The Perfect Storm: Hurricanes, Insurance, and Regulation

• Date: 01 March 2009
• Published date: 01 March 2009
• Author: Martin F. Grace,Robert W. Klein
• DOI: http://doi.org/10.1111/j.1540-6296.2009.01155.x

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Risk Management and Insurance Review, 2009, Vol.12, No. 1, 81-124

PERSPECTIVES ARTICLES

THE PERFECT STORM:HURRICANES,INSURANCE,

AND REGULATION

Martin F. Grace

Robert W. Klein

ABSTRACT

The intense hurricane seasons of 2004 and 2005 caused considerable instabil-

ity in property insurance markets in coastal states with the greatest problems

occurring in Florida and the Southeast. Insurers have substantially raised rates

and decreased their exposures. While no severe hurricanes struck the United

States in 2006 and 2007, market pressures remain strong given the high risk

still facing coastal states. These developments generate considerable concern

and controversy among various stakeholder groups. Government responses

have varied. In Florida, political pressures prompted a wave of legislation and

regulations to expand government underwriting and subsidization of hurri-

cane risk and constrain insurers’ rates and market adjustments. Other states’

actions seem more moderate. In this context, it is important to understand how

property insurance markets have been changing and governments have been

responding to increased catastrophe risk. This article examines important mar-

ket developments and evaluates associated government policies. We comment

on how regulation is affecting the equilibration of insurance markets and offer

opinions on policies that are helpful and harmful.

INTRODUCTION

The risk and cost of natural disasters and their effects on insurance markets and as-

sociated government policies are elements of an interesting and important story about

the interplay of economics and politics.1It is a story that may contain some familiar

as well as peculiar elements to students of political economy. In our opinion, the high

degree of uncertainty associated with disaster risk challenges insurers and its opaque

Martin F. Grace, James S. Kemper Professor, Department of Risk Management, Georgia State

University, P.O. Box 4035, Atlanta, GA 30302-4035; phone: 404-413-7469; fax: 404-413-7516; e-

mail: mgrace@gsu.edu. Robert W. Klein, Associate Professor and Directorof the Center for RMI

Research, Georgia State University, P.O. Box 4036, Atlanta, GA 30302-4036; phone: 404-413-7471;

fax: 404-413-7516; e-mail: rwklein@gsu.edu. This article was subject to double-blind peer review.

1Hurricane risk can be defined in different ways. A simple definition of hurricane risk is the

expected average annual loss from hurricanes. A broader definition would include various

dimensions of the estimated probability distribution for hurricane losses, e.g., its mean, variance,

and long right-hand tail. One could also include “parameter uncertainty” in the definition of

hurricane risk.

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nature enables politicians to shift risk more easily and obtain greater subsidies for those

exposed to disasters.2Also, we believe that the notion that natural disasters are “acts

of God” and beyond the control of their victims can affect the regulatory and political

climate facing insurers. Such a story is now unfolding with the increased threat of hurri-

canes striking the United States and the response of insurance markets and government

officials to this threat.

The intense hurricane seasons of 2004 and 2005 caused substantial instability in property

insurance markets in coastal states with the greatest pressure occurring in Florida and

the Southeast.3Other coastal states exposed to hurricanes also have experienced some

market pressures and changes.4The increased risk of hurricanes striking the United

States prompted significant changes in these same markets beginning in the early 1990s

but the particularly intense hurricane activity during 2004–2005 has led to another round

of market adjustments.5Both the loss shocks of the 2004–2005 storm seasons as well as

insurers’ belief that hurricane risk has increased have been major drivers of the recent

market adjustments. The fact that a severe hurricane did not struck the United States in

2006 and 2007 was a welcome relief allowing insurers and reinsurers to replenish some

of their lost capital but the risk of more hurricanes remains high and is still driving

conditions in property insurance markets. Unfortunately, the reprieve of major storm

activity in the United States was not permanent, as the 2008 storm season produced

several hurricanes that struck the United States.

Recent developments have generated considerable concern and controversy among

various groups of stakeholders. In the face of increased risk and uncertainty, insurers

have sought to adjust their rates and exposures in order to ensuretheir economic viability

in the short and long term. Reinsurers also made substantial adjustments; their prices

increased as new capital flowed in to replace recent losses and respond to the increased

demand for catastrophe reinsurance (Guy Carpenter, 2008). Presently, it appears that

affected property insurance and reinsurance markets have probably undergone most

of the adjustments necessary but the situation is fluid. There are indications that some

insurers believe their rates are still inadequate in Florida due to regulatory constraints.6

2Moss (2002) studies the political economy of the government’s assumption of risk with insights

pertinent to disaster risk. Meier (1988) and Klein (1995) consider alternative theories of regula-

tory behavior in terms of their application to the insurance industry.The themes in this literature

are reflected in our examination of the political and regulatory climate for property insurance

in hurricane-prone states.

3We support this observation in our discussion of market conditions in Florida in contrast with

other Southern coastal states. As we will show, Florida has been subject to the greatest rate

increases and market restructuring among coastal states. Grace and Klein (2007b) and Klein

(2008) further document market pressures in Florida.

4For a discussion of states other than Florida, see “Higher Insurance Costs Hit U.S. Coastal

Living.” International Herald Tribune,September 2006. The article states that “coverage has tripled

in some cases on Cape Cod ...and have risen as much as 50 percent on Long Island.”

5Lecomte and Gahagan (1998) and Grace et al. (2003) examine insurance market conditions in

Florida following Hurricane Andrew.

6In July 2008, State Farm filed for an overall rate increase of 47.1 percent for homeowners insur-

ance in Florida. A spokesperson for the Florida Insurance Council was quoted in a newspaper

article as stating, “It won’t be surprising if additional companies make rate filings ...the vast

HURRICANES,INSURANCE,AND REGULATION 83

There is considerable anecdotal evidence that many affected property owners are con-

cerned about sharp premium hikes and the diminished availability of coverage.7Al-

though the relatively benign storm seasons of 2006–2007 were a welcome relief to

insurers and others, they also appear to have undermined public acceptance of in-

surers’ rate increases as well as strengthened political pressure on government offi-

cials to constrain insurers’ actions and to ease conditions for consumers.8This was

reflected in a wave of legislative and regulatory actions in Florida in 2007 and 2008

aimed at lowering the cost of insurance to coastal property owners.9Some of these

changes expanded the state’s underwriting and subsidization of catastrophe risk and

others sought to place tighter constraints on insurers (Milliman, 2007). Unfortunately,

we believe these measures are undermining private markets and the private financ-

ing of catastrophe risk. We also note that coastal politicians are making a strong

push for the federal government to underwrite a significant portion of hurricane

risk.10

This article examines how insurance markets have changed and government policies

have evolved. Our main focus is Florida—the center of this “perfect storm”—where

market pressures are strongest and regulatory-legislative responses are particularly

severe. We also discuss developments in other selected coastal states that offer in-

teresting similarities as well as contrasts to Florida. These other states are Missis-

sippi, Louisiana, South Carolina, and Texas and are the states that appear to face

the most significant hurricane risk issues next to Florida. We offer observations on

how the interplay of economics and politics influences the management of catastrophe

risk.

The next section of this article briefly reviews the environmental, economic, and regula-

tory context for hurricane risk and property insurance and examines the structure and

performance of property insurance markets. We then describe and evaluate significant

regulatory actions and other government policies. We conclude with a summary of our

key observations.

majority of companies have continually told us that their rates are inadequate.” See “More

Insurance Rate Hike Requests Predicted,” Palm Beach Post, July 17, 2008. Florida Farm Bureau,

for example, asked for a 28.4 percent rate increase in late July 2008. See “State Probes Farm

Bureau Rate Plan,” Daytona News Journal, July 30, 2008.

7Consumer discontent has been reflected in town hall meetings, rallies, legislative hearings,

and letters to the editor that are documented in Florida newspapers. See, for example, “Rising

Rates a Top Priority for Most Voters, Poll Shows,” Tam pa Tr ibu ne ,October 26, 2006; “Rally Cries

for Insurance Relief,” St. Petersburg Times, October 8, 2006; and “Homeowners Rip Insurance

Package,” Palm Beach Post, July 25, 2006.

8Daniels et al. (2006) examine public policy issues associated with Hurricane Katrina and its

aftermath. Quigley and Rosenthal (2008) address a broader set of issues associated with various

disaster threats.

9The vehicle for the 2007 legislation was Florida House Bill 1-A (2007). The vehicle for the 2008

legislation was Florida Senate Bill 2860 (2008).

10 See, for example, the testimony of Kevin McCarty for the The National Association of Insurance

Commissioners before the Subcommittee on Housing and Community Opportunity of the

House Committee on Financial Services (March 27, 2008).