Affordable Housing Institute : US

As the devastation wrought by Hurricane Katrina sinks in upon us,

 

A street in Biloxi, Mississippi

 

and its economic toll continues to rise, the insurance industry is already reacting, as this St. Petersburg Times article (via Knowledgeplex) illustrates:

 

Its aftermath may hold a few more unexpected twists for Florida’s shell-shocked property insurance market. Not all for the best.

 

There are fears that homeowners’ rates could go up further or insurers could become even more selective in coverage.

 

On the positive side, however, Katrina’s multibillion dollar tab - including up to $600-million of it in Florida - is raising hopes that Washington politicians may finally rally around a national program to insure hurricane risk.

 

As long promoted by Florida, the program would help defray the price tag for a mega-storm, spreading the costs among all taxpayers or property owners.

 

Hurricane Andrew [in 1992] couldn’t drum up enough political resolve behind the idea. Neither could the Terrible Four of 2004: hurricanes Charley, Frances, Ivan and Jeanne.

 

This raises an important and illuminating question of public policy.  Set aside the near certainty that the Federal government will vote massive reconstruction aid on humanitarian and civic grounds.   

 

What catastrophic risks should government absorb?  And for what public-policy reasons?

 

Florida governor Jeb Bush was among those Monday who said Katrina might spark “a growing consensus” for a national fund.

 

“The concept is that there are disasters that take place - floods, earthquakes, hurricanes, fires. That makes sense to share that risk in a broader way than just one state bearing the burden,” Bush said.

 

Insurance costs, which are generally regulated, vary widely by state, because casualty frequency and casualty losses vary by state:

 

Both Florida and Louisiana already are among the most expensive homeowners’ markets in the country. As of 2002, the last comparison data provided by the National Association of Insurance Commissioners [whose annual meeting, ironically, was scheduled for New Orleans in two weeks — Ed.], Florida had the fourth-highest homeowners premiums behind Texas, Louisiana and Oklahoma.

 

Flood, hurricane, tornado, earthquake: whose natural disasters are national, whose are purely regional? 

 

Rates in Florida are supposed to be set based on risks in this state alone.

 

A spokesman for State Farm, the largest property insurer in both Florida and Louisiana, Tom Hagerty said he didn’t see how any damage in Louisiana, Mississippi or Alabama would affect Florida’s rates. “That was part of the reason we formed State Farm Florida: so the company here would stand on its own,” Hagerty added.

 

What Mr. Hagerty may have declined to mention is that isolating Florida meant Florida’s premiums could be higher than Mississippi and Alabama, not lower.  A classic risk-containment device, State Farm Florida protected policy holders in states other than Florida.

 

Sam Miller of the Florida Insurance Council, a statewide trade group, was more adamant: “Rates in Florida are not going to go up a penny because of what happens with this storm in other states,” he said.

 

Yet, even Miller conceded that holding down rates is not entirely in the hands of insurers.

Katrina could prompt a spike in the cost of reinsurance.  Reinsurance, bought by insurers as an added layer of coverage in case of huge losses, isn’t regulated in the same way as insurance.

 

Should residents of (say) Iowa pay a share of the costs of providing hurricane insurance?  How about earthquake insurance for California? 

 

An argument against.  Natural disasters are a fact of life.  For centuries insurance companies have made a living betting against catastrophe.  (The first insurance syndicate, Lloyds of London, got its start in the entrepreneurial 17th century providing coverage for the British East India Company.)  It would be one thing if insurers were wiped out en masse by a catastrophe, but isn’t precisely the sort of risk they are supposed to be able to assess? 

 

An argument for.  Without national reinsurance of large-scale geographic catastrophe, some parts of the country will lose coverage … and with it, loss of economic competitiveness.

 

During Florida’s hurricane series last year, many insurers insisted they were sticking with Florida.

 

Since then, however, Allstate decided not to renew 95,000 of its Florida policies. Some smaller insurers have pulled out entirely.  And Nationwide is considering dropping a significant number of customers here.

 

But wait!  Government already offers itself as the insurer of last resort:

 

Insurers also may opt to pull the reins in further on writing in Florida. That would force more homeowners into the state-run Citizens Property Insurance which, by state law, has more expensive rates than the marketplace.

 

A classic journalistic misnomer confusing cause and effect.  CPI doesn’t have higher rates by law; rather, by law it is required to cover groups others will not.  Under adverse selection, those who cannot get coverage elsewhere are riskier to insure, so if the CPI is to pay for itself, it has to charge higher rates. 

 

Rates for many in Florida have jumped in the double digits since last year’s hurricanes. Plus, property owners face a statewide surcharge of about 7% to help Citizens Property wipe out a $515-million deficit directly caused by the storms.

 

Thus homeowners throughout the state, including predominantly those who are obtaining private insurance, are subsidizing those who tap CPI.  This is analogous to property owners without children (or with children in private school) nevertheless paying property taxes to support public schools.

 

So Florida is already insuring the riskiest.

 

Another argument against.  Why should the Federal government (in this context, effectively on behalf of the other states) step in?  Don’t states handle it?

 

Only Florida and Hawaii have a so-called Cat [Catastrophe] Fund to help insurers pay losses from multibillion-dollar storms.  In Florida, the Cat Fund is funded by insurers through homeowners’ premiums.

 

Should adverse selection apply to states competing with other states?

 

 

Yes, said James Madison

 

 

No, said Alexander Hamilton

 

Why isn’t the distribution of insurance costs a matter for each state to decide for itself?  Obviously, individual states can do so:

 

Louisiana and other states may at long last try to emulate Florida’s model of a hurricane catastrophe fund.

 

 

Every state a king!

 

Another argument for.  The Federal government already intrudes into state practice by mandating certain levels of coverage such as flood insurance:

 

The National Flood Insurance Program took a closer look at who should and should not be required to have flood insurance after the 2004 season. Federal officials are expected to revisit flood maps in neighboring states because of the storm.

 

If the Feds mandate it, shouldn’t the Feds also partially pay for it?

 

Another argument for … at least, for affordable housing.  Who pays for insurance losses? 

 

In the short run, insurers.  In the long run, policyholders (because otherwise insurers go out of business) … or government (which can step in to help). 

 

When affordable housing is involved, government has chosen to step in, with money, to narrow the cost-value gap.  Higher insurance premiums for adversely selected properties occupied by ‘those people’ simply come back around to government in the form of higher subsidy requirements or more capital cost buydown (soft debt, soft equity). 

 

There are probably efficiency arguments to suggest that if government is going to pay indirectly anyhow (higher subsidy), then it might be prudent to pay directly (using government’s balance sheet and sovereign borrowing rate to absorb risk more cheaply than anyone else).

 

 

“You can pay me now, or pay me later.”

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