Why Insurance Companies Claim a Financial Crisis to Raise Rates and Blame Litigation
Insurance companies have increasingly pointed to a “financial crisis” as justification for skyrocketing premiums in recent years. They claim that excessive litigation and fraudulent claims are the culprits behind rising costs, yet deeper scrutiny reveals a different story. Often, these crises are exaggerated—or even fabricated—to protect insurers’ profits, shift blame, and push for regulatory changes that benefit the industry at the expense of policyholders.
The Cato Institute also found that if there is a problem with rising litigation costs, the problem does not track back to the plaintiff’s lawyers but to the hourly billing practices of insurance industry lawyers as a key reason why insurance litigation costs are rising.
Understanding Property Insurance Rates
Property and casualty insurance is one of the nation’s most important but least understood industries. Every person and business in America needs insurance. The unique accounting practices of the property & casualty insurance industry allow companies to identify “losses” that are not losses at all. To an insurance company, “loss” is short for “incurred loss.” When a company has an “incurred loss,” this does not mean the insurer has paid out this money. This figure includes estimates of future claims that they know about (reserves) and claims they do not even know about yet, called “incurred but not reported” (IBNR). Some of these claims may not even exist, and others may take years for a payout. It is this figure that insurers file with state insurance departments when seeking rate hikes.
Seven out of ten Americans believe their insurance company will pay for the total cost of rebuilding from a natural disaster or fire and would reimburse them for the total replacement cost of personal belongings. However, insurance companies “cap” the amount they will pay for a total loss and deduct it for depreciation when assessing damage to personal belongings.
How Do Insurers Make Money- By Investing the Premiums You Pay
Modern insurance companies are financial institutions seeking to maximize profits, just like banks and savings and loans. While the underwriting process is the principal source of revenue for insurance carriers, the income from investing those premiums is the primary source of profits for the industry.
Insurance rates reflect conditions in the financial marketplace as well as the assessment of risk. When interest rates increase, investment income from premiums produces a high return. Under these conditions, insurance companies reduce their prices and solicit and underwrite more significant risks to attract capital for investment. However, when interest rates are low and investment yields are correspondingly reduced, the industry increases premiums to maintain profit. This is known as the “insurance cycle.
The “Financial Crisis” Narrative
Insurance companies often cite rising claims, legal costs, and fraud as the primary reasons for financial strain. While these factors do exist, the scale of their impact is frequently overstated. Here’s why this narrative is misleading:
Manipulating Loss Ratios and Claim Reserves
- Inflated Reserves: Insurers artificially increase claim reserves (estimates of future claim payouts) to temporarily inflate their loss ratios. This creates the appearance of financial distress while allowing them to justify higher premiums.
- Post-Crisis Adjustments: Insurers often reduce these reserves after securing rate hikes, revealing healthier financial conditions than initially claimed.
Cherry-Picking Data
- Insurers highlight extreme examples, such as high-dollar lawsuits or fraudulent claims, while ignoring broader data trends that show most claims are legitimate and within reasonable cost ranges.
- For example, Florida insurers frequently blame litigation for rising rates but fail to provide evidence showing a direct correlation between lawsuits and premium hikes.
Fundamental Factors Driving Rate Increases
While insurers blame litigation and fraud, several other factors contribute more significantly to rising premiums:
Reinsurance Costs
- Insurers rely on reinsurance to cover catastrophic losses, particularly in high-risk areas like Florida. As global natural disasters increase, reinsurance premiums have risen sharply.
- These costs are directly passed on to policyholders, but insurers often downplay this factor when explaining rate hikes.
Natural Disaster Frequency
- Climate change has increased the frequency and severity of natural disasters like hurricanes and wildfires. Insurers must account for higher potential payouts, which drives up premiums.
Market Consolidation
- Several insurers have exited challenging markets, reducing competition and giving remaining companies greater pricing power. This creates a “hard market” where premiums rise due to limited consumer options.
Administrative Costs and CEO Compensation
- Administrative inefficiencies and high CEO salaries contribute to increased costs, but public narratives fail to highlight these factors.
How the Insurance Industry Manipulates Claim Reserves to Justify Rate Hikes
The insurance industry often presents rate hikes as necessary adjustments driven by increased losses or more significant risk. However, a deeper look reveals a pattern of manipulating claim reserves—estimates of the funds needed to pay future claims—at strategic moments. This practice not only inflates perceived losses but also justifies premium increases while reducing tax liabilities during periods of high profitability. Here’s how and why this happens.
Blaming Litigation
Litigation is often cited as the primary driver of rising premiums, but this claim doesn’t hold up under scrutiny:
- Misrepresenting the Role of Lawsuits: While lawsuits can contribute to higher costs, they often arise from insurers’ bad-faith practices, such as denying or underpaying valid claims. When insurers fail to act fairly, policyholders turn to litigation as a last resort. Studies show that litigation costs represent a small fraction of overall claims expenses in most states.
- The Assignment of Benefits (AOB) Myth: Insurers frequently blame Assignment of Benefits (AOB) abuse for rising costs, but reforms in states like Florida have already curtailed this practice. Despite this, premiums continue to increase, suggesting other factors are at play.
Lack of Evidence Linking Tort Reform to Lower Premiums
- Research Findings: Multiple studies have shown no direct correlation between tort reform measures and reduced insurance premiums. For example, a Consumer Federation of America study found that insurance companies did not pass savings from reduced litigation costs onto consumers through lower premiums.
- State Comparisons: States that enacted strict tort reform laws did not consistently experience lower insurance premiums than states without such laws. This suggests that market conditions and risk assessments play a more significant role in determining premium rates.
Using Litigation as a Lobbying Tool
- By framing lawsuits as a systemic problem, insurers push for tort reform, which often limits policyholders’ ability to seek fair compensation while doing little to address actual cost drivers.
How Homeowners Can Manage Rising Costs
While homeowners cannot control all the factors driving rate increases, there are steps they can take to mitigate costs:
- Shop Around: Comparing quotes from multiple insurers can help you find the most competitive rate. Working with an independent insurance agent or broker can also streamline this process.
- Invest in Risk Mitigation: Wind mitigation strengthens your home with hurricane-resistant roofs, storm shutters, and impact-resistant windows.
- Flood Prevention: Elevate utilities, install sump pumps, and consider purchasing separate flood insurance if needed.
- Raise Your Deductible: Increasing your deductible can lower premiums, but be sure you can afford the out-of-pocket expense in case of a claim.
- Evaluate Coverage Limits: Ensure your policy covers rebuilding costs rather than market value and remove unnecessary endorsements or riders.
Leverage Discounts
Many insurers offer discounts for:
- Installing security systems.
- Bundling home and auto insurance.
- Maintaining a claims-free history.
Need Help Navigating Florida’s Complex Property Insurance Landscape?
While rising claims, legal costs, and fraud are genuine concerns, insurers frequently overstate them to protect profits and justify rate increases. By recognizing these tactics and advocating for transparency, consumers and regulators can push for a fairer, more balanced insurance market. If you’re struggling with home insurance claims or need help navigating Florida’s complex insurance landscape, contact Williams Law, P.A. Call us at 1-800-451-6786 or fill out our contact form to schedule a free consultation.