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Why are my insurance rates going up?

Now that hurricane victims are collecting insurance claims, Wasudeo in Texas wants to know: how come insurance companies raise their rates a disaster?
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Now that hurricane victims are collecting insurance claims, Wasudeo in Texas wants to know: how come insurance companies raise their rates after a disaster?

Why do insurance companies increase the rates after a disaster; while all the other times they earn all the money and hardly pay a dime to their customers?

Wasudeo P. --Plano, TX

In simplest terms, they raise rates because they didn’t collect enough money in the first place to cover all the claims against losses.

At its most basic, insurance seems like a fairly simple business. Companies that write life insurance, for example, can predict fairly accurately -- thanks to a branch of statistics called actuarial science -- how much to collect. Based on decades of mortality data, they can calculate your life expectancy, based on age and other circumstances.

Women, for example, who on average live a bit longer, pay a little less. Smokers, who tend to die younger, pay more. And for every person who dies sooner and collects after paying less than their "share" of premiums, there will be someone else paying “extra” premiums well into their 90s. By keeping the pool large enough, and continually crunching the numbers, actuaries have a pretty good handle on how much to charge each policyholder.

But how do you predict how many more Katrina’s will hit in future hurricane seasons? Worse, how can you predict where they’ll hit: in the heart of a major city built below sea level or a little ways down the coast where there are just a few condos on the beach? A few miles can make a multi-billion-dollar difference.

When an insurance company gets hit with claims, it has to replenish the capital reserves it used paid out those claims, and then stash away more reserves to pay future claims. If it didn’t keep those reserves topped off, it would be selling you on a promise it couldn’t keep.

This year, the drain on reserves was a whopper. Though the total losses are still being tallied, 2005 will go on the record books as the worst year ever for insured catastrophic losses, more than twice the record set in 2004, according to the Insurance Information Institute. A report earlier this month pegged the loss at nearly $57 billion, but that’s just an estimate. And this was just the was the latest in a string of huge losses – including hurricanes Ivan and Charley in 2004, and the Sept. 11, 2001 attacks. Five of the 11 most expensive disasters in history have hit in the past four years, according to the III.

You could argue that insurance companies “blew it” by not charging enough before Katrina hit. But charging premiums for such a worst-case catastrophe would have meant the insurance industry was overcollecting over long periods that were relatively free from disaster.

There's no question the insurance industry was making a bundle before the hurricane season hit. Property casualty insurers posted a profit of nearly $31 billion for the first half of 2005 -- for a return of more than 15 percent. But the average return for the 15 years before that was 8.8 percent -- compared with 13 percent for the Fortune 500, according to the III. You may think insurance industry profits are "too high." But if investors can get more money elsewhere, insurance companies can't raise capital -- and you can't get insurance.

And even if it wanted to, your insurance company can’t just charge whatever its want. For one thing, it has to submit rates for approval by state regulators. While those regulators usually go along with rate increases, they don’t have to. State Farm recently got approval for an average 8.6 percent increase in homeowners insurance in Florida. Allstate, on the other hand, is appealing a decision by Florida regulators turning down its request for an 18 percent rate hike.

When claims get too big, some insurers simply refuse to cover certain types of disasters – like earthquakes or floods. After Katrina struck, some adjusters reportedly tried to deny claims by saying that damage was caused by flooding (which wasn’t covered) rather than the hurricane (which was.) Bring on the lawyers.

Some rate increases or decreases have nothing to do with claims – especially if insurance companies want to compete for your business. That’s why you see all those ads pleading with you for a chance to underbid your current policy. When lots of companies decide it’s a good time to write more insurance (what the industry calls a “soft” market), rates tend to go lower. Then, after they’ve cut rates too low, or they’ve been hit with big claims, or they lose money in the stock market, they decide maybe it’s not such a good idea to write new policies (a “hard market”) and rates go up.

It also costs your insurance company more to cover you after a big catastrophe. That’s because your insurance company buys its own insurance policy (called “reinsurance”),  essentially spreading the risk of paying claims onto a bigger insurance company. Since rates for reinsurance go up after a big disaster, insurance companies have to cough up for that expense too.

After the Sept 11 attacks, some major building owners couldn’t get terrorism insurance at any price. That’s why Congress stepped in and offered to back the biggest policies covering terror attacks. (Critics at the time called it an industry handout -- because insurance companies got to collect premiums while taxpayers are on on the hook for mega-losses in the event of another large-scale attack.)

Looking up your life expectancy on on an actuarial table (and asking a few question about your health) is pretty straightforward. But who can predict when the next terror attack will hit? Or how bad next year’s hurricane season will be? The unpredictability of these huge disasters has some insurance officials – and state insurance commissioners – saying the current system is broken. Some argue a building in a earthquake- or hurricane-prone area should not be insured unless it’s built to withstand the worst that Mother Nature has to offer. Others think government-backed insurance pools should be set up to try to keep a lid on rates.

But don’t lose a lot of sleep worrying about the insurance industry going out of business. Though some companies will likely report big losses when this year’s disaster claims are all paid, rest assured the insurance industry will figure out a way to keep making money.

Safety first
I will be receiving a settlement in the next couple of months. This money will be enough to place around 1 million in the bank, and to purchase a small house, with some extra left over. My question is: I want a safe investment, I am thinking of placing the entire 1 million in certificate of deposits at 10 different banks, for 5 years. I also want to have the interest paid out either monthly or quarterly so that at that time I can choose to either re-invest the money or to use it for bills. Is this a good ideal?

Lee M. -- Palmdale, CA

It’s an excellent idea, for several reasons. First, it’s simple and requires very little work on your part. Second, as you’ve probably already determined, by dividing the money up, each account will be insured for maximum $100,000 by the Federal Deposit Insurance Corporation. Lastly, you’ll have a steady, reliable source of income to pay your bills.

But once you get settled in your new home, and find out what your new living expenses are, you may want to consider other alternatives. The safety of CDs comes at a price: you’ll give up a chance for higher returns from other investment like stocks or bonds. Since you think you may want to invest some of the money, your original plan may turn out to be a bit too secure for the long term.

More security sometimes means less flexibility. As you get comfortable with your millionaire status, you may find yourself to reading up on investments and getting more comfortable with the idea of putting a toe in the water. (By all means, learn for yourself and don’t fall victim to the many pitches you’ll likely encounter when word gets around of your good fortune.) So you may want to spend an hour with a good financial planner (who doesn’t earn a living from commissions – the most important question you need to ask) to get some ideas.

To increase that flexibility, you may want to consider “laddering” the maturities or your CDs – so that some expire in 2, 3, or 4 years. That way, as they come due, you can decide whether to roll over to more CDs or invest in other higher-yielding or higher-growth investments.

You should also try to put together a budget. How much do you need to live on? How much would you like to spend on “extras” that you can now afford? If you don’t need all that income from CDs, you might want to consider investing the remainder in stocks or bonds.

And don’t forget that inflation is eating away at those CDs all the time. Unless you can get a rate of return higher than inflation, you’ll be spending principal – not interest – for living expenses. Depending on your budget, that could shrink your nest egg faster than you think.

Gains made simple
How do you calculate capital gains on investment real estate? Do closing costs and realtor commissions reduce capital gains?
Sue H., Port Charlotte, FL

Yes. To compute capital gains on any investment, you start with the price you get for selling it, then deduct the price you paid – plus any other “investment costs.”

Those costs include any fees paid for the closing -- of both the purchase and sale -- and realtor commissions. But don’t forget to include any other costs related to the investment: advisory fees, tax consulting, etc. If you owned the real estate as an investment property, any improvements you made are also subtracted from your gain.

If we’re talking about more than a few thousand dollars, it pays to have this handled by a good accountant. The list of what can and can’t be included as “investment cost” gets a little , and you should really have a professional look over your specific situation.

Short answer
Is energy cost due to the fact that President Bush and Vice-President Dick Cheney were connected to the energy industry? Am I the only one that is suspicious?
Mario -- Austin, Tex.

No. And no.