Aon Re Study: Poor Fundamentals in Homeowners Market in Hurricane-Prone States Should Lead to Major Change

October 3, 2005

Even before Hurricane Katrina made landfall, homeowners insurers in coastal states reportedly knew their returns were insufficient to sustain the capital required to support the growing exposure to catastrophes. An Aon study, released Monday, underscores this fact – average expected results for homeowners insurance in hurricane-prone states are insufficient to cover the cost of capital.

Randall Brubaker, head of the ratemaking support practice of Aon Re Services Inc. commented, “Many factors combine to create the continual need for higher premiums from homeowners in coastal states. These factors include constant population growth on concentrated coastlines, increasing home sizes and values, expansion of coverage through changing interpretations of policies or statutes, and an increase in the frequency of hurricanes making landfall.”

While these factors generate higher premium requirements, strong resistance from regulators and consumer advocacy groups reportedly artificially delay the inevitable rise in premiums for policyholders and accelerate insurer downgrades and insolvencies. Policyholder choices are limited in most coastal states.

After Hurricane Katrina and the four significant hurricanes of 2004, the underlying assumptions about the frequency and severity of storms will be adjusted by insurers to reflect their experience and expectations for the future. Capital levels have reportedly deteriorated so significantly for homeowners insurers that operating results must now generate new surplus to support even current risk levels. Coastal states insurance results are far from returning the cost of capital required to support operations.

Other states have had their own challenges through the past decade. With rate changes and other underwriting changes many of these states are reportedly producing returns consistent with the cost of capital.

While several non-hurricane- prone states appear to be competitive, simply earning the cost of capital is not sufficient to sustain competitive markets for policyholders nor does it allow cushion for any significant unusual events.

New underwriting strategies better incorporating the component costs of catastrophe risks, including more conservative views of the uncertainty associated with such risks, will be formulated over the course of the next year, particularly in hurricane-prone states.

Bryon Ehrhart, president of Aon Re Services Inc., commented, “Policyholders likely have a better appreciation for the value of homeowners insurance given recent events and should expect that insurers may need to raise rates to continue to provide their critical service.”

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