One of the most important and consistent financial transactions in American life is the purchase of a home, and the key to protecting that investment is having affordable insurance. Now, however, government price caps are undercutting insurers’ ability to offer risk-based rates, making insurance unaffordable for many Americans.
Take California, where Prop 103 created an arduous process requiring insurance companies to demonstrate the need for higher rates. It also gives the state insurance commissioner the power to delay or let premium claims die on the vine. These new restrictions push companies out of the market, reduce competition, and make insurance both less accessible andaccessible.
Understanding risk-based pricing in homeowners insurance
Companies write insurance policies to cover expected losses. In other words, they charge a premium that allows them to pay a policyholder’s claim if an event causes a covered loss. This requires insurance companies to make very accurate predictions about the likelihood that policyholders will make a covered claim. If an event is highly likely to cause the policyholder to make a claim, then the insurance company will charge a higher premium (ie price).
The US Chamber of Commerce published a report in 2021 that found both consumers and financial firms benefit from this risk-based pricing system because it gives more consumers access to credit and insurance at better prices and helps financial firms accurately forecast and account for risk.
How supply and demand shape insurance premiums
Government-imposed price controls, no matter what form, prevent insurance companies from charging a premium that takes risk into account. Capping the cost of insurance doesn’t make it more affordable – it makes it less affordable. Companies can no longer offer policies if they cannot charge premiums that cover expected losses.
In California and elsewhere, we see firsthand how government price controls hurt consumers and undermine competition in the insurance market. In California, Prop 103 requires insurance companies to maintain “pre-approval” before implementing new rates for property and casualty insurance. In practice, this means that insurance companies have not been able to charge higher premiums as risks have increased because the state insurance commissioner has rejected the increases or de facto refused by simply not approving them.
A Study of Competition in the Homeowners Insurance Market
In general, the US insurance market is very competitive. There are 2,651 property and casualty insurers operating in the U.S., according to a recent report from the U.S. Treasury Department.
Another measurement of market competition is the Hirschman-Herfindahl Index (HHI), which measures market concentration by measuring the size of companies relative to the size of the industry they are in and the degree of competitiveness. According to the National Association of Insurance Commissioners, the premium-based HHI for all lines of property and casualty is 297. For comparison purposes, antitrust enforcement agencies are interested in industries with higher HHIs, with an HHI above 2,500 considered highly concentrated .
When insurance companies are subject to rules that prevent them from charging premiums that cover expected losses, they may be forced out of the market in order to remain solvent. This could harm market competition.
Policymakers critical of insurance companies leaving California and other markets should consider removing price controls instead of creating new bars designed to promote “affordability.”
For the authors
Hulse oversees CCMC’s day-to-day efforts, including policy development, advocacy and communications.