Homeowners insurance with bundled catastrophe coverage.

ABSTRACT

We estimate the demand for homeowners insurance in Florida and New York with indicated loss costs as our proxy for the quantity of real insurance services demanded. We decompose the demand into the demand for coverage of catastrophe perils and the demand for noncatastrophe

coverage and estimate these demand functions separately. Our results are relatively consistent in New York and Florida, including evidence that catastrophe demand is more price elastic than noncatastrophe demand. We also find evidence that consumers value options that expand coverage, buy more insurance when it is subsidized through regulatory price constraints, and consider state guaranty fund provisions when purchasing insurance.

INTRODUCTION

The threat of mega-catastrophes striking major population centers has altered the insurance environment over the last decade. Probable maximum losses estimates from a catastrophe striking the United States range up to $100 billion depending on the location and intensity of the event (Grace, Klein, and Kleindorfer, 2001). While insurers' capital increased and they have employed other measures to increase their security against catastrophe losses, a severe disaster could still have a significant financial impact on the industry (Cummins, Doherty, and Lo, 2002).

We explore insurance markets threatened by natural disasters concentrating on the demand for residential/catastrophe insurance. Among the phenomena, we seek to illuminate are the sensitivity of demand to prices, income, and policy features. Further, we examine insurer and consumer decisions in different market and regulatory environments--Florida and New York--over a 4-year period.

Our analysis of the homeowner insurance demand yields a number of interesting results. First, for both New York and Florida, catastrophe coverage is more price elastic than for noncatastrophe coverage. Second, we find that the income elasticities are generally inelastic and, for the case of New York, insurance is an inferior good. We also find that rate compression by regulators increases the demand for insurance in both state markets. Further, regulation has had a bigger impact in the Florida market where rate compression has been more severe. We also find evidence consumers consider guaranty fund provisions when purchasing insurance. For Florida, we find high-quality solvency prospects (measured by A. M. Best Ratings) are more important for consumers who may have claims above the Florida guaranty fund coverage limits than for those consumers who would not have claims above the coverage limit.