Lawmakers Must Be Careful In Managing Hurricane Risks

In 1992, the financial fallout from Hurricane Andrew made it clear to insurers and regulators that natural disasters have a significant impact on the industry's ability to diversify and contain catastrophic risk. With 790,000 insurance claims and $26 billion in damage ($15.5 billion of it insured), Andrew became the costliest catastrophe in U.S. history.

Although catastrophe models are now used to spread the risk associated with catastrophes of that magnitude, there is still room for improvement.

According to the National Conference of Insurance Guaranty Funds, insurance company insolvencies resulting from Andrew led to nearly 25,000 unpaid claims totaling $500 million.

Shortly thereafter, insurers began using catastrophe models to better predict the risk associated with natural disasters, as regulators were forced to begin evaluating varying methods to ensure the economic stability of insurers and the availability and affordability of property coverage.

The challenge for insurers is that catastrophic events, by their very definition, are unexpected occurrences that offer very little predictability.

Seven of the top-10 most-costly hurricanes in U.S. history occurred during the 2004-2005 season, according to the National Oceanic and Atmospheric Administration.

When Hurricane Katrina hit in 2005, it resulted in an astronomical $80 billion loss (about half of that insured) to an already costly two-year season. The 2004-2005 season had already produced approximately $70 billion in combined damage from Hurricanes Charley, Wilma, Ivan, Rita, Frances, Jeanne and Dennis.

Since catastrophe models are largely based upon historical data, it is unlikely the models used prior to 2004-2005 would have predicted the season's heightened hurricane activity.

Unsurprisingly, catastrophe models and weather experts began to call for significant hurricane activity in 2006 and 2007. Fortunately, the 2006 season was relatively uneventful for the U.S. market, as was 2007.

Still, despite predictability and reliability challenges with catastrophe models, it is likely the cost associated with catastrophic events will continue to rise.

Regardless of whether global warming is a contributing factor, population growth and inflation will require additional risk management remediation. Indeed, damages from natural disasters are expected to double every 12 years, according to a report from the International Consortium of Insurers.

Insurers were hit by well over 1.7 million claims for damage following the devastation of Hurricane Katrina, according to the Insurance Information Institute.

The double-edged sword for regulators is to ensure the financial solvency of insurers and yet provide some guarantee of affordable coverage.

An evaluation of the 2004-2007 regulatory actions for the southern coastal states of Alabama, Florida, Georgia, Louisiana, Mississippi, North Carolina, South Carolina and Texas reflects 4,300 regulatory changes that pertain to property insurance, of which 86 percent contain a reference to flood, wind or hurricanes.

In addition, approximately 800--or roughly 90 percent--of all new or amended regulatory property-related actions issued for those states in 2007 also specifically reference flood, wind or hurricanes.

A topical analysis of the regulatory actions in 2007 indicates regulators realize that hurricane damage may still jeopardize the solvency of insurers, and could cause a subsequent financial burden for those who suffered losses.

The accompanying breakdown of the 2007 activity shows a substantial focus on insurer solvency, financial requirements and risk sharing/residual market mechanisms.

Bearing in mind the availability of property coverage for coastal areas from the private sector is dwindling (or in some cases nonexistent), and the wind-vs.-flood coverage conundrum is still tying up Katrina claims in court, it is no surprise regulators are focusing on risk sharing/residual market mechanisms.

Each state mentioned in this article has a FAIR Plan, Beach Plan or Wind Pool designed to provide coverage to those denied insurance in the private sector.

The number of policies issued under state FAIR Plans from 1990-2005 have doubled, and loss exposure has increased tenfold, according to the Insurance Information Institute.

However, this transfer of risk will not ultimately solve the problem, as the Insurance Information Institute also reported that in 2005, state FAIR Plans were operating under a $1.9 billion deficit.

Additional sources of coverage are under consideration on a federal level, as the House of Representatives passed the Flood Insurance Reform and Modernization Act of 2007, which proposes to add windstorm coverage under the National Flood Insurance Program. Opponents say this initiative will place a significant burden on taxpayers.

That warning is further supported by the fact that the NFIP had to borrow from the U.S. Treasury to pay Katrina claims, totaling $16.3 billion, with the eventual payout expected to reach $22 billion.

Another argument against the provision of windstorm coverage under the NFIP is the potential decrease of competition in the free market, which, if left alone, should be able to set risk-appropriate premium rates.

Despite the recent regulatory activity focused on ensuring the financial stability of the insurance market, and the use of catastrophe models by insurers to predict future risk, there is still no ideal solution in place to diversify catastrophic risk and ensure a plan of recovery.

The lessons learned from Andrew and Katrina purport that even if you have insurance with flood or windstorm coverage, you may not get a settlement sufficient to cover your losses.

In addition, any coverage offered under a FAIR Plan or federal program can pose a hazard to the competitive nature of the free market, and subsequently place a significant burden on taxpayers.

Therefore, unless we look at other potential solutions, or force the 53 percent of the U.S. population living in coastal areas to move inland to "safer" states, such as Idaho and Utah, we are setting the stage for continued failure to plan for, survive and recover from catastrophic events.

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