Insuring Against Insurance

NEW HAVEN -- Most people who save and invest do so for their entire lives. But most of the institutions upon which they rely for their investments and savings are geared to the short term. This mismatch causes fundamental problems.

An excellent example is homeowners’ insurance. Almost universally in the world today, homeowners’ insurance is short term. Typically, it is renewed annually, which means that it does not cover the risk that insurance companies will raise rates at any future renewal date.

Yet we have seen major changes recently in homeowners’ insurance rates. For example, the average homeowner premium in Florida soared from $723 at the start of 2002 to $1,465 in the first quarter of 2007. Such rapid increases represent a risk that is on the same order of magnitude as many of the damage risks that the policies are supposed to address.

In a study presented in early May at America’s National Bureau of Economic Research, the economists Dwight Jaffee, Howard Kunreuther, and Erwann Michel-Kerjan called for a fundamental change in policy aimed at developing true long-term insurance (LTI) that set insurance premiums for many years. Unless we do that, homeowners are unsure from year to year whether their insurance policies will be canceled or that their premiums will skyrocket unexpectedly as they have in coastal regions of Florida where there is hurricane and flood risk. As the authors point out, for insurers to even consider a long term policy they must have the freedom to charge premiums that reflects risk.