In September, 2009, Adrienne discussed the possibilities for the government’s help in addressing the ravages of a natural disaster. At that time, we hoped to hear from our readers with their thoughts on the feasibility of a national natural disaster insurance program. Then, we considered whether individuals felt comfortable remaining uninsured when faced with natural disasters such as Hurricane Katrine and the almost seasonal wildfires spurred by the Santa Ana winds. What level of risk do you deem acceptable? Then, we didn’t stop to envision the possibility that insurers would simply back out of certain catastrophe coverage markets. Yet, that is just what is happening in Florida, right now.
Times files | 1998
In the months following our entry, we remained curious about the effect of natural disasters on insurance companies and its treatment of policy-holders. The recent situation in Florida is a perfect example. Following a lengthy battle with the State of Florida to deregulate the insurance market in which the insurance giant’s bid for marked premium increases was denied, State Farm insurance has decided to pull out Florida’s property insurance market over a period of 18 months. As a result, some 1.2 million property insurance policies will be dropped – the majority of which are held by homeowners in the hurricane-prone state’s coastal regions – which will likely push many into the already bloated state-run insurer of last resort, Citizens Property Insurance Corp.
The insurer’s plans reflect a compromise between it and the Florida Office of Insurance Regulation. After announcing that it is losing approximately $20 million per month that it continues to operate in the state, State Farm Insurance attempted to withdraw its operations from Florida. Following 11 months of stalled negotiations, State Farm backed off its plans to withdraw from the state completely; instead, it would plug its financial leaks by dropping policies, abstain from offering discounted rates, and increasing the average rates by approximately 15%, statewide. The insurance giant promised that it would not leave policyholders stranded in the middle of hurricane season, but that its agents would aid customers in transferring their policies to one of 16 other insurers authorized to do business in the state.  Florida homeowners were outraged. But, really, should they have been?
Hurricane insurance rates were rising. In addition to rising premiums, some vulnerable insureds were faced with higher deductibles before being dropped entirely by their insurance providers. Homeowner insurance providers, like State Farm, were passing the costs of doing business onto their consumers. The companies, paid out higher than expected claims following the devastation in the wake of Andrew. (I’m sure the actuaries prognosticating those events weren’t around long following these natural disasters.) So, to mitigate the risk of additional future claim payouts, companies sought out reinsurance. And, that increased the company’s cost of doing business. As a result, insurers passed along those costs to consumers – the affected ones and the non-affected ones, too. It stands to reason, then, that with a glut of customers seeking new insurance providers, competition for new business would act as a control on prices, allowing consumers to obtain competitive prices.
Now, let’s backtrack for just a second. Would a national catastrophic insurance program be the best way to handle vulnerable properties? Should all taxpayers subsidize the decisions of those who chose to build in a low-lying or natural disaster-prone area? More specifically, how many times should a company pay out on a claim before it chooses to terminate the policy?
The Economic Logician examined the moral implications of a national catastrophe insurance program last September. In his post, he asked: “why did private insurance companies leave the hurricane insurance market in Florida?” A comment left on his blog stated:  “The implied answer to your question about private companies is that the risk in general is not fully priced into the government policy, and that on a practical basis the political tendency regarding differential risk based on location on government-sponsored insurance is that very high rates on at-risk property would meet more organized resistance than more moderately higher premiums across the board, which would imply in-landers would subsidize coastal folks.”
Was the commentator on The Economic Logician’s post correct in his conclusions?  Well, we can take a look at FEMA and its flood insurance program for an answer.
In 1968, Congress established the National Flood Insurance Program (NFIP) to enable vulnerable property owners in participating communities to buy insurance to protect against flood losses. In exchange, states and local communities committed to regulating construction in floodplains to reduce future flood damage. The floodplain management usually regulates the construction or expansion of structures in flood-prone areas. The insurance was meant to act as an alternative to federal disaster assistance.
But NFIP cannot work alone. Rather, it is intended to act in concert with a private insurance coverage portfolio in a way that appropriately apportions risk. Given this example, do you think that a national program – or even a state program like Florida’s Citizens Insurance – is the answer when a major disaster occurs and an insurance company is not equipped to handle the claims?
Posted by Krystyna on February 23, 2010 at 11:37am.
