Deductibles and coverage limits leave insured American homeowners responsible for 29% of their expected property losses, according to research published Oct. 5 by economists writing for the Federal Reserve Bank of New York β and the households holding the most of that leftover risk are the ones least able to absorb it.
The finding comes from Hyeyoon Jung, a financial research economist in the New York Fed’s Research and Statistics Group, and Jaehoon (Kyle) Jung, an assistant professor at the NYU Stern School of Business, in a post on the bank’s Liberty Street Economics blog. It is the second in a series drawing on millions of homeowners insurance contracts matched to property-level exposure, disaster risk and borrower characteristics, built from the McDash and CoreLogic datasets. The underlying work is New York Fed Staff Report No. 1171. The authors note that the views are their own and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.
Why homeowners are left holding risk on purpose
The economics here is not an accident of policy design. Insurers cannot observe how well a homeowner maintains or protects a property β the problem economists call moral hazard β so contract terms that make the policyholder absorb part of any loss preserve the incentive to keep the roof sound and the gutters clear. Deductibles and coverage caps are the instruments.
The authors built and estimated a model of contract design on the classic moral-hazard framework of HolmstrΓΆm to put numbers on the trade-off. Their answer: households are willing to pay substantially to transfer property risk to an insurer, and that willingness rises with both their risk aversion and the riskiness of the property, while the direct cost of moral hazard to insurers is “relatively modest.” The cost shows up elsewhere. “We estimate that this residual exposure is substantial,” they write: “deductibles and coverage limits leave households exposed to 29 percent of expected losses, even though the direct estimated cost of moral hazard is small.”
The distribution is the story
Averages hide the finding that matters. Sorting policyholders into FICO score deciles, the authors report that lower-score policyholders are estimated to be more risk averse, pay higher risk premia, face higher moral-hazard costs and retain more uninsured exposure. All four measures decline steadily as scores rise, and the estimates already account for property value.
“Thus, paradoxically, the households that may have the greatest difficulty absorbing a disaster-related loss are also those whose insurance contracts leave them most exposed to one,” the post says. The authors are careful about what that does and does not establish: the patterns “are correlations, not causal estimates, and could also reflect other factors correlated with FICO scores, not financial constraint alone.”
Geography compounds it. Residual exposure runs higher for properties facing greater tail disaster risk, and county-level maps in the post show that areas most exposed to severe disaster losses tend to be places where homeowners retain more risk through their contracts. That runs against the intuition that the riskiest locations would carry the most complete coverage. It sits alongside other work showing how fast the tail is moving: First Street has found that severe thunderstorms now cost insurers more than hurricanes, and Cotality has put $1.4 trillion of Western U.S. property value in the path of wildfire risk.
Insurer balance sheets shape who holds what
The paper also sorts insurers by risk-based capital ratios. More financially constrained carriers tend to insure riskier properties and collect higher dollar risk premia β but the risk premium as a share of total premium is roughly flat across insurer financial condition. Higher premiums at constrained insurers, the authors conclude, do not simply reflect fatter margins; those carriers are matched with riskier properties and different policyholders. The implication they draw is that insurer financial condition shapes not just pricing but which risks end up on which balance sheet.
Two validation checks support the moral-hazard interpretation without claiming causation. Estimated moral-hazard cost is lower among homeowners with lower loan-to-value ratios β more equity, more skin in the game β and lower in states that impose inspection or verification requirements, which narrow the information gap between insurer and owner. The results also hold when flood exposure, normally excluded from standard homeowners policies, is stripped out, and after adjusting for non-disaster claims by comparing modeled damages against realized claims.
What it means for the people writing the checks
For agents and lenders, our reading is that premium growth is only part of the affordability picture. Insurance costs have already reached a record $209 a month, and this research argues that the structure of the policy β not just its price β determines how much of a disaster a household eats. A buyer clearing a debt-to-income test with a premium quote in hand may still be carrying a deductible they could not fund.
The authors say a final post in the series will model the obvious policy response: requiring insurers to offer full coverage. They flag in advance why the answer is not simple. The contract features that leave households exposed are the same ones that preserve the incentive to maintain the property, so mandating fuller coverage trades one cost for another.
