Home Insurance Companies’ Computerized Models Yield High Rates

July 8, 2008

Hurricane Andrew, in 1992, brought havoc on Florida homes and on insurance companies, with over $15.5 in reported damages. Many home insurance companies couldn’t pay up and went out of business. Ever since, insurance companies have started to use specialized computer programs to try to predict hurricanes in coastal areas–instead of using the old method, of looking at an area’s past disaster statistics in order to determine rates.

Since 2005, in the wake of Hurricanes Rita and Katrina, these programs, called cat models, have been revised. The old models looked at area weather patterns to help home insurance companies predict potential losses over many decades. The new models are based on theories that the increasing ocean temperatures that accompany global warming will produce more devastating hurricanes. These new models, instead of looking at decades, look at the upcoming few years.

As a result of the new models, the price of insurance for houses located near the Gulf of Mexico and the Eastern seaboard has gone up by between 20% and 100% from 2004. The new cat models predict disaster, and home insurance companies have drawn extreme profits from insuring coastal homes. In 2006, the insurance companies drew a combined revenue of $65.8 billion from homes along the coast.

Earlier this month, Leanne Lord, a nurse living along Massachusetts’s Cape Cod, has made the decision to sell her house. The insurance premiums on the house increased by more than two-fold, and she can’t afford to pay. The real estate market along the coast is full of houses for sale, and has a dearth of buyers. “A lot of people can’t afford to live here anymore, between the insurance and the taxes having gone up so much,” says Lord.

Meanwhile, scientists and statisticians are criticizing the new cat models for imprecision. Insurers’ models “are being used as if they produce definitive answers rather than uncertain estimates,” says Karen Clark, the economist who created one of the first cat-modeling companies to serve insurers.

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