood coverage will make the New Orleans recovery that much more costly. For lower income families without any insurance, the prospect of rebuilding may seem hopelessly challenging.

The Flood Disaster Protection Act of 1973 made flood insurance mandatory in flood-prone areas for properties financed by federally regulated lending institutions or through federal assistance. A 2003 study by the Rand Corporation found that 49 percent of single-family homes in special flood hazard areas (SFHA) nationwide are covered by flood insurance, while in the South, the figure rises to over 61 percent.

However, the SFHA designations, which are delineated on maps produced by the National Flood Insurance Program, are based on a number of assumptions which are now being questioned, such as the extent to which levees will protect New Orleans from flooding. Households outside the designated flood zones and not compelled to purchase flood insurance by their mortgage lender are much less likely to opt for the coverage, despite its relative affordability. The Rand study found that only 1 percent of homeowners in non-SFHAs purchase flood insurance.

The potential for natural and man-made disasters is expected to remain high for the next 20 years. Community organizations must continue to educate and inform the uninsured about the benefits of insurance, the importance of building a cash reserve for disaster recovery, and the availability of community loan programs to mitigate potential losses by repairing homes, trimming trees and installing safeguards. At the same time, discussion must move forward about how to control the rise in insurance premiums for the average homeowner while keeping high-risk markets reasonably profitable for insurance companies.

This article was written by Ana Cruz-Taura, regional community development director in the Atlanta Fed’s Miami branch.