Natural Disasters
Public Policy Options for Changing the Federal Role in Natural Catastrophe Insurance Gao ID: GAO-08-7 November 26, 2007In recent years, much attention has been focused on the roles that the private sector and federal government play in providing insurance and financial aid before and after catastrophic events. In this context, GAO examined (1) the rationale for and resources of federal and state programs that provide natural catastrophe insurance; (2) the extent to which Americans living in catastrophe-prone areas of the United States are uninsured and underinsured, and the types and amounts of federal payments to such individuals since the 2005 hurricanes; and (3) public policy options for revising the federal role in natural catastrophe insurance markets. To address these questions, GAO analyzed state and federal programs, examined studies of uninsured and underinsured homeowners and federal payments to them, identified and analyzed policy options, and interviewed officials from private and public sectors in both high- and low-risk areas of the United States. GAO also developed a four-goal framework to help analyze the available options.
The federal government and some states have developed natural catastrophe insurance programs that supplement or substitute for private natural catastrophe insurance. These programs were created because homeowner coverage for catastrophic events is often not available from private insurers at prices deemed affordable by insurance regulators. Large losses associated with natural catastrophes are some of the biggest exposures that insurers face. Particularly in catastrophe-prone locations, government insurance programs have tended not to charge premiums that reflect the actual risks that homeowners face, resulting in financial deficits. After a resource-depleting disaster, the programs have postfunded themselves through, among other sources, payments from insurance companies and policyholders and appropriations from state and federal taxpayers. Large numbers of Americans are not insured for natural catastrophes. Homeowners may not purchase natural catastrophe insurance because doing so is voluntary and they may not believe that the risk justifies the expenditure. In addition, some homes may be underinsured--that is, not insured for the full replacement value. GAO estimates that the federal government made about $26 billion available to homeowners who lacked adequate insurance in response to the 2005 Hurricanes Katrina, Rita, and Wilma. Given the unsustainable fiscal path of federal and state governments, they will be challenged to maintain their current fiscal role. As Congress reevaluates the role of the federal government in insuring for natural catastrophes, Congress is faced with balancing the often-competing goals of ensuring that citizens are protected and limiting taxpayer exposure. This report examines seven public policy options for changing the federal government's role, including establishing an all-perils homeowner insurance policy, providing reinsurance for state catastrophe funds, and creating a mechanism to provide federal loans for state catastrophe funds. Each option has advantages and disadvantages, especially when weighed against competing public policy goals. For example, establishing an all-perils homeowner policy is a private sector approach that could help create broad participation. But low-income residents living in parts of the United States with high catastrophe risk could require subsidies, resulting in costs to the government. Similarly, federal reinsurance for state programs could lead to broader coverage, but could displace private reinsurance. GAO also identified several policy options for tax-based incentives for insurance companies, homeowners, investors, and state governments. But these options, which could help recipients better address catastrophe risk, could also result in ongoing costs to taxpayers. While some options would address the public policy goals of charging risk-based rates, encourage broad participation, or promote greater private sector participation, these policy goals need to be balanced with the desire to make rates affordable.
GAO-08-7, Natural Disasters: Public Policy Options for Changing the Federal Role in Natural Catastrophe Insurance
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Report to the Ranking Member, Committee on Financial Services, House of
Representatives:
November 2007:
Natural Disasters:
Public Policy Options for Changing the Federal Role in Natural
Catastrophe Insurance:
GAO-08-7:
GAO Highlights:
Highlights of GAO-08-07, a report to the Ranking Member, Committee on
Financial Services, House of Representatives.
Why GAO Did This Study:
In recent years, much attention has been focused on the roles that the
private sector and federal government play in providing insurance and
financial aid before and after catastrophic events. In this context,
GAO examined (1) the rationale for and resources of federal and state
programs that provide natural catastrophe insurance; (2) the extent to
which Americans living in catastrophe-prone areas of the United States
are uninsured and underinsured, and the types and amounts of federal
payments to such individuals since the 2005 hurricanes; and (3) public
policy options for revising the federal role in natural catastrophe
insurance markets. To address these questions, GAO analyzed state and
federal programs, examined studies of uninsured and underinsured
homeowners and federal payments to them, identified and analyzed policy
options, and interviewed officials from private and public sectors in
both high- and low-risk areas of the United States. GAO also developed
a four-goal framework to help analyze the available options.
What GAO Found:
The federal government and some states have developed natural
catastrophe insurance programs that supplement or substitute for
private natural catastrophe insurance. These programs were created
because homeowner coverage for catastrophic events is often not
available from private insurers at prices deemed affordable by
insurance regulators. Large losses associated with natural catastrophes
are some of the biggest exposures that insurers face. Particularly in
catastrophe-prone locations, government insurance programs have tended
not to charge premiums that reflect the actual risks that homeowners
face, resulting in financial deficits. After a resource-depleting
disaster, the programs have postfunded themselves through, among other
sources, payments from insurance companies and policyholders and
appropriations from state and federal taxpayers.
Large numbers of Americans are not insured for natural catastrophes.
Homeowners may not purchase natural catastrophe insurance because doing
so is voluntary and they may not believe that the risk justifies the
expenditure. In addition, some homes may be underinsured”that is, not
insured for the full replacement value. GAO estimates that the federal
government made about $26 billion available to homeowners who lacked
adequate insurance in response to the 2005 Hurricanes Katrina, Rita,
and Wilma. Given the unsustainable fiscal path of federal and state
governments, they will be challenged to maintain their current fiscal
role.
As Congress reevaluates the role of the federal government in insuring
for natural catastrophes, Congress is faced with balancing the often-
competing goals of ensuring that citizens are protected and limiting
taxpayer exposure. This report examines seven public policy options for
changing the federal government‘s role, including establishing an all-
perils homeowner insurance policy, providing reinsurance for state
catastrophe funds, and creating a mechanism to provide federal loans
for state catastrophe funds. Each option has advantages and
disadvantages, especially when weighed against competing public policy
goals. For example, establishing an all-perils homeowner policy is a
private sector approach that could help create broad participation. But
low-income residents living in parts of the United States with high
catastrophe risk could require subsidies, resulting in costs to the
government. Similarly, federal reinsurance for state programs could
lead to broader coverage, but could displace private reinsurance. GAO
also identified several policy options for tax-based incentives for
insurance companies, homeowners, investors, and state governments. But
these options, which could help recipients better address catastrophe
risk, could also result in ongoing costs to taxpayers. While some
options would address the public policy goals of charging risk-based
rates, encourage broad participation, or promote greater private sector
participation, these policy goals need to be balanced with the desire
to make rates affordable.
Selected Advantages and Disadvantages of Options for Changing the
Federal Role in Natural Catastrophe Insurance:
Option 1: All-Perils Homeowners Insurance Policy;
This option would create a homeowner insurance policy that would provide
coverage against all types of natural catastrophes.
Advantages:
* A mandatory all-perils policy could eliminate the problems of
uninsured property owners and adverse selection;
* A mandatory all-perils policy would end homeowners‘ uncertainty about
coverage for some perils.
Disadvantages:
* The all-perils option could require government subsidies for low-
income property owners;
* Premiums for an all-perils policy could be more expensive than
current homeowner policy premiums, and these premium increases could be
seen as unfair.
Option 2: Federal Reinsurance for State Catastrophe Funds;
This option would create federally backed reinsurance policies for state
catastrophe funds. In one version of this option, states would create
catastrophe funds that would be reinsured by the federal government. In
another version, the Secretary of the Treasury would create an auction
process for the sale of reinsurance contracts to private and state
insurers and reinsurers.
Advantages:
* The federal reinsurance option could lead to greater participation
from private insurers;
* This option would not use tax dollars if premiums were risk-based.
Disadvantages:
* Federal reinsurance could compete with the private reinsurance
sector;
* Federal reinsurance could create inequities among states because of
geographical differences in natural catastrophe risk.
Option 3: Federal Lending to State Catastrophe Funds;
This option would create a federal lending facility to provide temporary
loans at market prices to state catastrophe funds.
Advantages:
* This option could help state catastrophe insurance funds with
financing needs after a disaster;
* The federal lending option would require states to demonstrate that
they were doing all they could to attract private capital.
Disadvantages:
* The federal lending option imposes credit risk on taxpayer– the risk
that the loans would not be repaid;
* Political pressure could be exerted to keep the terms and conditions
of federal loans more favorable than those in the private market.
Option 4: Insurance Company Catastrophe Reserving;
This option would permit private insurance companies to establish
tax-deferred reserves for future natural catastrophes.
Advantages:
* With reserves, insurance companies could be more willing to
underwrite policies;
* Insurance regulators could be more willing to approve risk-based
rates for consumers, because premium income could be set aside in a
reserve fund.
Disadvantages:
* Allowing insurance companies to build reserves could involve tax
benefits that favored one type of activity over another and could
hamper economic efficiency;
* Reserves could be costly for the federal government, because they
would reduce federal tax revenue.
Option 5: Homeowner Catastrophe Savings Accounts;
This option would permit individuals to establish tax-deferred reserves
to pay expenses related to disasters.
Advantages:
* Allowing homeowners to use tax-deferred dollars to pay for
catastrophe insurance could induce more people to buy it;
* This option might encourage more homeowner mitigation activities.
Disadvantages:
* Such accounts may not be enough to induce people to buy costly
catastrophe insurance and, thus, may not broaden citizen participation
in natural catastrophe insurance programs;
* These accounts would reduce federal tax revenues but must be weighed
against any reduction in post-disaster spending by the federal
government.
Option 6: Favorable Tax Treatment for Catastrophe Bonds;
This option would facilitate the onshore creation of catastrophe bonds
through tax exemptions for income from the underlying assets.
Advantages:
* Favorable tax treatment of catastrophe bonds would increase the
ability of insurance markets to access capital markets;
* Insurance companies could be more willing to underwrite catastrophe
risk because the risk could be passed on to investors.
Disadvantages:
* This option creates a new class of reinsurer that would operate under
regulatory and tax advantages not afforded U.S. reinsurance companies;
* It is not clear how this option would encourage risk-based premiums
or lead to more citizen participation in catastrophe insurance
programs.
Option 7: Property Tax Assessment for Private Insurance with Federal
Deductible Payment;
This option has property tax assessments paying a premium for an all-perils
catastrophe insurance policy that would be provided by private insurance
companies, with the federal government responsible for the deductible.
Advantages:
* This option would protect the tax base of a state‘s economy;
* The property tax assessment option would increase homeowner
participation in catastrophe insurance programs.
Disadvantages:
* The property tax assessment option would reduce federal tax revenue;
* This option could be expensive for taxpayers because the federal
government would pay some portion of the homeowner deductible.
Source: GAO.
What GAO Recommends:
This report does not contain recommendations. However, GAO evaluates
seven public policy options that are discussed in the right-hand column
and on the reverse side of this page. In written comments, the National
Association of Insurance Commissioners (NAIC) generally agreed with
GAO‘s report findings.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www/GAO-08-07]. For more information, contact Orice
Williams at (202) 512-8678 or williamso@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Government Natural Catastrophe Insurance Aims to Provide Affordable
Protection but Often Requires Postfunding after Large Natural
Catastrophes:
Because Many Americans Are Inadequately Insured for Natural
Catastrophes, Federal Programs Play a Significant Role in Recovery:
Options for Changing the Federal Role in Natural Catastrophe Insurance
Attempt to Address Market Issues but May Not Limit Federal Exposure:
Agency Comments and Our Evaluation:
Appendixes:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Selected State Natural Catastrophe Insurance Programs:
Appendix III: Comments from the National Association of Insurance
Commissioners:
Appendix IV: GAO Contact and Staff Acknowledgments:
Related GAO Products:
Figures:
Figure 1: Catastrophic Risk in the United States--Earthquake,
Hurricane, Tornado, and Hail:
Figure 2: Insured Property Value, by County:
Figure 3: Estimated Federal Disaster Assistance Obligated for
Homeowners and Renters Lacking Adequate Insurance in Five Gulf Coast
States after the 2005 Hurricane Season:
Figure 4: Advantages and Disadvantages of Seven Public Policy Options
for Changing the Federal Role in Natural Catastrophe Insurance:
Figure 5: Comparison of Selected State Natural Catastrophe Insurance
Programs in 2005:
Abbreviations:
CDBG: Community Development Block Grant:
CEA: California Earthquake Authority:
DLP: Disaster Loan Program:
FAIR: Fair Access to Insurance Requirements:
FCIC: Federal Crop Insurance Corporation:
FEMA: Federal Emergency Management Agency:
FHCF: Florida Hurricane Catastrophe Fund:
FIRM: Flood Insurance Rate Map:
FWUA: Florida Windstorm Underwriting Association:
GUA: Georgia Underwriting Association:
HA: Housing Assistance:
HRA: High Risk Account:
HUD: Department of Housing and Urban Development:
IHP: Individuals and Households Program:
JUA: Florida Residential Property and Casualty Joint Underwriting
Association:
MIUA: Mississippi Insurance Underwriting Association:
NAIC: National Association of Insurance Commissioners:
NFIP: National Flood Insurance Program:
NOAA: National Oceanic and Atmospheric Administration:
ONA: Other Needs Assistance:
PLA: Personal Lines Account:
SBA: Small Business Administration:
SFHA: Special Flood Hazard Areas:
[End of section]
United States Government Accountability Office:
Washington, D.C. 20548:
November 26, 2007:
The Honorable Spencer Bachus:
Ranking Member:
Committee on Financial Services:
House of Representatives:
Dear Mr. Bachus:
Natural disasters not only devastate communities and individuals but
also are costly to insurers, state governments, and the federal
government. As the 2005 hurricane season showed, costs associated with
a large natural disaster, such as a hurricane or major earthquake, can
be enormous. Aside from the human toll, Hurricanes Katrina, Rita, and
Wilma caused insured losses of an estimated $56.5 billion and total
economic losses--including both insured and uninsured losses--of more
than $100 billion. The federal government alone has appropriated more
than $88 billion for disaster relief and recovery from the 2005
hurricanes. Future disasters could be even more expensive. One
catastrophe modeling firm estimates that a large hurricane in southeast
Florida could cause insured losses of more than $130 billion and a
total economic loss of more than $260 billion.[Footnote 1] Similarly,
if San Francisco's 1906 earthquake were to be repeated today, it is
estimated that it would cause insured losses of more than $70 billion
and a total economic loss of more than $280 billion. Also, a rupture of
the Puente Hills fault in the Los Angeles basin could lead to estimated
insured losses of more than $140 billion and a total economic loss of
more than $500 billion.
As we reported earlier in 2007, large losses associated with natural
catastrophes are some of the biggest exposures that property and
casualty insurers face.[Footnote 2] To remain financially solvent,
these companies must estimate and prepare for the potential impact of
such events. Because of the increased risk of natural catastrophes and
the challenges of predicting losses from them, insurance companies have
started limiting both renewals of existing contracts and the writing of
new contracts in catastrophe-prone regions of the United States, such
as coastal areas (from Massachusetts to Texas), earthquake zones in
California, and the Mississippi River area of the central United States
along the New Madrid earthquake fault.
Such events place enormous stress on insurance markets and governments,
carry huge costs, and have raised concerns about who ultimately bears
the costs and receives the benefits of government disaster insurance
programs. For these reasons, debate has arisen about the appropriate
role for the federal government in insuring against and in recovering
from natural catastrophes.[Footnote 3] While many public policy
observers agree that the federal government does and should play an
integral role in disaster relief and infrastructure recovery, some
other public policy observers have asked whether the government's
current role is the most appropriate and have suggested alternatives.
Some have argued for more federal involvement, but others believe that
the federal government may be doing too much, crowding out private
insurance and reducing the private market's ability and willingness to
provide insurance-based solutions.[Footnote 4] Public policy observers
have raised moral hazard concerns, noting that generous federal
disaster relief may discourage homeowners from purchasing natural
catastrophe insurance.[Footnote 5] These observers have also pointed
out that government catastrophe insurance programs are vulnerable to
adverse selection, in that homeowners who are at the most risk are also
the most likely to buy catastrophe insurance.[Footnote 6]
In the context of your concerns about finding ways to ensure that the
federal government and the private sector each play an appropriate role
in the provision of natural catastrophe insurance, we examined (1) the
rationale for and resources of the federal and state programs that have
supplemented or substituted for private natural catastrophe insurance
and their funding; (2) the extent to which Americans living in
catastrophe-prone areas of the United States are uninsured and
underinsured and the federal payments that have been made to such
individuals since the 2005 hurricanes; and (3) public policy options
for revising the federal role in natural catastrophe insurance markets.
We reviewed or analyzed documents on federal and state catastrophe
insurance programs, the numbers of uninsured and underinsured and
federal payments that have been made, options to redefine the federal
role in natural catastrophe insurance, and goals that could be used as
a basis for designing and evaluating options for change. We interviewed
officials from public interest groups, insurance companies, reinsurance
companies, insurance agents, insurance brokers, insurance and
reinsurance associations, insurance agent associations, state
catastrophe insurance and reinsurance plans, state insurance
departments, state economic development departments, the National
Association of Insurance Commissioners (NAIC), the Federal Emergency
Management Agency (FEMA), the National Flood Insurance Program (NFIP),
the Department of Agriculture's Risk Management Agency, the Department
of Housing and Urban Development (HUD), the Small Business
Administration (SBA), Fannie Mae, Freddie Mac, rating agencies, risk
modeling organizations, academia, law firms, a hedge fund, an insurance
research organization, a private research organization, a consumer
group, and others. To determine the mechanisms that governments use to
supplement or substitute for private catastrophe insurance markets, we
collected oral and documentary information from public and private
officials in various states with high and low catastrophe risk and from
Washington, D.C. To determine the number of uninsured and underinsured
Americans and payments made to such individuals after the 2005
hurricanes, we collected information from states, examined federal
agency data, interviewed federal officials who prepared these data,
sought information from the private sector, and interviewed state
officials responsible for disbursing federal disaster funds. Data on
the numbers and amounts of money going to the uninsured and
underinsured were incomplete and had a number of limitations, which are
described in appendix I. We determined that these data were sufficient
for the purposes of this engagement.
We identified various options for altering the role of the federal
government in catastrophe insurance by looking at bills before the
current and previous Congresses as well as other options that were not
included in current legislative proposals--for example, a proposal
before a committee of NAIC. After fieldwork for this report concluded,
we were informed that additional public policy options not considered
in this report were being discussed before a committee of NAIC. We
sought out both supporters and critics of each option, and our
discussion of the third objective presents mainly advantages and
disadvantages that they have identified. We developed a four-goal
framework that was based on challenges faced by current government
natural catastrophe insurance programs and used the framework to
analyze current options for changing the federal role in natural
catastrophe insurance. We developed these goals by drawing insights
from the following: past GAO work, legislative histories of laws that
changed the roles of state governments and the federal government after
disasters, bills before the current and previous Congresses, interviews
with public and private sector officials, and refereed articles written
by academics in insurance economics. Although we identified numerous
possible goals that could assist our analysis, we believe the four
goals that we chose accurately capture the essential concerns of the
federal government. The congressional policy choices ahead involve
striking an appropriate balance among these goals.
The scope of our work covered hurricane and earthquake perils. We did
not investigate tornado, hail, or other perils, such as wildfires. We
focused on the property and casualty insurance line, especially
homeowners insurance. In reporting on the amount of federal disaster
assistance to individuals who lacked adequate insurance in the Gulf
Coast states following the 2005 hurricanes, we attempted to identify
payments to homeowners only. However, because in some instances we
could not separate out payments to renters, we included payments to
both homeowners and renters in some of our calculations. Judgments
about whether market failure did or did not exist in any particular
state's property and casualty insurance market--and whether the cost of
doing something about it was or was not more expensive than the federal
government's not acting--were outside the scope of this report.
Appendix I contains additional details of our objectives, scope, and
methodology. We did fieldwork in Alabama; California; Connecticut;
Florida; Illinois; Indiana; Louisiana; Massachusetts; Mississippi;
Missouri; New York; Ohio; Texas; and Washington, D.C. Our work was
conducted between March 2006 and October 2007 in accordance with
generally accepted government auditing standards.
Results in Brief:
The federal government and some states have developed natural
catastrophe insurance programs that supplement or substitute for
private natural catastrophe insurance. For example, the Federal Crop
Insurance Corporation (FCIC) currently insures crops for losses from
multiple perils, and NFIP insures against flood losses. Although these
programs were created to provide affordable insurance coverage, by
design they are not adequately funded--that is, the premium rates do
not cover the government's exposure--and rely on postfunding mechanisms
to cover catastrophic loss years. Unlike private insurers that base
premium rates on the risk of loss associated with properties, these
programs offer legislatively mandated premium subsidies to encourage
participation, and Congress appropriates funds for emergency disaster
relief as needed. Similarly, some state governments have intervened
when private sector insurance became prohibitively expensive or was not
widely available, offering state-sponsored catastrophe insurance
programs. For example, California created an earthquake fund in 1996
when private insurers significantly reduced the writing of homeowner
earthquake coverage following the Northridge Earthquake. Likewise,
Florida has created the Citizens Property Insurance Corporation
(Florida Citizens)--the largest home insurer in Florida--to provide
state-backed insurance coverage, including for wind damage, for
homeowners who cannot get coverage in the private sector. The natural
catastrophe insurance programs in Florida, Louisiana, Texas, and other
states are funded through a combination of premium payments and
postevent assessments and bonds. Like the federal programs, some state
natural catastrophe insurance programs have been criticized for not
charging premiums sufficient to cover risks. After the 2005 hurricanes,
for example, some of these programs faced large accumulated deficits
and required substantial public funding to continue operations.
The 2005 hurricanes made clear that, even with the federal and state
natural catastrophe insurance programs, significant numbers of
Americans lacked adequate insurance against natural catastrophes for
their homes. These property owners were either uninsured or
underinsured, for a variety of reasons. Perhaps most significantly,
buying natural catastrophe insurance is in many cases voluntary, and
homeowners may choose not to buy it because they do not understand
their risk exposure, do not understand the protection catastrophe
insurance offers, or cannot afford it. In some cases, homeowners have
insurance, but it covers less than the full replacement value of their
property or has other policy limitations. Underinsurance can be
exacerbated following a natural catastrophe, when rebuilding costs can
increase substantially. Uninsured and underinsured homeowners may
compound the challenge of providing affordable natural catastrophe
insurance by relying on the federal government for postdisaster
assistance to rebuild their homes. These homeowners may seek federal
disaster relief from several federal agencies, including grants from
FEMA and HUD, and real property loans from SBA. As we found, a
significant portion of post-Katrina payments to Americans have gone to
homeowners who were inadequately insured. We estimated that a quarter
to a third of all federal emergency appropriations after the 2005
hurricanes, or around $26 billion in grants and loans, was obligated to
homeowners and renters who lacked adequate natural catastrophe
insurance.
As Congress and the industry continue to reevaluate the role of the
federal government in insuring for natural catastrophes, Congress is
faced with balancing the often-competing goals of limiting taxpayer
exposure and ensuring that citizens are protected. We identified seven
public policy options for changing the role of the federal government
in natural catastrophe insurance, including a mandatory all-perils
homeowners insurance policy, federal reinsurance for state catastrophe
funds, a federal lending facility for state catastrophe funds, and
several tax-based incentives to encourage greater participation by
insurers and homeowners in managing natural catastrophe risks. As shown
in figure 4, each of these options has advantages and disadvantages. As
part of our evaluation, we weighed each of the options against four
public policy goals that we identified for federal involvement in
natural catastrophe insurance programs: (1) to have premium rates fully
reflect actual risks, (2) to encourage private markets to provide
natural catastrophe insurance, (3) to encourage broad participation in
natural catastrophe insurance programs, and (4) to limit costs to
taxpayers before and after a disaster. We found that a mandatory all-
perils policy, for example, could help create broad participation and
provide a private sector solution. But this option could also require
subsidies for low-income residents and thus potentially create
substantial costs for the federal government. Similarly, while federal
reinsurance for state catastrophe funds could lead to greater
participation by private insurers, it could also displace the private
reinsurance market. Also, a federal lending facility could also help
state catastrophe insurance funds with financing needs after a
catastrophe but could also expose the federal government--and
taxpayers--to the risk that a loan might not be repaid. Given the often-
competing purposes of many public policy options, some options may be
more appealing than others, but all warrant discussion as part of the
current debate. While some options would address the goals of charging
rates that reflect the true risk of catastrophic loss, encourage broad
participation, or promote greater private sector participation, these
goals must be balanced with the desire to make rates affordable.
We provided a draft of this report to NAIC and provided excerpts from
the draft to Alabama Insurance Underwriting Association (Alabama Beach
Pool), California Earthquake Authority (CEA), Department of Housing and
Urban Development (HUD), Federal Crop Insurance Corporation (FCIC),
Federal Emergency Management Agency (FEMA), Florida Hurricane
Catastrophe Fund (FHCF), Florida Citizens Property Insurance
Corporation (Florida Citizens), Georgia Underwriting Association (GUA),
Louisiana Citizens Property Insurance Corporation (Louisiana Citizens),
Mississippi Windstorm Underwriting Association (Mississippi Windpool),
the North Carolina Insurance Underwriting Association (North Carolina
Beach Plan), Small Business Administration (SBA), the South Carolina
Wind and Hail Underwriting Association (South Carolina Windpool), and
the Texas Windstorm Insurance Association (Texas Windpool). NAIC
provided written comments that are reprinted in appendix III. In these
comments, NAIC officials said that our approach was thorough and that
we had done an admirable job of evaluating the public policy aspects of
the seven proposals. The officials also mentioned two additional
proposals that merit consideration, including a proposal that includes
an allocation system for determining what portion of hurricane damages
should be attributed to wind and what portion to flood, and another
proposal for the creation of a federal entity to oversee property
insurance rates in coastal zones. While these options were put forth
too recently to be included in our review and analysis, we will collect
additional information about them, to the extent possible, during the
course of other ongoing work involving NFIP. NAIC also commented on
allegations made by some critics of state regulation, who have
suggested that regulators may be suppressing rates for some catastrophe
insurers, and cautioned against assuming widespread rate suppression by
state insurance regulators. As NAIC noted, our report does not allege
any such activity on the part of state insurance regulators but notes
that it is a concern raised by some critics. We recognize that
determining the appropriate rates for natural catastrophe insurance is
challenging and is often a negotiated process between the insurers and
regulators. Alabama Beach Pool, the CEA, FCIC, Florida Citizens, FHCF,
the GUA, Louisiana Citizens, MWUA, the North Carolina Beach Plan, SBA,
the South Carolina Windpool, and the Texas Windpool provided technical
comments that we incorporated in this report as appropriate.
Background:
The United States is exposed to several major hazards, in particular
earthquakes and hurricanes, in coastal areas. As shown in figure 1, the
Pacific, South Atlantic, and Gulf Coasts face the highest risk of
earthquakes and hurricanes. According to the National Oceanic and
Atmospheric Administration (NOAA), 53 percent of the nation's total
population, or approximately 153 million people, lived in coastal
counties in 2003.[Footnote 7] Moreover, the total coastal population
increased by 33 million people, or 28 percent, between 1980 and 2003.
California led in coastal population change, with the number of
residents increasing by 9.9 million people. Florida showed the greatest
percentage population change between 1980 and 2003, increasing nearly
75 percent. The nation's coastal population is expected to increase by
more than 7 million people by 2008 (over current levels) and by 12
million people by 2015.
Figure 1: Catastrophic Risk in the United States--Earthquake,
Hurricane, Tornado, and Hail:
[See PDF for image]
This figure is a map of the United States with depictions of the paths
and/or landfalls of earthquakes, hurricanes, tornadoes and hail. Shaded
areas on the map indicate risk, from low risk to high risk. Twenty-one
different shadings are indicated on a continuum from lowest risk (1) to
highest risk (21), with the following cities depicted: Phoenix: 2;
Las Vegas: 3;
New York: 4;
Philadelphia: 5;
Portland: 6;
Washington, DC, Boston, Chicago: 7;
San Diego: 9;
Salk Lake City: 10;
Raleigh: 11;
Atlanta, San Antonio: 12;
St. Louis, Denver: 13;
Seattle, Los Angeles: 14;
Anchorage: 16;
Tampa, Houston, Dallas: 17;
New Orleans, Memphis, Oklahoma City: 18;
Charleston, San Francisco: 19;
Honolulu: 20;
Miami: 21.
Source: Risk Management Solutions.
[End of figure]
The housing supply in coastal areas also continues to grow, despite the
high risk of earthquakes and hurricanes. NOAA reported that coastal
counties contained 52 percent of the nation's total housing supply in
2000.[Footnote 8] The leading states in terms of total housing units in
coastal counties were California, Florida, and New York, which together
have 41 percent of the total housing supply in these counties. One
study put the estimated insured value of coastal property in states
bordering the Atlantic Ocean and Gulf of Mexico at $7.2 trillion as of
December 2004.[Footnote 9] As shown in figure 2, properties along the
Pacific and North-Atlantic Coasts and the Gulf of Mexico have some of
the highest insured property values. The value of residential and
commercial coastal property in Florida and New York was $1.94 trillion
and $1.90 trillion, respectively, in 2004.
Figure 2: Insured Property Value, by County:
[See PDF for image]
This figure is a map of the continental United States, depicting the
insured property value, by county. Counties are shaded into the
following five categories by insured property value, in billions:
Less than 5;
Five to ten;
Eleven to fifty;
Fifty-one to one hundred;
More than 100.
Source: Copywrite, 2007 AIR Worldwide Corporation.
[End of figure]
Private Natural Catastrophe Insurance:
Insurance coverage against natural catastrophes for a home may or may
not be included in homeowners insurance contracts. For example,
coverage against wind loss from an event such as a hurricane is
typically included. However, in some areas of certain states--mostly
coastal regions--wind coverage may be excluded from homeowners
insurance contracts and may be available only through the surplus lines
insurance market or a state-managed entity.[Footnote 10] Similarly,
earthquake coverage is commonly excluded from homeowners insurance
contracts and instead is sold separately by insurance companies or, in
the case of California, through a state-managed program.
The price of property and casualty insurance is affected by both the
annual expected loss and the cost of diversifying the risk of
catastrophic losses.[Footnote 11] Insurers can diversify the risk of
catastrophic losses by, among other things, purchasing reinsurance,
which is insurance for insurance companies, or by selling financial
instruments such as catastrophe bonds. Insurance companies do not know
in advance what their actual costs are going to be, because they can
determine these costs only after a policy has expired. The insurer's
objectives are to calculate premiums that will make the business
profitable, enable the company to compete effectively with other
insurers, and allow the company to pay claims and expenses as they
occur.
When insurers, reinsurers, and investors in catastrophe financial
instruments perceive that the expected frequency or severity of natural
catastrophes has increased, they may increase the price of insurance.
If a company believes that the risk of loss--for example, from flooding
or earthquake--is unacceptably high given the rate that can be charged,
it declines to offer coverage.
State Regulation of Insurance Prices:
While the federal government retains the authority to regulate
insurance, it has given primary responsibility for insurance regulation
to the states, in accordance with the McCarran-Ferguson Act of
1945.[Footnote 12] State insurance commissioners are responsible for
regulating rates, monitoring the availability of insurance, and
assessing insurance firms' solvency. The insurance regulators of the 50
states, the District of Columbia, and the U.S. territories have created
NAIC to coordinate regulation of multistate insurers. NAIC serves as a
forum for the development of uniform policy, and its committees develop
model laws and regulations that, when adopted by state legislatures or
promulgated by state regulators, govern the U.S. insurance industry.
Critics of state insurance regulation argue that insurance prices and
terms of coverage, particularly for homeowners insurance in areas prone
to natural catastrophes, are highly regulated and that the insurance
industry is generally not allowed to respond freely to changing risks
or market conditions. In particular, these critics say that:
* insurance regulators do not allow private insurers in catastrophe-
prone areas to charge rates sufficient to build surpluses or transfer
risks to reinsurers,
* regulators may be subject to voter pressure and thus to legislative
pressure to keep insurance premiums affordable and coverage readily
available, and:
* regulatory and political restrictions prevent markets from giving
consumers accurate price signals regarding the risks of living in
catastrophe-prone areas.
NAIC officials told us that projected loss costs to cover the insurer's
catastrophe exposure vary widely depending on which risk-modeling firm
the insurer selects to produce its catastrophe loss costs. Only future
results prove whether insurance company actuaries or insurance
regulator actuaries are correct. The officials said that one should not
assume that insurers and their actuaries have perfect information about
what catastrophes will occur during the next year and about how the
economy will behave. They added that one should also not assume that
actuaries working for insurance companies are always correct in their
projections of the needed price for the future experience period and
that actuaries working for insurance regulators are always wrong.
In the aftermath of natural catastrophes, some insurers responded by
limiting their exposure in catastrophe-prone areas with restrictions on
underwriting, higher deductibles, and lower coverage limits.[Footnote
13] In particular, there were property insurance affordability and
availability crises in the Gulf Coast states or Florida after Hurricane
Camille in 1969, Hurricane Celia in 1970, Hurricane Andrew in 1992, and
the 2005 hurricanes; and in California following the Northridge
Earthquake in 1994. Various proposals have been put forth over the past
15 years seeking to have the federal government take a larger role--for
example, as a reinsurer or by allowing insurance companies to
accumulate tax-deferred reserves--in addressing the affordability and
availability of natural catastrophe insurance.[Footnote 14]
Federal Natural Catastrophe Insurance and Disaster Aid:
The federal government engages in a wide variety of insurance
activities, among them providing multiperil crop insurance to farmers
and flood insurance to homeowners and businesses.[Footnote 15] In
addition, the federal government provides disaster assistance to
individuals and households.[Footnote 16] FEMA, SBA, and HUD are the
primary agencies administering federal disaster relief and recovery
programs.
FCIC provides insurance coverage for farmers who suffer financial
losses when their crops are damaged by droughts, floods, or other
natural disasters. By law, FCIC pays the premium for catastrophic
coverage against losses of 50 percent of a farm's normal yield at 55
percent of the market price.[Footnote 17] In addition, FCIC offers
premium subsidies for "buy-up" coverage against crop, revenue, and
prevented planting losses, with coverage for losses ranging from 50 to
90 percent of a farm's normal yield.[Footnote 18] FCIC estimates that
participation of eligible farmers is approximately 80 percent of acres
planted.
FEMA, through NFIP, offers insurance to homeowners and businesses for
losses due to flooding and currently has 5.3 million policyholders. By
law, NFIP must offer reduced premium rates for homes built in
floodplains prior to the creation of flood insurance rate maps (pre-
Flood Insurance Rate Map (FIRM) properties). About one quarter of NFIP
policies are pre-FIRM and pay about 40 percent of the risk-based rate.
According to NFIP, homes built in floodplains to an approved building
code after the creation of flood maps pay actuarially sound premiums.
Participation in the program is mandatory for homeowners with mortgages
issued by federally regulated lenders on properties in special flood
hazard areas (SFHA) where flood insurance is available.[Footnote 19]
According to the RAND Corporation, about half of all homeowners who
live in SFHAs purchase flood insurance.
In addition to providing crop, flood, and other insurance, the federal
government provides disaster assistance to individuals. FEMA provides
disaster relief and recovery assistance to individual citizens through
its Individuals and Households Program (IHP), which is intended to
provide money and services to people in a disaster area when losses are
not generally covered by insurance and property has been damaged or
destroyed. IHP includes Housing Assistance (HA) and Other Needs
Assistance (ONA). FEMA may provide five types of HA: financial
assistance to rent temporary housing, "direct" temporary housing
assistance, repair assistance, replacement assistance, and permanent
housing construction in certain areas outside of the continental United
States and other remote areas. FEMA may provide ONA grant funding for
transportation expenses, medical and dental expenses, and funeral and
burial expenses. ONA grant funding may also be available to replace
personal property, repair and replace vehicles, and reimburse moving
and storage expenses under certain circumstances. IHP is not intended
to restore damaged property to its predisaster condition.
SBA's Disaster Loan Program (DLP) is the primary federal program for
funding long-range recovery for private sector, nonfarm disaster
victims. Eligible losses include under or uninsured damages and can not
duplicate benefits received from another source (i.e. insurance
recovery, FEMA, etc.) The Small Business Act authorizes SBA to make
available the following two types of disaster loans: (1) physical
disaster home loans to homeowners, renters, and businesses of all
sizes, and (2) economic injury disaster loans to small
businesses.[Footnote 20] Homeowners and renters can borrow up to
$40,000 for repair or replacement of household and personal effects.
Homeowners can also borrow up to $200,000 to repair or replace a
primary residence. Businesses of all sizes can borrow up to $1.5
million to repair or replace disaster damaged real estate, machinery
and equipment, inventory, etc. Small businesses can borrow up to $1.5
million for disaster related economic injury resulting from the
declared disaster. The combined loans to a business for physical loss
and economic injury cannot exceed $1.5 million. Homeowners and
businesses must provide reasonable assurance that they can repay the
loan out of personal or business cash flow, and they must have
satisfactory credit and character.
HUD also provides disaster recovery assistance through several
programs. After the 2005 hurricanes, Congress appropriated $16.7
billion to the Community Development Block Grant (CDBG) program for
disaster recovery. The CDBG program generally provides funding to
metropolitan cities and urban counties that have been designated as
entitlement communities and to states for distribution to other
communities.[Footnote 21] Grant recipients must give maximum feasible
priority to activities, including emergency-related activities, that
(1) benefit low-and moderate-income families or aid in the prevention
or elimination of slums or blight, or (2) meet urgent community
development needs. However, HUD can waive regulatory and statutory
program requirements to increase the flexibility of the CDBG funds for
disaster recovery. These grants afford states and local governments a
great deal of discretion to help them recover from presidentially
declared disasters.[Footnote 22]
Government Natural Catastrophe Insurance Aims to Provide Affordable
Protection but Often Requires Postfunding after Large Natural
Catastrophes:
Government natural catastrophe insurance programs were created because
certain perils are difficult to insure privately and because, when
private insurance is available, it may not be affordable. To keep
natural catastrophe insurance available and affordable, government
insurance programs operate differently than private insurance
companies. Private insurance companies generally rely on premiums
collected from those they insure to cover operating costs and losses
and set premium rates at levels that are designed to reflect the risk
that the company assumes in providing the insurance. These companies
may also accumulate reserves to cover large losses. Federal and state
government insurance programs also collect up-front premiums, but their
rates do not always reflect the risks that the programs assume. Because
premiums are inadequate to cover operating costs and losses, the
government programs generally have limited resources and often face
deficits after disasters. However, unlike private insurers, federal
insurers may obtain funds after a catastrophic event through emergency
appropriations. State programs may also access postevent funding
through various means, including assessments on private insurers,
bonds, and private reinsurance. State programs may also be postfunded
through state general revenue funds and federal disaster relief
payments. This structure has several implications. First, it may
encourage homeowners in catastrophe-prone locations to seek coverage
from government programs, crowding out the private market and
increasing the government's financial exposure. Second, homeowners may
not receive appropriate price signals about the risk of living in
catastrophe-prone locations. Third, taxpayers who live in less risky
locations may be subsidizing those living in catastrophe-prone
locations. Finally, the added burden of private insurers' assessment
obligations may provide another reason for them to leave already
stressed markets.
Federal natural catastrophe insurance programs fill gaps in private
insurance markets and help limit disaster relief payments. For example,
FCIC and NFIP were created because private insurers had determined that
multiperil crop and flood losses were uninsurable and declined to
provide coverage. A 1937 study by the Executive Committee on Crop
Insurance, which noted that commercial attempts to insure against crop
losses had been unsuccessful, provided the impetus for creating FCIC in
1938. Initially, the program was experimental and suffered heavy
losses. The Federal Crop Insurance Act of 1980 expanded the program to
replace free disaster coverage (in the form of compensation to farmers
who were unable to plant crops and who suffer yield losses) with
insurance. The flood insurance program was initiated because it had
become clear by the 1950s that private insurance companies could not
profitably provide affordable flood coverage because of the
catastrophic nature of flooding and the impossibility of developing an
actuarial rate structure that could adequately reflect the risk to
flood-prone properties, among other reasons. One of the primary
purposes of the National Flood Insurance Act of 1968, which created
NFIP, was to reduce federal expenditures for disaster assistance and
flood control.
State natural catastrophe insurance programs were created to avoid
homeowners insurance crises that threatened the states' housing
markets. For example, the California Earthquake Authority was formed in
1996 in response to a crisis in the residential property insurance
market following the Northridge earthquake in 1994. According to the
Insurance Information Institute, California insurers had collected only
$3.4 billion in earthquake premiums in the 25-year period prior to the
Northridge earthquake but had paid out more than $15 billion on
Northridge claims alone. Moreover, insurers representing about 95
percent of the homeowners insurance market in California began to limit
their exposure to earthquakes by writing fewer or no new homeowners
insurance policies, triggering a crisis that threatened California's
housing market and stalled the state's recovery from recession. See
appendix II for a more detailed description of state natural
catastrophe insurance programs.
Florida Citizens is a nonprofit tax-exempt entity that provides
residential and commercial property insurance coverage when private
insurance is not available. Florida Citizens was established in 2002
after two separate insurance pools--the Florida Windstorm Underwriting
Association (FWUA) and the Florida Residential Property and Casualty
Joint Underwriting Association (JUA)--were combined.[Footnote 23] In
addition, the Florida Hurricane Catastrophe Fund (FHCF) provides an
alternative to traditional hurricane reinsurance, reducing the cost of
coverage significantly below that of private reinsurance and lowering
the cost of insurance to homeowners. The FHCF was established in 1993
in response to Hurricane Andrew, which resulted in a severe shortage of
catastrophe property reinsurance capacity, stricter policy terms and
conditions, and sharp increases in property catastrophe reinsurance
rates in the year following the storm.[Footnote 24] The post-Andrew
reaction of a number of insurance companies was to attempt to reduce
their underwriting exposure, and 39 insurers stated in early 1993 that
they intended to either cancel or not renew approximately 844,000
policies in Florida.[Footnote 25] Other states--including Alabama,
Louisiana, Mississippi, and Texas--have created state funds to make
natural catastrophe insurance available and affordable.
Premium Rates for Government Natural Catastrophe Insurance Programs Are
Often Determined by Factors Other Than Risk:
Because government natural catastrophe insurance programs are often
created to ensure the availability and affordability of natural
catastrophe insurance, homeowner premiums for these programs--although
risk-related--are generally not based entirely on the homeowners level
of risk. Federal natural catastrophe insurance program premium rates
are often set by statute and involve government subsidies. For example,
to encourage broad participation in the crop insurance program, federal
law seeks to ensure that the premiums are affordable to all farmers by
requiring FCIC to pay a portion of the premium cost.[Footnote 26]
Specifically, FCIC offers farmers varying subsidy rates for crop
insurance, depending on the level of protection they seek.[Footnote 27]
Crop insurance subsidies totaled about $2.3 billion in crop years 2005
and 2006. In addition, federal crop insurance legislation directs FCIC
to operate at a loss ratio of no more than 1.075.[Footnote 28] A loss
ratio greater than 1.00 indicates that the program paid more in claims
than it collected in premiums.[Footnote 29] Furthermore, we have
previously reported that NFIP is not designed to be actuarially
sound.[Footnote 30] Annually, flood insurance subsidies total about
$1.3 billion.[Footnote 31]
State natural catastrophe insurance program premium rates may also be
set by statute. Florida Citizens historically has been required to
maintain premium rates that were not competitive with the private
insurance market. However, in January 2007, the Florida Legislature
allowed Florida Citizens to charge competitive rates.[Footnote 32] Even
by 2006, Florida Citizens was the largest property insurer in Florida.
It receives much of its reinsurance coverage from the FHCF, which
charges premium rates that are estimated to be about a quarter to a
third the cost of private market reinsurance. The program can charge
these rates because of its tax-exempt status and ability to postfund
claims losses through bonds, among other advantages. These two state
programs are able to charge lower premiums than private insurance
companies, encouraging more people to seek coverage in the state
programs and leaving the state more financially vulnerable in the event
of a large hurricane.
State natural catastrophe insurance program premium rates are also
subject to approval by state insurance regulators that have generally
resisted rate increases. The Mississippi Windstorm Underwriting
Association (Mississippi Windpool) provides coverage against windstorms
and hail for people in the six coastal counties of Mississippi who
might not be able to get wind coverage in the private insurance market.
After Hurricane Katrina, the Mississippi Windpool sought a rate
increase of almost 400 percent, primarily to cover the increased cost
of reinsurance. The state insurance regulator granted a 90 percent
increase. Furthermore, the state government will use $50 million in
federal disaster recovery funds provided by HUD to offset the increased
cost of reinsurance in 2007 and 2008. In addition, the state government
created a reinsurance fund that uses state general revenue funds to
offset the increased cost of reinsurance.
Similarly, the Texas Windstorm Insurance Association (Texas Windpool)
offers wind and hail coverage in 14 coastal counties and other
specified areas. By law, Texas Windpool residential and commercial
premium rates may not increase more than 10 percent above the rates for
noncommercial windstorm or hail insurance that are in effect at the
time the request for an increase is filed. However, the insurance
commissioner may suspend this rule to ensure rate adequacy in the
catastrophe area.[Footnote 33] In May 2006, the Texas Windpool sought a
19 percent residential and 24 percent commercial rate increase, but the
insurance commissioner approved a 3.1 percent residential and 8 percent
commercial rate increase. When the Texas Windpool sought a 20 percent
residential and 22 percent commercial rate increase in November 2006,
the insurance commissioner approved a 4.2 percent residential and 3.7
percent commercial rate increase. In both instances, the insurance
commissioner stated that he favored an incremental approach to
strengthening the Texas Windpool that did not put an undue economic
burden on coastal homeowners.
Federal and State Natural Catastrophe Insurance Programs Have Incurred
Large Postdisaster Deficits Because of Inadequate Resources and
Reliance on Postfunding:
Unlike private insurance companies, government natural catastrophe
insurance programs often do not employ accrual accounting and are not
always required to accumulate adequate resources to meet their
obligations. Generally, insurance premiums are paid in advance, but the
period of protection extends into the future. Private insurers are
required by statutory accounting rules to establish reserves for
incurred or known claims and for the cost of "incurred but not
reported" claims to ensure that the premiums collected in advance will
be available to pay future losses.[Footnote 34] Incurred but not
reported claims are insured losses that have already happened but that
for any of a variety of reasons have not yet been reported to the
insurer. Most government natural catastrophe insurance programs are not
required to have these resources, because they are structured to
postfund losses. As we have previously mentioned, NFIP and the federal
crop insurance program are postfunded by emergency appropriations from
federal taxpayers. State programs are generally postfunded by several
mechanisms, including assessments on private insurers, bonds, and
proceeds from general revenues. In most property and casualty insurance
lines, state assessments are often passed through to policyholders. As
a result, homeowners living in less risky locations also contribute to
cover the shortfall--a scenario known as cross-subsidization. In those
states where assessments cannot be passed through in some manner,
private insurers must pay the assessments, while at the same time
paying large claims from their own policyholders. In such instances,
some companies may be reluctant to continue offering coverage in the
state or may become insolvent.
In the wake of recent natural catastrophes, some government natural
catastrophe insurance programs suffered losses that eliminated their
accumulated resources. For example, NFIP reported unexpended cash of
approximately $1 billion following fiscal year 2004, but the program
had suffered almost $16 billion in losses from Hurricane Katrina alone
as of May 31, 2007.[Footnote 35] Similarly, Florida Citizens' high-risk
account had a surplus of approximately $1.1 billion prior to the 2004
hurricane season, but the program incurred over $2 billion in losses
from the 2004 hurricanes and almost $2 billion in losses from the 2005
hurricanes.[Footnote 36] The FHCF had accumulated net assets of $5.5
billion at the end of the 2004 fiscal year but had an estimated
shortfall of approximately $1.4 billion following reimbursements to
participating insurers after the 2004 and 2005 hurricane
seasons.[Footnote 37] Prior to 2007, the Mississippi Windpool did not
have resources beyond premiums and reinsurance because year-end profits
and losses were shared by member companies. By the end of 2005,
following Hurricane Katrina, the Mississippi Windpool had incurred a
net loss of $473 million.[Footnote 38] In Louisiana, Citizens Property
Insurance Corporation (Louisiana Citizens), which has a structure
similar to that of Florida Citizens, had $80 million in cash reserves
prior to the 2005 hurricane season but suffered more than $1 billion in
losses after Hurricanes Katrina and Rita.[Footnote 39]
Emergency appropriations authorizing funding for federal natural
catastrophe insurance programs after disasters have often been
significant. In the case of FCIC, not only are premium rates subsidized
by almost 59 percent for the most popular coverage, but farmers may
receive additional emergency disaster relief--for example, farmers
received $1.6 billion following Hurricane Katrina.[Footnote 40] In the
case of NFIP, not only are premium rates for pre-FIRM homes subsidized
up to 60 percent on average, but after Hurricane Katrina NFIP was
authorized to borrow over $20 billion to pay claims.
State natural catastrophe insurance programs have also often required
postfunding to satisfy their obligations in the wake of large natural
catastrophes. For example, to fund its 2004 and 2005 deficits, Florida
Citizens assessed insurance companies in most property and casualty
lines $516 million and $205 million, respectively, and these amounts
will be passed through to policyholders.[Footnote 41] In addition, the
Florida Legislature appropriated $715 million from the general revenue
fund to reduce the size of the 2005 deficit. Furthermore, to fund a
bond issuance to cover the FHCF's shortfall, eligible Florida insurance
policyholders incurred a 1 percent assessment that will be levied over
at least 6 years beginning in January 2007. In June 2006, the FHCF
issued a $1.35 billion postevent revenue bond to cover 2005 losses, and
in July 2006 it issued a $2.8 billion preevent financing bond to
provide liquidity for 2006 and future years.
Similarly, Louisiana Citizens assessed all property insurance companies
in the state $193 million after the 2005 hurricanes. It has also issued
a postevent bond for $978 million to cover 2005 losses that will be
financed by emergency assessments on insurers in certain lines of
property and casualty insurance. These assessments are levied directly
on policyholders, who may claim a tax credit against state income tax.
The assessments will continue for as many years as needed to cover the
plan's deficit. Both Florida Citizens and Louisiana Citizens have been
declared to be municipalities rather than insurance companies by their
respective state legislatures, and as a result cannot declare
bankruptcy until the bond obligations are satisfied. In addition, the
Mississippi Windpool funded its deficit through $525 million in
assessments on member companies in proportion to their share of
business in the state.[Footnote 42] At the time, these assessments
could not be directly passed through to policyholders. At least one
private insurance company found that its assessment liability was more
than the entire amount of premiums it collected in the state and was
forced to liquidate. Finally, the Texas Windpool assessed private
insurance companies in Texas for the first $100 million in program
losses and expenses from Hurricane Rita beyond its ability to pay from
premiums and other income.
Because Many Americans Are Inadequately Insured for Natural
Catastrophes, Federal Programs Play a Significant Role in Recovery:
The 2005 hurricanes illustrated how many Americans are uninsured and
underinsured for natural catastrophes and the federal government's role
in recovery from natural catastrophes. An analysis by HUD found that of
the 192,820 owner-occupied homes with major or severe damage from
Hurricanes Katrina, Rita, and Wilma, approximately 78,000, or about 41
percent, did not have any insurance or did not have enough insurance to
cover the damage incurred.[Footnote 43] Homeowners do not purchase
natural catastrophe insurance for a variety of reasons, including
financial reasons. Moreover, buying a natural catastrophe insurance
policy does not guarantee complete coverage for a dwelling. For
example, if the home's replacement value is calculated inaccurately,
the homeowner will buy too little insurance to cover all of the damage.
More and more frequently, responsibility for supporting the needs of
individuals who lack adequate insurance against natural catastrophe
risk is falling to the federal government. We estimate that the federal
government made approximately $26 billion available for homeowners and
renters who lacked adequate insurance in response to the 2005
hurricanes.
Homeowners May Not Be Insured against Natural Catastrophes for Several
Reasons:
Homeowners may not purchase natural catastrophe insurance because they
face budget constraints, underestimate the risk they face, or fail to
understand the protection such insurance affords.[Footnote 44]
Information on the number of individuals who are uninsured against
natural catastrophe risks is somewhat limited but helps demonstrate the
extent to which homeowners do not purchase natural catastrophe
insurance. About 41 percent of homes that sustained severe damage from
any peril during the 2005 hurricanes were uninsured or underinsured.
HUD reported that of the 60,196 owner-occupied homes with major or
severe wind damage, almost 23,000, or 38 percent, lacked insurance
against wind loss. Also, the Insurance Information Institute reported
that about 86 percent of Californians did not have earthquake insurance
on their homes in 2004. Furthermore, only about one half of eligible
single-family homes in Special Flood Hazard Areas (SFHA) nationwide
have purchased flood insurance.[Footnote 45] In areas outside of SFHAs,
where flood insurance is voluntary, only about 1 percent of owners of
single-family homes have purchased flood insurance, even though 20 to
25 percent of NFIP's claims come from outside of SFHAs.
Purchasing insurance to protect homes against natural catastrophes is
mandatory for some homeowners, but often it is voluntary. For example,
homeowners who do not have mortgages are generally not required to have
property and casualty coverage, and in some areas certain types of
hazards are routinely excluded from homeowners policies. As we have
seen, wind coverage is often excluded in some coastal areas, and the
surplus lines market or a state-managed entity may offer coverage
separately. Although lenders may require homeowners to purchase this
supplemental insurance, those who own their homes outright may choose
not to buy it. A similar situation exists with earthquake coverage in
certain areas of the country. In earthquake-prone areas, earthquake
coverage is commonly excluded from the homeowners insurance contract
and is sold separately by insurance companies or, as in the case of
California, by a state-managed program. In general, lenders do not
require earthquake insurance as a condition of extending a mortgage.
Consumers will purchase natural catastrophe insurance on the basis of
their perception of risk. Studies have shown that consumers often
consider the likelihood of a future catastrophe to be much lower than
insurance companies' estimates. According to academic research, some
homeowners may underestimate the risk of loss, have an overly
optimistic view of expected losses, or be unaware that insurance is
available. One insurance expert has concluded that if people believe
that the chance of a serious event occurring is low, they often
consider insurance unnecessary and will not seek out information on its
benefits and costs. Reluctance to purchase insurance protection can be
compounded by budget constraints. For some homeowners with relatively
low incomes, disaster insurance is considered an expense that can be
made only after taking care of necessities.
An insurance expert has noted that insurance trade associations,
consumer advocacy groups, and governments can provide better
information to consumers about risk probabilities, insurer
profitability, and prices to motivate better insurance purchasing
behavior.[Footnote 46] One study of those living in earthquake zones
has identified a variety of reasons for declining to purchase
earthquake insurance.[Footnote 47] Some consumers are unwilling or
reluctant to pay high premiums to insure against potentially large but
rare disaster losses. Some consumers believe that the deductible for
earthquake insurance--the standard deductible is 15 percent of the
value of the home--is too high, given the premium rates and amount of
coverage provided.[Footnote 48] A study of flood insurance market
penetration rates cites several reasons why people do not purchase
flood insurance.[Footnote 49] For property owners in SFHAs, the
decision to purchase insurance is affected primarily by its price.
Outside of SFHAs, property owners are not purchasing flood insurance
because they may not be aware of flood risk, and because flood
insurance agents have less interest in promoting flood insurance and in
learning how to write flood policies. Also, certain limitations of the
coverage, such as limits on basement flooding, make the policies less
attractive in inland areas.
Inaccurate Home Valuations Can Result in Underinsurance:
Text box:
Coinsurance Clause Formula:
Homeowners who carry less than 80 percent of the full replacement cost
of their homes receive an amount calculated by formulas. Generally, the
amount will be the larger of the following two amounts:
(1) Actual cash value of that part of the building damaged (minus
depreciation cost) or;
(2) Amount of insurance carried divided by 80 percent multiplied by
replacement cost, then multiply that amount by Loss.
To illustrate, assume that a dwelling has a replacement cost of
$400,000, but it is insured for only $240,000. The roof of the house is
10 years old and has a useful life of 20 years, so it is 50 percent
depreciated. Assume the roof is severely damaged by a hurricane, and
the replacement cost of a new roof is $40,000. Ignoring the deductible,
the insured receives the larger of the following two amounts:
(1) Actual cash value equals $40,000 minus $20,000, which equals
$20,000; or:
(2) $240,000 divided by 80 percent times $400,000; multiplied by
$40,000, equals $30,000.
The insured receives $30,000 for the loss. The entire loss of $40,000
would have been paid if the insured had carried at least $320,000 of
insurance.
[End of text box]
Homes may be underinsured because replacement costs are not calculated
accurately. Replacement cost has been defined as the amount necessary
to repair or replace the dwelling with material of like kind and
quality at current prices. Replacement cost may not be calculated
accurately for several reasons, including the effects of inflation,
custom home building, remodeling, high demand for contractors, and
changes in building codes following a natural catastrophe.
Generally, property insurance losses are partial losses rather than
total losses. However, in catastrophe-prone areas, the prospect of a
total loss of property is real. If a homeowner suffers a total loss of
property as a result of a natural catastrophe and the replacement cost
has not been properly calculated, the property will not be fully
insured. An insurance industry consultant estimates that in 2006
approximately 58 percent of the residential housing stock in the United
States was undervalued for insurance purposes by an estimated 21
percent.
Homeowners insurance coverage can vary by type of policy and from
insurer to insurer, but there are fundamental similarities. The
broadest coverage generally provides that a policyholder will receive
full replacement cost with no deduction for depreciation (up to the
policy limit) if a policyholder maintains coverage limits of 80 percent
or more of the dwelling's full replacement cost.[Footnote 50]
Otherwise, the homeowner receives a lesser amount according to the
formula in the policy (see sidebar).
The reasons that replacement costs may not be calculated accurately,
leaving homeowners underinsured, are complex. First, replacement costs
must be periodically updated to account for inflation. Second,
beginning in the early 1980s developers began building more custom
homes, and a significant percentage of homes were remodeled, sometimes
extensively. Historically, the methodologies that the insurance
industry used to calculate replacement costs did not always capture
custom features. The industry has improved its calculation
methodologies, but an insurance industry consultant told us that a
large number of policies had not been properly updated. Furthermore,
homeowners whose properties were remodeled may not have understood the
need to tell their insurers about the remodeling, possibly to avoid
rate increases. The problem of underinsurance can be exacerbated in the
wake of a natural catastrophe when demand for contractors and materials
to repair homes is high and the supply is tight. This phenomenon is
known as "demand surge." In these circumstances, the short-term costs
of repairing and rebuilding homes can escalate substantially, and
replacement costs become significantly higher. In addition, over time a
community may implement improved building codes, so that rebuilding may
have to conform to stricter standards than those that were in place
when a dwelling was first built.[Footnote 51] This situation can also
make replacement costs much higher, as it did in Florida in the
aftermath of Hurricane Andrew in 1992.
Large Amounts of Federal Postdisaster Aid Have Been Distributed to
Uninsured and Underinsured Homeowners:
As of May 2007, Congress approved approximately $88 billion in
emergency appropriations to assist in relief and recovery efforts in
the Gulf Coast states following the 2005 hurricanes.[Footnote 52] Three
federal agencies--FEMA, SBA, and HUD--received over $60 billion, or
about two-thirds, of this amount. As we have previously noted, these
agencies play a significant role in distributing federal disaster
relief funds to individual victims. We estimate that, as of June 2007,
the agencies had obligated approximately $26 billion, or between a
quarter and a third, of the emergency appropriations to homeowners and
renters in Alabama, Florida, Louisiana, Mississippi, and Texas who
lacked adequate insurance (see fig. 3).
Figure 3: Estimated Federal Disaster Assistance Obligated for
Homeowners and Renters Lacking Adequate Insurance in Five Gulf Coast
States after the 2005 Hurricane Season:
[See PDF for image]
The following data is depicted in table format:
Hurricane-related emergency supplemental funding, in billions:
Total: 87.755;
Total congressional funds to assist Gulf Coast States: 100%.
FEMA IHP: 42.576;
SBA DLP: 0.988;
HUD CDBG: 17.099;
Portion of congressional funds to FEMA, SBA, and HUD: 69%;
Estimated amount obligated by FEMA, SBA, and HUD to homeowners and
renters lacking adequate insurance:
FEMA IHP: 15.115;
SBA DLP: 0.794;
HUD CDBG: 9.904;
Portion of congressional funds used for homeowners and renters who did
not have adequate insurance: 29%.
Source: GAO analysis of FEMA, HUD, and SBA documents and interviews.
Note: These five Gulf Coast states are Alabama, Florida, Louisiana,
Mississippi, and Texas. The 2005 hurricane season included Hurricanes
Katrina, Rita, and Wilma. The SBA-obligated amount represents the
subsidy cost of disaster loans at 14.64 percent, as of January 31,
2007. The FEMA-obligated amount includes HA, ONA, and manufactured
housing funds as of June 18, 2007. The HUD-obligated amounts are as of
May 16, 2007. The totals for each agency were calculated using
different methodologies and data sources. For details, see appendix I
of this report.
[End of figure]
Federal disaster assistance for homeowners and renters comes from FEMA,
SBA, and HUD. For example:
* For disasters declared between October 1, 2004, and October 1, 2005,
FEMA could provide a maximum of $26,200 for housing and other needs
assistance to an individual or household in a disaster area if property
was damaged or destroyed and the losses were not covered by
insurance.[Footnote 53] In total, FEMA obligated over $15 billion to
homeowners and renters through IHP grants and manufactured housing. We
have reported extensively on the difficulties that FEMA experienced in
distributing disaster assistance through IHP.[Footnote 54]
* Homeowners and renters can borrow up to $40,000 in personal property
loans from SBA to repair or replace clothing, furniture, cars, and
appliances damaged or destroyed in a disaster. SBA can also make real
property loans up to a maximum of $200,000 to repair or restore a main
residence to its predisaster condition. Any proceeds from insurance
coverage on the personal property or home are deducted from the total
loan amount. The interest rates on SBA disaster loans do not exceed 4
percent for those who are unable to obtain credit elsewhere or 8
percent for those who can get other credit. As of January 31, 2007, SBA
approved over $5 billion in disaster loans for homeowners and renters
after the 2005 hurricanes, at an interest subsidy cost of almost $800
million to the federal government. We have reported on the difficulties
that SBA experienced in distributing disaster loans.[Footnote 55]
* The largest recovery program for homeowners and renters after the
2005 hurricanes was HUD's CDBG program, which received $16.7 billion in
supplemental appropriations to help homeowners with long-term recovery
(including providing funds for uninsured damages), restore
infrastructure, and fund mitigation activities in the declared disaster
areas of Alabama, Florida, Louisiana, Mississippi, and Texas.[Footnote
56] To receive CDBG funds, HUD required that each state submit an
action plan describing how the funds would be used, but the agency
waived some program requirements for disaster recovery purposes. For
example, HUD granted a waiver to Mississippi so that a portion of the
CDBG funds could be used to pay reinsurance costs for 2 years for wind
pool insurance maintained by the Mississippi Windpool. Two of the
states receiving the largest allocation from the emergency CDBG
appropriations were Louisiana and Mississippi, both of which opted to
direct the vast majority of their housing allocations to homeowners.
Both states based the amount of compensation that homeowners received
on the value of their homes before the storms and the amount of damage
that was not covered by insurance or other forms of
assistance.[Footnote 57] The grants provided up to $150,000 for
eligible homeowners.[Footnote 58] Both programs also attached various
conditions to the acceptance of grants, such as requiring homeowners to
rebuild their homes above the latest available FEMA advisory base flood
elevation levels and establishing covenants to the land requiring that
homeowners maintain hazard and flood insurance.
It will be a challenge for federal, state, and local governments to
sustain their current role in natural catastrophe insurance going
forward. The Comptroller General of the Unites States has repeatedly
warned that the current fiscal path of the federal government is
"imprudent and unsustainable."[Footnote 59] In addition, we reported
that, for state and local government sectors, large and growing fiscal
challenges will begin to emerge within the next few years in the
absence of policy changes.[Footnote 60] The fiscal challenges facing
all levels of government are linked and should be considered in a
strategic and integrated manner.
Options for Changing the Federal Role in Natural Catastrophe Insurance
Attempt to Address Market Issues but May Not Limit Federal Exposure:
We identified seven public policy options for changing the role of the
federal government in natural catastrophe insurance (see fig. 4). These
policy options have many variants and are often contained in other
proposals, including some bills that are before Congress.[Footnote 61]
Some of these proposals are also being debated in venues such as the
NAIC committees. We examined the advantages and disadvantages of these
policy options and evaluated them against four broad public policy
goals. These goals are:
* charging premium rates that fully reflect actual risks,
* encouraging private markets to provide natural catastrophe insurance,
* encouraging broad participation in natural catastrophe insurance
programs, and:
* limiting costs to taxpayers before and after a disaster.
Our analysis showed that each of the seven options met at least one of
the policy goals but failed to meet others. The first option--a
mandatory all-perils homeowners insurance policy--would help create
broad participation and could provide a private sector solution. But
this option could also require subsidies for low-income residents and
thus potentially create substantial costs for the federal government
that would have to be balanced against money saved from reduced
disaster relief. A second option would involve providing federal
reinsurance for state catastrophe funds--a change that could lead to
greater private insurance market participation but that could also
displace the private reinsurance market. A third option, establishing a
federal lending facility for state catastrophe funds, could help such
funds with financing needs after a catastrophe. But this option exposes
the federal government to the risk that a state fund might not repay a
loan and thus might not limit taxpayer exposure. The remaining four
options include tax-based incentives to encourage greater participation
by insurers and homeowners in managing natural catastrophe risks. These
incentives offer some advantages, but could also represent ongoing
costs to the federal government and taxpayers.
Figure 4: Advantages and Disadvantages of Seven Public Policy Options
for Changing the Federal Role in Natural Catastrophe Insurance:
[See PDF for image]
Option 1: All-Perils Homeowners Insurance Policy:
This option would create a homeowner insurance policy that would
provide coverage against all types of natural catastrophes.
Advantages:
* A mandatory all-perils policy would encourage broad participation in
natural catastrophe insurance programs.
* A mandatory all-perils policy could reduce the number of Americans
needing postdisaster payments and possibly limit the federal
government‘s exposure.
* A mandatory all-perils policy could eliminate the problems of
uninsured property owners and adverse selection.
* A mandatory all-perils policy would end homeowners‘ uncertainty about
coverage for some perils.
Disadvantages:
* It is not clear how the private market would be encouraged to
underwrite all risks.
* The all-perils option could require government subsidies for low-
income property owners.
* Premiums for an all-perils policy could be more expensive than
current homeowner policy premiums, and these premium increases could be
seen as unfair.
* Enforcement of an all-perils policy could be extremely challenging.
* Insurers traditionally oppose the all-perils option because of
concern about large loss liabilities.
Option 2: Federal Reinsurance for State Catastrophe Funds:
This option would create federally backed reinsurance policies for
state catastrophe funds. In one version of this option, states would
create catastrophe funds that would be reinsured by the federal
government. In another version, the Secretary of the Treasury would
create an auction process for the sale of reinsurance contracts to
private and state insurers and reinsurers.
Advantages:
* The federal reinsurance option could lead to greater participation
from private insurers.
* The federal reinsurance option would eliminate timing risk for
insurance companies.
* Insurance companies may be less interested in canceling policies in
coastal regions if they have a stable source of reinsurance, their
costs are reduced, and their liability is limited.
* This option would not use tax dollars if the premium charged was risk-
based.
* The federal reinsurance option is preferable to federal disaster
assistance.
* This option would add stability to reinsurance rates.
Disadvantages:
* Federal reinsurance could compete with the private reinsurance sector.
* Rates for federal reinsurance could be subject to consumer and hence
political pressure to keep them below the private sector rates.
* Federal taxpayer subsidies could favor those living in catastrophe-
prone states.
* Federal reinsurance could create inequities among states because of
geographical differences in natural catastrophe risk.
* Federal reinsurance could encourage further development and
population growth in high-risk areas.
* Government reinsurance that does not mimic what the private sector
does could lead to government losses.
Option 3: Federal Lending to State Catastrophe Funds:
This option would create a federal lending facility to provide
temporary loans at market prices to state catastrophe funds.
Advantages:
* This option could help state catastrophe insurance funds with
financing needs after a disaster.
* The federal lending option would eliminate timing risk for insurance
companies.
* Supporters of this option maintain that taxpayers would bear little
or no insurance risk.
* The federal lending option would require states to demonstrate that
they were doing all they could to attract private capital, and this
could lead to regulatory reform.
Disadvantages:
* It is not clear how this option would encourage risk-based premiums,
would broaden citizen participation, or would be a cost-effective
solution from the perspective of the federal government.
* The federal lending option imposes credit risk on taxpayers”the risk
that the loan would not be repaid.
* The federal lending option could require the creation of a new
federal agency to manage the program.
* Political pressure could be exerted to keep the terms and conditions
of federal loans more favorable than those in the private market.
* This option would decrease incentives for insurers and reinsurers to
accurately assess, underwrite, and price risk.
Option 4: Insurance Company Catastrophe Reserving:
This option would permit private insurance companies to establish tax-
deferred reserves for future natural catastrophes.
Advantages:
* Tax-deferred reserving could mean that state regulators would be more
willing to approve risk-based rates.
* With reserves, insurance companies could be more willing to
underwrite policies, thus encouraging a private sector solution.
* This option would encourage broader-based citizen participation in
catastrophe insurance programs.
* Insurance regulators could be more willing to approve risk-based
rates for consumers, because premium income could be set aside in a
reserve fund.
* Allowing insurance companies to build reserves could reduce pressure
to create state catastrophe insurance programs.
Disadvantages:
* Allowing insurance companies to build reserves could involve tax
benefits that favored one type of activity over another and could
hamper economic efficiency.
* Reserves could be costly for the federal government, because they
would reduce federal tax revenue.
* Tax-deferred reserves could be subject to manipulation, if they were
used to smooth income flows across years and obscure current income.
Option 5: Homeowner Catastrophe Savings Accounts:
This option would permit individuals to establish tax-deferred reserves
to pay expenses related to disasters.
Advantages:
* Allowing homeowners to use tax-deferred dollars to pay for
catastrophe insurance could induce more people to buy it.
* This option might encourage more homeowner mitigation activities.
Disadvantages:
* Such accounts may not be enough to induce people to buy costly
catastrophe insurance and, thus, may not broaden citizen participation
in natural catastrophe insurance programs.
* These accounts would reduce federal tax revenues but must be weighed
against any reduction of postdisaster spending by the federal
government.
Option 6: Favorable Tax Treatment for Catastrophe Bonds:
This option would facilitate the onshore creation of catastrophe bonds
through tax exemptions for income from the underlying assets.
Advantages:
* Favorable tax treatment of catastrophe bonds would increase the
ability of insurance markets to access capital markets.
* Insurance companies could be more willing to underwrite catastrophe
risk because the risk could be passed on to investors.
Disadvantages:
* This option creates a new class of reinsurer that would operate under
regulatory and tax advantages not afforded U.S. reinsurance companies.
* It is not clear how this option is the most cost-effective for the
federal government.
* It is not clear how this option would encourage risk-based premiums
or lead to more citizen participation in catastrophe insurance programs.
* This option would only benefit larger insurers.
* Given that catastrophe bonds were just issued by the two largest U.S.
insurance companies, it is not clear why this tax treatment is needed.
Option 7: Property Tax Assessment for Private Insurance with Federal
Deductible Payment;
This option has property tax assessments paying a premium for an all-
perils catastrophe insurance policy that would be provided by private
insurance companies, with the federal government responsible for the
deductible.
Advantages:
* This option is market-based and designed to involve the private
sector.
• If risk-based premiums are required, the option is not a ’government
relief program.“
* This option would protect the tax base of a state‘s economy.
* The property tax assessment option would increase homeowner
participation in catastrophe insurance programs.
* With this option, the high deductible could result in a lower
insurance premium.
Disadvantages:
* The property tax assessment option would reduce federal tax revenue.
* This option could be expensive for taxpayers because the federal
government would pay some portion of the homeowner deductible.
* It is not clear whether or not this option is a cost-effective
solution for the federal government.
* Premiums paid by homeowners might not be an effective signal of the
risk of living in a particular location.
* Homeowners could resist high property taxes implied by this option.
Source: GAO.
[End of figure]
An All-Perils Policy Would Broaden Participation but Could Require
Government Subsidies:
A mandatory all-perils policy would require private insurers to provide
coverage against all perils in a single standard homeowners policy that
would be priced according to the risk of natural hazards each homeowner
faced.[Footnote 62] For example, the policy would cover not only theft
and fire but also wind, floods, and earthquakes. It would also be
mandatory for all homeowners.[Footnote 63]
This type of option offers several potential advantages. First, a
mandatory all-perils policy, by definition, would encourage broad
participation in natural catastrophe insurance programs. Moreover,
including all American homeowners in natural catastrophe coverage could
help reduce the number of Americans needing postdisaster payments and
possibly limit the federal government's exposure. An all-perils policy
would also eliminate existing gaps in coverage and remove the
uncertainty many homeowners face in determining whether certain perils
are covered and by whom--an issue that was spotlighted after Hurricane
Katrina, when disputes emerged between private insurers and homeowners
over the extent of the insurers' obligations to cover certain damages.
Finally, because it would be mandatory and broad-based, an all-perils
policy could lessen the problem of adverse selection that is often
identified as the reason that some types of catastrophes, such as
flooding, are considered to be uninsurable. This type of policy would
spread risks geographically and potentially would make the policy more
affordable than other options.
However, this option is not without its disadvantages. First, it is
unclear how private markets would be encouraged to underwrite all
risks. Second, a mandatory all-perils policy might not be a cost-
effective solution for the federal government, because it could create
affordability concerns for low-income residents in certain areas and
might require targeted government subsidies.[Footnote 64] If they did
not sufficiently reduce postevent disaster relief, these subsidies
could increase costs to taxpayers. Third, an all-perils policy would
undoubtedly be more expensive than current homeowner policy premiums in
some regions of the country. As a result, at least during the
transition, it could lead to complaints about higher premium costs from
residents of catastrophe-prone areas. Moreover, homeowners in
relatively low-risk areas could wind up subsidizing the costs of
insurance for those living in high-risk areas. Fourth, enforcement
would be extremely challenging, as we have seen with mandatory flood
insurance in communities in designated floodplains. Finally, this
policy option faces opposition from the private insurance industry, in
part because of concerns about state insurance regulators impeding
private insurers' ability to charge premiums that reflect the actual
risk of loss in catastrophe-prone areas. Private insurers have also
traditionally opposed all-perils policies because of the difficulty of
pricing flood and earthquake coverage. One insurance company has said
that an all-perils policy would cause rates to skyrocket and could
cause many insurers to abandon the homeowners insurance market. NAIC
officials told us that the homeowners market was a $55 billion market-
-not counting flood and earthquake exposure--and that most insurers
were unlikely to walk away from a market this large.
Federal Reinsurance Could Eliminate Timing Risk for Insurance Companies
but Could Displace the Private Market:
A federal reinsurance mechanism would provide an additional layer of
insurance coverage for very large catastrophes, or megacatastrophes,
and could be implemented in two ways.[Footnote 65] The first version of
this option would create a federal mechanism that would serve as a
backstop for state catastrophe funds to increase the amount of
insurance and reinsurance available to states, expand the availability
of catastrophe coverage, and possibly improve its affordability.
[Footnote 66] States would create catastrophe funds and enter into
agreements with the federal government--possibly, but not necessarily,
the U.S. Treasury--and pay premiums for the reinsurance that would be
used to support the reinsurance fund. Each state's payments would be
based on risk and determined using actuarial and catastrophe modeling,
and the states would be responsible for collecting premiums from
insured commercial and residential property owners. The federal fund
would provide payments to state funds for storms of a certain magnitude
up to some predetermined level of payments. If the federal reinsurance
fund was not adequately financed at the time of a catastrophe, it would
issue government-backed bonds.
A related but different version of this federal reinsurance option
would authorize the Secretary of the Treasury to create an auction
process for the sale of reinsurance contracts to private and state
insurers and reinsurers.[Footnote 67] The secretary would make
available reinsurance contracts covering both earthquakes and wind
events. The auction process would be open to state and private insurers
and reinsurers and would take place in at least six separate geographic
regions, so that risks would be based on local factors and insurers in
less risk-prone areas would not be subsidizing those in riskier areas.
State programs would have to reach a minimum loss level before they
would be eligible for federal funds. This version also establishes a
disaster reinsurance fund within the U.S. Treasury to be credited with,
among other sources of funds, amounts received from the sale of
reinsurance contracts. The Treasury would be authorized to issue debt
if the fund's resources were insufficient to pay claims--and
reinsurance premiums paid to Treasury would be used to make interest
payments to debt holders--but the fund would not receive federal
appropriations. A national commission on catastrophe risks and
insurance loss costs would advise the secretary.
Both versions of this option offer advantages and disadvantages. First,
federal reinsurance is advantageous because it has the potential to
help insurance companies by limiting timing risk--the possibility that
events will occur before insurers have collected enough premiums to
cover them--potentially making insurers more willing to underwrite
natural catastrophe insurance policies.[Footnote 68] Second, primary
insurance companies may be less interested in canceling catastrophe
insurance policies in coastal regions after a disaster if stable
sources of reinsurance are available from state catastrophe funds. This
option could also encourage the provision of catastrophe insurance via
private insurance markets by limiting private insurers' liability for
very large events and thus increasing their willingness to offer
insurance for less catastrophic events. And a greater supply of natural
catastrophe insurance could reduce the cost of insurance as competition
for business intensified. Third, this option may also be advantageous
because, if it were appropriately structured--that is, if program
losses were funded by upfront premium payments--federal reinsurance
should not require the use of taxpayer dollars. Finally, to the extent
that this option increased the availability and affordability of
catastrophe insurance, it would be preferable to postdisaster
assistance and could limit the need for some types of postevent
government payouts.
While federal reinsurance has some appealing options, it is not without
disadvantages. For example, neither version of the reinsurance option
is intended to displace or compete with the private reinsurance market,
because reinsurance contracts would not be sponsored in markets where
private reinsurance markets offered coverage. However, federal
reinsurance could compete with and possibly displace private
reinsurance if the government offered coverage at levels that were well
within private market capacity or set premium rates below what the
private sector would charge for comparable risk. While the stated
intent of this option is to charge a premium that fully reflects the
risk assumed by the federal reinsurance fund, political and consumer
pressures could be put on the federal fund to underprice premiums in
terms of risk to keep premiums low for policyholders in high-risk
areas. Charging a reinsurance premium that was not fully risk-based
would expose the federal fund and the government to potentially
significant unfunded contingent insurance risk. As a result, federal
reinsurance could disproportionately benefit those living in high-risk
areas. Should the fund experience losses that exceeded the premiums
collected, the difference would have to be paid by the taxpayers,
creating a cross-subsidy that favored those in catastrophe-prone areas.
Also, the existence of federal reinsurance might affect market
discipline, leading private insurers and state catastrophe insurance
funds to loosen underwriting guidelines--that is, to insure properties
that would not have been insurable without the availability of (low-
cost) federal reinsurance. Such a change could be costly for the
reinsuring federal facility. As a result, a federal reinsurance role
could inadvertently encourage further development and population growth
in areas with high natural catastrophe risk. Finally, government
natural catastrophe insurance programs are not purely insurance
programs and may have social goals. But if the government plans to
intervene in the catastrophe insurance market, it may want to use
mechanisms that mimic as closely as possible what operating private
markets could have been expected to do. When federal insurance programs
mimic private insurance, and base decisions on risk (as consistent with
social goals), then government losses are more likely to be contained.
A Federal Lending Facility Would Eliminate Timing Risk for State
Catastrophe Insurance Programs but Would Face the Risk That the Loan
Might Not Be Repaid:
A federal lending facility would allow the federal government to use
its borrowing power to extend temporary loans to state catastrophe
funds. State catastrophe funds may not have the creditworthiness to
borrow at acceptable interest rates. One proponent of this plan has
suggested that the private insurance market could handle all or nearly
all catastrophe exposure, but possibly not at the moment the
catastrophe happened. Creating a lending facility in the federal
government would allow the government to provide the capital to meet
the temporary shortage and spread the repayment over time without
assuming the underwriting risk held by the insurers. Under this option,
state catastrophe funds would be required to secure private reinsurance
and would have the ability to sell catastrophe bonds to repay the money
loaned to them by the federal government. The loans would be made at
market prices to guarantee that capital was efficiently allocated and-
-given that an insurance company that has just paid out a large claim
does not have the same quantity or quality of assets as a solvent
insurer or bank--would be secured both by the future income stream of
premium payments from state residents through insurance companies to
the state catastrophe funds and by bond proceeds. The loans would be of
short duration, perhaps 2 to 3 years at maximum, and would provide
state catastrophe funds with encouragement and time to access the
private capital market. State catastrophe funds would be expected to
demonstrate to the federal lending facility that the states were doing
all that they could to attract private capital. A proposed trigger for
the federal lending facility would be a megacatastrophe.
The creation of a federal lending facility would have several
advantages. First, a federal lending facility would shift timing risk,
which is significant in the catastrophe insurance business, from the
insurance industry to the federal government. The federal government,
because of its borrowing power, is uniquely able to deal with timing
risk. Second, a federal lending facility could mean that taxpayers
would assume little or possibly no insurance risk, because the insurers
would be responsible for paying all of the losses from catastrophic
events, although not necessarily in the year of the catastrophe.
Finally, through the requirement that the states do all that they can
to attract private capital, the option may lead to insurance regulatory
reforms in areas such as rate regulation that have inhibited the influx
of private capital.
A federal lending facility would also have a number of disadvantages.
First, it is not clear how this federal lending facility would
encourage premiums that reflected risks, would foster broad citizen
participation, or would be a cost-effective solution. Second, it would
expose the facility and ultimately taxpayers to credit risk if a state
did not repay its debt. Third, a federal lending facility could also
require the creation of a new federal entity or structure to administer
the system. Fourth, like the federal reinsurance option, such a lending
facility could have a competitive advantage over the private
reinsurance sector, particularly if the terms were too easy or if
borrowed funds did not have to be repaid. States in high-risk regions
would have a financial incentive to seek nonmarket terms and conditions
in loans. Finally, this option would decrease the incentives for
insurers and reinsurers to accurately assess, underwrite, and price
risk.
Tax-Deferred Reserves for Insurance Companies Could Encourage Greater
Private Sector Coverage but Could Be Costly for the Federal Government
and Have Other Disadvantages:
A fourth policy option would be to permit private insurers to establish
tax-deferred reserves for future catastrophes.[Footnote 69] This option
could encourage some insurers to maintain or expand their catastrophe
insurance coverage in regions with significant or projected catastrophe
exposures. This option is also intended to provide insurers with an
incentive to write catastrophe coverage in hazard-prone areas while
improving their own financial strength. It would require amending the
U.S. Tax Code, because current tax laws and accounting principles
discourage U.S. property and casualty insurers from accumulating long-
term assets specifically for payment of future losses by taxing these
assets.[Footnote 70] Because the size and timing of disasters that have
not taken place is uncertain, assets set aside for catastrophe losses,
together with any interest accrued, are taxed as corporate income in
the year in which they are set aside. Although there is a federal
income tax deduction for losses that have already occurred, reserves
for uncertain future losses are not tax deductible.
Tax-deferred reserving has its advantages. Tax-deferred reserving could
mean that state regulators would be more willing to approve risk-based
rates, because premiums could now be set aside rather than flow into
profits. Consistent with the intended purpose of this option, tax-
deferred reserving could increase the willingness of insurance
companies to increase capacity without risking insolvency, because the
companies would be less dependent on the uncertain prices available in
reinsurance markets. In this case, the option would encourage a
solution by private insurance markets and more broad-based
participation in catastrophe insurance programs. Finally, this approach
could reduce the need for state catastrophe insurance mechanisms by
increasing the willingness of private insurers to remain or enter
certain catastrophe-prone markets, such as Florida and other Gulf Coast
states.
However, tax-deferred reserving also raises a number of broader issues
that must be considered. Tax-deferred reserving would reduce current
federal tax revenue. However, as with other options, the net cost would
have to be determined by weighing the tax cost against potential
savings from federal postdisaster assistance programs. Deferring taxes
on reserves for insurance companies could also be disadvantageous if
this system created tax benefits that favored one type of activity over
another. For example, to the extent that tax-deferred reserving became
prevalent, it could displace the reinsurance market or other forms of
hedging. Finally, such reserves could also be subject to manipulation
or abuse if insurers used them to obscure current income by smoothing
income flows across years.
Homeowner Catastrophe Savings Accounts Could Broaden Participation in
Catastrophe Insurance Programs but Could Reduce Federal Tax Revenue:
Like tax-deferred reserves, the fifth policy option would also require
amending the U.S. Tax Code to provide a tax incentive, but this one
would be aimed at homeowners, who would be allowed to accumulate before-
tax funds to pay expenses related to disasters. The accounts would
operate much like those currently in use for health care expenses,
allowing homeowners to withdraw both savings and interest for qualified
disaster expenses such as deductibles, uninsured losses, flood damage,
and structural upgrades to mitigate damage from future storms. A bank
or another designated organization would be the custodian for these
accounts. Under one current option, homeowner contributions would be
limited to (1) $2,000 for individuals with homeowners insurance and
deductibles of not more than $1,000, and (2) the lesser of $15,000 or
twice the insurance deductible for homeowner insurance deductibles of
more than $1,000. In June 2007, the South Carolina Legislature passed
legislation authorizing the creation of catastrophe savings accounts
for use by state residents in paying natural catastrophe insurance
deductibles.[Footnote 71]
This option could induce more homeowners to participate in natural
catastrophe insurance programs. Moreover, allowing homeowners to use
tax-deferred savings to cover mitigation expenses might encourage more
mitigation activities to reduce natural catastrophe risk. However,
implementation challenges pose disadvantages that would have to be
addressed. For example, it is unclear to what extent such a mechanism
would encourage those who are not insured to purchase insurance. Rather
than increasing participation, it could result in a tax benefit for
those who are already insured. Like the tax-free reserves option, these
savings accounts would also cost the federal government in reduced tax
revenues. But once again, the actual net cost to the government would
depend on the potential offsetting savings from postcatastrophe funding
mechanisms.
Favorable Tax Treatment for Catastrophe Bonds Could Increase Insurers'
Access to Capital Markets, but Some Question the Need for Such Tax
Treatment:
The sixth policy option would create certain tax advantages for
catastrophe bonds.[Footnote 72] Historically, catastrophe bonds have
been created in offshore jurisdictions where they are not subject to
any income or any other tax (i.e., in tax havens). This option would
facilitate the creation of onshore transactions, potentially reducing
transactions costs and allowing for increased regulatory oversight. Tax
treatment of catastrophe bonds would be similar to the treatment
received by issuers of asset-backed or mortgage-backed securities that,
for example, are generally not subject to tax on the income from
underlying assets, which is passed on to investors.[Footnote 73] More
favorable tax treatment of catastrophe bonds would increase the ability
of insurance markets to access capital markets by making these products
more attractive to investors. Making catastrophe bonds more attractive
to issuers and investors could, in turn, make insurance and reinsurance
companies more willing to underwrite catastrophe risk and increase the
availability of coverage, because these companies could pass on more
catastrophe risk to investors.
One disadvantage of this option is that it is not clear how its
implementation would encourage premiums that fully reflect risk or how
it would encourage broad-based participation in catastrophe insurance
markets. It is also not clear how this option would be a cost-effective
solution for the federal government when both predisaster and
postdisaster costs are counted. Some reinsurers have pointed out that
favorable tax treatment of catastrophe bonds could be disadvantageous
because it could create a new class of reinsurer that would operate
under regulatory and tax advantages not afforded U.S. reinsurance
companies. Finally, recent catastrophe bond issuances by the two
largest U.S. primary insurance companies may indicate that catastrophe
bonds do not need a different tax treatment to make them economically
viable.[Footnote 74] However, if market transparency and the
development of uniform terms and conditions do not take place, only the
largest insurers may be able to take advantage of catastrophe bonds.
Property-Tax Assessment for Federal Reinsurance May Broaden
Participation but May Be Costly for the Federal Government:
The final policy option we examined was a state plan, funded by state
property taxes, that would require mandatory all-perils natural
catastrophe insurance coverage on residential property. All primary
residential properties in a state would be required to have catastrophe
insurance coverage. Participating insurers would assume the primary
risk on the property and would have reinsurance from a qualifying
reinsurance company. The state would pay an annual natural catastrophe
insurance premium financed by an annual property tax assessment on all
residential and commercial properties in the state, and homeowners
could deduct the cost from their federal taxes.[Footnote 75] The
insurance coverage would be provided by private insurance companies
selected by a government administrator who would qualify them as
providers of catastrophe insurance. To ensure that premiums were
reasonable, the primary and reinsurance coverage would require large
deductibles that would be paid in layers by the homeowner, the state,
and the federal government. Homeowners would be responsible for the
first 10 percent of the value of the home, with a state catastrophe
fund paying the next layer of the deductible. The state would provide a
fixed-dollar deductible--for example, $100 million--for all homeowners,
with the federal government as the backstop provider, paying a
deductible that was a multiple of the amount that the state put up.
Proponents of this plan point out that it is market-based, designed to
involve the private sector, and if risk-based premiums are required is
not a "government relief program." Plan supporters also point out that
the option protects the tax base of a state's economy as well as the
creditworthiness of a state's bond rating. One possible advantage of
this policy option for the consumer is that the premiums paid from
property taxes are intended to be tax deductible.[Footnote 76]
Moreover, paying the premium from property taxes could increase
participation at the state level and create a broad-based program that
would limit adverse selection and moral hazard. Finally, maintaining
higher deductibles could result in lower insurance premiums.
However, this plan also has its disadvantages. Paying the premium from
homeowner property taxes collected by the state would reduce federal
tax revenues, and, if a disaster occurred, the federal government would
have to pay some portion of the deductible. Like the other tax-related
options, this option could reduce federal tax revenue if the new
deduction were not offset by savings from the elimination of preevent
premium subsidies or postevent disaster relief. As a result, it is not
clear whether this option may or may not be the most cost-effective for
the federal government. Also, using property taxes to pay insurance
premiums might diminish the effectiveness of using the price of
insurance as a signal of the risk of living in a particular location.
One critic has argued that allowing homeowners to deduct the premium
portion of the property taxes combined with the federal deductible
could result in a double federal subsidy. Finally, this policy option
would raise homeowners property taxes, potentially creating homeowner
resistance to the assessment.
Agency Comments and Our Evaluation:
We provided a draft of this report to NAIC for comment and provided
excerpts from the draft to Alabama Beach Pool, the CEA, FCIC, FHCF,
Florida Citizens, FHCF, the GUA, HUD, Louisiana Citizens, Mississippi
Windpool, the North Carolina Beach Plan, SBA, the South Carolina
Windpool, and the Texas Windpool. NAIC provided written comments that
are reprinted in appendix III. In these comments, NAIC officials said
that our draft report was thorough, and that they were pleased that we
outlined the advantages and disadvantages of several proposals rather
than favoring a single outcome. NAIC officials suggested that we also
include in this report two recently proposed options, including one
that includes an allocation system for determining what portion of
hurricane damages should be attributed to wind and what portion to
flooding and the creation of a federal entity to oversee property
insurance rates in the coastal zone. While there are interesting
features to both options, they were too recent to be included in our
review and analysis. However, we will explore both options during the
course of our ongoing work involving NFIP.
NAIC officials also commented on the language in the draft report
discussing allegations made by some critics of state rate regulation
who suggest that state regulators may be suppressing rates for some
catastrophe insurers. As these officials pointed out, the allegations
in this report are attributed to others and are not presented as our
position. We recognize the challenges involved in ensuring that
consumers are charged appropriate premiums that reflect their risk of
exposure to natural catastrophes. Given that premium rates requested
are based on a variety of factors that involve a certain amount of
judgment--including anticipated losses on claims and related expenses;
the need to build a surplus; and other factors, including profit--the
rate-setting process is open to interpretation and some amount of
negotiation. That is, reasonable but different assumptions about the
probability of future losses can result in substantial disagreements
about rates. However, if state regulators and the insurance markets
consistently have divergent opinions about the cost of the risk
exposures, the implications can be far-reaching. As we discuss in this
report, for state natural catastrophe insurance programs, if premium
rates determined by state insurance regulators consistently result in
financial resources that are inadequate to pay policyholder claims
after a disaster, postfunding mechanisms must be used to pay
shortfalls. Postfunding can result in costs to the private insurance
market and may mean that taxpayers in low-risk areas are subsidizing
the costs of those living in high-risk areas. Similarly, a pattern of
regulator-approved rates for private insurance companies that are
consistently below what the market believes to be the true risk rate
may result in the withdrawal of healthy, diversified insurance
companies from the market. However, if premium rates are set at a level
reflecting the market's perception of the true risk rate, more
competitors are likely to enter.
Alabama Beach Pool, the CEA, FCIC, FEMA, Florida Citizens, FHCF, the
GUA, Louisiana Citizens, Mississippi Windpool, the North Carolina Beach
Plan, SBA, the South Carolina Windpool, and the Texas Windpool provided
technical comments that we incorporated in this report as appropriate.
As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of the report until 30 days
from the date of this letter. At that time, we will provide copies to
interested congressional committees; the Chairman and Ranking Member of
the Senate Committee on Banking, Housing, and Urban Affairs; and the
Chairman of the House Committee on Financial Services. We will also
make copies available to others upon request. In addition, this report
will be available at no charge on the GAO Web site at [hyperlink,
http://www.gao.gov].
Please contact me at (202) 512-8678 or williamso@gao.gov if you or your
staff have any questions concerning this report. Contact points for our
Offices of Congressional Relations and Public Affairs may be found on
the last page of this report. Key contributors to this report are
listed in appendix IV.
Sincerely yours,
Signed by:
Orice M. Williams:
Director, Financial Markets and Community Investment:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
Our objectives in this report were to examine (1) the rationale and
funding of the federal and state programs that have supplemented, or
substituted for, private natural catastrophe insurance; (2) the extent
to which Americans living in areas of the United States that are at
high risk for natural catastrophes are uninsured and underinsured, and
the types and amounts of federal payments to such individuals since
Hurricanes Katrina, Rita, and Wilma; and (3) public policy options for
revising the federal role in natural catastrophe insurance markets.
We reviewed or analyzed documents on federal and state natural
catastrophe insurance programs, the numbers of uninsured and
underinsured and federal payments to them, options to redefine the
federal role in natural catastrophe insurance, and principles on which
change options can be based and evaluated. We interviewed officials
from public interest groups, insurance companies, reinsurance
companies, insurance brokers, insurance and reinsurance associations,
insurance agents and their associations, state catastrophe insurance
plans, state insurance departments, federal catastrophe insurance
agencies, the Department of Housing and Urban Development (HUD), the
Small Business Administration (SBA), Fannie Mae, Freddie Mac, rating
agencies, a risk modeling organization, academia, law firms, a hedge
fund, a private research organization, consumer groups, and others. To
determine the mechanisms governments use to supplement or substitute
for private catastrophe insurance markets, we collected oral and
documentary information from public and private officials in various
states with high and low catastrophe risk and in Washington, D.C. We
sourced financial data for government natural catastrophe insurance
programs from financial statements, bond offering documents, and other
similar financial documents.
To determine the number of uninsured and underinsured Americans and
payments made to such individuals after the 2005 hurricanes, we
collected information from states, examined federal agency data,
interviewed federal officials who prepared these data, sought
information from the private sector, and interviewed state officials
responsible for disbursing federal disaster funds. We focused our
analysis on the federal disaster assistance to homeowners and renters
who lacked adequate insurance in the five Gulf Coast states directly
impacted by Hurricanes Katrina, Rita, and Wilma. These five states are
Alabama, Florida, Louisiana, Mississippi, and Texas. Data on the
numbers and amounts of money disbursed to the uninsured and
underinsured were incomplete and had a number of limitations. For
instance, because we often could not separate payments to homeowners
versus payments to renters, we generally included the entire amount in
our analysis. Also, we generally excluded administrative and other
expenses that federal disaster assistance programs incur in
distributing assistance. Our analysis was limited to the major federal
disaster assistance programs that we identified as providing relief to
homeowners and renters. These programs are the Federal Emergency
Management Agency's (FEMA) Individuals and Households Program (IHP),
SBA's Disaster Loan Program (DLP), and HUD's Community Development
Block Grant (CDBG) program. Our identification of relevant federal
disaster assistance programs may be incomplete. Other federal agencies
are involved in federal disaster assistance according to the mission
assignment issued and approved by FEMA, as we reported separately in
Disaster Relief: Governmentwide Framework Needed to Collect and
Consolidate Information to Report on Billions in Federal Funding for
the 2005 Gulf Coast Hurricanes, GAO-06-834 (Washington, D.C.: Sept. 6,
2006).
To determine the amount of federal disaster assistance appropriated by
Congress to FEMA and the amount paid to homeowners and renters who
lacked adequate insurance through FEMA IHP, we obtained and analyzed
data provided by FEMA officials describing the funds obligated for the
subcategories of Housing Assistance, Other Needs Assistance, and
Manufactured Housing in Alabama, Florida, Louisiana, Mississippi, and
Texas following Hurricanes Katrina, Rita, and Wilma. In analyzing these
data, we had to make certain judgments in deciding which specific
subcategories of funds to include in our analysis. In particular, FEMA
noted that the Other Needs Assistance data contained funds for services
that would not be provided by personal property coverage in standard
private homeowners insurance, such as medical and funeral expenses.
However, we included Other Needs Assistance data in our analysis
because these are expenses that may have been covered by other types of
insurance, such as health and life, and, therefore, still provide a
reasonable approximation of insurance coverage. Also, FEMA officials
noted that the Manufactured Housing data included expenses that would
not be included in additional living expenses coverage provided by
standard private homeowners insurance. For example, other expenses
included unit purchase, haul/install, utilities, site lease,
maintenance, deactivation, and the transition out of service. We
included these data in our analysis because they are designed to serve
a similar purpose as the additional living expenses coverage provided
by insurance companies. We assessed the reliability of the data
provided by agency officials by interviewing agency officials
knowledgeable about the data systems; obtaining oral responses from the
agency; and reviewing agency reports regarding (1) the agency's methods
of data collection and quality control reviews, (2) practices and
controls over data entry accuracy, and (3) any limitations of the data.
It is possible that FEMA's data analysis methodology is different from
that employed by the other agencies we reviewed. Nevertheless, we
determined that these data were sufficiently reliable for the purposes
of our engagement. Finally, we interviewed officials from FEMA Disaster
Assistance Directorate, which administers IHP, and reviewed the
document entitled Oversight of Gulf Coast Hurricane Recovery, A
Semiannual Report to Congress, October 1, 2006-March 31, 2007, by the
President's Council on Integrity and Efficiency and the Executive
Council on Integrity and Efficiency.
To determine the amount of federal disaster assistance appropriated by
Congress to SBA and the amount paid to homeowners and renters who
lacked adequate insurance through SBA DLP, we reviewed the previously
mentioned document entitled Oversight of Gulf Coast Hurricane Recovery,
and interviewed agency officials. We obtained and analyzed data
provided by SBA that included, among other things, the amount of loan
funds approved net of other federal disaster assistance and insurance
proceeds to loan recipients. We multiplied this total by the subsidy
rate of the loans--14.64 percent in 2006. That is, for every $100 that
SBA lends, the cost to the federal government is $14.64. The subsidy
rate is roughly the percentage of loan principal that is not repaid as
well as the difference between the market interest rate and the rate
charged by SBA. We believe that subsidy cost is the most accurate
representation of the amounts made available and paid to homeowners and
renters because the loans under DLP must be repaid by recipients at a
subsidized interest rate. We assessed the reliability of the data
provided by agency officials by interviewing agency officials
knowledgeable about the data systems and obtaining from the agency
written responses regarding (1) the agency's methods of data collection
and quality control reviews, (2) practices and controls over data entry
accuracy, and (3) any limitations of the data. It is possible that
SBA's data analysis methodology is inconsistent with that employed by
the other agencies we reviewed. Nevertheless, we determined that these
data were sufficiently reliable for the purposes of our engagement.
To determine the amount of federal disaster assistance appropriated and
paid to homeowners and renters who lacked adequate insurance through
the HUD CDBG program, we interviewed agency officials and reviewed the
previously mentioned document entitled Oversight of Gulf Coast
Hurricane Recovery. We obtained publicly available data from HUD and
each of the five Gulf Coast states that received emergency CDBG
appropriations. We reviewed GAO testimony on Gulf Coast rebuilding that
described the CDBG programs established in the Gulf Coast
states.[Footnote 77] Congress approved emergency appropriations for HUD
CDBG in two installments: $11.5 billion in December 2005 and $5.2
billion in June 2006, for a total appropriation of $16.7 billion. Our
goal was to determine what portion of the total appropriation was
intended for homeowners in the five Gulf States. We made certain
judgments in deciding whether particular subcategories of funds applied
to our calculations for each state. It is possible that we did not
identify all of the relevant funds.
For Florida, we used the Florida Department of Community Affairs, 2005
Disaster Recovery Initiative Action Plan (Apr. 14, 2006) and 2006
Disaster Program Action Plan (Dec. 19, 2006). HUD designated for
Florida $82.9 million of the original $11.5 billion included in the
December 2005 emergency appropriation. Florida's action plan calls for
the funds to be distributed through entitlement communities,
nonentitlement communities, and federally recognized Indian tribes.
Grant recipients are required to use at least 70 percent of the funds
for the provision of affordable housing. Therefore, approximately $58
million of the Florida CDBG grants will be allocated to the provision
of affordable housing. In addition, the June 2006 emergency
appropriation included $5.2 billion to the CDBG program, and, on August
18, 2006, HUD made $100,066,518 available to Florida for repair,
rehabilitation, and reconstruction of affordable rental housing, and
for the unmet needs of evacuees who were forced from their homes and
are now living in other states. The entire amount has been made
available for mitigation programs through the My Safe Florida Home
Program and other programs.
For Alabama, we interviewed officials from the Alabama Department of
Economic and Community Affairs (DECA). We obtained and analyzed
information from DECA officials regarding the plan for distribution of
HUD CDBG disaster recovery funds. We learned that DECA determined to
make $14,460,588 available for unmet housing needs. In addition, on
August 18, 2006, HUD made $21,225,574 available to Alabama for repair,
rehabilitation, and reconstruction of affordable rental housing, and
for the unmet needs of evacuees who were forced from their homes and
are now living in other states. Of this amount, $16,964,296 has been
made available for Disaster Relief, Recovery and Restoration of Housing
and Infrastructure, and Affordable Rental Housing.
For Mississippi, we used the Mississippi Development Authority,
Homeowner Assistance Program Partial Action Plan (Mar. 31, 2006).
Mississippi's partial action plan made $3 billion available for the
Homeowner Grant Assistance Program, which is for people who owned homes
located outside of the federally designated flood zone, yet still
suffered structural flood damage caused by Hurricane Katrina. In
addition, on August 18, 2006, HUD made $423,036,059 available to
Mississippi for repair, rehabilitation, and reconstruction of
affordable rental housing, and for the unmet needs of evacuees who were
forced from their homes and are now living in other states.
For Louisiana, we obtained the Louisiana Recovery Authority, The Road
Home Housing Programs, Action Plan for the Use of Disaster Recovery
Funds (May 11, 2006) and the Louisiana Recovery Authority, Proposed
Action Plan for the Use of Disaster Recovery Funds Allocated by P.L.
109-234 (May 16, 2007). Louisiana made $3,551,600,000 available to the
Road Home Program, which is intended to help owner-occupants repair or
rebuild their homes, buy or build replacement homes, or sell unwanted
properties so that they can be redeveloped or converted to open space.
In addition, on July 11, 2006, HUD allocated $4.2 billion to Louisiana
for the Road Home Program. Louisiana designated $2,496,150,000 of this
funding as assistance to owner-occupants to compensate them for their
hurricane loss.
For Texas, we used the State of Texas Action Plan for CDBG Disaster
Recovery Grantees under the Department of Defense Appropriations Act,
2006 (Apr. 13, 2006, and May 9, 2006) and the Proposed Partial Texas
Action Plan for Disaster Recovery to Use Community Development Block
Grant (CDBG) Funding to Assist with the Recovery of Distressed Areas
Related to the Consequences of Hurricanes Katrina, Rita, and Wilma in
the Gulf of Mexico in 2005 (Dec. 15, 2006). Texas' action plan made
$38,938,268 available for its "Minimum Housing Need Allocation." In
addition, on August 18, 2006, HUD made $428,671,849 available to Texas
for repair, rehabilitation, and reconstruction of affordable rental
housing, and for the unmet needs of evacuees who were forced from their
homes and are now living in other states. Of this amount, $305,238,257
has been made available for a Homeowner Assistance Program, Sabine Pass
Restoration Program, and Rental Housing Stock Restoration Program.
We identified various options for altering the role of the federal
government in catastrophe insurance by looking at bills before the
current and previous Congresses as well as other change options that
were not in current legislative proposals--for example, a proposal
before a committee of the National Association of Insurance
Commissioners (NAIC). We sought out advantages of these options from
their supporters and disadvantages from critics. We also developed a
four-goal framework, on the basis of challenges faced by current
government natural catastrophe insurance programs, to analyze current
options for an increased federal role in natural catastrophe insurance.
We developed these goals by drawing insights from the following: past
GAO work, legislative histories of laws that changed the roles of state
governments and the federal government after disasters, bills before
the current and previous Congresses, interviews with public and private
sector officials, and articles written by experts in insurance
economics. Although we identified numerous possible goals that could
assist our analysis, we believe the four goals we chose accurately
capture the essential concerns of the federal government. The scope of
our work covered hurricane and earthquake perils--we did not
investigate tornado, hail, or other perils. Also, we focused on the
property and casualty insurance line--especially homeowners insurance.
We did fieldwork in Alabama; California; Connecticut; Florida;
Illinois; Indiana; Louisiana; Massachusetts; Mississippi; Missouri; New
Jersey; New York; Ohio; Texas; and Washington, D.C. Our work was
conducted between March 2006 and October 2007 according to generally
accepted government auditing standards.
[End of section]
Appendix II: Selected State Natural Catastrophe Insurance Programs:
State government natural catastrophe insurance programs, in most cases,
have been created after disasters because homeowners insurance coverage
for catastrophic events is often not available from private insurers at
prices deemed affordable by state legislators and insurance regulators.
These programs supplement or substitute for private natural catastrophe
insurance. For example, California created an earthquake fund in 1994
when private insurers stopped writing homeowner earthquake coverage
following the Northridge Earthquake. Likewise, Florida created Citizens
Property Insurance Corporation (Florida Citizens)--the largest home
insurer in Florida--to provide state-backed insurance coverage,
including for wind damage, for homeowners who cannot get coverage in
the private sector. State natural catastrophe insurance programs differ
in their details, including the percentage of homeowners covered,
geographic locations covered, coverage limits, deductible levels, how
the premiums are calculated, losses, and other details. The natural
catastrophe insurance programs in California, Florida, and other states
are funded through a combination of premium payments and postevent
assessments and bonds. Particularly in catastrophe-prone locations,
government insurance programs have tended not to charge premiums that
reflect the actual risks that homeowners face, resulting in financial
deficits. After the 2005 hurricanes, for example, some of these state
programs faced large accumulated deficits and required substantial
public funding to continue operations. See figure 5 for a comparison of
the features of selected state natural catastrophe insurance programs,
especially their losses, after the 2005 hurricanes. The text that
follows figure 5 contains the most recent information on the state
programs.
Figure 5: Comparison of Selected State Natural Catastrophe Insurance
Programs in 2005:
[See PDF for image]
Primary Insurance: Florida Citizens Property Insurance Corporation;
Program availability: Hail and wind only in the high risk area; full
coverage policy in rest of Florida;
Coverage Limits, property: At least 100 percent of the estimated
replacement value;
Coverage Limits, contents: [Empty];
Coverage Limits, other: [Empty];
Deductible, 1%: [Empty];
Deductible, 2%: [Check];
Deductible, 5%: [Check];
Deductible, 10%: [Check];
Deductible, 15%: [Empty];
Deductible, $: $500;
Premium methodology: Not lower than highest average rate among
20largest insurers in geographic area;
Gross written premium (in millions): $1,609;
Number of policyholders: 810,017;
Total exposure (in billions): $165;
Gross losses incurred (in billions): $2.6;
Assessment structure: Every insurer licensed to write fire, industrial
fire, allied lines, farmowners/homeowners multiperil, commercial
multiperil, mobile homes, and residual market participants. Regular
assessment, premium surcharge, and emergency assessment. Insurer may
pass-through to insureds.
Primary Insurance: Louisiana Citizens Property Insurance Corporation;
Program availability: Coastal Plan for areas along Gulf Coast; FAIR
Plan for noncoastal areas. Fire, hail, and wind, or homeowners;
Coverage Limits, property: $500,000;
Coverage Limits, contents: $250,000;
Coverage Limits, other: [Empty];
Deductible, 1%: [Empty];
Deductible, 2%: [Check];
Deductible, 5%: [Check];
Deductible, 10%: [Check];
Deductible, 15%: [Empty];
Deductible, $: [Empty];
Premium methodology: 10% above highest average rate in parish;
Gross written premium (in millions): $33[C];
Number of policyholders: 134,169;
Total exposure (in billions): $14.9;
Gross losses incurred (in billions): $1.3[F];
Assessment structure: Every insurer licensed to write fire, allied
lines, homeowner multiperil, and property portion of commercial
multiperil. Regular assessment, market equalization surcharge, and
emergency assessment. Insurer may pass-through to insureds.
Primary Insurance: Mississippi Wind-storm Underwriting Association;
Program availability: Hail and wind coverage only in coastal counties;
Coverage Limits, property: $1,000,000;
Coverage Limits, contents: $250,000;
Coverage Limits, other: [Empty];
Deductible, 1%: [Empty];
Deductible, 2%: [Empty];
Deductible, 5%: [Empty];
Deductible, 10%: [Empty];
Deductible, 15%: [Empty];
Deductible, $: $500;
Premium methodology: Subject to the commissioner‘s approval and not
discriminatory;
Gross written premium (in millions): $14;
Number of policyholders: 15,252;
Total exposure (in billions): $1.9;
Gross losses incurred (in billions): $0.6;
Assessment structure: Every insurer licensed to write property
insurance. Member insurers pay first 10%, can reduce second 90% by
voluntary writing.
Primary Insurance: Texas Windstorm Insurance Association;
Program availability: Hail and wind coverage in Texas coastal counties;
Coverage Limits, property and contents: $1,500,000[A] for homeowners;
Coverage Limits, other: [Empty];
Deductible, 1%: [Check];
Deductible, 2%: [Empty];
Deductible, 5%: [Empty];
Deductible, 10%: [Empty];
Deductible, 15%: [Empty];
Deductible, $: Not less than $100;
Premium methodology: Reasonable, adequate, not unfairly discriminatory
and nonconfiscatory to any class of insurer;
Gross written premium (in millions): $114;
Number of policyholders: 118,413[D];
Total exposure (in billions): $27.5[E];
Gross losses incurred (in billions): $0.2;
Assessment structure: Every authorized insurer licensed to write
property insurance. Member insurers pay first $100 million; second
assessment if losses exceed the first assessment, reinsurance, and a
trust fund; and third assessment if losses exceed the above. Third
assessment may be credited against state premium tax.
Primary Insurance: California Earthquake Authority;
Program availability: Insurers must offer coverage with homeowners;
Coverage Limits, property: Homeowners policy coverage amount;
Coverage Limits, contents: $5,000 up to $100,000;
Coverage Limits, other: %1,500 up to $15,000 (loss of use);
Deductible, 1%: [Empty];
Deductible, 2%: [Empty];
Deductible, 5%: [Empty];
Deductible, 10%: [Check];
Deductible, 15%: [Check];
Deductible, $: [Empty];
Premium methodology: Actuarially sound, based on best scientific
information, location, construction type, age, and mitigation measures;
Gross written premium (in millions): $503;
Number of policyholders: 751,767;
Total exposure (in billions): $240;
Gross losses incurred (in billions): $0.0;
Assessment structure: Participating insurers who elect to join the CEA.
Two industry assessment layers: $2.2 billion below reinsurance and $1.5
billion above reinsurance. First layer assessment authority ends in
2008.
Reinsurance: Florida Hurricane Catastrophe Fund;
Program availability: Mandatory for all licensed property insurers;
Coverage Limits: $15 billion[B];
Deductible: $4.5 billion industry aggregate;
Premium methodology: Actuarially indicated premium for each Zip code or
other limited-geographical area;
Gross written premium (in millions): $737;
Number of policyholders: 205;
Total exposure (in billions): $1,508.4;
Gross losses incurred (in billions): $4.5;
Assessment structure: Every insurer licensed to write property/casualty
lines, except medical malpractice, federal flood, accident, and health.
Emergency assessment collected from insurance companies.
Source: GAO.
Note: This figure is intended to show the state of the selected state
natural catastrophe insurance programs during the 2005 hurricane
season. Many features of these selected programs have changed since
that time, as reflected in the narratives that follow this table.
[A] As of June 2006.
[B] As of May 2006.
[C] As of September 30, 2005.
[D] As of June 2006.
[E] As of March 2006.
[F] Estimated.
[End of figure]
California Earthquake Authority:
Program Overview:
The California Earthquake Authority (CEA) is an instrumentality of the
state that sells earthquake insurance policies for residential property
throughout California. Most standard homeowners insurance policies do
not cover earthquake damage. However, California law requires insurers
that sell residential property insurance in California to offer
earthquake coverage to their policyholders every 2 years. In offering
earthquake coverage, insurance companies can manage the risk themselves
or they can become a CEA-participating insurance company and offer the
CEA's residential earthquake policies. The CEA is managed by a
Governing Board composed of the Governor, Treasurer, and Insurance
Commissioner. An 11-member Advisory Panel advises the board.
The base CEA policy, known as a "minipolicy," is a reduced-coverage,
catastrophic earthquake insurance policy intended to protect a
dwelling, while excluding coverage for costly nonessential items, such
as swimming pools, patios, and detached structures. Dwelling coverage
will help pay to repair or (up to the policy limit) replace an insured
home when structural damage exceeds the policy deductible. Coverage for
fire is not included; fire is covered in the companion homeowners
insurance policy. The dwelling coverage limit is determined by the
insured value of the home, as stated on the companion homeowners
insurance policy. Personal property coverage provides up to $5,000 to
replace items, including furniture, televisions, audio and video
equipment, household appliances, bedding, and clothing. Policyholders
can increase their personal property coverage to as much as $100,000.
The CEA policy provides $1,500 of Additional Living Expense coverage to
pay for necessary increases in living expenses incurred to maintain a
normal standard of living. Policyholders can increase that coverage to
as much as $15,000. In addition to providing funds for repairing or
replacing a home, the CEA base policy includes an additional $10,000 in
Building Code Upgrade coverage. For policies that renew or become
effective on or after July 1, 2006, policyholders can choose to
increase Building Code Upgrade coverage by an additional $10,000, for a
total Building Code Upgrade coverage limit of $20,000. The CEA policy
offers two deductible options: the standard base-limit deductible of 15
percent of the policy of the total coverage or a 10 percent deductible
option. Damage to personal property is not covered, unless the dwelling
deductible is met. There is no deductible for Additional Living
Expense/Loss of Use coverage. CEA coverage is available to homeowners
only from the insurance company that provides their residential
property insurance and only if that company is a CEA- participating
insurance company. Participating insurance companies process all CEA
policy applications, policy renewals, invoices, and payments and handle
all CEA claims.
CEA Was Created in the Wake of the Northridge Earthquake to Avoid
Collapse of the Homeowners Insurance Market:
The Northridge Earthquake jolted the San Fernando Valley in January
1994. It caused 57 deaths and an estimated $49.3 billion in economic
losses. California insurers had collected only $3.4 billion in
earthquake premiums in the 25-year period prior to the Northridge
Earthquake and paid out more than $15 billion on Northridge claims
alone. In January 1995, insurers representing about 95 percent of the
homeowners insurance market in California began to limit their exposure
to earthquakes by writing fewer or no new homeowners insurance
policies. This triggered a crisis that by mid-1996 threatened the
vitality of California's housing market and stalled the state's
recovery from recession. In 1995, California lawmakers passed a bill
that allowed insurers to offer a reduced-coverage earthquake insurance
policy that became the "minipolicy." The CEA became operational in
December 1996.
CEA Premium Rates Are Required to Be Actuarially Sound:
In determining premium rates, the CEA is required by law to use the
best science available and is expressly permitted by law to use
earthquake computer modeling, to establish actuarially sound rates. The
CEA will examine rating factors, such as the rating territory
(determined by ZIP code), age, and type of construction of a home, in
determining the premium rate. The CEA applies a 5 percent premium
discount to dwellings that meet the following requirements: the
dwelling was built before 1979, it is of a wood-frame construction-
type, the frame is tied to the foundation, it has cripple walls braced
with plywood or its equivalent, and the water heater is secured to the
building frame. The CEA governing board establishes premium rates,
subject to the prior approval of the Insurance Commissioner. The
Governing Board voted to reduce the base policy rates on July 1, 2006,
by a statewide average of 22.1 percent resulting in a rate reduction
for approximately 85 percent of CEA policyholders. The CEA says that a
sharp drop in the cost of reinsurance and several years without a major
earthquake, allowing CEA insurers to build up reserves, made the cut
possible. While consumer advocates support the cut, some industry
experts fear that the lower rates could make the CEA financially
vulnerable in the event of a major earthquake.
CEA Accumulates Surplus When Premiums Exceed Claims Paid:
No state funds and no public money are used to finance the CEA. The CEA
is funded from policyholder premiums, contributions from and
assessments on participating insurers, returns on invested funds,
borrowed funds, and reinsurance. Assessments on participating insurers
may not be directly passed through to policyholders. The CEA is
authorized to issue bonds, and may not cease to exist so long as its
bonds are outstanding. As of January 2006, the CEA had a projected
total claims-paying capacity of $7.8 billion, but if an earthquake
causes insured damage greater that the CEA's claims-paying capacity,
then policyholders affected will be paid a prorated portion of their
covered losses. The surplus of the CEA increases each year in which
there is no major event.
Participation in the CEA Is Relatively Low:
The CEA is one of the world's largest residential earthquake insurers,
with about 755,000 policies and $501.4 million in premiums in 2006. The
CEA states that over 8 million households in California have homeowners
insurance, and that about 12 percent of these households have
earthquake insurance. The CEA states that there would not be enough
capacity to support 100 percent participation in the program. There are
insurance companies that offer only earthquake coverage and do not
write homeowners insurance. Such companies physically select the
properties that they will insure. Private insurers accounted for about
30 percent of the earthquake insurance market in California in 2005.
Florida Citizens Property Insurance Corporation:
Program Overview:
Citizens Property Insurance Corporation (Florida Citizens) is a not-
for-profit and tax-exempt government entity that provides property
insurance for personal, commercial residential, and commercial
nonresidential properties when private insurance is unavailable or, in
the case of residential insurance, unaffordable. Florida Citizens
maintains three accounts: (1) the high-risk account (HRA) provides
personal and commercial multiperil and wind-only coverage in certain
high-risk coastal areas ("HRA areas");[Footnote 78] (2) the personal
lines account (PLA) offers personal residential multiperil policies
outside of the HRA areas, and ex-wind policies for residential
properties inside of the HRA areas; and (3) the commercial lines
account (CLA) offers commercial residential and commercial
nonresidential multiperil policies outside of the HRA areas, and ex-
wind policies inside of the HRA areas. Florida law requires Citizens to
maintain the separate accounts until the retirement of bonds issued by
Citizens' predecessors prior to Citizens' formation. Since these
predecessor bonds have been retired, the separate accounts may be
combined, but Citizens has made no decision to do so.
Policies are sold by independent insurance agents, who receive 6 to 8
percent commissions for residential policies and 7 to 12 percent
commission for commercial policies.[Footnote 79] Underwriting standards
are somewhat limited, as the company is intended to be an insurer of
last resort. Hurricane deductibles are offered at $500, 2 percent, 5
percent, and 10 percent for personal lines multiperil policies and at
$500, 2 percent, 3 percent, 4 percent, 5 percent, and 10 percent for
personal lines wind-only policies. All-other-peril deductibles are
$500, $1,000, and $2,500. Coverage limits for homeowners policies must
be at least equal to 100 percent of the estimated replacement value.
Florida Citizens offers premium discounts up to 45 percent to
homeowners who take qualifying mitigation measures. Florida Citizens
imposes a surcharge on older homes that reaches a maximum of 20 percent
for homes over 40 years old, while policyholders with newer homes can
receive a premium credit of up to 10 percent.
Florida Citizens Was Created to Consolidate Separate Residual Market
Mechanisms and Achieve Tax-Exempt Status to Lower Costs:
Florida Citizens was established in 2002 after two separate insurance
pools, known as the Florida Windstorm Underwriting Association (FWUA)
and the Florida Residential Property and Casualty Joint Underwriting
Association (JUA) were combined. The FWUA was created by statute in
1970 to provide high-risk, windstorm and hail residual market coverage
in selected areas of Florida. Florida Citizens' HRA assumed the debt
and obligations of the FWUA. The JUA was created in December 1992, in
the wake of the capacity crisis following Hurricane Andrew, to provide
residual market residential-property multiperil insurance coverage,
excluding wind if the property was within FWUA-eligible areas. Florida
Citizens' PLA and CLA assumed the debt and obligations of the JUA. A
primary driver for the merger was that the combined entity obtained
federally tax-exempt status, thus saving federal income taxes that
otherwise would have been paid by the FWUA and the JUA. In addition, as
a tax-exempt entity, Florida Citizens is able to issue lower coupon tax-
free bonds postevent, as well as taxable preevent bonds. The merger
also resulted in some overhead cost savings by having a single
organization.
Florida Citizens Premium Rates Are Required to Be Actuarially Sound,
but Are Subject to Legislative Change:
Until recently, Florida Citizens' premium rates were required to be
noncompetitive with the voluntary market, using a formula that
determined rates on a county-by-county basis, on the basis of the
highest rate offered in the voluntary market among the state's top 20
insurers writing in that area. Then, as part of legislation passed in
May 2006, Florida Citizens' rates were required to be high enough to
purchase reinsurance to cover 1-in-100-year hurricane probable maximum
loss in the PLA and 1-in-70-year hurricane probable maximum loss in the
CLA. Finally, in January 2007, legislation was passed that eliminated
both of these requirements and required that Florida Citizens' rates be
actuarially sound and not excessive, inadequate, or unfairly
discriminatory. In addition, the legislation rescinded a rate increase
that took effect on January 1, 2007; froze 2007 rates at the December
31, 2006, rate level; and required Florida Citizens to make a new rate
filing to be effective January 1, 2009.
In the Event that Florida Citizens Has Losses That Exceed Surplus, It
Can Levy Assessments to Recover the Deficit:
Storms in 2004 and 2005 resulted in more than $30 billion in insured
damage in Florida. Florida Citizens sustained deficits of $515 million
in 2004 and $1.8 billion in 2005. To fund its deficit, Florida Citizens
is required by statute to assess admitted insurers in proportion to the
amount of property and casualty insurance business (except for workers'
compensation or accident and health) they write in Florida, and also to
assess its own policyholders and surplus lines policyholders. The
admitted insurers have the ability to recoup regular assessments from
their policyholders upon renewal of a policy or issuance of a new
policy. If the amount of the deficit exceeds the amount Florida
Citizens can collect as a regular assessment, it is required to levy
emergency assessments on its own policyholders, on surplus lines
policyholders, and on the policyholders of admitted insurers. Admitted
insurers collect emergency assessments from their policyholders and
remit the collections to Citizens.
To fund its 2004 deficit, Florida Citizens assessed insurance companies
and surplus lines insureds over $515 million in regular assessments. To
fund the 2005 deficit of approximately $1.8 billion, the Florida
Legislature appropriated $715 million from the Florida general revenue
fund, which reduced the size of the regular assessment from $878
million to $163 million. The regular assessment imposed to fund the
2005 deficit was reduced from an estimated 11.2 percent to 2.07 percent
due to the infusion of general revenue funds. The Florida Legislature
also directed Florida Citizens to amortize the collection of the
emergency assessment for the remaining $888 million deficit over a 10-
year period, resulting in a 1.4 percent emergency assessment levied
beginning in June 2007.
Florida Citizens' resources also come from its reinsurance arrangement
with the Florida Hurricane Catastrophe Fund (FHCF). In 2006, the FHCF
provided coverage for Florida Citizens for 90 percent of $4 billion in
losses above its deductible. As a tax-exempt entity, Florida Citizens
is able to issue tax-exempt postevent bonds as well as taxable preevent
bonds. The tax-exempt status is beneficial because in the event of a
major disaster, Florida Citizens can finance loss payment by issuing
bonds that carry low interest rates, thereby reducing financing costs
over the years by hundreds of millions of dollars. In June 2006,
Florida Citizens completed a $3.05 billion taxable pre-event bond sale.
In February 2007, Florida Citizens closed a $1 billion tax-exempt
postevent bond issuance. In June 2007, Citizens completed a $1.95
billion preevent financing plan consisting of a $1 billion line of
credit and $950 million in bonds. Under its enabling statute, Florida
Citizens is a government entity and not a private insurance company. As
long as Florida Citizens has bonds outstanding, it may not file a
voluntary petition under Chapter 9 of the Federal Bankruptcy Code.
Florida Citizens Has Had Moderate Growth in All but 2 Years, Partially
Due to Depopulation Incentives:
Except for 2 years, Florida Citizens' growth has been relatively
moderate given the market dynamics. Since its establishment in 2002,
when it had 658,085 policies, the policy count has increased to 1.38
million policies-in-force as of September 30, 2007. Over this 5-year
period, there has been nominal growth in Citizens' formerly wind-only
HRA of 10 percent. Most of the growth of Florida Citizens has been in
its PLA and has been caused by the following factors: (1) the private
market pulling back following eight hurricane events in 2004 and 2005,
(2) private insurers' curtailing coverage in sinkhole parts of the
state, and (3) the July 2006 assumption by Florida Citizens of
approximately 300,000 policies following the insolvency of a private
insurer. Aside from 2006, the only other significant policy increase
occurred in 2003, a 25 percent increase. By comparison, total policies
grew by only 7 percent in 2004, decreased by 7 percent in 2005, and
grew by 7 percent for the first 9 months of 2007--all net of
depopulation activities.
Prior to 2007, part of Florida Citizens' lower growth rate was the
result of incentives to private insurers to take policies out of
Citizens, also known as depopulation incentives. Florida Citizens had
the authority to pay insurers a take-out bonus of up to 12.5 percent of
premiums removed from the HRA. The incentive program required that a
minimum of 25,000 policies or a total insured value of at least $5
billion be removed. Insurers could earn higher bonuses, up to 10
percent, for assuming more than the minimum. They were required to
retain the policies for either 3 or 5 years. Take-out incentives were
eliminated in 2007. Nonetheless, through August 31, 2007, 131,000
policies have been removed without incentives.
Louisiana Citizens Property Insurance Corporation:
Program Overview:
The Louisiana Citizens Property Insurance Corporation (Louisiana
Citizens) is a nonprofit, tax-exempt entity that acts as a market of
last resort for residential and commercial property insurance in
Louisiana. Louisiana Citizens is modeled on a similar Citizens Plan
created in Florida. Louisiana Citizens was specifically organized to
operate the state's Coastal Plan and Fair Access to Insurance
Requirements (FAIR) Plan. The Coastal Plan offers coverage in coastal
areas of the state. The FAIR Plan offers coverage in the rest of the
state. Louisiana Citizens offers coverage for fire, vandalism,
windstorm, hail, and homeowners. Residential policy limits are up to
$750,000 for property, and up to $375,000 for contents. Policy
deductibles are offered at various levels, with 2 and 5 percent offered
for wind/hail coverage. Underwriting standards are somewhat limited
since the company is intended to be an insurer of last resort. A 15-
member governing board supervises company operations. The company has
very limited infrastructure in place, as it maintains an administrative
services contract with the Property Insurance Association of Louisiana,
a nonprofit organization of licensed insurance carriers in the state.
The company also entered into agreements for underwriting, policy
management, and claims management services with three service
providers.
Louisiana Citizens Was Created to Change Assessment Structure of
Residual Market Mechanisms:
Louisiana created the Louisiana Joint Reinsurance Plan (the predecessor
to the FAIR Plan) in 1968 to provide a residual market for property
insurance in inner cities within the state in response to damage caused
by civil unrest. The state created the Louisiana Insurance Underwriting
Plan (the predecessor to the Coastal Plan) in 1970 to provide a
residual market for property insurance in coastal areas of the state in
response to damage caused by Hurricane Camille. All insurers licensed
to write property insurance in the state were required to participate
in the predecessor insurance plans. Property losses caused by
hailstorms, Hurricane Lili, and Tropical Storm Isidore resulted in
assessments against the participating insurers that were not
recoverable from policyholders. The insurers became reluctant to write
insurance in the state. The legislation creating Louisiana Citizens
gave participating insurers the ability to recoup a regular assessment
from policyholders and gave Louisiana Citizens the ability to impose
emergency assessments directly on policyholders.
Citizens Rates Are Not Competitive with the Private Market and
Necessitated Postfunding:
Louisiana Citizens premium rates are required to be actuarially sound.
Premium rates are not intended to be competitive with the private
market and are set at least 10 percent above the average rate of the
insurer that had the highest rate of the top 10 insurers by parish,
provided they make up at least 3 percent of the market. In 2005,
Louisiana Citizens suffered more than $1 billion in losses from
Hurricanes Katrina and Rita, with the vast majority of the losses in
the FAIR Plan. Citizens had not built up sufficient reserves to meet
its obligations. It had only $80 million in cash reserves and tapped
into its reinsurance for an additional $295 million. In October 2005,
because there was still a deficit, Citizens assessed all property
insurance companies in the state a one-time regular assessment of a
maximum amount of 15 percent of premium: 10 percent for the FAIR Plan
and 5 percent for the Coastal Plan. Insurers recoup the amount of their
regular assessments from their policyholders in the subsequent year.
The regular assessment following the 2005 hurricanes generated
approximately $200 million for Louisiana Citizens. Because a deficit
situation still existed after the regular assessment was levied,
Citizens was authorized by law to issue bonds. In December of 2006,
Citizens received approval from the State Bond Commission to issue up
to $1.4 billion of tax-exempt revenue bonds. The actual bond issue in
April 2006 was for approximately $978 million. The bond offering will
be financed by an emergency assessment on policyholders that is
estimated to be about 5 to 6 percent of insurance premiums per year for
as many years as needed to cover the plan deficit.[Footnote 80]
Mississippi Windstorm Underwriting Association:
Program Overview:
The Mississippi Windstorm Underwriting Association (Mississippi
Windpool)[Footnote 81] is a nonprofit association of all insurance
companies writing property insurance in Mississippi on a direct basis.
It was established by the legislature to provide an adequate market for
windstorm and hail insurance in the six coastal counties of
Mississippi. The maximum coverage available for residential coverage is
$1 million for the dwelling and $250,000 for contents. The policy
contains a "named storm" deductible of 2 percent of the insured value
of the home with a $500 minimum or, if coverage exceeds $500,000, a
$1,000 minimum. Any structure built after June 1, 1987, in an area that
has not adopted the standard building code must produce proof that the
structure is built in substantial accordance with the code. Otherwise,
it is not insurable by the Mississippi Windpool. Policies can be sold
by any approved insurer, and agents receive a 15 percent commission on
new business and a 10 percent commission on renewals.
Mississippi Windpool Was Created in the Wake of Insurance Crisis
Following Hurricane Camille:
The Mississippi Insurance Underwriting Association (MIUA), the
predecessor to the Mississippi Windpool, was created by the Mississippi
Legislature in 1970 as the state struggled to recover from Hurricane
Camille in 1969. The MIUA provided fire and windstorm coverage in the
six coastal counties of the state, and its basic purpose was to enable
individuals to secure a mortgage since there was no private market for
fire and wind coverage. In 1987, the legislature found that the market
for fire coverage had recovered, but there remained the need for
residual windstorm coverage. Thus, the legislature created the
Mississippi Windpool.
Mississippi Windpool Premium Rates Are Significantly Less Than
Requested:
Mississippi Windpool premium rates are required to be nondiscriminatory
as to the same class of risk, and are subject to the approval of the
state insurance commissioner. Prior to 2007, in light of agent
commissions and the servicing carrier agreement, the Mississippi
Windpool recovered just over 75 percent of premium payment on new
business and about 82 percent of premium payment on renewals. The
Mississippi Windpool used most of the premium to buy reinsurance. In
2004, the Windpool sought to raise premium rates by 76 percent, but the
insurance commissioner approved a 22 percent increase. In April 2006,
the Mississippi Windpool sought approval of a 397.8 percent rate
increase for residential coverage. Much of the increase was needed to
buy adequate reinsurance, which cost the Mississippi Windpool about
$0.65 to $0.70 per dollar of reinsurance. The state insurance
commissioner granted a 90 percent increase. To defray the cost of
reinsurance for the Mississippi Windpool, the state requested that HUD
allow it to allocate up to $50 million in CDBG funds. HUD gave the
state permission to use $30 million in 2006 and $20 million in 2007 for
the Mississippi Windpool reinsurance. In 2007, the State Legislature
created the Mississippi Windstorm Underwriting Association Reinsurance
Assistance Fund for the purpose of defraying the cost of Mississippi
Windpool reinsurance. The fund will be financed using state tax dollars
and may be used only by the state insurance department upon
appropriation by the State Legislature. The Mississippi Windpool was
also granted authority to issue bonds and other debt instruments.
Catastrophic Mississippi Windpool Losses Are Borne by Participating
Insurers:
Following Hurricane Katrina, the Mississippi Windpool suffered about
$720 million in losses. It received loss claims from every
policyholder, about 18,000 total. About 700 to 800 policyholders did
not meet their deductible, but the vast majority of claims resulted in
payment. Prior to 2007, the Mississippi Windpool did not retain
profits, if any, at year-end, but distributed them to participating
insurers. The Mississippi Windpool did not have adequate reinsurance
and capital to cover their losses in Katrina, and assessed
participating insurers $525 million, on the basis of their level of
participation in the state property insurance market. About 400
companies were participating in the Mississippi Windpool at the time.
Each could reduce their assessment liability by $1.40 for every $1.00
of voluntarily written premium for property insurance in the coastal
area. This credited amount came out of the second 90 percent of the
assessment; all members were responsible for the first 10 percent of
the assessment. No company completely wrote themselves out of the
Katrina assessment, and some companies incurred greater direct losses
than their assessment. However, some companies were assessed more than
their entire direct written premium received in the state. Legislation
passed in 2007 requires the state insurance commissioner to levy a
surcharge on all property insurance premiums in the state to recover
within 1 year the amount of the regular assessment for reimbursement to
assessable insurers who paid the regular assessment.
Texas Windstorm Insurance Association:
Program Overview:
The Texas Windstorm Insurance Association (Texas Windpool) offers
windstorm and hail coverage for residential and commercial properties
in 14 coastal counties and parts of Harris County (but not Houston).
About 25 percent of the state's population lives along the coast. The
membership of the Texas Windpool includes every property insurer
licensed to write property insurance in the state. Each company's
percentage of participation is based on their statewide sales. The
Texas Windpool is governed by a nine-member board of directors.
Coverage limits are adjusted annually to reflect inflation. Effective
January 1, 2007, residential coverage for a dwelling and its contents
is capped at $1.597 million. Policies include coverage for wind-driven
rain, loss of use, and consequential losses. Since 2004, the Texas
Windpool has required that residential properties that it insures
conform to the International Residential Code. However, under certain
conditions, the Texas Windpool will insure homes built before 1988 that
were not built according to any recognized building code. Policies are
sold by individual licensed agents who receive 16 percent of gross
written premium as commission.
Texas Windpool Was Created Due to Insurance Crisis Following Hurricane
Celia:
Hurricane Celia struck the Texas coast in August 1970 and caused an
estimated $310 million in insured losses ($1.55 billion in 2005
dollars). Many insurers decided to stop writing business in the state's
coastal communities. In response, the State Legislature created the
Texas Catastrophe Property Insurance Association (predecessor to the
Texas Windpool) in 1971.
Texas Windpool Premium Rates Are Less Than Requested:
The Texas Windpool must file all rates with the state insurance
commissioner for approval. The commissioner assesses whether the rates
are reasonable, adequate, not unfairly discriminatory, and
nonconfiscatory as to any class of insurer. Approved rates must be
uniform throughout the 14 coastal counties. By law, the Texas Windpool
residential premium rates may not increase by more than 10 percent
above the rate for noncommercial windstorm or hail insurance in effect
at the time of filing, but the insurance commissioner may suspend this
rule after a catastrophe or series of catastrophes to ensure rate
adequacy in the catastrophe area.[Footnote 82] In May 2006, the Texas
Windpool sought a 19 percent residential and 24 percent commercial rate
increase. The insurance commissioner approved a 3.1 percent residential
and 8 percent rate increase. Again, in November 2006, the Texas
Windpool sought a 20 percent residential and 22 percent commercial rate
increase. The insurance commissioner approved a rate increase of 4.2
percent for residential policies and 3.7 percent for commercial
policies.
Texas Windpool Claims-Paying Capacity Mixes Industry Assessments and
Reserves:
The Texas Windpool is authorized to assess participating insurers for
excess losses. In addition, the State Legislature created the
Catastrophe Reserve Trust Fund, into which Texas Windpool profits are
deposited, rather than distributed to participating insurers. Under the
plan, companies are assessed the first $100 million losses in excess of
the Texas Windpool's premiums and other income. Losses in excess of
this amount are funded by private reinsurance and the trust fund. An
additional $200 million assessment can be levied if private reinsurance
and the trust fund are inadequate to cover losses. In March 2006, the
Texas Windpool had the ability to fund $1.3 billion in excess losses
based on a combination of assessments, reinsurance, and other means.
Losses in excess of $1.3 billion are funded through further industry
assessments. An insurer may credit the amount paid under this top-layer
assessment against its premium tax. Hurricane Rita produced estimated
losses of between $160 million and $165 million for the Texas Windpool.
The payment of some 11,506 Hurricane Rita claims in 2005 resulted in a
deficit and a $100 million assessment on insurance companies. The pool
grew from almost 69,000 policyholders at the end of 2001 to about
207,000 at the end of September 2007. Texas Windpool liability, or
exposure to loss, was about $56 billion as of the end of September
2007.
Alabama Insurance Underwriting Association:
Program Overview:
Alabama Insurance Underwriting Association (Alabama Beach Pool) is a
voluntary unincorporated nonprofit association established to provide
essential residential and commercial insurance coverage to the beach
area counties of Baldwin and Mobile. Twelve percent of Alabamans live
on the coast. Every licensed property insurer in the state is a member
of the Alabama Beach Pool. The Beach Pool offers two types of policies:
fire and extended coverage, and wind and hail. The Beach Pool offers
coverage limits on residential buildings up to a maximum of $500,000,
combined dwelling and contents. A hurricane deductible of 5 percent
($1,000 minimum) is applicable in the event of a named storm. Policies
covering property located in certain areas may opt for a 2 percent
hurricane deductible for an additional premium. The standard deductible
for all other perils is $500. Buildings must conform to the Southern
Standard Building Code for the Alabama Beach Pool to provide coverage.
Any insurance agent licensed in Alabama can sell Beach Pool policies
and receive an 8 percent commission. The Beach Pool is managed by a
board of directors.
Alabama Beach Pool Was Created Due to Insurance Crisis Following
Hurricane Camille:
The Alabama Beach Pool was created in the aftermath of Hurricane
Camille in 1969. Insurance companies operating in Alabama voluntarily
agreed to join the association at the behest of the state insurance
commissioner. The Beach Pool was not created by the State Legislature,
but is subject to regulation by the Alabama Department of Insurance.
Alabama Beach Pool Premium Rates Have Been Subject to Political
Pressure:
The Alabama Beach Pool and other insurers operating in the state must
file premium rate change requests with the Alabama Department of
Insurance. Alabama is a "prior approval" state, meaning that insurers
must either allow a waiting period to expire or receive approval from
the insurance department prior to using those rates in pricing
insurance coverage. Insurance company officials told us that they are
not always able to get their requested rates, and that Alabama Beach
Pool rates are too low. Prior to Hurricane Katrina, the state insurance
department conducted a study comparing Beach Pool premium rates with
rates charged by state-run coastal insurance programs in Florida and
Mississippi. The study showed that Alabama Beach Pool rates were higher
than the Florida and Mississippi programs. The State Legislature put
pressure on the insurance department to lower Beach Pool rates. In the
wake of Hurricane Katrina, however, coastal insurance rates in Florida
and Mississippi are higher than in Alabama.
Alabama Insurers May Not Pass-Through Alabama Beach Pool Assessments to
Policyholders:
The Alabama Beach Pool is authorized to make assessments upon all
member insurers. The calculation of the assessment is based on the
member's proportion of net direct premiums of property insurance in the
state. Members can receive annual credit against assessments for
property insurance voluntarily written in the coastal area. In the
event of catastrophe loss requiring assessment, a first partial loss
assessment will be limited to not exceed $2 million per member insurer.
Members may not pass-through assessments to policyholders. The Beach
Pool currently has about 8,500 policies, insuring about $1.5 billion in
property.
Georgia Underwriting Association:
Program Overview:
The Georgia Underwriting Association (GUA) was created by insurance
companies licensed to write property insurance in Georgia to administer
the state FAIR Plan. The plan insures homeowners throughout the state
who have not been able to find certain types of insurance coverage in
the voluntary market, and also coverage against windstorm and hail
damage in coastal counties and off-shore islands. The coverage limit
for any one building, including the dwelling and its contents, for
windstorm and hail coverage is $2 million. The deductible for windstorm
and hail coverage is at least 1 percent, subject to a minimum of $500.
Any structure in the windstorm and hail area that is less than 10 years
old and not built in compliance with the Southern Standard Building
Code or its equivalent is not eligible for coverage. Replacement cost
and loss of use coverage are available as supplemental coverage.
Homeowners may apply for GUA coverage directly or through a state-
licensed insurance agent. Agents receive a commission of 10 percent of
the premium. Premium rates either may be approved by the state
insurance commissioner and must not be excessive, inadequate, or
unfairly discriminatory or may be advisory rates and premiums from the
Insurance Services Office, Inc. The average premium for coverage is
about $590. The GUA maintains reinsurance of $100 million in excess of
$50 million, and a second-event limit covers a second loss greater than
$25 million. The GUA is authorized to assess member insurers for
program losses in proportion to each member's property insurance
premiums written during the most recent calendar year. Member
assessments may not be passed-through to policyholders. Member insurers
also share in program profits. In June 2006, the GUA had 26,882
policies in-force, of which 7,136 policies were on the coast. The
exposure statewide as of June 2006 was $3.2 billion, of which $1.3
billion was coastal exposure.
South Carolina Wind and Hail Underwriting Association:
Program Overview:
The South Carolina General Assembly authorized the creation of the
South Carolina Wind and Hail Underwriting Association (South Carolina
Windpool) in 1971. All admitted property and casualty companies
licensed by the South Carolina Department of Insurance are members of
and are required to participate in the South Carolina Windpool. The
Windpool provides wind and hail coverage in the coastal areas of the
state, which are specifically designated by statute. The state director
of insurance recently expanded the territory eligible for Windpool
coverage and divided the territory into two zones. Insurance companies
writing policies in the defined territory may either offer wind
coverage or exclude wind coverage (for a reduced premium). If an
insurer excludes wind coverage, that coverage may be written by the
South Carolina Windpool (for an additional premium). Cover limits for
one-to-four family dwellings, including mobile homes and condominiums,
is $1.3 million. Items that are specifically excluded from coverage
include property over water and wind-driven rain. South Carolina
Windpool policies are actual cash value contracts. Primary residences
are eligible to purchase replacement cost coverage. The standard
building/contents deductible is 3 percent of the policy limit in zone 1
with a minimum deductible of 2 percent in zone 2. Loss of use coverage
is subject to a time deductible that is based on the underlying
building/contents deductible. Policies may be sold by any insurance
producer or broker licensed by the state. Premium rates must be
approved by the state director of insurance. Premium rate increases or
decreases of 7 percent may take effect on a file-and-use basis; rate
increases or decreases of more than 7 percent are subject to prior
approval. In 2005, the average premium per residential policy for the
South Carolina Windpool was $1,385. In 2007, the State Legislature
required the Windpool to ensure rate adequacy so as to permit it to be
self-sustaining. The South Carolina Windpool is authorized to assess
member insurers to cover program losses. Insurers may pass through
assessments to policyholders through future rate filings. In June 2007,
the State Legislature authorized the South Carolina Windpool to sell
bonds and incur debt. The South Carolina Windpool had 36,196
residential policies in-force as of September 30, 2007, compared with
16,430 residential policies in-force in 2001. Windpool exposure was
almost $13.735 billion as of September 30, 2007.
North Carolina Insurance Underwriting Association:
Program Overview:
The North Carolina Insurance Underwriting Association (North Carolina
Beach Plan) was created in 1969 to provide insurance coverage to people
not able to buy it through the standard insurance market only on the
barrier islands adjacent to the Atlantic Ocean. In 1998, the North
Carolina General Assembly expanded the Beach Plan to include the
state's 18 coastal counties for windstorm and hail only coverage. A 14-
member board of directors acts as the North Carolina Beach Plan
policymaking body. All property and casualty insurance companies that
do business in North Carolina participate in funding the plan. The
North Carolina Beach Plan provides Basic coverage, which includes most
major perils, and broad coverage, which includes a broader array of
perils. Coverage limits are up to $1.5 million on private dwellings.
Coverage is provided on an actual cash value basis or replacement cost
if certain specific criteria are met. Policies meeting plan criteria
are continuous 1 year policies if premiums are paid. Underwriting
standards are somewhat basic since the North Carolina Beach Plan is
intended to be an insurer of last resort. North Carolina Beach Plan
premium rates must be filed with the state insurance commissioner by
the North Carolina Rate Bureau for approval prior to their use. In
2007, homeowner rates were raised by an average of 25 percent for beach
and coastal areas. Homeowners wind-only policies were increased 25
percent for beach areas and 38 percent for the coastal areas. In 2006,
dwelling extended coverage rates were increased about 25 percent. For
commercial property maximum coverage limits are $3 million (combined
building and contents) and $300,000 for business income. The Beach Plan
adopts Insurance Services Office commercial loss cost filings approved
by the state insurance commissioner. All member insurers share in North
Carolina Beach Plan expenses, profits, and losses in proportion to
their property insurance net direct premium written in the state.
Member insurers can receive credit against expenses, profits, and
losses for property insurance voluntarily written in the beach and
coastal areas. The North Carolina Beach Plan has a "take out" program
within its plan of operation; however, to date, this program has not
been initiated. As of fiscal year end September 30, 2007, the Beach
Plan had over 162,000 policies in-force with an exposure of $64.1
billion, compared with about 88,000 policies and an exposure of $28.9
billion at the end of fiscal year 2004.
Florida Hurricane Catastrophe Fund:
Program Overview:
The goal of the FHCF has been to provide a cost-effective source of
reinsurance to residential property insurers in the state. It is
structured as a tax-exempt state trust fund under the direction and
control of the State Board of Administration of Florida (State Board).
The State Board is a constitutional entity of Florida state government.
It is governed by a Board of Trustees composed of the Governor, Chief
Financial Officer, and Attorney General. The State Board appoints a
nine-member advisory council to provide the State Board with
information and advice with its administration of the FHCF. The
management and day-to-day operations of the FHCF is the responsibility
of the Senior Officer. The Senior Officer currently manages eight
professional staff. Paragon Strategic Solutions, Inc. is the FHCF
administrator as well as the actuarial consultant to the State Board.
The FHCF collects premiums from and provides reimbursements to insurers
writing residential property and casualty insurance policies within the
state. As a condition of doing business in Florida, each insurer
writing "covered policies" is required to contract with the FHCF.
"Covered policies" means any insurance policy covering residential
property in the state that provides wind or hurricane coverage. This
includes any such policy written by Florida Citizens. A limited
exemption is available for insurance companies with less than $10
million in covered exposure (not premium). The FHCF is obligated,
pursuant to reimbursement contracts, to reimburse participating
insurers for a specified percentage of qualifying losses on the basis
of selected coverage (45, 75, or 90 percent) in excess of loss
retention thresholds (or deductibles). Nearly 85 percent of insurers
selected the 90 percent coverage option for fiscal year 2005-2006 (July
1, 2005 through June 30, 2006). There were 205 insurance companies that
contracted with the FHCF during that period.
The aggregate industry deductible is set by law at $4.5 billion to be
adjusted to reflect increased exposure to the FHCF. Currently, the
aggregate deductible is $6.089 billion for the contract year ending May
31, 2007. An individual insurer's deductible is based on an insurer's
pro rata share of reimbursement premium due for a contract year and
other factors. An insurer's full deductible shall apply to each of the
insurer's largest two hurricanes. The insurer's full deductible would
then be adjusted to one third for any other hurricanes occurring during
the contract year.
The insured value of property reinsured by the FHCF in contract year
2007 is estimated to be approximately $2 trillion. The FHCF's claims-
paying capacity in a contract year is set by law, and legislation
passed in early 2007 will increase capacity from $15 to $38.4 billion.
Due to actual coverage selected, the resulting capacity was $27.83
billion. The FHCF's multiyear claims-paying capacity is over $50
billion. The cap on capacity represents the limited liability of the
FHCF--it is not obligated by contract if losses in a given contract
year exceed claims-paying capacity. In contract years where there is
growth in the FHCF's cash balance, the capacity is allowed to increase
to the lesser of the growth in the cash balance or the growth in the
reported insured property values.
The projected payout for a participating company is set as a pro rata
share of the FHCF's annual capacity. Prior to reimbursement, an
insurer's loss reports are examined by the State Board and tested for
reasonableness. Limited apportionment companies, which possess capital
not exceeding $20 million, are entitled to reimbursement first. No one
county is responsible for more than 9.8 percent of the fund's exposure.
Dade, Broward, and Palm Beach Counties are contiguous and make up less
than 28 percent of the fund's total exposure.
FHCF Was Created in 1993 after Hurricane Andrew Limited the
Availability of Reinsurance:
On August 24, 1992, Hurricane Andrew hit the southern coast of Florida
just south of Miami and caused economic damages estimated in excess of
$25 billion, including an estimated $15.5 billion in insured losses.
The major impacts for primary insurance company buyers of reinsurance
in the year following Andrew included a severe shortage of catastrophe
property reinsurance capacity and stricter policy terms and conditions,
as well as sharp increases in property catastrophe cover rates.
The poststorm reaction of a number of insurance companies was to
attempt to reduce their underwriting exposure. In early 1993, 39
insurers stated they intended to either cancel or not renew 844,433
policies in Florida. The factors influencing these private insurers
included:
* the inability to obtain adequate reinsurance or, when available, the
cost for reinsurance was too high;
* new catastrophe risk models indicated that exposure levels were
higher than previously thought, and the exposure levels were
disproportionate to company and industry financial resources;
* significant reductions in insurers' policyholders surplus;
* concerns about rate adequacy, especially for coastal counties and
certain risk categories, such as condominiums;
* "hidden" exposures from potential assessments by various other
insurance mechanisms, for example, residual markets and catastrophe
funds; and:
* fear that unfavorable catastrophe exposure would hurt ratings from
agencies such as A.M. Best and Standard & Poor's.
The Department of Insurance (now called the Office of Insurance
Regulation) issued a study examining the state of the property
insurance market and enumerating many recommendations. Among the
recommendations was a proposal (originally suggested and supported by
the two largest private insurers in the state--State Farm and Allstate)
to establish a tax-free state catastrophe fund to provide reinsurance
protection between that provided by the private market and a proposed
federal fund. Later, the legislature created a Study Commission on
Property Insurance and Reinsurance to look into the viability of the
property insurance industry and the adequacy of reinsurance. Of the 40
recommendations made by the commission, a key recommendation included
the establishment of a state catastrophe fund "to fill the void between
currently available private sector reinsurance and the proposed federal
catastrophic fund program." Virtually all of the recommendations from
the commission were enacted with minor alterations, including creation
of the FHCF.
FHCF Premiums Are Significantly Less Than Private Reinsurance Premiums:
The cost of FHCF coverage is significantly less than the cost of
private reinsurance (one fourth to one third the cost) due to the
FHCF's tax-exempt status, low administrative costs, and lack of a
profit or risk-load. The tax-exempt status of the FHCF removes a level
of potential income taxation for participating insurers resulting from
the annual buildup of contingent reserves in years when there are few
or no hurricanes, and, thus, allows for the accumulation of funds for
the payment of Florida losses. Another reason FHCF premiums are low is
that a significant part of the coverage provided by the FHCF may be
paid by long-term debt issued by the FHCF after a large hurricane event
occurs, as discussed below.
A company's annual reimbursement premium is based on an actuarial
formula that considers property location, type of construction,
deductible, and loss mitigation. Premiums have been stable over time
due to mandatory participation but have increased significantly since
2004 when the FHCF's capacity was increased. Growth in reported
exposure has also factored into increased premiums. The top 10 insurers
in the FHCF contribute 64 percent of the total reimbursement premiums
paid. The FHCF is expected to collect $736 million in reimbursement
premium during contract year 2006. Beginning in 2006, the FHCF was
required to charge a rapid cash build-up factor equal to 25 percent of
premiums, which was expected to provide $200 million annually. However,
the Florida Legislature repealed this provision in early 2007.
According to the FHCF, most insurers select the 90 percent coverage
option. Insurers may purchase private market reinsurance to cover their
hurricane losses for amounts below the retention, above their
reimbursement limit, or for the coinsurance amount (10 percent - along
side) that is the insurer's responsibility for the layer of coverage
provided by the FHCF. In fact, for some large national insurers, the
FHCF is a small part of their total reinsurance program.
FHCF Maintains Reserves, but They May Not Be Adequate to Handle
Catastrophe Losses:
The FHCF is not required to have the loss reserves that are required of
insurers or reinsurers under state law. Financial reserves of the FHCF
accumulated steadily through fiscal 2004 due to limited hurricane
activity. Specifically, the FHCF had accumulated net assets of $5.5
billion at the end of the 2004 fiscal year (June 30, 2004). Following
the 2004 and 2005 hurricane seasons, the FHCF reimbursed participating
insurers over $5 billion, which has eliminated the reserves and created
an estimated shortfall of $1.425 billion. Standard & Poor's states that
this cyclical financial performance is expected, given the nature of
FHCF funding requirements.
FHCF Authorized to Postfund Revenue Shortfalls:
To support the capacity of the FHCF, revenue bonds may be issued. The
Florida Hurricane Catastrophe Fund Finance Corporation was formed in
1996 to issue bonds and engage in such other financial transactions as
are necessary to provide sufficient funds to achieve the purposes of
the FHCF. The corporation is governed by a five-member board of
directors, including the governor, chief financial officer, attorney
general, director of the Division of Bond Finance of the State Board,
and the Senior Officer. Revenue bonds issued are exempt from state and
federal taxes. The corporation has authority to create preevent and
postevent financing. In June 2006, the corporation undertook postevent
financing of $1.35 billion to address its 2005 shortfall. In July 2006,
the corporation undertook preevent financing of $2.8 billion to address
2006 liquidity needs.
To pay debt service on outstanding revenue bonds and to reimburse
insurers for the reimbursable losses under a covered event, the State
Board directs the Office of Insurance Regulation to levy an emergency
assessment which insurance companies collect from their policyholders.
Emergency assessments are levied on premiums for all assessable lines
of business in Florida. For 2006, there are 27 assessable lines, and
medical malpractice policies will be added in 2010. In 2004, surplus
lines insurers were added to the emergency assessment base. Excluded
lines include accident and health, workers' compensation, and federal
flood insurance. The assessment base, which totaled $35 billion in
2005, has grown at a compound annual growth rate of 14.6 percent since
1970. Over 40 percent of the direct-written premium base is from auto
insurance. In May 2006, a 1 percent emergency assessment was directed.
The assessments are collected by insurance companies from policyholders
and remitted to the FHCF throughout the year. Policyholders are
required to pay the assessments, and insurers are required to treat the
failure to pay the assessment as a failure to pay premium, which
permits an insurer to cancel the policy. The maximum assessment in a
single season is 6 percent of premium, and the aggregate limit is 10
percent of the premium base. Emergency assessments had never been
assessed or collected prior to the levy of assessments relating to the
issuance of the June 2006 bonds. Statewide assessments can also be
levied for Florida Citizens and the state insurance guarantee fund. The
emergency assessment of 1 percent for the FHCF is expected to be in
place for 6 years.
[End of section]
Appendix III: Comments from the National Association of Insurance
Commissioners:
NAIC: making progress together:
National Association Of Insurance Commissioners:
Executive Headquarters:
2301 Mcgee Street:
Suite 800:
Kansas City Mo 64108-2662:
Voice 816-842-3600:
Fax 816-783-8175:
Government Relations:
Hall Of The States:
444 North Capitol St NW:
Suite 701:
Washington DC 20001-1509:
Voice 202-471-3990:
Fax 202-471-3972:
Securities Valuation Office:
48 Wall Street, 6th Floor
New York NY 10005-2906:
VOICE 212-398-9000:
FAX 212-382-4207:
World Wide Web: www.naic.org:
October 31, 2007:
Ms. Orice Williams:
Government Accountability Office:
Financial Markets and Community Investment:
441 G Street, NW, Room 2440-B:
Washington, DC 20548:
RE: GAO Study on Changing the Federal Role in Disaster Insurance Dear
Ms. Williams:
Thank you for the opportunity to review the GAO's study on the
possibility of changing the role of the Federal Government related to
disaster insurance.
The review of the study was conducted by several senior staff at the
NAIC. The NAIC staff found that the approach taken by the GAO was
thorough and identified several possibilities for Congress to consider.
The NAIC staff was pleased that the GAO decided to outline the
advantages and disadvantages of each rather than giving its opinion as
to a single outcome.
There are seven distinct proposals considered by the GAO in its study.
The GAO has done an admirable job of evaluating the public policy
aspects of each. Since the project was undertaken, the NAIC has become
aware of two more possibilities that deserve some consideration by
public policymakers. South Carolina Insurance Director Scott Richardson
has developed a proposal that includes an allocation system for
determining what portion of a claim should be attributed to flood and
what portion should be attributed to wind. Since this proposal would
involve changes to the National Flood Insurance Program, we believe it
deserves to be mentioned. In addition, state insurance regulators heard
from representatives of the Travelers regarding a proposed coastal zone
plan involving the creation of a Federal entity to oversee property
insurance rates in the coastal zone. While regulators were generally
not enthusiastic about the Travelers proposal, it should be mentioned
as a possibility for study regarding its advantages and disadvantages.
One final point should also be made. There are often allegations that
some state insurance regulators are involved in rate suppression. Some
statements along this line occur in the GAO study. They are all
properly attributed by the GAO. Those who allege that regulators are
suppressing rates often assume that insurance industry actuaries have
perfect information about the pricing of risk. They assume if a
regulator does not grant the industry filer all that was requested in a
rate filing, the regulator is involved in rate suppression.
Regulators have found wide differences of opinion among the several
risk modelers that assist insurers with the development of the
estimated future catastrophe loss costs. If an industry actuary selects
a higher priced option among the modelers and the regulatory actuary
disagrees, the regulator is labeled a rate suppressor. Since reasonable
actuaries can and do have different opinions about the correct answer
when it comes to pricing insurance products, particularly when covering
perils subject to catastrophe losses, we wanted to caution readers of
this report so they could avoid falling into the trap of assuming that
there is widespread rate suppression by state insurance regulators.
Sincerely,
Signed by:
Catherine J. Weatherford:
NAIC Executive Vice President and Chief Executive Officer:
cc:
Patrick S. Dynes, GAO:
Lawrence D. Cluff, GAO:
Philip J. Curtin, GAO:
[End of section]
Appendix IV: GAO Contact and Staff Acknowledgments:
GAO Contact:
Orice M. Williams, (202) 512-8678 or williamso@gao.gov:
Staff Acknowledgments:
In addition to the person named above, Lawrence D. Cluff, Assistant
Director; Joseph A. Applebaun, Patrick S. Dynes; Philip J. Curtin;
Carrie Watkins; John P. Forrester; Emily R. Chalmers; Thomas J. McCool,
Marc W. Molino; David S. Dornisch; and Tania L. Calhoun made key
contributions to this report.
[End of section]
Related GAO Products:
[End of section]
Federal Insurance:
National Flood Insurance Program: Preliminary Views on FEMA's Ability
to Ensure Accurate Payments on Hurricane-Damaged Properties. GAO-07-
991T. Washington, D.C.: June 12, 2007.
Climate Change: Financial Risks to Federal and Private Insurers in
Coming Decades Are Potentially Significant. GAO-07-285. Washington,
D.C.: March 16, 2007.
Definitions of Insurance and Related Information. GAO-06-424R.
Washington, D.C.: February 23, 2006.
Federal Emergency Management Agency: Improvements Needed to Enhance
Oversight and Management of the National Flood Insurance Program. GAO-
06-119. Washington, D.C.: October 18, 2005.
Crop Insurance: Actions Needed to Reduce Program's Vulnerability to
Fraud, Waste, and Abuse. GAO-05-528. Washington, D.C.: September 30,
2005.
Catalogue of Federal Insurance Activities. GAO-05-265R. Washington,
D.C.: March 4, 2005.
Catastrophe Risk: U.S. and European Approaches to Insure Natural
Catastrophe and Terrorism Risks. GAO-05-199. Washington, D.C.: February
28, 2005.
Catastrophe Insurance Risks: Status of Efforts to Securitize Natural
Catastrophe and Terrorism Risk. GAO-03-1033. Washington, D.C.:
September 24, 2003.
Catastrophe Insurance Risks: The Role Risk-Linked Securities and
Factors Affecting Their Use. GAO-02-941. Washington, D.C.: September
24, 2002.
Insurers' Ability to Pay Catastrophe Claims. GAO/GGD-00-57R.
Washington, D.C.: February 8, 2000.
Budget Issues: Budgeting for Federal Insurance Programs. GAO/AIMD-97-
16. Washington, D.C.: September 30, 1997.
Natural Disaster Insurance: Federal Government's Interests
Insufficiently Protected Given Its Potential Financial Exposure. GAO-T-
GGD-96-41. Washington, D.C.: December 5, 1995.
Federal Disaster Insurance: Goals Are Good, but Insurance Programs
Would Expose the Federal Government to Large Potential Losses. GAO/T-
GGD-94-153. Washington, D.C.: May 26, 1994.
Flood Insurance: Financial Resources May Not Be Sufficient to Meet
Future Expected Losses. GAO/RCED-94-80. Washington, D.C.: March 21,
1994.
Property Insurance: Data Needed to Examine Availability, Affordability,
and Accessibility Issues. GAO/RCED-94-39. Washington, D.C.: February 9,
1994.
Crop Insurance: Federal Program Faces Insurability and Design Problems.
GAO/RCED-93-98. Washington, D.C.: May 24, 1993.
Crop Insurance: Program Has Not Fostered Significant Risk Sharing by
Insurance Companies. GAO/RCED-92-25. Washington, D.C.: January 13,
1992.
Disaster Assistance: Crop Insurance Can Provide Assistance More
Effectively Than Other Programs. GAO/RCED-89-211. Washington, D.C.:
September 20, 1989.
Congress Should Consider Changing Federal Income Taxation of the
Property/Casualty Insurance Industry. GAO/GGD-85-10. Washington, D.C.:
March 25, 1985.
Federal Disaster Assistance:
Gulf Coast Rebuilding: Observations on Federal Financial Implications.
GAO-07-1079T. Washington, D.C.: August 2, 2007.
Gulf Coast Rebuilding: Preliminary Observations on Progress to Date and
Challenges for the Future. GAO-07-574T. Washington, D.C.: April 12,
2007.
Small Business Administration: Additional Steps Needed to Enhance
Agency Preparedness for Future Disasters. GAO-07-114. Washington, D.C.:
February 14, 2007.
Hurricanes Katrina and Rita: Unprecedented Challenges Exposed the
Individuals and Households Program to Fraud and Abuse; Actions Needed
to Reduce Such Problems in Future. GAO-06-1013. Washington, D.C.:
September 27, 2006.
Catastrophic Disasters: Enhanced Leadership, Capabilities, and
Accountability Controls Will Improve the Effectiveness of the Nation's
Preparedness, Response, and Recovery System. GAO-06-618. Washington,
D.C.: September 6, 2006.
Disaster Relief: Governmentwide Framework Needed to Collect and
Consolidate Information to Report on Billions in Federal Funding for
the 2005 Gulf Coast Hurricanes. GAO-06-834. Washington, D.C.: September
6, 2006.
Small Business Administration: Actions Needed to Provide More Timely
Disaster Assistance. GAO-06-860. Washington, D.C.: July 28, 2006.
Federal Disaster Assistance: What Should the Policy Be? PAD-80-39.
Washington, D.C.: June 16, 1980.
[End of section]
Footnotes:
[1] According to the Insurance Information Institute, the term
"catastrophe" is often used in the property and casualty insurance
industry in a narrow way to mean a catastrophic event that exceeds a
dollar threshold in claims payouts, which is now set at $25 million in
insured damage to property.
[2] GAO, Climate Change: Financial Risks to Federal and Private
Insurers in Coming Decades Are Potentially Significant, GAO-07-285
(Washington, D.C.: Mar. 16, 2007). Property insurance covers losses
from damage to real estate and personal property because of perils such
as wind or earthquake. Casualty insurance covers liability or loss
resulting from an accident.
[3] "Insurance" is a practical method of handling a major risk. It is
the pooling of potential losses by transferring the risk to insurers
that agree to indemnify those they insure against such losses.
[4] See Justin R. Pidot, "Coastal Disaster Insurance In the Era of
Global Warming: The Case for Relying on the Private Market," Georgetown
Environmental Law & Policy Institute (Washington, D.C.: 2007); and
Wharton Risk Center Extreme Events Project, University of Pennsylvania,
Managing Large-Scale Risks in a New Era of Catastrophes: The Role of
the Private and Public Sectors in Insuring, Mitigating and Financing
Recovery from Natural Disasters in the United States, Report on Phase
One of the Study (Philadelphia, Penn.: February 2007).
[5] "Moral hazard" is an increase in the probability of loss that could
be caused by the behavior of the policyholder. For example, providing
insurance protection to an individual may lead that person to behave
more carelessly than before.
[6] "Adverse selection" occurs when insurers cannot distinguish between
less risky and more risky properties, although homeowners can. When
premiums do not reflect differences in risk that are known to potential
policyholders, those who buy insurance are often at greatest risk for
the hazards covered. Adverse selection in the market for natural
catastrophe suggests that homeowners who are at the highest risk of
experiencing a natural catastrophe will buy available insurance.
[7] National Oceanic and Atmospheric Administration, Population Trends
Along the Coastal United States: 1980-2008 (Washington, D.C.: September
2004). We checked numerous sources for more recent data on this
subject, but this document contained the best available data.
[8] Population Trends Along the Coastal United States (September 2004).
We checked numerous sources for more recent data on this subject, but
this document contained the best available data.
[9] Karen M. Clark, "The Coastline at Risk: Estimated Insured Value of
Coastal Properties," AIR Worldwide Corporation. We checked numerous
sources for more recent data on this subject, but this document
contained the best available data.
[10] "Surplus lines" refers to any type of insurance for which there is
no available market within a state and which the state allows
nonadmitted insurers to offer. A "nonadmitted" insurer is not licensed
to do standard business in the state.
[11] Martin F. Grace, Robert W. Klein, and Zhiyong Liu, "Increased
Hurricane Risk and Insurance Market Responses," Journal of Insurance
Regulation, vol. 24, no. 2 (Winter 2005).
[12] Pub. L. No. 79-5, ch. 20, 59 Stat. 33 (1945) codified as amended
at 15 U.S.C. §§ 1011-1015. See also GAO, Ultimate Effects of McCarran-
Ferguson Federal Antitrust Exemption on Insurer Activity Are Unclear,
GAO-05-816R (Washington, D.C.: July 28, 2005).
[13] "Underwriting" refers to the process of selecting and classifying
applicants for insurance. See George E. Rejda, Principles of Risk
Management and Insurance, 9TH ed. (Boston, Mass.: Addison Wesley,
2005), 587.
[14] GAO, Federal Disaster Insurance: Goals Are Good, But Insurance
Programs Would Expose the Federal Government to Large Potential Losses,
GAO/T-GGD-94-153 (Washington, D.C.: May 26, 1994). This report provided
an analysis of S. 1350, 103RD Congress (1993), which would have set up
three interrelated programs--a multihazard disaster mitigation program,
a primary insurance program for earthquakes and volcanic eruptions, and
a reinsurance program to limit insurer losses when a major disaster
strikes.
[15] The federal government operates at least 135 different programs
that provide insurance-like benefits to individuals and businesses. See
Council of Economic Advisors, Economic Report of the President
(Washington, D.C.: Feb. 13, 2007). See also GAO, Catalogue of Federal
Insurance Activities, GAO-05-265R (Washington, D.C.: Mar. 4, 2005).
[16] Section 408 of the Robert T. Stafford Disaster Relief and
Emergency Assistance Act, 42 U.S.C. § 5174, is the general authority
for the President to provide assistance to individuals and households.
Until the 1950s, the federal government assisted Americans harmed by
disasters only occasionally on an ad hoc basis. Prior to then,
policymakers did not typically view disaster relief as an ongoing
federal responsibility. See David A. Moss, When All Else Fails:
Government as the Ultimate Risk Manager, (Cambridge, Mass.: Harvard
University Press, 2002), 260-267.
[17] 7 U.S.C. § 1508(e).
[18] 7 U.S.C. § 1508(e).
[19] Previous studies have shown that 50 to 60 percent of single-family
homes in special flood hazard areas are subject to the mandatory
purchase requirement. Estimating the percentage of homes complying with
the mandatory purchase requirement is difficult because of uncertainty
about whether a home has a mortgage and whether that mortgage is
subject to the mandatory purchase requirements. See Lloyd Dixon, Noreen
Clancy, Seth A. Seabury, and Adrian Overton, The National Flood
Insurance Program's Market Penetration Rate: Estimates and Policy
Implications (Santa Monica, Calif.: RAND Corporation, 2005).
[20] 13 C.F.R. § 123.5.
[21] For further information about the CDBG program, see GAO, Community
Development Block Grants: Program Offers Recipients Flexibility but
Oversight Can Be Improved, GAO-06-732 (Washington, D.C.: July 28,
2006).
[22] GAO, Gulf Coast Rebuilding: Preliminary Observations on Progress
to Date and Challenges for the Future, GAO-07-574T (Washington, D.C.:
Apr. 12, 2007).
[23] The FWUA was created by statute in 1970 to provide windstorm and
hail coverage to high-risk areas of Florida. The JUA was created in
December 1992 in the wake of the capacity crisis that followed
Hurricane Andrew and provided residential multiperil insurance
coverage, excluding wind coverage if the property was within FWUA-
eligible areas.
[24] Howard Kunreuther and Richard J. Roth, Sr., eds., Paying the
Price: The Status and Role of Insurance Against Natural Disasters in
the United States (Washington, D.C.: Joseph Henry Press, 1998).
[25] Kunreuther and Roth, Paying the Price.
[26] 7 U.S.C. §1508(e).
[27] Specifically, for 55 percent coverage, the premium subsidy rate is
64 percent; for 65 percent coverage, the premium subsidy rate is 59
percent; for 75 percent coverage, the premium subsidy is 55 percent;
and, for 85 percent coverage, the premium subsidy is 38 percent.
[28] A "loss ratio" is calculated as claims paid divided by total
premiums collected.
[29] GAO, Crop Insurance: Actions Needed to Reduce Program's
Vulnerability to Fraud, Waste, and Abuse, GAO-05-528 (Washington, D.C.:
Sept. 30, 2005).
[30] GAO, Federal Emergency Management Agency: Improvements Needed to
Enhance Oversight and Management of the National Flood Insurance
Program, GAO-06-119 (Washington, D.C.: Oct. 18, 2005); Flood Insurance:
Financial Resources May Not Be Sufficient to Meet Future Expected
Losses, GAO/RCED-94-80 (Washington, D.C.: Mar. 21, 1994); Effect of
Premium Increases on Achieving the National Flood Insurance Program's
Objectives, GAO/RCED-83-107 (Washington, D.C.: Feb. 28, 1983); and
GAO's High-Risk Program, GAO-06-497T (Washington, D.C.: Mar. 15, 2006).
[31] Statement of Donald B. Marron, Acting Director of the
Congressional Budget Office, "The Budgetary Treatment of Subsidies in
the National Flood Insurance Program," before the Committee on Banking,
Housing, and Urban Affairs of the U.S. Senate (Jan. 25, 2006), 1.
[32] Legislation passed in May 2006 required Florida Citizens to charge
rates sufficient to purchase a certain amount of reinsurance, but this
requirement was repealed by the January 2007 legislation.
[33] Section 2210.359(a) and (b) of the Texas Insurance Code.
[34] Policyholders' "surplus" is the difference between an insurer's
assets and its liabilities.
[35] Center on Federal Financial Institutions, "National Flood
Insurance Program" (Washington, D.C.: Sept. 25, 2006). See also FEMA,
"Significant Flood Events, 1978-May 31, 2007," available at [hyperlink,
http://www.fema.gov/business/nfip/statistics/sign1000.shtm].
[36] Fitch Ratings, "Citizens Property Insurance Corporation-High Risk
Account" (New York, NY: May 26, 2006).
[37] Standard & Poor's, "Florida Hurricane Catastrophe Fund Finance
Corp.-Florida Hurricane Catastrophe Fund" (New York, NY: July 7, 2006).
[38] Mississippi Windstorm Underwriting Association, "Accounting Report
for Year Ended December 31, 2005" (Mar. 1, 2006).
[39] Fitch Ratings, "Louisiana Citizens Property Insurance Corporation"
(New York, NY: Apr. 11, 2006).
[40] The most popular coverage for crop insurance is 70 percent of
average yield. See Congressional Research Service, "Agricultural
Disaster Assistance" (Washington, D.C.: Oct. 6, 2006).
[41] Florida Governor's Property and Casualty Insurance Reform
Committee, "Interim Report and Recommendations" (Nov. 16, 2006),
available at [hyperlink, http://www.floir.com].
[42] Mississippi Code, § 83-34-9.
[43] U.S. Department of Housing and Urban Development, Office of Policy
Development and Research, "Current Housing Unit Damage Estimates:
Hurricanes Katrina, Rita, and Wilma" (Washington, D.C.: Feb. 12, 2006).
We asked the insurance departments in several states whether they could
provide information on the numbers of uninsured and underinsured
homeowners, but they were unable to do so.
[44] Federal disaster assistance is sometimes cited as a reason
homeowners do not purchase natural catastrophe insurance. However, some
studies have suggested that individuals may not anticipate receiving
any federal aid following a disaster. See Howard Kunreuther, "Has the
Time Come for Comprehensive Disaster Insurance?" in On Risk and
Disaster: Lessons from Hurricane Katrina, ed. Ronald J. Daniels, and
others, (Philadelphia, Penn.: University of Pennsylvania Press, 2006),
175-201.
[45] Federally insured or regulated lenders must require flood
insurance as a condition of extending a mortgage in SFHAs.
[46] Howard Kunreuther and Mark V. Pauly, "Neglecting Disaster: Why
Don't People Insure Against Large Losses?" Journal of Risk and
Uncertainty, vol. 28, no. 1 (January 2004), 5-21.
[47] Risa Palm and Michael Hodgson, After a California Earthquake:
Attitude and Behavior Change, University of Chicago Research Papers
(Chicago, Ill.: 1992); and Paul Slovic, The Perception of Risk (London,
England: Earthscan, 2000).
[48] Dwight M. Jaffee, "Commentary," Federal Reserve Bank of St. Louis
Review (July/August 2006), 381-85.
[49] Making estimates of the number of homes in SFHAs that have flood
insurance is difficult because it can be hard to determine whether a
home has a mortgage and whether a mortgage is subject to the mandatory
purchase requirement. See Dixon, Clancy, Seabury and Overton, The
National Flood Insurance Program's Market Penetration Rate.
[50] This contract language is also known as the "coinsurance clause,"
which is a contractual provision that requires a property owner to
insure the property for a stated percentage of its insurable value. The
fundamental purpose of coinsurance is to achieve rate equity.
Policyholders who meet the coinsurance requirement are not penalized at
the time of loss, and the policyholder who is underinsured (i.e.,
maintains insurance limits that are less than 80 percent of the
replacement cost of the dwelling) is penalized.
[51] To provide some coverage for the costs of rebuilding to new codes,
Insurance Services Organization Form HO-3 was revised in 1994 to
provide "ordinance and law" coverage of up to 10 percent of the
coinsurance provision replacement cost.
[52] On May 25, 2007, Congress approved an additional $3.4 billion in
emergency appropriations to FEMA for disaster relief from Hurricane
Katrina. See Pub. L. No. 110-28, 121 Stat. 169 (May 25, 2007).
[53] The maximum amount is adjusted annually to reflect changes in the
Consumer Price Index.
[54] GAO, Hurricanes Katrina and Rita Disaster Relief: Improper and
Potentially Fraudulent Individual Assistance Payments Estimated to Be
between $600 Million and $1.4 Billion, GAO-06-844T (Washington, D.C.:
June 14, 2006); Hurricanes Katrina and Rita: Unprecedented Challenges
Exposed the Individuals and Households Program to Fraud and Abuse;
Actions Needed to Reduce Such Problems in Future, GAO-06-1013
(Washington, D.C.: Sept. 27, 2006); Hurricanes Katrina and Rita
Disaster Relief: Continued Findings of Fraud, Waste, and Abuse, GAO-07-
252T (Washington, D.C.: Dec. 6, 2006); and Hurricanes Katrina and Rita
Disaster Relief: Continued Findings of Fraud, Waste, and Abuse, GAO-07-
300 (Washington, D.C.: Mar. 15, 2007).
[55] GAO, Small Business Administration: Actions Needed to Provide More
Timely Disaster Assistance, GAO-06-860 (Washington, D.C.: July 28,
2006); and Small Business Administration: Agency's Response to Gulf
Coast Hurricanes Highlights Need to Enhance Preparedness for Future
Disasters, GAO-07-114 (Washington, D.C.: Feb. 14, 2007).
[56] The total emergency appropriation to HUD was $17.099 billion, and
$16.7 billion of that amount was made available to the CDBG program.
[57] Pursuant to federal statute, homeowner assistance provided by
these funds may not duplicate benefits derived from any other source
received by the homeowner as a result of damages incurred during the
hurricanes. Thus, the granting of CDBG funds to a homeowner cannot
duplicate insurance, FEMA, or other payments received by the homeowner.
[58] Mississippi established a second phase of its program that offers
grants of up to $100,000 to eligible homeowners.
[59] GAO, The Nation's Long-Term Fiscal Outlook, August 2007 Update:
Despite Recent Improvement in the Annual Deficit, Federal Fiscal Policy
Remains Unsustainable, GAO-07-1261R (Washington, D.C.: Sept. 28, 2007).
[60] GAO, State and Local Governments: Persistent Fiscal Challenges
Will Likely Emerge within the Next Decade, GAO-07-1080SP (Washington,
D.C.: July 18, 2007).
[61] Combinations of public policy options could have a different
overall effect than individual public policy options.
[62] National Association of Insurance Commissioners, National
Catastrophe Risk Plan: Creating a Comprehensive National Plan (Kansas
City, Mo.: Dec. 11, 2006), 4; and Kunreuther "Has the Time Come?" Some
countries--such as France and Spain--have government programs that
include multiple perils like earthquake and floods. See GAO,
Catastrophe Risk: U.S. and European Approaches to Insure Natural
Catastrophe and Terrorism Risks, GAO-05-199 (Washington, D.C.: Feb. 28,
2005), 33.
[63] "Mandatory" can also mean that insurers would be required to offer
a policy that includes all of the catastrophe perils. However, in this
public policy option, we mean mandatory purchase by the consumer.
[64] State governments could also be providers of premium subsidies.
[65] Experts debate the dollar threshold for insured losses beyond
which a catastrophe becomes a "megacatastrophe."
[66] Elements of this proposal are contained in several bills before
the 110TH Congress, including the Homeowners Insurance Protection Act
of 2007 (H.R. 91), the Homeowners Protection Act of 2007 (S. 928), and
the Homeowners Defense Act of 2007 (H.R. 3355).
[67] See the Homeowners Insurance Availability Act of 2007, H.R. 330,
110TH Congress. See also Christopher Lewis and Kevin Murdock, "The Role
of Government Contracts in Discretionary Reinsurance Markets for
Natural Disasters," The Journal of Risk and Insurance vol. 63, no. 4
(December 1996).
[68] "Timing risk," or the smoothing out of cash flows, is a
significant issue for the insurance industry. Insurance ventures need
to be able to pay annual losses out of annual premiums. It is unclear
whether the capital of the insurance industry, or even a subset of the
industry, would be sufficient at a given point in time to meet the
demands of a major catastrophe. Given its taxing and borrowing
authority, the federal government has an advantage in bearing the
timing risk associated with disasters.
[69] This proposal was initially developed by an NAIC committee and is
reflected in the Policyholder Disaster Protection Act of 2005, H.R.
2668, 109th Congress.
[70] A "property casualty company loss reserve" is an accounting entry,
a liability on the balance sheet, for the amount of money the company
expects to pay out in the future to cover indemnity payments that will
come due on policies already written for losses that have already been
incurred and the costs of dealing with the associated claims. Loss
reserves do not reflect the pattern of future claims payments. Premium
payment funds that cannot be put into loss reserves must be treated as
underwriting profits.
[71] Omnibus Coastal Property Insurance Reform Act of 2007, South
Carolina Act No. 78 (June 11, 2007).
[72] Catastrophe bonds are risk-based securities that pay relatively
high interest rates and provide insurance companies with a form of
reinsurance to pay catastrophe losses, such as those caused by a major
hurricane. They allow insurance risk to be sold to institutional
investors in the form of bonds, thus spreading risk.
[73] GAO, Catastrophe Insurance Risks: The Role of Risk-Linked
Securities and Factors Affecting Their Use, GAO-02-941 (Washington,
D.C.: Sept. 24, 2002); Catastrophe Insurance Risks: Status of Efforts
to Securitize Natural Catastrophe and Terrorism Risks, GAO-03-1033
(Washington, D.C.: Sept. 24, 2003); and Catastrophe Risk: U.S. and
European Approaches to Insure Natural Catastrophe and Terrorism Risks,
GAO-05-199 (Washington, D.C.: Feb. 28, 2005). Asset-backed securities,
for example, are backed by loans or accounts receivable originated by
banks, credit card companies, or other providers of credit.
[74] The first catastrophe bond is a $4 billion principle at-risk
variable rate note issued by Merna Re for the ultimate benefit of State
Farm Insurance Company. It transfers a portion of State Farm's risk of
natural catastrophe losses in the United States and Canada, including
hurricane, earthquake, tornado, hail, winter storm, and brush fire. The
second catastrophe bond is a $2 billion principle at-risk variable rate
note issued by Willow Re for the ultimate benefit of Allstate Insurance
Company. The first issuance under this bond is a $250 million tranche
that covers hurricane risk in New York, New Jersey, and Connecticut.
[75] National Association of Insurance Commissioners, Catastrophe
Insurance (C) Working Group, "The Utah Catastrophe Insurance Plan"
(June 3, 2007).
[76] Property taxes are not deductible in all tax situations--for
example, with the alternative minimum tax. This proposal would require
changes in tax law if the intention is for property taxes related to
catastrophe perils to be deductible in all situations.
[77] GAO, Gulf Coast Rebuilding: Preliminary Observations on Progress
to Date and Challenges for the Future, GAO-07-574T (Washington, D.C.:
Apr. 12, 2007).
[78] Legislation passed in early 2007 permits Florida Citizens to issue
multiperil policies in the HRA.
[79] These are the "effective" commission rates as related to the total
policy premium. The stated rates exclude certain components of the
premium and are lower rates.
[80] In March 2007, Fitch Ratings issued a Negative Ratings Watch on
Louisiana Citizens and the bond offering because of computer problems
experienced by Louisiana Citizens making it difficult for it to
retrieve financial data for 2005 and 2006. More recently, an official
at Louisiana Citizens told us that the problems were being resolved,
and that the Negative Ratings Watch had been lifted.
[81] In 2007, the Mississippi Legislature passed House Bill 1500, "the
Mississippi Economic Growth and Redevelopment Act of 2007," which
changed the structure of the Mississippi Windstorm Underwriting
Association. We attempted to reflect certain changes instituted by the
bill in this section.
[82] Section 2210.359(a) and (b) of the Texas Insurance Code.
[End of section]
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