Nat'l Strategy Needed

For Disaster Financing

By Gregory V. Serio

While the final damage totals remain unclear, estimates indicatethat Hurricane Katrina caused insured losses far beyond the worstcatastrophe in U.S. history, 1992′s Hurricane Andrew, which costcarriers over $20.3 billion in 2003 dollars.

On top of Katrina's devastating punch came Hurricane Rita'swallop, punctuating the point for anyone who might not have beenconvinced of nature's fury and the toll it can exact. All losses,though, are not alike, and Katrina and Rita's collective wrath willscar the economy in ways that Andrew never managed.

One key variable is how much of the loss is determined to beinsurable, and thereby covered by private carriers. If the damageis considered to be within the definitions of the typical policy,or if flood insurance was purchased, then coverage for propertyloss, hotel rental, business interruption and actions by governmentauthorities (such as sustained evacuation orders) will likely beprovided.

However, if the losses are deemed to be from flooding, stormsurge or broken levees, then the coverage issues, as we are alreadyseeing, will be as murky as the water that sat dormant for days inNew Orleans.

One television commentator early on in the emergency observedthat Katrina was different from Andrew in that the former was awind and water event, while the latter was primarily a wind event.Undoubtedly, that reporter had no idea just how important their30-second analysis would be in the grand scheme of things.

Andrew was favorable (if anything like that could be said) froman insured's perspective and very bad from an insurer's view inthat it was clear the losses were, in fact, covered. As a result,as many as 10 insurers, meeting the clear mandate of theirpolicies, went insolvent in the process.

While some loss estimates from Katrina compare closely with orare greater than those of Andrew, the impact upon insurers is stillunknown because so much of the damage was, and continues to becaused by water rather than wind.

It remains unclear–even after an initial meeting with insuranceregulators and industry representatives a week after the event–ifthe fact that so much flooding in New Orleans came from brokenlevees, or that so much property and business loss came from thecivil disobedience will change the coverage dynamic to suddenlyturn more "favorable" for insureds.

The bottom line, of course, is that nobody wins from thedevastating effects of Katrina, Rita or any other catastrophicevent–natural or man-made. And no one wins from the fact that,under our current system, time and again it is largely a matter ofsheer luck whether someone is covered for losses, whether aninsurer is responsible for loss payments, and whether an insurer orinsured actually survives the process.

The enormous pressure on insurers to do the right thing foraffected policyholders will have to be balanced with the rightthing to do in terms of the original policy terms and conditions,as well as the carriers' other insureds and shareholders. It is amost unenviable position to be in when the difference may be in thetens or hundreds of billions of dollars.

As much progress as we may think we make going from one disasterto another, learning hard-earned lessons, we are still confrontingmany of the same aftereffects and outcomes as with previous naturaland man-made catastrophes.

Again having to weigh legitimate concerns of whether there willbe private insurance or government coverage for actual damagessustained, and whether there will be an after-market for insurancecoverage in any coastal state going forward, shows just how much wehave not progressed in learning from the events of the past.

Rate increases and insurers leaving the homeowners insurancemarkets in Florida are the present-day aftermath of last year'sfour devastating hurricanes there–and the impact would have beenmuch worse if Florida had not made bold moves after HurricaneAndrew to set up safety nets in the insurance system.

In fact, recognizing the pressure on the insurance system causedby the repeated pounding taken by Florida in the past severalyears, the state insurance director recently called for thecreation of a national catastrophe fund, and regulators fromFlorida, California and New York will meet in November to furtherdiscuss the issue.

Since such a fund does not presently exist, however, and sinceprevious efforts to tackle the issue have been fruitless, marketfallout similar to that seen in Florida post-Andrew or after the2004 hurricanes is now likely in the Gulf Coast states mostimpacted by Katrina and Rita.

The federal government–recognizing that Washington often becomesthe insurer of last resort if the public fails to buy insurance, orthe right coverage–recently started to encourage greater privatesector disaster preparedness as a way to at least mitigate losses,if not avoid them altogether.

The Intelligence Reform Act of 2004 provides both a standard forpreparedness activities by private entities (incorporating byreference the National Fire Prevention Association's Standard 1600)and a method of oversight by insurers and credit rating agencies tomake certain these preparedness standards are actually used.

However, given the reality of the seemingly random applicabilityof coverage relative to the nature or mechanism of loss, it appearsequally arbitrary that the preparedness activities undertaken wouldbe specific enough to actually eliminate the need for the federalgovernment to once again serve as the insurer of last resort.

The incomplete approach to greater private sector preparednessin the Intelligence Reform Act, and the one-dimensional effortsaimed at addressing specific risks (such as the terrorism insuranceplan created in 2002 or the establishment of earthquake orhurricane funds) are all coming up short in terms of adequatelyprotecting homes and businesses–insurers included–over the longterm.

The variety and cost of catastrophic risks that are common tothis country require a much more comprehensive approach to bothmanaging and financing such exposures.

It is clear that if we are to materially address many of therisks facing the United States and the global insurance market, wemust take a new approach to the financing and underwriting ofcatastrophic risk by private insurers. We must properly interfacethe private insurance system with strategic public financinginitiatives, and clearly articulate responsibilities for privatecitizens and businesses to care for themselves.

Our national policy toward managing and financing risk shouldnot be, as a recent headline in The New York Times noted, a matterof "wind or water"–or, for that matter, terrorism or earthquake, orany other Hobsian choice of one peril over another.

As Katrina and Rita so boldly remind us yet again, none of thiscan be accomplished without a national catastrophe policy.

So often, public policymakers make a charade out of catastrophefinancing reform by imposing more requirements on insurers toexpand the nature of coverage applicable to disasters after thefact. Insurers try to equalize these new demands–and the lossesthat a disaster brings–through restrictions on underwriting andhigher rates.

Catastrophe financing is still largely an ad hoc and incompletediscipline in an area that demands comprehensive strategizing andplanning for the broad array of risks that are now the norm ratherthan the exception.

Clearly, a national strategy is required in which thegovernment, the insurance industry and the private sectorcollaborate to provide a more secure, reliable and affordablesafety net for disaster victims.

The federal government, along with the citizens and businessesof states at risk for coastal wind or flood disasters, earthquakes,terrorism, tornadoes and any other unique catastrophe exposures,will all benefit from a national policy on catastrophe financing,with the key elements detailed in the "Key Components"breakdown.

Insurers, as the nation's main bankers for catastrophe relief,will also greatly benefit from both a more rational and predictableapproach to risk management and finance.

Gregory V. Serio, managing director at Park Strategies, LLC inNew York, was the state's superintendent of insurance from2001-2005.

Flag: Key Components

Head: What Should Washington Do?

The key to crafting a new national strategy to financerecoveries from catastrophes is to create one uniform and effectiveprotocol for disasters of all kinds. A catastrophe fund is animportant component but not an exclusive remedy. In addition, thegovernment should:

o Allow catastrophe reserving by insurers–so-called "rainy day"accounts.

o The accounts should be tied directly to broader and moreflexible coverage for property loss that can apply to the varietyof risks out there, especially in homeowners and businessinterruption protection.

o There should be shared funding of loss between privateinsurers and the federal and state governments through the use ofstrategic stop loss and excess-of-loss pools.

o We need to increase opportunities for the securitization ofrisk and other alternative risk-funding initiatives that assureboth the adequacy of resources to effectively respond to disasters,as well as maintain insurance markets with minimal disruption inavailability in post-event environments.

o These efforts need to be joined with rules for greater privatesector preparedness connected to real economic incentives, such asspecial tax credits or deductions, for making the investment inpreparedness.

Quotebox, with mug:

"We must properly interface the private insurance system withstrategic public financing initiatives and clearly articulateresponsibilities for private citizens and businesses to care forthemselves."

Gregory V. Serio