Homeowners with lower credit scores carry significantly more property risk than their wealthier counterparts, even when insured, according to a new analysis from the Federal Reserve Bank of New York published October 5. The study, which examined millions of insurance contracts alongside property-level disaster risk data, found that deductibles and coverage limits leave households exposed to 29 percent of expected losses on average. Most importantly, the research reveals that financially constrained households—precisely those least equipped to weather a major loss—end up shouldering the largest share of residual risk.
The pattern emerges starkly when contracts are sorted by borrower FICO scores. Lower-FICO policyholders are estimated to be more risk averse, pay higher risk premiums, face greater costs tied to moral hazard, and retain more uninsured exposure than higher-score borrowers. All four measures decline steadily as credit scores rise, revealing what the authors call a paradox: the households that value insurance protection most are also the ones whose contracts leave them most vulnerable to disaster-related losses. Geographic variation is equally pronounced. Properties facing greater tail disaster risk—those in areas most exposed to severe losses—also show higher residual exposure. Counties with the highest estimated moral hazard costs and uninsured risk cluster in disaster-prone regions, according to the spatial analysis. The data also shows that more financially constrained insurers, measured by risk-based capital ratios, tend to insure riskier properties and collect higher dollar premiums, though the risk premium as a share of total premium remains flat across insurer financial conditions.
The report explains that this arrangement stems from a fundamental trade-off in insurance design. Because insurers can't perfectly observe how well homeowners maintain or protect their properties—a problem economists call moral hazard—contract terms like deductibles play a crucial role in balancing risk sharing against incentives. By requiring policyholders to bear part of a loss, insurers preserve incentives for homeowners to take actions that reduce damage risk. The authors write that "the direct cost of moral hazard appears to be small, in part because insurers can mitigate moral hazard through contract terms that leave households bearing more of the risk." The study validates this interpretation through several checks: estimated moral hazard costs are lower among homeowners with more equity in their properties and in states with inspection or verification requirements that reduce information gaps between insurers and policyholders.
The research raises a natural policy question: if deductibles leave vulnerable households exposed to substantial property risk, why not require insurers to offer more complete coverage? The authors note the answer isn't straightforward, because the same contract features that expose households to risk also help maintain incentives to protect the property. In a forthcoming companion post, they plan to use their model to examine this trade-off directly and explore what would happen if insurers were mandated to provide full insurance. The core takeaway remains stark: moral hazard may be relatively inexpensive for insurers to manage, but the method they use to control it leaves households—particularly those with fewer financial resources—carrying substantial disaster risk they can least afford to absorb.