Property Insurance and Redlining in the Inner City

Prepared by: Michael Sacks·Professor of Sociology·Trinity College
Hartford, CT 06106·(860)297-2345

Prepared for: Citizens for Action in New Britain·19 Chestnut Street
New Britain, CT 06051·(860)225-7683

Trinity Center for Neighborhoods
190 New Britain Avenue
Hartford, CT 06106-3100
(860)297-5170
Maria Simao, Project Director
Research Project17
April, 1996

There is widespread concern that property insurance in poor urban neighborhoods is inadequate in coverage, difficult to obtain and unaffordable for many. In part, the situation may be worsening as a result of new threats to profits in the insurance industry. Large claims due to major catastrophes (hurricanes, earthquakes, fires as well as such events as the riots in Los Angeles) have spurred companies to reduce their liability in high risk areas and seek out the most profitable markets.¹ Worsening social and economic conditions in many urban areas is certainly an important factor as well. The aging housing stock, the crime, fires and fire hazards, and the low income of the residents make inner cities less profitable than middle-class suburbs.² This gives rise to a vicious cycle: The difficulty in obtaining insurance in poor neighborhoods itself contributes to greater risk and less economic investment (no insurance, no mortgage money) in the inner city, and this in turn makes these communities less attractive to the insurance companies.³

REDLINING AND PROFIT

One manifestation of a neighborhood's decline is a growing disparity between the cost of buying a house and the cost of material and labor required to replace that same house should it be destroyed. In a deteriorating area the market value plummets well below the replacement value. Insurance companies fear the "moral hazard" -- the temptation to burn down a house that is insured for its replacement costs.⁴

A multiplicity of studies⁵ show that insurance companies are using a simple, low cost method of reducing their exposure to risk: Avoid business in areas that are unprofitable. Why waste time and effort in an area where housing is older and more dilapidated and where the crime rate is high? Put agents (or contract free agents to represent you) and advertising where policies are sold for big dollars and property loss or destruction is a very low risk; no need for credit checks and housing inspections that take time and money. Why bother returning calls that originate in areas where you know there are potentially undesirable clients? Just as the competition among insurance firms and low risk of property loss will result in attractive prices and features being offered in desirable areas, high deductibles and high premiums will serve as another way of assuring that few policies are issued in those risky areas.⁶

In sum, a short-cut to predictable results for the company is to use readily applicable categories for differentiating among potential customers. This amounts to redlining -- "a practice . . . which . . . ignores the individual characteristics of property owners and their properties, and instead discriminates by relying upon gross generalizations and racial stereotypes to all property owners within a given geographical territory."⁷ From an industry point of view, this is simply "good business practice" for controlling risk. Moreover, profit maximization is ultimately the way to be socially responsible:

Lenders and insurers, along with their regulators, observe that as managers of private capital, their first obligation is to their stockholders. Yet healthy profits and competitive markets benefit consumers as well. To insurance companies, this means that prices must be kept high enough to ensure adequate profits and the companies' solvency. The argument is based on the correct assumption that nobody wants to purchase a policy from a company that may go bankrupt and be unable to make good on a claim. Therefore, the primary responsibility of insurance regulators is to preserve the profitability of the industry.⁸

PROMISING NEW DEVELOPMENTS

Redlining, in the past, has not been a very risky strategy. Interpretations of the 1945 McCarran Ferguson Act have left the insurance industry largely free of federal regulation. The public has not had access to information regarding the practices of private insurance companies. State insurance regulators, according to Feldstein, have a "cozy relationship" with the insurance industry, because the "insurance companies have helped bankroll the political campaigns of those who are supposed to regulate their behavior."⁹

The situation is changing. Among the most important developments was the success of the redlining suit in Milwaukee against American Family Mutual Insurance Company, marking "the first successful use anywhere of the federal Fair Housing Act to counter discrimination in insurance"¹⁰ The courts have ruled that the Department of Housing and Urban Development has the authority to "receive and investigate discriminatory practices related to property insurance."¹¹ Of particular importance in the Milwaukee case was the finding by 7th US Circuit Court of Appeals in Chicago that property insurance and home ownership were inextricably interconnected: "Lenders require borrowers to secure property insurance. No insurance, no loan; no loan; no house; lack of insurance thus makes housing unavailable."

The case against American Family Mutual Insurance Company began in 1990 and was the result of years of effort by the ACLU, the Legal Aid Society and the NAACP. The evidence of racial discrimination was blatant; especially important was an explicit company memo advising agents to avoid offering certain policies to African Americans. The memo was made available by a disgruntled former employee. In another successful case that was waged in San Francisco and Los Angeles against California Insurance Group, a "former employee sent the [California Department of Insurance] a street map of San Francisco, in which large portions had been highlighted in yellow. Other former and current employees testified in depositions that they were instructed by their senior managers to refer to the map before offering coverage, and to decline commercial insurance for buildings located within" the designated areas.¹²

This kind of evidence is particularly effective in legal cases; unfortunately, such smoking guns are usually hard to find. An individual is often unable to perceive how his or her personal troubles fit into a broader pattern that constitutes discrimination. In a recent small survey of African American and Hispanic inner city residents, half expressed the belief that insurance companies discriminated against minorities. But only 15 percent believed that they had personally been misled by an agent. Those rejected for insurance overwhelmingly were convinced that the decision was based on legitimate grounds.¹³ By contrast, discrimination is clearly revealed by "paired testing" studies in which "individuals are matched in terms of their insurability, differing only in terms of the racial composition of the neighborhood of the home they are trying to insure. These studies consistently find that residents of minority communities are denied policies more frequently, offered lesser coverage, charged higher prices, and in many ways given disadvantageous terms and conditions than comparable risks from white communities."¹⁴ Evidence from 9 cities reportedly showed that "discrimination occurred more than 50% of the time."¹⁵

Another kind of very useful evidence can be assembled from the geographic location of insurance agents. One study made use of the Yellow Pages to get the addresses of agents representing the 20 largest companies providing homeowner insurance in Milwaukee. This was combined with census data for each neighborhood in the city, and trends were examined over the years 1960, 1970 and 1980. This permitting sorting out a range of important factors: "Race is clearly associated with agency location, and the effect of race remains significant even after accounting for the effects of income, housing conditions, owner-occupancy, and related neighborhood characteristics that presumably influence the location of insurance agencies."¹⁶

By simply making telephone calls to the states 20 biggest homeowner insurers, the Massachusetts Affordable Housing Alliance was able to demonstrate a clear pattern in the Boston area. The group looked at the location of the independent agents which each company had contracted to offer their policies. Agents were far less likely to be located in areas of minority concentration.¹⁷ A prior nationwide study of 22 cities including Boston showed that "poorer neighborhoods were getting less access to reasonably priced insurance policies than higher-income neighborhoods". This type of evidence contributed to passage of new legislation in Massachusetts.

LEGISLATION IN MASSACHUSETTS

This legislation entailed both forcing the release of information to document insurance company practices and also actions to promote more affordable insurance for those in the inner city. The key aspects were the following (based on press releases by the Massachusetts Affordable Housing Alliance):

The insurance companies are required to give the Commissioner of Insurance and the Attorney General information on location of properties (zip code area for Boston and larger territorial designations for the remainder of the state) where insurance coverage has been provided. The companies must also provide information on their losses and earnings from the policies. Starting in 1997 the Commissioner of Insurance will release this information for each of the 25 top companies operating in the state. The report will also include the number of incidences in which policies were canceled or not renewed. There are many other states where similar efforts are being undertaken to pass legislation to compel insurance companies to collect and release information that would make it possible to monitor insurance company practices. There have also been efforts to pass federal legislation of this type.¹⁹
An incentive has been provided to encourage private companies to provide insurance in regions where insurance has been very difficult to obtain. Those currently unable to obtain insurance from a private company can get insurance through the "Fair Plan" insurance pool that was established after the urban riots of the 1960s. The Fair Plan derives its resources from all insurance companies that do business in the state. Each company's payment is based on the proportion of the business in the state done by that company. The new legislation reduces this payment if the insurance company writes policies in locations where residents are eligible for participation in the Fair Plan
The ban on discrimination based on race, gender, marital and family status will be strengthened. This is to facilitate legal action to redress discrimination.
There are provisions to control rate increases in areas eligible for Fair Plan insurance.
To reduce the cost of property insurance, insurance companies and the Fair Plan will have the option of offering coverage for the market value of the home. Most private policies and the Fair Plan policies are currently only for replacement costs. Replacement cost requires higher premiums, but it provides better protection against major or total loss.²⁰

THE LIMITS OF REFORM

The Fair Plan by itself is not the solution, as even these policies may be too costly for some residents. The Fair Plan standard policy has high deductibles, less coverage of personal items and other provisions which also make it less desirable.²¹ This is why the control of costs and the encouragement of private insurance competition in areas eligible for Fair Plan policies is especially important.

The ruling that the Federal Fair Housing Act applies to property insurance, evidence from a variety of studies plus the active lobbying by consumer groups are certainly having an impact on the insurance industry.²² HUD had been able to award $2.3 million to 12 fair housing agencies to look into insurance industry practices,²³ but more recently Congress has weakened the ability of HUD to enforce the Act.²⁴

Vulnerability to lawsuits may be leading to a change in industry practices. An article in National Underwriter²⁵ advises companies to be much more careful to use consistent and less subjective criteria in reviewing applicants. This will entail somewhat higher costs of doing business. But more careful procedures could help identify the low risk properties within formerly redlined areas and bring profitable new business -- a carrot to promote industry reform. Insurance companies in Boston that offer policies in Roxbury and Dorchester can reduce their payments to the Fair Plan. In one pilot program Traveler Insurance Company gave a special insurance offer to the participants in a "Neighborhood and Home Safety Program." The community played a direct role in reducing risk and, thus, preserving company profits.²⁶ The Texas Market Assistance Plan helps individuals from "underserved" areas find a company that will provide insurance -- a "way for insurer and consumer to match their needs." The program, however, is purely voluntary; it does not force insurers to make decisions that may interfere with their bottom line.²⁷

Some question whether needed insurance coverage can be provided by private carriers. What happens if it is not profitable to insure a property at a price that is affordable to the resident? Making agents available and applying criteria evenhandedly may not be sufficient. A member of the City Council in Dallas suggested that the high insurance premiums for the aging housing in the city may require local government to subsidize residents.²⁸ If the insurance company pools low and high risk properties in calculating rates, some argue that this is an unacceptable "hidden tax" on the majority of insurance policyholders.²⁹ There is concern in the insurance industry that, as is required of banks by the 1977 federal Community Reinvestment Act, insurers may be compelled to reinvest in the communities in which they do business. Stiff resistance to such an extension of the 1977 law can be expected.³⁰

One solution may be to create "cooperative insurance services that could be public regulated like utilities. These insurance cooperatives could reinvest profits in low-income communities to beef up crime- and fire-prevention as a way to reduce insurance losses in the first place."³¹ Gregory Squires, who has done important research on redlining over several decades, concludes that "we may get a law that provides for a little bit more disclosure of insurance activity. We may have a few lawsuits that will cause some companies to do things a little differently. But after a flurry of activity, the ongoing institutionalized nature of these practices will by and large continue intact."³²

CONCLUSION

The greater potential for successful lawsuits against insurance companies as a result of the new interpretation of the federal Fair Housing Act is a very positive development. Pressure can be brought to bear upon insurance companies by gathering evidence from disgruntled consumers, surveying companies to determine the location of contracted agents and possibly from "pair testing." An important immediate goal is to achieve the disclosure of detailed information on industry practices. Redlining is a widespread problem and a significant threat to the economic viability of many urban communities. Close monitoring of local insurance industry practices and coordinated political action are needed. Redlining, however, may be a symptom of deeper and more intractable problems.

¹"Prudential to Pull Out of the District Move Part of a trend Toward Insurers Leaving Unprofitable Markets," Washington Post, 16 September 1994, p. D3).

²"HUD Hears Ins. Redlining Charges," National Underwriter, 29 August 1994, p. 3.

³See, for example, "Insurance Even Tougher to Find Since the Riots," Los Angeles Times, 8 May 1994, p. B7; Squires, Gregory and William Velez, "Insurance Redlining and the Transformation of an Urban Metropolis," Urban Affairs Quarterly 23 (September 1987): 64.

⁴"Homeowners Ensure Company Does Right Thing With American Family Settlement," Milwaukee Journal Sentinel, 26 November 1995, p. 12.

⁵See, for example, "Opening the Books: The Case for Public Disclosure of Homeowners Insurance Data," unpublished report of the Massachusetts Affordable Housing Alliance, 3 March 1995.

⁶"Anti-redlining Push Reveals Lobby's Grip, Insurers Act to Hamper Discrimination Testing," Milwaukee Journal Sentinel, 17 September 1995, p. 3; "Insurance Soliciting Raises 'Redlining' Issue," Journal Inquirer (Manchester, Connecticut), 10 October 1994, p. C1. Inner city residences may be attracted to cheap rates offered by foreign based insurance companies, only to discover that these firms end up in bankruptcy when faced with heavy claims (Feldstein, Mark, "Insurance Redlining: Hitting the Poor Where they Live," The Nation 258 [4 April 1994]: 452).

⁷This is a quotation from the ruling of the 7th US Circuit Court of Appeals in Chicago ("Homeowners Ensure Company Does Right Thing With American Family Settlement," Milwaukee Journal Sentinel, 26 November 1995, p. 12).

⁸ Squires, Gregory and William Velez, "Insurance Redlining and the Transformation of an Urban Metropolis," Urban Affairs Quarterly 23 (September 1987): 64.

⁹Feldstein, Mark, "Insurance Redlining: Hitting the Poor Where they Live," The Nation 258 (4 April 1994): 454.
The National Association of Insurance Commissioners collected data from 23 states on the property insurance being offered and issued a report in September 1994 documenting the high cost and limited availability of property insurance in the inner city. The Massachusetts Affordable Housing Alliance has documented their long and futile efforts to get this information from the Massachusetts Commissioner. See "Opening the Books: The Case for Public Disclosure of Homeowners Insurance Data," unpublished report of the Massachusetts Affordable Housing Alliance, March 3, 1995.

¹⁰"Homeowners Ensure Company Does Right Thing With American Family Settlement," Milwaukee Journal Sentinel, 26 November 1995, p. 12.

¹¹"Fair Housing Act Bars Insurance Redlining," Journal of Risk and Insurance 62 (September 1995): 602.

¹² "California Insurance Group Agrees to Assessment and Reforms in Alleged Redlining Case," Business Wire, 19 August 1993.

¹³Beemer, C. Britt, "The Redlining Lie," Best's Review (January 1995): 49-52.

¹⁴ "Survey Does Not Tell Whole Story on Redlining," National Underwriter, 8 May 8 1995, p. 17.

¹⁵"Anti-Redlining Push Reveals Lobby's Grip," Milwaukee Journal Sentinel, 17 September 1995, p. 3.

¹⁶Squires, Gregory D., William Velez and Karl E. Taeuber, "Insurance Redlining, Agency Location, and the Process of Urban Disinvestment," Urban Affairs Quarterly 26 (June 1991): 581.

¹⁷"Survey Cites Poor Policy on Insurance," Boston Globe, 13 March 1995, p. 18.

¹⁸"AG Will Ask Insurance Carriers to Aid Probe Into Possible Bias," Boston Globe, 4 April 1995, p. 26.

¹⁹See, for example, "State Lawmakers Introduce Model Redlining Legislation," National Underwriter, 26 September 1994, p. 4, 76.

²⁰ Massachusetts and Michigan are the only states where Fair Plans were prohibited from issuing policies for the "fair market value" of the property ("Boston's Uninsured Homes," The Boston Globe, 25 April 1995, p. 1.

²¹Ibid.

²²"Insurers Fear the Fallout From Redlining," Best's Review 95 (2): 42.

²³"State Farm, HUD Huddle on Redlining," National Underwriter, 17 April 1995, pp. 3, 43.

²⁴"Anti-Redlining Push Reveals Lobby's Grip," Milwaukee Journal Sentinel, 17 September 1995, p. 3; "Study Finds Redlining is Widespread in Home-Insurance Policies," Wall Street Journal, 12 September 1995, p. A6.

²⁵"Insurers Can Minimize Redlining Exposures," 19 February 1996, p. 17.

²⁶"ACORN, Two Insurers Strike Deals," National Underwriter, 1 August 1994, p. 3.

²⁷"State Committee Tries to Put a Stop to Insurance 'Redlining'," San Antonio Express-News, 8 November 1995.

²⁸"Council to Seek Help for Underinsured," The Dallas Morning News, 30 January 1996, p 15A.

²⁹ "HUD Hears Ins. Redlining Charges," National Underwriter, 29 August 1994, p. 3.

³⁰"Insurers Fear the Fallout From Redlining," Best's Review 95 (2): 42.

³¹Feldstein, Mark, "Insurance Redlining: Hitting the Poor Where they Live," The Nation 258 (4 April 1994): 454.

³²Quoted in Feldstein, Mark, "Insurance Redlining: Hitting the Poor Where they Live," The Nation 258 (4 April 1994): 454.