Will Insurance Survive? Yes, but at a Price

Questions about insurance in California in the wake of the Jan. 17 Northridge earthquake are simple and dramatic: Will insurance be available to homeowners and commercial property owners? Who will provide it? What will it cost?

Answers are that some kind of insurance will be available, probably at much higher premium rates. As a stopgap measure, a state-ordered assigned-risk plan will probably provide coverage. Premiums will be higher and insurance companies will be assessed to pay claims.

But a state-run plan won’t make the insurance situation any more stable. Companies can still be driven to insolvency by major disasters. 20th Century Industries was forced to abandon its homeowners business as a result of the quake, on which damage claims for all companies total $6 billion so far.

In the long run, rates will go up for earthquake coverage and all property insurance. The recognition is dawning, among public officials as well as industry, that disaster coverage has to be more expensive because rebuilding has come to cost much more than insurance companies had counted on.

Misjudgment has caused a crisis in insurance, in California and nationwide. But it is not permanent. The insurance business, and coverage for homes and properties, should recover their balance in the next few years. Indeed, smart business people are already looking forward.

Meanwhile, Florida offers clues to what lies immediately ahead for California. Insurance rates have gone up in Florida, which suffered $18 billion in losses from Hurricane Andrew in August, 1992. After Andrew, insurance companies wanted to reduce coverage in coastal cities, just as insurers are reluctant to take on new customers in California today.

Florida’s insurance commissioner, Tom Gallagher, wielded stick and carrot: He forced insurers to be gradual in reducing coverage. But as an incentive to insurers to write new business, he has been allowing 20% to 25% increases in premiums.

California Insurance Commissioner John Garamendi has already granted 20th Century Industries a 17% increase in homeowners rates, and he was ready to approve a tripling of its rates for earthquake insurance before the Woodland Hills firm decided to withdraw from homeowners lines over the next two years to concentrate on auto insurance, its main business.

Garamendi could do the same for other major insurers--State Farm, Allstate, Farmers, Safeco and others--when he meets with them Thursday to seek solutions to the current impasse.

The companies have stopped taking on new customers because they don’t want to write new earthquake coverage, which must be offered along with conventional home policies.

The impasse threatens an economic crisis because home buyers can’t obtain mortgages without insurance. That’s why an emergency state plan is needed.

Also, Garamendi, Gallagher and other insurance commissioners are urging Congress to set up a program of federal insurance for catastrophic losses.

But a federal program may not be needed. As the current crisis resulted from mistakes by insurance companies and regulators, so it can be corrected by better management and regulation.

Sometimes companies and regulators got caught short because natural disasters proved worse than historic patterns. The Northridge quake, for example, ranked low on the Richter scale, but by other measures of its shaking it was as violent as the great 1906 San Francisco quake.

Similarly, hurricanes in Florida, Hawaii and South Carolina, and ice storms in the Northeast, have been stronger because weather patterns are more disorderly than those of the 1980s, says Joanne Morrissey, head of Firemark Research, a New Jersey insurance consulting firm.

But other factors also are driving up damage claims. Population density in cities and suburbs everywhere multiplies claims. So does the fact that modern building codes make rebuilding more expensive. And the American sense of entitlement, which magnifies losses and calls on government to pay for uninsured people, drives up costs.

The industry had failed to take all these factors into account and so wrote policies at premiums that were too low.

But that day has gone. “Insurance companies got a scare from Andrew and from other hurricanes,” says Charles T. Munger, vice chairman of Berkshire Hathaway, the holding company that has just written $400 million of reinsurance coverage to back 20th Century’s earthquake policies as they phase out in the next year.

“We are well capitalized and can take the risk,” says Munger, who also is a partner in the Los Angeles law firm Munger Tolles & Olson.

Other companies also are looking to opportunities. Aon Corp., a large Chicago-based firm, has formed a reinsurance joint venture with CNA and Lazard Freres.

Smart companies making moves like that says louder than any public pronouncement that insurance will be available in future--but also that premiums are going up to reflect the more expensive risks of modern America.