House Financial Services Subcommittee Issues Testimony From CRS Financial Economics Specialist
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Chairman Davidson, Ranking Member Cleaver, and Members of the Subcommittee, thank you for the opportunity to testify before you today. My name is
My testimony today will begin with a brief introduction regarding the current issues in property and casualty insurance markets1 and then address specific drivers of the rising insurance prices and reduced insurance availability that many people are experiencing. I look forward to answering any questions the committee members may have.
Introduction
Insurance consumers across
Cycles in insurance prices and availability are not uncommon, particularly for property and casualty insurance.6 Periods of high prices and reduced availability are termed hard markets, with soft markets referring to periods of relatively low prices and wider availability. Hard markets can occur when particularly unexpected events occur in claims payouts or in an insurer's asset/investment portfolio or when both sides of an insurer's balance sheet are affected.
1 Property insurance is "coverage protecting the insured against loss or damage to real or personal property from a variety of perils, including but not limited to fire, lightening, business interruption, loss of rents, glass breakage, tornado, windstorm, hail, water damage, explosion, riot, civil commotion, rain, or damage from aircraft or vehicles," while casualty insurance is "a form of liability insurance providing coverage for negligent acts and omissions such as workers compensation, errors and omissions, fidelity, crime, glass, boiler, and various malpractice coverages." See
2 "Motor vehicle insurance" detailed expenditure category from
3
4 Most of these insurers of last resort are known generally as Fair Access to Insurance Requirements (or FAIR) plans. For more information, see NAIC, "Fair Access to Insurance Requirements (FAIR) Plans," updated
5
6 Life insurance, particularly on the claims side, tends to be much more stable than property and casualty insurance. In addition, most life insurers also have substantial annuity business, in which changes in death rates work in the opposite direction than in life insurance.
High prices and unavailable insurance tend to draw policymakers' attention to insurance markets and possible solutions to these issues. Most such solutions, like insurance regulation generally, are enacted at the state level. States typically focus on lines of insurance such as auto, homeowners, or workers' compensation, where such insurance may be required by a third party. At the federal level, government interventions occur less frequently. Examples include:
* The Terrorism Risk Insurance Act, which provides a federal reinsurance backstop for the terrorism coverage following the 9/11 terrorist attacks;7
* The Liability Risk Retention Act, which aimed to increase insurance supply through reducing regulatory burden during a liability insurance crisis in the 1980s; 8 and
* The National Flood Insurance Program, which provides flood insurance directly to individuals and businesses following the pullout of private insurance from the flood market in the 1960s.9
Insurance prices generally react to a wide variety of factors at both the systemic and the individual levels. The current rising prices and limited availability in property and casualty insurance markets can largely be traced to the interplay between two different factors: (1) a macroeconomic environment marked by sharply rising inflation and interest rates and lower investment returns and (2) increasing losses from natural catastrophes. In addition, particular aspects of the insurance regulatory system in two large states,
Inflation, Interest Rates, and Investments
Insurance at its most basic level is a relatively simple economic proposition--a premium is paid for an insurer to take on a risk and then pay out a claim for future loss if the negative outcome occurs. The obvious focus in such an equation is estimating the probability of loss and the size of the claim. Nearly as important, however, can be the fact that the premium is paid in dollars today, while claim is paid out in dollars in the future. If inflation and interest rates or other investment returns remain relatively constant, or at least as expected, over the time period, then this can be relatively easily incorporated into the calculation of premiums. If these variables change dramatically and unexpectedly, however, the insurance equation can become highly uncertain, and insurers may struggle to price correctly, with swings in pricing as a result.
Inflation through the 2010s remained unusually low compared to the previous decades, typically around or below the 2% threshold used by the
7 For more information, see CRS In Focus IF11090, The Terrorism Risk Insurance Act (TRIA), by
8 For more information, see CRS Report RL32176, The Liability Risk Retention Act: Background, Issues, and Current Legislation, by
9 For more information, see CRS In Focus IF10988, A Brief Introduction to the National Flood Insurance Program, by
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...to have had a significant impact on driving behavior, with increased traffic fatalities and increase insurance claim severity.10
Increases in underlying prices have a fairly direct and obvious effect on insurance pricing, while increases in interest rates are not as straightforward. Investments in bonds make up approximately 50% of insurer assets.11 For the decade or more that interest rates, along with inflation, were very low, investing in bonds resulted in relatively low income for insurers, thus squeezing profitability. Increasing interest rates will increase this income for newly purchased bonds or variable rate bonds. But for the large stock of existing fixed rate bonds, increasing interest rates reduce the value of these bonds, and the steeper the increase, the greater the drop in value. This effect on insurers' capital levels is essentially immediate, compared to the increase in interest income, which occurs over time. Drops in the value of other investments, such as the approximately 33% that general property and casualty insurers held in equities in 2022, have a straightforward effect, decreasing insurer capital and surplus levels.12
In 2022, the
Increasing Catastrophe Losses
Large-scale losses from natural events--primarily tropical and other severe storms but also events such as wildfires, floods, and droughts--have been increasing over the past decades. These increasing losses have been largely attributed to population growth in disaster-prone areas, rising property values in hazardous areas, inadequate building codes, and climatological changes in weather patterns and storm intensities.15 The
10
11 NAIC, "
12 Capital and surplus are "a company's assets minus its liabilities." See NAIC, "Glossary of Insurance Terms." 13 NAIC, "
14 Gallagher Re, "Reinsurance Market Report, Results for Full-Year 2022,"
15 See, for example,
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...inflation-adjusted costs have increased along with the frequency, from
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Table 1. NOAA Comparisons of
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These
Increasing disaster losses are occurring across the globe, and the global experience matters particularly in catastrophe insurance, as losses in almost any country are significantly borne by global reinsurers. Thus, a catastrophe on the other side of the world can result in a decreasing amount of insurance capacity--and likely higher prices--in
Large hurricanes, such as Ian, cause outsized losses, but so-called secondary perils--lower cost but higher frequency events--caused higher combined losses in 2022 and have become a substantial source of concern.19 Through the third quarter of 2023, nine of the 10 costliest global insured loss events in the year were secondary peril events in
16 Gallagher Re, "Natural Catastrophe Report of 2022," p. 10, https://www.ajg.com/gallagherre/-/media/files/gallagher/ gallagherre/gallagher-re-nat-cat-review-2022.pdf.
17
18 Banerjee et al., "A Perfect Storm," pp. 5-6.
19 Gallagher Re, "Natural Catastrophe Report of 2022," p. 10.
20
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...wildfire has become a particular concern, with insurers in
Insurance Regulation and Market Disruption
In general, insurance is a highly regulated industry with complex products, many of which span long time frames. Insurers generally face solvency regulation (which focuses on making sure they have sufficient resources to fulfill the promises of future payments made in their products) as well as regulation of both the content and the pricing of their products. (
In a highly regulated environment, it is possible for regulation to become in some way out of step with the market and potentially contribute to market disruptions rather than solving market issues--the usual goal of regulation. This was seen, for example, in the
21 See, for example,
22 For a discussion of issues in
23 Testimony of
24
25
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...into the rate base.26 Rather than reducing regulations, a representative for the
The California Insurance Commissioner recently announced a number of regulatory changes aimed at improving conditions in the insurance market. With regard particularly to the criticisms of the regulatory process, the changes will allow usage of "catastrophe modeling and
26
27 Testimony of
28
29 Florida OIR, "Property Insurance Stability Report,"
30 For a discussion of, and viewpoint on, assignment of benefits and attorneys' fees, see
31 A. M. Best, "US Homeowners Line Well Capitalized, but Weather Events Pose Significant Uncertainty,"
32 Florida OIR, "Property Insurance Stability Report," p. 3.
33 For summaries of the legislation by the
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...with Florida Citizens United (the state FAIR plan) saying that it was receiving fewer lawsuits.34
34
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Original text here: https://docs.house.gov/meetings/BA/BA04/20231102/116528/HHRG-118-BA04-Wstate-WebelB-20231102.pdf
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