Property insurance for coastal residents: governments" "ill wind".

• Author: Pompe, Jeffrey J.
• Position: Essay

It's an ill wind that blows nobody any good.

--Proverb

Living in coastal areas entails the risk of property damage from catastrophic storms, such as hurricanes and northeasters. (1) In recent years, costs associated with such storm damage, which disproportionately affect property owners living near the coast, have risen precipitously. In reaction, property owners have successfully applied pressure on lawmakers to intervene on their behalf. Unfortunately, government policies have been counterproductive, shifting costs to taxpayers at large and actually encouraging growth in such hazardous areas.

The greatest likelihood of severe damage from hurricanes is along the coastlines of the southeastern Atlantic and Gulf of Mexico states, where 112 major hurricanes struck between 1851 and 2006 (Blake, Rappaport, and Landsea 2007). (2) Although predictions of where the next major storm will hit are problematic, some locations clearly are more prone to suffer from storms than are others. In the past, 39 percent of all major hurricanes in the United States have battered Florida, and 71 percent of category 4 or 5 hurricane strikes have pummeled either Florida or Texas.

After a period of infrequent hurricane activity between 1971 and 1994, hurricane activity has increased in recent years. The five most intense consecutive storm seasons on record occurred between 1995 and 2000. In 2004, an unprecedented four hurricanes (Charley, Frances, Ivan, and Jeanne) damaged Florida communities. The 2005 hurricane season was the busiest and costliest in U.S. history, with twenty-eight named storms, fifteen of which were hurricanes, including the most devastating one, Hurricane Katrina (South Carolina Department of Insurance 2007, 14). Katrina caused at least twelve hundred deaths along the Gulf Coast from Mobile, Alabama, to New Orleans and was especially damaging to New Orleans, large areas of which are below sea level. Total insured losses from all 2005 hurricanes are estimated to have been more than $60 billion, with private insured losses alone estimated at $40 billion (South Carolina Department of Insurance 2007). The 2004 and 2005 hurricane seasons produced seven of the ten costliest insured losses ever in the United States; the costliest losses were from Katrina, which caused $40.6 billion in damages (table 1). In total, the seven hurricanes caused $79.3 billion in insured losses.

In part, recent storms have become costlier because of rapid population growth in coastal areas, with the consequent construction of more homes and businesses. The National Oceanic and Atmospheric Administration's report on coastal population trends in the United States shows that from 1980 to 2003, coastal population increased from 120 million to 153 million, an increase of 28 percent (Crossett et al. 2004, 1). Current projections indicate that another 11 million people will have moved to coastal counties by this year (2008), producing a further 7 percent increase. Much of the coastal population growth has occurred on the shorelines of southeastern and Gulf Coast states. Coastal population density of the Southeast region increased from 142 to 224 persons per square mile between 1980 and 2003, and is expected to increase to 241 by 2008 (Crossett et al. 2004, 16). The current population density of the Southeast region is two and a half times the average population density of the nation, which is 98 persons per square mile. The 2006 population of Dade, Broward, and Palm Beach counties, along Florida's eastern coast, was 5.5 million, which was greater than the population of thirty states together. Gulf Coast population growth has also been rapid. In 2005, there were 9.46 million people living in coastal counties stretching from Louisiana to the Florida Keys. The sixty-seven coastal counties in these four states had a population density of 188.8 people per square mile (U.S. Department. of Commerce 2005).

Storm-damage costs are also rising because property values along coastlines have risen dramatically, especially since 1970. The estimated value of properties in coastal areas has doubled in the past decade. In 2004, the total value of insured residential and commercial coastal property was $7.2 trillion (AIR Worldwide Corporation 2005). In South Carolina alone, insured coastal property value was $148.8 billion in 2004, an increase of 377 percent since 1988 (South Carolina Department of Insurance 2007, 17). Stricter building standards have increased construction costs, but more significant has been the trend toward bigger and more elaborate structures. Costs from storm damage also rise because of the skyrocketing cost of building materials and labor after hurricanes. In a storm's aftermath, a "demand surge" for materials and labor drives up their prices and hence the amount of insured losses (Tibbetts 2007).

Storm surge--the rapid rise of sea level that accompanies hurricanes--creates the greatest flood damage to shoreline properties. The risk of damage from storm surge decreases significantly as distance from the shore increases. A very strong hurricane can produce a storm surge of as much as twenty feet, which generally would dissipate within ten miles of the shoreline (Pielke and Pielke 1997, 120). Hurricanes also cause wind damage, which is not covered by flood insurance and accounts for the largest portion of property loss associated with storms. Although wind velocity decreases as hurricanes make land, serious wind damage can still occur many miles inland.

Insurance is an important means of mitigating the adverse effects of storm damage, but as premiums rise, alternative locations away from the coast become more attractive. Individuals ordinarily respond to the rising costs associated with storm damage by moving out of harm's way, if ever so reluctantly. Unfortunately, as we show in this essay, governmental policies have had the effect of keeping insurance premiums below projected losses, especially with respect to flood insurance, thereby neutralizing the market incentives that would have encouraged a retreat from the seaside and discouraged excessive building in high-risk coastal zones. We argue that government involvement in private insurance markets should be limited in order to allow private insurers to meet coastal residents' needs.

Government Involvement in the Coastal Property Insurance Market

After offering flood insurance in the early twentieth century, insurance companies determined that adverse selection and high correlation of risks caused premiums to be too high for consumers (Kunreuther and Roth 1998, 40). Flood insurance was thereafter generally unavailable until 1968, when Congress created the National Flood Insurance Program (NFIP), which provided federally backed flood insurance for property owners. A community can participate in the NFIP if it agrees to establish land-use direction that limits damage exposure to storms in flood-prone areas. Under the supervision of community management, the NFIP was intended to guide development away from flood-prone areas and to enforce building standards, thus reducing federal disaster-relief payments arising from loss of life and property.

NFIP insurance, which is administered by the Federal Emergency Management Agency (FEMA), covers property damage for homeowners up to a maximum of $250,000 for structures and $100,000 for contents. In addition, it is possible to buy additional flood insurance from private companies. In 2006, the average amount of flood coverage was $190,849, and the average annual premium was $474 (Insurance Information Institute 2007b). There are four categories of flood zones: V, A, C, and X. Zones V and A are hazard areas, and properties in zone V are subject to the greater risk. In zones C and X, which are nonhazard zones, flood insurance is optional. For coverage up to $250,000, an NFIP insurance premium is, on average, approximately $317 per year for a low-to-moderate-risk residence and $4,323 per year for a high-risk coastal property (FEMA 2007a). In 2007, the NFIP collected $2.2 billion in total premiums on $1 trillion of coverage for almost 5.5 million policies, covering nearly twenty thousand communities (FEMA 2007a).

Communities in certain high-risk areas, which are included in the 1982 Coastal Barrier Resource Act (CBRA), are restricted from receiving NFIP insurance. CBRA prohibits federal financial assistance, post-storm reconstruction, and erosion control in undeveloped areas of barrier islands designated by the Department of Interior. Barrier islands parallel mainland areas and thus provide a buffer against storms and offer a valuable habitat for fish and wildlife. The goal of CBRA, which was amended by the Coastal Improvement Act in 1990, is to protect barrier island ecosystems by not encouraging their development with federal subsidies. The original 186 CBRA locations were expanded to 590 in 1990 (Pasternick 1998, 146).

Besides enacting and amending CBRA, legislators have made numerous other policy modifications that deal with problems of the initial NFIP. The Flood Disaster Protection Act of 1973 requires those who receive federal disaster assistance to purchase flood insurance. In 1983, the NFIP began the Write-Your-Own Program (WYOP), which allows private companies to sell federally underwritten flood insurance policies. WYOP companies write 95 percent of all NFIP policies (U.S. GAO 2007). The 1988 Stafford Disaster Relief and Assistance Act made disaster assistance available and attempted to lessen the moral hazard that federal disaster assistance creates.

The National Flood Insurance Reform Act of 1994 created incentives to encourage mitigation measures and floodplain-management plans. The Disaster Mitigation Act of 2000 increased funding for state and local government activities that improve hazard preparedness and response. The Flood Insurance Reform Act of 2004 was designed to reduce the number of repetitive property losses, which...