Insurance is a long-term enterprise that presumes a world in which the frequency and the severity of insured losses are both individually uncertain and collectively predictable. The uncertainty of individual losses makes insurance a worthwhile purchase for insureds: by paying an insurance premium, each insured purchases a promised degree of security. The collective predictability of losses assures a reasonable underwriting profit to insurers, which calculate appropriate pure premium rates and expense ratios.
Since at least the Great Fire of London in 1666, property-liability insurance has endured, often prospered, in this individually unpredictable and collectively predictable world. Insurance has also survived, basically unchanged, despite some relatively short-term fluctuations, such as the Great Depression of the 1930s and the urban riots which brought us the Fair Access to Insurance Requirements (FAIR) plans in the 1960s.
Recently, however, a virtual avalanche of natural disasters, persistent terrorist threats, and current fears of global warming have led some insurers and insureds to believe that their world has fundamentally, permanently, changed. Many property-liability insurers are not only dramatically increasing their premiums—they're also refusing to renew existing coverages unless insureds take unprecedented loss control measures. Other insurers are leaving some markets entirely.
In response, Insureds are turning to government officials and other public leaders, urging them to demand that insurers continue offering the same coverages for the same premiums, regardless of the underwriting consequences. As a result, some would now say that our industry faces a crisis. They claim our world is fundamentally changing for the worst, warning that we must make some basic changes in our industry's operations. To respond intelligently, we must address two questions. First, is our world really changing? Second, if so, what should we do?
A Changing World?
Looking at just the last 3 to 5 years, one could find credible evidence of real change in our world. First, there have been unusually frequent and severe hurricanes, floods, and wildfires. Moreover, terrorism has changed many of our traditional social and political priorities, so that terrorism insurance is no longer an automatic coverage add-on. In addition, climatic changes are leading scientists to convince us that global warming is cause for alarm. Perhaps the most direct evidence that insurers think our world has fundamentally changed is that they have sharply increased property premiums. Is this an effort to restore depleted catastrophe loss reserves in 1 or 2 years rather than the next 10-20 years that actuarial science says we should take to prepare for the next "10-year" or "20-year" storm, while perhaps arranging for appropriate reinsurance as these loss reserves are rebuilding? It almost seems that insurers themselves have lost confidence in the traditional long-term strategies that underlie the insurance mechanism.
This alarm over impending changes has been echoed and amplified by legislative and regulatory officials. Many of these folks seem to believe that they can make insurance function more effectively than those who have dedicated their careers to the principles and mechanics of the industry. Short-term, politically driven, mandates for change in policy language, premium rates, and loss-adjusting procedures are, in fact, only undermining the very principles of how insurance should work.
Right now, I believe that no one can yet tell whether our insurable world has fundamentally changed. Therefore, we need to rise above the current cacophony to gain a longer range perspective on what is happening. In the short term, we need to first be patient, to be the collective source of the strength and stability for which our industry has always been renowned.
At the same time, however, we need to respond to current concerns that face both insurers and insureds now. The recent events that have challenged our industry might very well be temporary, but the effects they have caused may prove severe. Perhaps we need to explore some new ways that insurers and insureds can work together to overcome the current dilemmas, ways which can serve the insurance industry well into the future.
If So, What Should We Do?
Without committing our industry to hasty actions, we should explore at least three avenues for overcoming the current frustrations of both insurers and insureds.
First, because preventative safety measures have always been a more cost-effective risk management strategy than financing measures to pay for damage that has already occurred, we should look for ways in which insurers can help insureds pay for the safety measures which insurers have recently been requiring as a prerequisite for writing or renewing coverage. For example, if insurers want homeowners to install steel roofs in vulnerable areas, perhaps these insurers can offer low-interest loans to help homeowners finance these safeguards. As a further incentive, these insurers may also offer significant premium reductions in anticipation of the lower fire and windstorm losses that insurers believe these roofing changes promise. By helping share the costs of these added safety measures, insurers can demonstrate their willingness to cooperate with their insureds in keeping everyone adequately insured.
Second, if eventually, we realize that the current changes are fundamental, then another way to finance loss controls is by granting tax credits for investments that policyholders make to that end. Granting tax credits shifts the cost of loss control to the government, to society as a whole, rather than just imposing these costs on only insureds and/or the insurance industry.
Third, in time, whether the current onslaught of losses from disasters, terrorism, and global warming are temporary or permanent, insurers should explore joining with community groups in advocating long-term changes in zoning regulations. Some of these changes should prohibit building or rebuilding any structures in areas where catastrophes are virtually certain to occur (perhaps every 5 years or less). A second set of zoning changes should mandate the necessary loss-control measures appropriate for that high-risk area. By encouraging communities to take a more active role in safeguarding themselves from losses which prove too costly and too frequent, insurers can maintain their traditional function in today's changing world.
Lisabeth A. Groller contributed greatly to the substance of this article.
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