It'll Function Fine Until the Next Storm

In the May 14 issue of BusinessWeek there was an article titled "Hurricane Ahead, But Lower Insurance", subtitled "Why the price of property coverage is going down in the face of dire predictions". The article notes that even after Katrina and other recent, costly storms:

In most of the country, property insurance rates for homeowners and businesses are actually lower than they were before Katrina. And amazingly, insurance rates have been falling recently in many parts of Florida and the Gulf Coast that stand to suffer severe losses from hurricanes, encouraging continued construction in low-lying areas.

There are some financial reasons given for this, but the other big one is government interference in the market:

Regulators and the insurance industry are only beginning to grapple with the problems of pricing coverage in an era of potentially big storms. By some calculations, actuarially correct premiums would be so high as to freeze economic development in places such as Miami and New Orleans.

But of course that isn't happening, because actual risk calculations are not determining the market. Government regulators are capping rate increases and in some cases "broadening the availability of state-subsidized insurance for highly exposed property owners who can't get coverage from the private market". Consider this:

Under Governor Charlie Crist, Florida has gone the furthest in challenging market forces. In January, the state legislature massively increased government involvement in the insurance business in hopes of rolling back homeowners' rates. It blocked rate hikes by the state-controlled Citizens Property Insurance Corp., which insures people who can't get coverage in the private market. That allowed Citizens to undercut private insurers. To keep private companies from bailing out of Florida, it intends to make available an additional $16 billion in highly subsidized reinsurance from a state fund.

Trouble is, if a series of big hurricanes empties out the Citizens reserve fund and the reinsurance fund, the state will have to raise the money to pay claims via a special assessment of thousands of dollars apiece on all policyholders in the state. "It'll function just fine until the next storm. Then we'll see," says Joshua D. Shanker, an equity analyst at Citigroup Investment Research.

Well, duh. That is a classic line: "It'll function just fine until the next storm. Then we'll see."

How many times have you seen people's homes or businesses destroyed, not by freak occurrences that are hard to predict like a tornado, but by regular occurrences that one should expect in certain areas, like damage from being too close to a river or an ocean? And how often do those people then say, on camera, "Well, it is a tough loss. But we'll rebuild." The many times I've seen and heard this I've always thought two things. First, I'm glad you are picking yourselves up and are eager to rebuild your lives and rebound from disaster. But second, why are you going to rebuild in the same location?!?! How could you afford to do that given the massive increase in insurance that will no doubt hit you... oh wait, it won't, because the government will subsidize you and encourage you to rebuild in that high-risk location. And this will be a cycle that will continue and continue, with billions of dollars wasted time and again.

The article continues:

The political fix temporarily alleviates the financial pain, but it worsens the underlying problem. Developers continue to erect condos in vulnerable parts of Florida in part because of the availability of state-subsidized insurance. Florida already has $2 trillion in coastal exposure and remains one of the fastest-growing states. That will raise the cost of the next Big One. "People have the expectation that insurance is a commodity and should be flatly priced," says Robert Muir-Wood, chief research officer of Risk Management Solutions Inc. But in an actuarially ideal world, he says, the rate for the South Florida beachfront should be perhaps 50 times higher than the rate for an elevated property in northern Florida. "The wealthiest people tend to benefit the most from this aberration," Muir-Wood says.

Meanwhile, the Florida state government's decision to fight the market and absorb more hurricane risk is benefiting other parts of the country. As private insurers and reinsurers are being driven out of Florida, they are writing more policies elsewhere, which is helping to lower rates in other places, like Mississippi.

The dip in rates is not likely to survive another year like 2005. Insurers are being more rigorous in setting rates and paying closer attention to their risk models than in the past, says Timothy R. Gardner, global head of the property specialty practice of Guy Carpenter and Co. The influx of capital could ebb. And if another Katrina-type hurricane hits, regulators and politicians will find it harder to defy nature and enforce unrealistically low rates for coastal property.

Harder, perhaps. But I don't think one more Katrina-level disaster will lead to change in this system. A change in thinking is what is needed, not just more financial disaster and hardship -- and I don't think just one more massive-damage event will get the relevant parties' thinking to change. Government needs to get out of the insurance-subsidizing business, and individuals and businesses need to stop building and re-building in such high-risk areas. If you are wealthy and can and want to take the risk -- either by not having insurance or by buying expensive insurance that is priced according to the actual risks involved -- then fine. But anything other than that is an evasion of reality. I mean, do people expect the government to subsidize the insurance for their new home or business that they want to build on the side of an active volcano? I'd like to think that the obvious answer there is "of course not", and the essence of the situation in Florida and other high-risk areas is relevantly similar. Live there without an insurance safety net, pay the price for your insurance safety net, or don't live there at all.