Researchers Suggest Multi-Year Insurance Policies to Cut Premiums, Losses

Published September 13, 2010

A new study finds multiyear insurance polices induce homeowners to do more to protect their houses from storm damage while reducing insurance premiums.

 “Long-Term Property Insurance,” by Dwight Jaffee, Howard Kunreuther, and Erwann Michel-Kerjan of the Risk Management and Decision Processes Center at The Wharton School of the University of Pennsylvania, proposes long-term insurance, or “LTI,” as an alternative to the standard annual property insurance policy.

LTI offers significant benefits by reducing insurers’ administrative costs, lowering consumers’ search costs, providing stability to consumers, and giving property owners the incentive to invest in risk-reducing measures, the study found.

‘Natural Disaster Syndrome’
The Wharton study points to what it describes as “natural disaster syndrome” as a factor making homeowners reluctant to mitigate. Before a disaster, the study finds, many property owners see the risk of disaster as too low to justify the upfront costs of mitigation.

“It is only after suffering losses that these same individuals claim they should have purchased insurance and invested in mitigation measures,” the authors write.

Even after hurricanes caused extensive damage to large parts of the U.S. Atlantic and Gulf Coasts during the 2004 and 2005 hurricane seasons, many residents had still not invested in relatively inexpensive loss reduction measures for their property, nor had they undertaken emergency preparedness measures, the Wharton study found.

“A survey of 1,100 adults living along the Atlantic and Gulf Coasts undertaken in May 2006 revealed that 83 percent of the responders had not taken any steps to fortify their home, 68 percent had no hurricane survival kit and 60 percent had no family disaster plan,” the report noted.

Similar reluctance is seen in earthquake and flood-prone areas, and not just among homeowners but also private businesses and public-sector organizations, the authors note.

Flood Insurance Reform
Recognizing there could be difficulty in modifying the insurance regulatory system in each of the 50 states, and using the history of the development of long-term mortgages in the United States as a benchmark, the paper discusses applying long-term contracts for reforming the government’s National Flood Insurance Program (NFIP).

“Multiyear flood insurance policies would encourage investments in cost-effective mitigation measures and provide stability to the program, in view of the large number of homeowners who cancel their annual policies after just two or three years,” the report noted, which the authors say suggests multiyear catastrophe insurance would complement proposals for a federal natural disaster insurance plan introduced in Congress in recent years.

In the NFIP model, the authors suggest redesigning the NFIP to provide long-term insurance tied to the property rather than the homeowner. The length of the insurance policy could be 5, 10, or even 20 years.

An LTI insurance policy could be coordinated with long-term home improvement loans to reduce insurance premiums and smooth the cost of the mitigation investment, the authors write. “This would encourage residents in disaster-prone areas to make their houses more resilient to floods, hurricanes or other type of hazards,” the study argues.

Insurers’ Reluctance
But even though the private market is involved in mitigation—insurers often offer discounts for proven mitigation measures and design techniques—insurers aren’t yet jumping on board with long-term policies, and they may not ever jump on board.

Insurers want to react quickly and nimbly to individual risks and to changes in market conditions. Having the ability to respond to policyholders who have more claims than others allows an insurer to keep the overall cost of insurance lower, and the standard 12-month homeowners insurance policy accomplishes this, according to Chris Hackett, the Property Casualty Insurers Association of America’s director of personal lines policy.

And in today’s market, with home values decreasing, replacement values drop, Hackett notes. “A consumer could be locked into paying high replacement costs with a multiyear policy. A 12-month policy allows an insurer to adjust prices.”

“Consumers also benefit from a 12-month policy because they can shop for a lower-priced policy,” Hackett says. “A 12-month policy promotes competition in the market. An insurer may be reluctant to offer a multiyear policy to new customers if an insurer feels it is not going to be able to quickly respond to individual risk and the marketplace as a whole. The 12-month policy works for both consumers and insurers.”

Credibility Concerns
Dan Sutter, an economics professor at the University of Texas-Pan American in Edinburg, says people “appear reluctant to invest in mitigation, even if mitigation appears to be a good deal. They seem reluctant to pay for the cost of mitigation up front with the promise of lower homeowners insurance rates in the future. For some reason that promise doesn’t seem credible to them.”

He says a multiyear insurance policy could be an incentive for them to do storm mitigation.

“Homeowners could see the savings. An insurer could foot the bill upfront, knowing he would get it back in the form of reduced losses over time. If insurers and policyholders could overcome the problem of upfront costs, this could encourage mitigation without relying on government grants or some sort of government mandate requiring everyone to mitigate.”

Dennis Kelly ([email protected]) is a freelance writer in Columbia, Maryland.

Internet Info

“Long-Term Property Insurance,” Wharton School, University of Pennsylvania: http://www.budgetandtax