Market Implications of Public Policy Interventions: The Case of Florida's Property Insurance Market
Author | J. Bradley Karl,Lorilee A. Medders,Charles M. Nyce |
Published date | 01 September 2014 |
DOI | http://doi.org/10.1111/rmir.12006 |
Date | 01 September 2014 |
Risk Management and Insurance Review
C
Risk Management and Insurance Review, 2013, Vol.17, No. 2, 183-214
DOI: 10.1111/rmir.12006
MARKET IMPLICATIONS OF PUBLIC POLICY
INTERVENTIONS:THE CASE OF FLORIDA’SPROPERTY
INSURANCE MARKET
Lorilee A. Medders
Charles M. Nyce
J. Bradley Karl
ABSTRACT
This article asserts that the market for property insurance, particularly home-
owners insurance, in the State of Florida is experiencing failures, and that a
combination of market problems, externalities, and interventions unique to
Florida led to these failures. The authors provide evidence of market failures
in the form of undesirable market outcomes, both over time and in comparison
to other coastal states. Also, they provide a narrative description of the market
events, problems, and policies preceding these adverse market developments
and link the narrative to the evidence. Recommendations for a return to risk-
based pricing and incentives for appropriate property mitigation are made.
INTRODUCTION
The number and magnitude of catastrophic events in recent years, such as the September
11, 2001 terrorist attacks, Hurricane Katrina, and the March 2011 Japanese tsunami, have
inspired a rise in the attention devoted to catastrophes by academics. The impact of
catastrophes on insurance markets, in particular, has been a subject of attention from
policymakers, the media, academics, and the general public in recent years. Beginning
with Hurricane Andrew in 1992, Florida has been at the forefrontof discussions related to
natural catastrophes and insurance markets. The state, given its loss history and exposure
to hurricanes, provides an excellent setting to analyze the effectthat catastrophe exposure
and catastrophe losses have on property insurance market operations and performance.
While Florida’s heavy geographic exposure to catastrophic tropical windstorms is
clear, it is is only one of myriad factors that impact Florida’s property insurance
This article was subject to double-blind peer review.
Lorilee A. Medders and Charles M. Nyce are at Florida State University, College of Busi-
ness, Room 233 RBB, Tallahassee, FL 32306-1110; phone: 850-645-8393; fax: 850-645-8391; e-mail:
lmedders@fsu.edu. J. Bradley Karl is at East Carolina University,College of Business. The authors
wish to thank the Florida Catastrophic Storm Risk Management Center for financial support as
well as Patrick F. Maroney and Sue EllenSmith for their valuable contributions to this article.
183
184 RISK MANAGEMENT AND INSURANCE REVIEW
market. One particular factor is that the availability of private capital to support catas-
trophic windstorm exposure is contingent upon regulatory and legislative directives
intended to ease market pressures and stabilize pricing. We submit that recent regula-
tory and legislative directives in Florida’s property insurance market have suppressed
prices and increased long-term state market pressures that create questions of market
sustainability.1
The purpose of this article, therefore, is to provide evidence that regulatory and leg-
islative directives in the state of Florida, made in response to recent catastrophe losses
and continued catastrophic exposure, had a direct and detrimental effect on Florida’s
property insurance marketplace. We detail how problems in the Florida homeowners
insurance market—of which the natural risk and loss exposure are primary—led to high
prices and decreased capacity, which led to policy pressures to increase affordability
and availability. While we provide evidence that policy choices made in response to
catastrophic loss and exposure did reduce property insurance prices, we also assert that
these policy directives also resulted in market failures, namely, a loss of private market
capacity and potentially inadequate capital to cover losses. By so doing, we contribute
to literature related to understanding the role catastrophes play in insurance market
operations, the role of regulation in insurance markets, and the operations and status of
Florida’s property insurance market.
The article consists of four sections. “Risky Insurance Markets, Capacity Constraints,
and Government Interventions: Review of the Literature” contains a discussion of the
prior literature relevant to insurance market problems, market performance, and their
relationship to government interventions. “Evidence of Market Challenges in Florida”
establishes Florida’s residential property insurance system as a failing market through
an assessment of its exposure, structure, and condition, both over time and in com-
parison with residential property markets in other states. “Recent Performance of the
Florida Homeowners Insurance Market” examines market problems faced in Florida
and the negative externalities created by government responses to these problems that
the authors assert all have contributed to the market’s failures. “Factors Leading to
Florida’s Recent Property Insurance Market Failures: Market Problems and Govern-
ment Responses” offers concluding thoughts and avenues of future research.
RISKY INSURANCE MARKETS,CAPACITY CONSTRAINTS,AND GOVERNMENT INTERVENTIONS:
REVIEW OF THE LITERATURE
Prior research on catastrophe insurance market problems and government response is
ample. The relationship between these and market performance has also been studied.
Findings relevant to the current research follow.
1The government interventions specifically discussed in this article are related to pricing and
pricing discounts that were originally intended to combat the affordability problem in Florida’s
homeowners insurance market. Other government actions may impact this market to some
extent as well, but the authors contend other such policies to be, at worst, secondary factors in
the marketplace.
MARKET IMPLICATIONS OF PUBLIC POLICY INTERVENTIONS 185
Problems in High-Risk (Catastrophe) Insurance Markets
Markets that include high potential for catastrophic industry losses are prone to a variety
of problems. The relationships between demand–supply efficiencies, resulting market
performance, and aggregate market capacity are important in the study of catastrophe-
exposed markets. Arrow (1971) and Dionne and Harrington (1992) describe basic models
for insurance demand by individuals, and Kunreuther (1998) describes the special effects
of catastrophic risk on these models. Several studies, such as Ehrlich and Becker (1972),
Kunreuther (1978), Dionne and Eeckhoudt (1985), and Kunreuther and Kleffner (1992),
have established the individual insurance purchase in the face of disaster potential as
being, to some extent, a choice between loss mitigation (self-insurance) and risk transfer
(insurance).2Additional research has found evidence of an inverse relationship between
expectations of government disaster relief and both structural mitigation and insurance
demand. The findings of Kaplow (1991), Kelly and Kleffner (2003), and Kunreuther and
Pauly (2006) are consistent with the idea that disaster assistance reduces incentives for
individuals to invest in risk reduction or private risk transfer.
The literature on supply-side problems in insurance markets reveals that solvency con-
straints limit the available capacity of the marketplace.3Klein and Kleindorfer (2003)
develop a theoretical illustration of the negative externalities, and ultimately market
failures, that can result from decreases in the price ceiling within catastrophe-prone
markets. The resulting choice by private insurers to decrease market exposure, and thus
decrease capacity in the highest-risk zones, is of particular relevance to our research.4
The prior literature pertaining to the underwriting cycle also offersinsight into the factors
that impact insurance availability.5Wealso note that capacity constraints associated with
the underwriting cycle can have an indirect effect on the supply of property insurance
in catastrophe-prone markets. For example, Cummins (2006) states, “Insurance markets
tend to respond adversely to mega-catastrophes. They respond to large events. . . by
restricting the supply of insurance and raising the price of the limited coverage available.
This occurred, for example, following Hurricane Andrew in 1992 ...” (p. 338).
2The findings of research regarding the actual relationship between the availability/pricing of
insurance and personal investments in risk-reducing activities are mixed; while insurance trans-
fers risk of financial loss from the individual to the insurance company it inherently creates an
incentive for insurance companies to develop a pricing scheme that rewards policyholders who
mitigate. So while the availability of insurance reduces the incentive to make mitigation expen-
ditures, all else the same, insurance prices can be adequately high to encourage mitigation. See
Klein and Kleindorfer (2003) for mathematical illustration and additional literature pertaining
to the relationship between insurance and mitigation.
3Stone (1973) and Herring and Vankudre (1987), followed by Grace, Klein, and Kleindorfer
(1999) lay out the capacity issues faced by insurers when considering risk taking in problematic
markets.
4Also of relevance to our research are studies such as Doherty (1980), Nielson (1984), and Cum-
mins et al. (2002) that have examined issues related to capacity and we use such studies as
a guide for analyzing the supply side problems associated with Florida’s property insurance
market.
5See Cummins (2006) for other literature that links insurance capacity to underwriting cycles,
such as Gron (1994) and Fung et al. (1998).
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