Hurricanes and Disaster Risk Financing Through Insurance: Challenges and Policy Options

^Pr^ep^ar^{ed f}^o^r^M^e^m^b^ers^an^d^Com^mⁱ^t^t^ees^of^C^ong^r^e^ss

The U.S. Atlantic and Gulf of Mexico coastal states, Hawaii, Puerto Rico, and the U.S. Virgin
Island are exposed to relatively high levels of risk from hurricanes and tropical storms. To address
the financial and economic effects of such risks, residents and business owners have relied on
private insurance, state-sponsored insurance pools, and/or federal emergency disaster assistance
to manage their natural hazard risk.
The 2005 hurricane season was devastating to residents and businesses in the coastal high-hazard
areas of the Gulf Coast and New Orleans. Although insured catastrophe losses in 2005 totaled
$61.2 billion, the industry had the financial resources to pay all insured claims without
threatening its solvency and claims-paying ability. . Hurricane Katrina losses was $41.1 billion.
Insurance industry participants, legislators, and policymakers learned a great deal from both
Hurricane Andrew in 1992 and the four major hurricanes during the 2004 season, and they took
specific actions that had the effect of minimizing the impact of the 2005 hurricane season.
Nevertheless, most disaster experts and policymakers did not anticipate nor were they prepared
for the magnitude of flood damage and the subsequent number of flood claims filed in the wake
of Hurricane Katrina. As a result, the U.S. Congress was called upon to consider major revisions
to the National Flood Insurance Program (NFIP). On September 27, 2007, the full House
approved H.R. 3121, the Flood Insurance Reform and Modernization Act of 2007, to restore the
financial solvency of the program. On November 1, 2007, Senator Christopher Dodd introduced
S. 2284 to reform the flood insurance program while forgiving the estimated $17.5 billion in debt
owed to the U.S. Treasury, as of December 31, 2007.
With respect to the broader issues of managing and financing catastrophe risk, members of the ^th
110 Congress might also focus attention on the long-term budgetary implications of disaster
recovery expenses incurred by the federal government, and finding ways to expand private-sector
capacity for insuring disaster losses. Previous Congresses responded to insurers’ concerns by
considering legislation to create a federal catastrophe reinsurance program for residential
property.
This report examines the role of insurance in financing disaster risk and the changes implemented
by insurers and legislators that helped to minimize market disruptions following the 2005 and
2004 hurricane seasons. After reviewing the congressional interest in financing catastrophe risk
and summarizing the results of the last two hurricane seasons, the report describes lessons
learned, the insurance market’s response to hurricanes, and existing mechanisms for insuring
hurricane losses. The concluding two sections analyze issue and policy options as well as future ^th
challenges that policymakers in the 110 Congress face.
This report will be updated as events warrant.

Introduc tion ..................................................................................................................................... 1
Financing Catastrophic Risk With Insurance............................................................................2
Congressional Interest In Financing Catastrophic Risk..................................................................3
The 2005 Hurricane Season.............................................................................................................7
The 2004 Hurricane Season.............................................................................................................9
Insurance Lessons Learned from Hurricane Andrew (1992).........................................................10
Insurance Market Response to Past Hurricanes............................................................................12
Hurricane Insurance Deductibles............................................................................................12
Capital Market Instruments Linked to Catastrophe Risk........................................................13
Building Codes and Construction Standards...........................................................................14
Catastrophe Modeling and Insurance Underwriting...............................................................15
Transferring Risk Through Insurance............................................................................................15
Federal Flood Insurance Program...........................................................................................16
State-Sponsored Lost-Sharing Mechanisms............................................................................17
Fair Plans..........................................................................................................................18
Beach and Windstorm Insurance Plans.............................................................................18
Market Assistance Plans (MAP).......................................................................................21
Surplus Lines Insurance..........................................................................................................21
Challenges for the 110^th Congress and Beyond.............................................................................21
Population Growth and Coastal Development........................................................................22
Rising Property Values in Coastal Areas.................................................................................23
Climatological and Environmental Changes...........................................................................23
Issues and Policy Options..............................................................................................................24
Conclusion ..................................................................................................................................... 26
Table 1. Value of Insured Coastal Properties Vulnerable to Hurricanes By State, 2004.................4
Table 2. Total U.S. Insured Losses and Federal Outlays for Uninsured Losses from Major ^a
Disasters: 1995-2005...................................................................................................................5
Table 3. Ten Most Costly Catastrophes in the United States...........................................................8
Author Contact Information..........................................................................................................27

The eighteen states along the U.S. Gulf and Atlantic coast,¹ extending from Texas to Maine, along
with Hawaii, Puerto Rico and the U.S. Virgin Islands, are at relatively high risk from hurricanes ²
and tropical storms. Hurricanes and tropical storms typically produce violent winds, heavy rains,
and storm surges that result in flooding, coastal erosion, and ecological damage. When they strike
in populated, commercial, or industrial areas, hurricanes and tropical storms can cause dozens of
deaths and billions of dollars in both direct costs (e.g., loss of capital stock and investments) and
indirect costs (e.g., disruption of economic activity, including loss of income, employment and ³
services).
Hurricanes are normally described as being in one of five categories, depending on their wind
velocity. Category one hurricanes have winds of 74 to 95 miles per hour, category two hurricanes
have winds of 96 to 110 miles per hour, category three hurricanes have winds of 111 to 130 miles
per hour, category four hurricanes have winds of 131 to 155 miles per hour, and category five
hurricanes have winds greater than 155 miles per hour.
Lessons learned from the 2005 and 2004 hurricane seasons have led the 110^th Congress to focus
attention on the mounting cost of federal outlays for disaster assistance involving hurricanes, and
deciding whether and how the federal government could improve the nation’s ability to finance
the losses created by these events. Insurers, legislators and policymakers learned a great deal from
the devastation caused by Hurricane Andrew in 1992, especially in the areas of pre-disaster
mitigation and the financing of catastrophic risk, and actions they took served to minimize market
disruption following both the devastating 2005 and 2004 hurricane seasons. However, the short-
term insurance solutions designed to finance loss caused by a small (category one) or moderate
hurricane (category two, three or four) will not work for a catastrophic hurricane (category five)
because state pools lack the financial capacity for financing events of such magnitude.
Prior to the beginning of the 110^th Congress, some Members of Congress had begun to rethink
federal disaster policy, particularly with respect to the financing of catastrophic risk and the
unwillingness or inability of insurers to provide property insurance coverage to the extent sought
and needed. An important issue these Members grappled with was deciding how to reconcile the
possible roles for the public and private sectors in disaster risk financing and risk reduction.
Several questions arose: What has been the experience of using financial tools, such as insurance
and other financial services, to reduce disaster risk? What challenges and opportunities exist for
disaster risk transfer and risk reduction schemes? And lastly, what concrete steps must be taken,
and by whom, to form partnerships between the public and private sectors to use insurance and
other financial services for disaster risk reduction?

¹^T^h^{ese 1}⁸^st^at^{es are:}^A^l^ab^a^m^a,^Coⁿⁿ^ectⁱ^c^u^t^,^Del^a^w^a^r^e^,^F^l^o^rⁱ^d^a,^G^e^o^r^gi^a,^L^o^uⁱ^si^an^a,^M^a^ry^l^aⁿ^d^,^M^a^ssach^u^s^et^t^s^,
^Mis^sⁱ^s^sⁱ^ppi,^Ma^ine^,^N^e^w^H^a^m^p^s^h^ir^e^,^N^e^w^J^e^r^s^ey^{, N}^e^w^Y^o^r^k^{, N}^o^r^t^{h C}^a^r^o^li^na^{, S}^out^{h C}^a^r^o^lina^,^T^e^x^a^{s, Ve}^r^m^ont,
^Vⁱ^rg^inia^.
²^Hu^rri^can^{es are f}^o^r^m^edⁱⁿ^t^h^{e N}^o^r^t^h^A^t^l^aⁿ^tⁱ^c^,^Cari^bb^ean^Ocean^,^G^u^l^f^o^f^M^e^xi^co^,^an^d^t^h^e^P^aci^fⁱ^{c Co}^ast^o^f^M^e^xi^co^.^T^h^e
^g^r^e^a^t^e^s^{t lik}^e^lihood^of^a^hur^rⁱ^c^aⁿ^e^s^t^rⁱ^kⁱ^ng^la^{nd a}^r^e^a^s^is^a^l^ong^t^h^e^G^u^lf^C^o^a^s^{t a}^{nd t}^h^e^S^out^he^a^s^te^rⁿ^Se^a^boa^r^d^{, a}^s^w^e^{ll a}^s
^Ha^w^aⁱⁱ^.^S^o^m^e^h^u^rri^can^{es h}^a^{ve st}^ru^{ck cen}^t^r^al^P^eⁿⁿ^s^y^l^vanⁱ^{a an}^d^t^h^e^co^ast^o^f^Ne^w^Jerse^y^,^Ne^w^Yo^rk,^M^a^ry^l^aⁿ^d^,^and
^N^e^w^Eng^l^a^nd.
³^Rach^el^A^.^Davi^d^s^oⁿ^,^an^{d Kel}^l^y^B.^L^a^m^b^ert^,^“Co^m^p^a^riⁿ^g^t^h^{e Hu}^rri^can^{e Di}^sast^{er Ri}^{sk o}^f^U.^S^.^Co^ast^a^l^Co^un^tⁱ^e^s,^”
^Na^tu^{ral Ha}^za^r^d^{s Review}^{, A}^u^g^u^s^t²⁰⁰^1,^p.¹³^2.

In preparation for continued debate on financing disaster risks in the 110^th Congress, this report
examines the role of insurance in financing disaster risk and the changes implemented by insurers
and state legislators that helped to minimize market disruptions following the 2005 and 2004
hurricane seasons. After reviewing the congressional interest in financing catastrophe risk and
summarizing the results of the last two hurricane seasons, the next three sections describe lessons
learned, insurance market’s response to hurricanes, and existing mechanisms for insuring
hurricane losses. The concluding sections analyze issues and policy options as well as future ^th
challenges that policymakers in the 110 Congress face.
Individuals and policymakers have two options to reduce losses from disasters: pre-disaster
mitigation that reduces physical /environmental vulnerabilities and risk financing designed to
reduce financial vulnerabilities. The first step in the disaster management framework is to
mitigate damages from disasters. The residual economic risk can then be managed with risk
financing strategies. Financing is thus an integral part of managing disaster risk; it would not be
feasible to quickly reconstruct the damaged property and infrastructure, and also to restore the
livelihood of the affected persons without adequate financial arrangements.
Insurance is the primary method of financing natural disaster losses in the U.S. Risk financing
with insurance avoids the time lag that is associated with post-disaster assistance or financing.
Insurers are able to assess damages and reimburse disaster victims for financial losses. In
providing insurance coverage, an insurer will agree to assume a portion of the policyholder’s
disaster risk exposure in exchange for a premium. From this premium payment, the insurer sets
aside loss reserves to pay expected claims and build up capital reserves to “buffer” against the
risk of insurer insolvency from low-probability, high-cost events. Insurance companies
supplement this arrangement by purchasing reinsurance from a reinsurance company so that ⁴
losses from a catastrophic event are spread worldwide.
Most insurance experts agree that although primary insurers and traditional reinsurers could
absorb the loss shock from a moderate (category two, three, or four) hurricane (e.g., less than $50
billion in insured losses), their financial capacity may not be adequate to cope with a catastrophic
(category five) hurricane. Estimates of the probable maximum losses (PMLs) from a catastrophic
hurricane striking the U.S. range up to $100 billion, and this figure could be even higher
depending on the location, time and intensity of the event. The PML loss from a Category 5
hurricane directly hitting a densely populated area along the Gulf and Atlantic Coast (e.g., the
Miami-Ft. Lauderdale area) could exceed the total capacity (policyholder surplus) of the U.S. ⁵
insurance industry. The policyholders surplus of the entire property and casualty insurance ⁶
industry stood at approximately $521.6 billion at the end of 2007. Only a fraction of this

⁴^Re^insura^nc^e^pr^ov^ide^s^c^onsi^d^e^r^a^b^le^prote^c^tⁱ^{on t}^o^t^h^e^prim^a^r^y^insure^{r by}^{: (1) lim}^iting^tha^tⁱⁿ^sure^{r’s los}^s^e^x^posure^to
^le^v^e^{ls c}^o^m^m^eⁿ^sura^te^w^{ith the}ⁱ^{r n}^e^{t a}^sse^{ts; (2) re}^duc^ing^t^h^e^wⁱ^de^sw^ing^sⁱⁿ^prof^{it a}ⁿ^d^{loss m}^a^rg^{ins inhe}^re^nt^{to t}^h^e
^ins^u^r^a^nc^e^b^u^sⁱ^ne^s^s^;⁽³⁾^pr^ote^c^ting^a^g^aⁱ^ns^{t c}^a^t^a^s^tr^ophic^l^o^s^s^;^aⁿ^d⁽⁴⁾^inc^r^e^a^s^ing^c^a^p^a^cⁱ^t^y^or^the^d^o^lla^r^a^m^{ount of}^rⁱ^s^k^aⁿ
^insure^{r c}^aⁿ^pru^d^eⁿ^tly^a^ssu^m^e^{, ba}^se^{d on}^{its su}^r^p^l^u^{s a}ⁿ^d^the^na^ture^of^the^b^u^sine^{ss w}^r^itte^n.
⁵^Davi^d^J.^Cu^mmⁱⁿ^s,^Nei^l^A^.^Do^h^e^rt^y^an^d^Aⁿⁱ^t^a^L^o^,^“Can^In^su^rers^P^a^y^f^o^{r t}^h^{e ‘Bi}^g^On^{e’? M}^easu^rⁱⁿ^{g t}^h^{e Cap}^aci^t^y^o^f
^an^In^su^raⁿ^{ce M}^a^{rket to}^Resp^on^d^t^o^Catastro^ph^{ic L}^o^sses,^”^J^our^na^{l o}^f^Ba^nk^ing^a^nd^Fin^anc^e^,^vo^l.²⁶^,^no^.^2,^p.⁵⁵^7.
⁶^P^o^lⁱ^c^y^h^o^l^d^e^{rs su}^r^p^l^u^s^ref^e^{rs t}^o^“n^et^w^o^rt^h^”^o^r^“o^wⁿ^{ers’ eq}^uⁱ^t^y^{” i}ⁿ^o^t^h^e^{r i}ⁿ^du^st^ri^es.^Itⁱ^s^{a m}^e^a^s^u^r^{e o}^f^t^h^{e cap}^aci^t^y^o^f
^ins^u^r^e^r^s^to^u^nde^r^w^r^ite^polic^ie^s^,^aⁿ^{d it m}^u^s^t^inc^r^e^a^s^e^{to m}^e^e^t^the^de^m^a^nds^of^a^g^r^ow^ing^U^.^{S. e}^c^onom^y^a^{nd c}^l^aⁱ^m^s
^resu^ltin^g^f^r^o^m^h^u^rrican^{es an}^d^o^t^h^e^{r n}^a^tu^{ral h}^azard^s^.

industry-wide total surplus amount would be available to compensate victims of a hurricane.
Insurers must rely on this same limited pool of capital to pay for other potentially catastrophic
and unpredictable risks, such as terrorism, mold, and medical malpractice and asbestos liability
claims. Insurers may have to liquidate bonds and other financial assets in order to pay claims, ⁷
triggering an adverse impact on U.S. financial markets.

The property and casualty insurance industry will be able to pay all claims from the devastating
2005 hurricane season without jeopardizing the solvency and claims-paying ability of the industry
as a whole. In the absence of an efficient and effective catastrophe insurance market—one that
provides property insurance at reasonable rates to residents and business owners and spreads
catastrophe risk globally—the government often becomes the de facto financier of disaster
recovery efforts through existing government disaster response and recovery programs and the
“traditional” appropriation process.
As the frequency and severity of natural disasters increase, state governments have used their
taxing and bonding capacities to establish public/private insurance pools to engage in catastrophe
risk management and financing. Recent catastrophes, however, have strained these pools and
most insurance market analysts would agree the private sector insurance industry has enormous
capacity to provide catastrophe risk insurance, but that coverage is limited. As demonstrated by
the 2004 and 2005 hurricane seasons, the industry can readily handle a series of events with
insured damages above $60 billion. Some reinsurers experts and insurance analysts insist the
insurance industry can handle a single insured event approaching $100 billion in claims.
Hurricane Katrina has focused public debate on whether to implement a comprehensive (ex-ante
or post-disaster financing) solution to the problems presented by natural catastrophe exposure. In
an environment of budgetary deficits and spending constraints, policymakers are seeking to find ^th
ways to confront the excessive and inequitable reliance upon federal disaster relief. The 110
Congress might be asked to consider proposals which would permit federal reinsurance payouts
for events over the level of exposure that the private sector can adequately and appropriately
insure.
Table 1, which shows the value of insured coastal properties in the 18 states along the U.S. Gulf
and Atlantic coasts, indicates that $6.8 trillion out of $19 trillion in insured property is vulnerable
to hurricanes. The nation realizes this risk when hurricanes strike and individuals, businesses, and
communities suffer, while American taxpayers, through the federal government, bear the costs
associated with indemnifying uninsured victims of natural disasters and rebuilding critical
infrastructure.

⁷^R^o^s^s^J^.^D^a^vⁱ^ds^on^J^r^{., “}^W^or^kⁱ^ng^T^o^w^a^r^d^a^C^o^m^p^r^e^he^ns^iv^e^N^a^tiona^{l Str}^a^te^gy^f^o^r^Fun^dⁱⁿ^g^C^a^ta^s^t^r^o^p^h^e^Ex^pos^ur^e^s^,”
^J^ourⁿ^a^{l o}^f^Iⁿ^s^u^r^anc^e^Re^gul^atioⁿ^,^v^o^{l. 7,}ⁿ^o^.^{2, W}ⁱ^nte^r¹⁹^98,^p.¹^34.

Table 1. Value of Insured Coastal Properties Vulnerable to Hurricanes By State, 2004
^{($ Billion)}
^{State Coastal}^Total^Exposure^a^{Coastal as a Percent o}^f^Total
^{Florida $1,93}^7.4^$2,44^3.5^79%
^{New York}^1,90^1.6^3,12^3.6⁶¹
^{Texas 740.}⁰^2,89^5.3²⁶
^Massach^{usetts 662.}⁴^1,22^3.0⁵⁴
^{New Jers}^ey^505.⁸^1,50^4.8³⁴
^{Connecticut 404.}⁹^641.³⁶³
^{Louisiana 209.}³^551.⁷³⁸
^{South Carolina}^148.⁸^581.²²⁶
^{Virginia 129.}⁷^1,14^0.2¹¹
^{Maine 117.}²^202.⁴⁵⁸
^{North Carolina}^105.³^1,18^9.3⁹
^{Alabama 75.9}^631.³¹²
^{Georgia 73.0}^1,23^5.7⁶
^{Delaware 46.4}^140.¹³³
^{New Ham}^pshire^45.6^196.⁰²³
^{Mississippi 44.7}^331.⁴¹³
^{Rhode Island}^43.8^156.⁶²⁸
^{Maryland 12.1}^853.¹
^{Coastal States}^$6,86^3.0^$19,0^41.1³⁶
^Source:^{AIR Worldwide Corpo}^ration.
^a.^Expos^{ure is t}^{he total amount of i}^nsur^{ed prope}^{rty in t}^{he state.}
Table 2 shows that while the frequency of catastrophic events in the last few years is less
compared with earlier years, insured losses have increased significantly. The increasing
magnitude of both insured and uninsured losses from natural disasters represent an ongoing
challenge for governments and the private sector. Catastrophes result in large government outlays
for disaster assistance and they place a financial strain on private disaster insurance/reinsurance
markets. The federal government alone, facing fiscal constraints to cover the losses to the private
sector, will find it challenging to meet long-term disaster-related spending. Further, insurers have
been and will continue to be reluctant to cover properties in high-risk areas because of high long-
run costs (which translates into high prices for disaster insurance) and low demand for disaster ⁸
insurance. To make insurance available and affordable, state governments have created
public/private partnerships (state-sponsored catastrophe funds) to provide catastrophe insurance
or reinsurance coverage at subsidized rates.

⁸^T^h^e^hig^h^lo^ng^-^r^uⁿ^c^o^s^t^s^aⁿ^{d l}^o^w^de^m^a^{nd f}^o^r^dis^a^s^t^e^r^ins^u^r^a^nc^e^r^e^s^u^lts^f^r^om^ins^u^r^e^r^s^ha^vⁱ^ng^to^hol^d^hug^e^a^m^ounts^of
^c^a^p^ita^{l to}^pa^y^c^l^aⁱ^m^s^re^sulting^f^r^om^ra^r^e^but^poteⁿ^tia^lly^la^rg^e^c^a^ta^st^rop^h^e^losse^{s, a}ⁿ^d^the^lⁱ^m^ite^{d w}^illingⁿ^e^{ss of}^m^aⁿ^y
^coⁿ^s^u^m^{ers t}^o^p^a^y^ri^sk-b^ased^p^r^emⁱ^u^m^s^f^o^{r d}ⁱ^sast^{er i}ⁿ^su^ran^ce,^res^p^ectⁱ^v^el^y^.

Table 2. Total U.S. Insured Losses and Federal Outlays for Uninsured Losses from
Major Disasters: 1995-2005^a
^{($ mill}^ions)
^{Insured Losses}^{Uninsured Losses}
^{Number of}^Dollars^Insured^Total^b
^Number^Claims^When^{Losses in}^Appr^opriations^Federal^c
^Year^{of Events}^(Mill^ions)^Occ^urred²⁰⁰^{4 Dollars}^{(available funds)}^Outlays
¹⁹⁹^{5 34}^2.7^$8,31⁰^$10,0³³^$4,23⁵^$2,49²
¹⁹⁹^{6 41}^3.9^7,37⁵^8,64⁹^4,04²^2,58¹
¹⁹⁹^{7 25}^1.6^2,60⁰^2,98¹^5,24⁸^2,89⁸
¹⁹⁹^{8 37}^3.5^10,0⁷⁰^11,3⁶⁷^2,15⁵^2,24²
¹⁹⁹^{9 27}^3.3^8,32¹^9,19⁰^2,59⁷^4,14⁹
²⁰⁰^{0 24}^1.4^4,60⁰^4,91⁵^3,01⁹^2,85³
²⁰⁰^{1 20}^1.6^26,5⁴⁸^27,5⁸²^6,24⁹^3,41³
²⁰⁰^{2 25}^1.8^5,85⁰^5,93²^12,6⁷⁷^4,11⁴
²⁰⁰^{3 21}^2.6^12,8⁸⁵^12,8⁸⁵^2,25⁵^8,76¹
²⁰⁰^{4 22}^3.4^27,4⁹⁰^27,4⁹⁰^2,06⁸^3,08²
²⁰⁰^{5 24}^4.3^56,7⁷⁹^56,7⁷⁹^70,5⁴²^N/A
^Source:^In^sura^{nce Services}^Offic^{e, Inc., Jersey City, New Je}^rsey
^Note:^{NA = not applicable.}
^a.^{The definition of a catastrophe}^c^{hanged in}¹⁹^{96. Beginning i}ⁿ¹⁹⁹⁷^the^catastrop^{he definition was}^raised
^{from $5}^{million to $25 milli}^{on in insured damage. This cha}^{nge mig}^{ht ex}^{plain why t}^he^num^{ber of}^rec^orded
^catastrophes^{and t}^{he aggregate lo}^{sses attrib}^{uted to catastrop}^{hes o}ⁿ^{average is lower t}^{han in ea}^{rlier years.}
^{The figures}^{for ap}^{propriations an}^{d outlays in the last two columns}^{are different}^beca^{use Congr}^ess
^approp^{riates fu}^{nds to make it ava}^{ilable, but the act}^{ual amounts s}^p^e^{nt could be differe}^nt.
^b.^{Total appropriations into the Disaster Relief Fund. Figures are in}²⁰⁰²^consta^{nt dollars.}
^c.^{These figures, w}^{hich are}^{in 2}⁰⁰²^{constant dollars, come from CRS Report RL33}⁰⁵^3,^{Federal Staffor}^d^Act
^{Disaster Assistance:}^{Presidential Declarations, Eligible Activities, and Fun}^ding^{, by Keith Bea.}
The last two columns in Table 2 show total appropriations into and outlays from the Disaster
Relief Fund (DRF) for federal disaster assistance to help individuals, families, state and local
governments, and certain nonprofit organizations affected by severe disasters. Average annual
federal outlays exceeded $3.6 billion since 1995 because of significant hurricanes (Andrew and
Inniki FY1992), earthquakes (Northridge in FY1994), floods (Midwest floods of 1993, Red River
Floods of 1995) the terrorists attacks of September 11, 2001, and the sequence of four major ⁹
hurricanes in 2004. For purposes of illustration, prior to FY1989, outlays from the DRF averaged ¹⁰
$568 million, and on only two occasions exceeded $1 billion.
Most disaster experts and policymakers did not anticipate and therefore were unprepared for the
magnitude of flood damage, and the subsequent number of flood claims filed, in the wake of

⁹^C^R^S^R^e^por^{t R}^L³³⁰⁵³^,^Fe^de^ra^{l S}^t^affor^d^Ac^{t Dis}^a^ste^r^Assistanc^e^:^P^r^e^s^ideⁿ^{tial De}^c^l^ar^atio^{ns, E}^ligi^b^le^Ac^tiv^itie^{s, a}^nd
^Fun^dⁱⁿ^g^,^by^K^e^{ith Be}^a^.
¹⁰^Ibid^{, p}^.⁷^.

Hurricane Katrina. Given the magnitude of Katrina-related damages and their impact on the ^th
NFIP, the 110 Congress might be called upon to consider ways to overhaul the program.
With respect to the broader issue of managing and financing catastrophe risk, the 110^th Congress
might choose to focus attention on the long-term budgetary implications of disaster recovery
expenses incurred by the federal government and finding ways to expand private-sector capacity
for insuring disaster losses. The last time Congress took a critical examination of the federal ¹¹
disaster policy was in 1998.
This is likely to occur in 2008 at the same time that the property insurance industry seeks some
type of federal assistance in reducing their catastrophe exposure. Ironically, the insurance industry
has historically opposed federal intervention in the insurance marketplace. But, faced with new
terrorism risk following the September 11, 2001, terrorists attacks, and the recognition of a
possible mega-catastrophic hurricane far more devastating than Hurricanes Katrina, Rita, and
Wilma, some insurers and their trade associations have begun to rethink their support for federal
involvement in disaster insurance markets.
Previous Congresses responded to insurers’ concerns about a mega-catastrophe that threatens the
solvency and claim-paying ability of the insurance industry by considering legislation to create a ¹²
federal catastrophe reinsurance program for residential property. Despite broad bipartisan
support for addressing America’s exposure to natural disasters, the full Congress did not approve
the creation of a federal reinsurance program until the enactment of the Terrorism Risk Insurance ¹³
Act (TRIA) of 2002. TRIA provides a temporary federal reinsurance backstop for future
terrorist acts once a high insurance-industry loss is sustained. The law, which was scheduled to ¹⁴
expire on December 31, 2007, was extended through the end of 2014.
All federal disaster insurance bills have one thing in common: they seek to improve the nation’s
ability to finance catastrophe risk through insurance as opposed to increased direct spending for
federal disaster assistance. Their justification is based on the argument that such initiatives will:
(1) enhance the current catastrophe funding system; (2) make property insurance more available
and affordable in high-risk areas; (3) promote the funding of research studies (i.e., earthquake
science, actuarial science, economics, and finance) on disaster insurance issues; and (4) expand
our knowledge and understanding of the scientific and financial aspects of natural hazards.
Professor Howard Kunreuther at the University of Pennsylvania has suggested that improvements
in the scientific and financial areas are thought to be important because of the urgency in finding
ways to predict the probability and magnitude of future natural hazards, plan for the necessary
funding for disaster recovery, and devise the optimum allocation of resources after the event in
order to promote speedy economic recovery of the affected region and the rebuilding of the ¹⁵
damaged residential, commercial, and public structures.

¹¹^S^{ee U.}^S^.^C^oⁿ^g^ress,^Ho^u^s^{e Co}^m^mⁱ^t^t^{ee o}ⁿ^t^h^{e Bud}^g^et^,^T^a^{sk F}^o^rce^oⁿ^B^u^d^g^et^P^r^o^cess,^Bu^d^g^et^ary^T^r^eat^m^eⁿ^t^o^f
^Em^e^r^g^e^nc^ie^s^,^he^a^r^ing^,¹⁰⁵^th^Co^ng^{., 2}^nd^s^e^s^s^{., J}^une^23,¹⁹⁹⁸^W^a^s^hⁱⁿ^g^t^{on: G}^P^O^,
¹²^Ellio^{tt Mi}^tte^{r, “}^A^lte^rna^tiv^e^Na^tiona^{l Ea}^rth^qua^k^e^Insura^nc^e^P^r^og^ra^m^s^,”^E^a^rt^h^q^u^a^{ke Sp}^ect^ru^m^{, A}^u^g^u^s^{t 19}^91,^v^o^l.^7,
^{no. 3, p. 75}^7.
¹³^P^.^L^.¹⁰^7-²⁹⁷^;¹¹⁶^Sta^t²³^22.
¹⁴^C^R^S^R^e^por^{t R}^L³⁴²¹⁹^,^T^e^rro^ris^m^{Risk In}^su^ran^{ce L}^e^gⁱ^sl^a^tionⁱⁿ²⁰⁰⁷^{: Issu}^{e Su}^mma^{ry an}^{d S}ⁱ^d^e^-b^y-^Sⁱ^d^e^{, by}^B^a^ir^d
^We^b^e^l^.
¹⁵^Ho^w^a^rd^Kuⁿ^r^eu^t^h^{er an}^{d Ri}^ch^ard^J.^Ro^t^h^,^S^r^.^,^P^a^yⁱⁿ^g^the^Pr^ic^e^:^Th^e^Stat^us^aⁿ^d^Role^{of I}ⁿ^s^u^r^a^nc^e^Ag^ains^{t N}^a^t^u^r^a^l
^Disa^{sters in}^th^{e U}ⁿ^ited^S^t^a^t^es⁽^W^a^s^hing^ton^:^J^o^s^e^ph^H^e^nr^y^P^r^e^s^s^,¹⁹⁹⁸⁾^,^p.⁹²

Opponents of federal disaster insurance, however, say such measures conflict with long-
established sociological, economic, and actuarial principles that focus on the “true”cost of
government programs (the opportunity cost of the funds), the foregone benefits of a competitive
insurance marketplace (e.g., cost efficiency and rate competition), and the absence of consumer ¹⁶
choice (the ability to decide whether to purchase coverage). Citing the development of
innovative financial instruments for natural disaster risk management and expanded reinsurance
capacity, critics of public insurance systems say there is no need for a federal insurance program
at this time. They insist that such programs shield the private sector from loss while creating
sizable taxpayer-financed subsidies that undermine private-sector incentives for efficient risk
management. Further, it has been argued that these programs encourage population growth and
development in high-risk, hurricane-prone areas that should not be developed, and would allow
insurers to “cherry pick” the best risks and send the federal government the poor risks. Rather
than providing insurance protection for natural hazard losses, critics argue, the federal
government should take actions to expand private-sector capacity for insuring disaster losses.
Proponents of federal disaster insurance argued that such a scheme would reduce dependence on
“free” disaster assistance and support efficient risk management by households and businesses.

The 2005 hurricane season was the most destructive in recent U.S. history. There were 27 named
storms of which 14 were hurricanes. The 27 named storms more than doubled the national
average over the past five decades. According to researchers at Tillinghast-Towers Perrin, a
global actuarial, management, and financial services consulting firm, over the past 50 years, there
have been, on average, 9.8 named storms, 5.8 hurricanes, and 2.3 intense hurricanes. Not all of
these storms made landfall. Some catastrophe risk modeling firms contend that while the 2005
hurricane season was above normal, it was not so unusual. According to their hurricane models,
insurers should expect to see four hurricanes making landfall in the United States approximately
once every 12 years and this is within the range to which most insurers manage their catastrophe
risk.
Table 3 shows that the three major hurricanes in 2005 (Katrina, Rita, and Wilma) and three of
four of the major hurricanes in 2004 (Charley, Ivan, and Frances) accounted for six of the top 10
most costly catastrophes in U.S. history. Before the 2005 hurricane season, Hurricane Andrew
ranked as the single most costly U.S. natural disaster at $22.9 billion in 2007 dollars. Insured
losses from Hurricane Katrina alone are estimated to be $43.6 billion. The three most destructive
hurricanes in 2005 together account for $60.5 billion. Total economic losses from Katrina will
likely exceed $200 billion. Despite the magnitude of the insured property losses suffered in 2005,
the insurance industry has the financial strength to pay the claims from Hurricane Katrina.

¹⁶^K^unr^e^u^t^h^e^r^{, p. 93.}

Table 3. Ten Most Costly Catastrophes in the United States
^{($ billions)}
^Rank^Date^Disaster^{Dollar Losses When}^Oc^cur^red^{In 2007 Dollars}
¹^{Aug. 20}⁰⁵^Hurrica^{ne Katrina}^$41,1⁰⁰^$43,6²⁵
²^{Aug. 19}⁹²^Hurrica^{ne Andrew}^15,5⁰⁰^22,9⁰²
³^{Sept. 200}¹^{WTC Terrorist Attacks}^18,8⁰⁰^22,0⁰⁶
^{4 Jan.}¹⁹⁹⁴^{Northridge, CA Eart}^hq^uake^12,5⁰⁰^17,4⁸⁵
⁵^{Oct. 20}⁰⁵^Hurrica^{ne Wilma}^10,3⁰⁰^10,9³³
⁶^{Aug. 20}⁰⁴^Hurrica^{ne Cha}^rley^7,47⁵^8,20³
⁷^{Sept. 200}⁴^Hurrica^{ne Iva}ⁿ^7,11⁰^7,80³
⁸^{Sept. 198}⁹^Hurrica^{ne H}^ugo^4,19⁵^7,01³
⁹^{Sept. 200}⁵^Hurrica^{ne Rita}^5,62⁷^5,97³
¹⁰^{Sept. 200}⁴^Hurrica^{ne Fran}^ces^4,59⁵^5,04³
^Source:^In^sura^{nce Services}^Offic^{e’s Property Claims Service; Ins}^u^{rance I}^{nformation I}^nstitute.
Hurricane Katrina caused widespread damage to homes and businesses in six states—Louisiana,
Mississippi, Alabama, Florida, Tennessee, and Georgia. Much of the damage from the storm was
the result of flooding, rather than wind. In response to the devastation from the 2005 hurricane
season, rating agencies are changing their methods of assessing the adequacy of an insurer’s ¹⁷
capital. In the past, rating agencies examined an insurer’s exposure to loss relative to a “100-
year” catastrophe event. That is, they looked at a disaster that occurred once every 100 years. The
new capital adequacy threshold is 250-year events, because the 100-year events are forecast to
increase in frequency. Rating agencies are also considering the potential losses from catastrophes
in the aggregate and requiring an insurer’s estimate of its probable maximum loss to include the
increase in the cost of labor and materials as the reconstruction cost rises.
Several insurance coverage issues have arisen in the wake of Hurricane Katrina. For example,
losses from floods are not covered under homeowners insurance policies, and homeowners have
filed lawsuits against insurers seeking to void the flood exclusion in homeowners policies. In
other lawsuits, plaintiffs claim that flooding was caused by negligence in the construction and
maintenance of the levees which broke and inundated the city rather than an “Act of God.” With
respect to business and commercial property losses, plaintiff lawyers representing homeowners
have pursued oil and chemical businesses, seeking compensation for damages. Many of these
businesses, which face longer and costly business interruption losses and untold amounts of extra
expenses incurred in an attempt to restore business operations, are suing their insurers. Insurers
are still assessing individual losses and analyzing various scenarios that will affect ultimate claim
payments.

¹⁷^S^u^sann^{e S}^c^l^a^f^aⁿ^a^,^“Bi^g^Cat^s^F^o^{rce Ch}^an^{ge i}ⁿ^Di^sast^{er M}^o^d^e^l^s^,^”^N^a^tion^a^l^Und^e^{rwriter Pro}^p^e^{rty an}^{d Ca}^sua^lty
^Editi^on^,^D^e^c^e^m^b^e^r^{5, 2}⁰⁰⁵^,^p.^20.

According to the National Oceanic and Atmospheric Administration (NOAA), there were 12
named storms during the 2004 hurricane season, of which nine affected the United States: three as
tropical storms (Bonnie, Hermine and Matthew) and six as hurricanes (Alex, Charley, Frances,
Gaston, Ivan and Jeanne). Four of the hurricanes (Charley, Ivan, Frances and Jeanne) made
landfall as “major” or Category 3 or higher events on the Saffir-Simpson Hurricane Scale. Three ¹⁸
other hurricanes (Danielle, Karl, and Lisa) did not make landfall. The nine named storms that
affected the United States resulted in 21 Presidential declarations of major disaster covering 12 ¹⁹
states, Puerto Rico and the U.S. Virgin Islands. Florida was affected the most by the four ²⁰
hurricanes followed by Alabama, Georgia, Pennsylvania, and North Carolina.
Table 3 shows that three of the four 2004 major hurricanes—Charley, Ivan, and Frances—rank
among the top ten for both the costliest U.S. hurricanes and insured loss events in U.S. history.
For the first time since 1886, three hurricanes—Charley, Frances, and Jeanne—made landfall in ²¹
the same state—Florida; Ivan made landfall in Alabama, but continued its path across Florida.
Meteorological forecasters had correctly predicted above-normal activity during the 2004 ²²
hurricane season, based on a trend of above-average activity during seven of the last nine
seasons. Insurers therefore had knowledge of and presumably were prepared for these events.
According to climatologists, the level of activities for 2004 was similar to that of 2003, but
consumers and insurers were spared huge losses in 2003 because very few of the tropical storms ²³
and hurricanes made landfall in the United States. Thus, insurers faced limited losses from the
2003 hurricane season in terms of damages relative to their activity, but that was not the case in

2004 when four major hurricanes made landfall in August and September.

The Insurance Information Institute in New York indicated that the four major hurricanes that
struck Florida and other Gulf and Atlantic Coast states in 2004 caused $21.0 billion in wind-²⁴
related insured losses, and total claims filed of 2.2 million. Total economic losses were about ²⁵
$56 billion. The four major hurricanes, as a whole, exceeded the property damages from the
9/11 terrorist attacks ($22.0 billion) and Hurricane Andrew ($22.9 billion). In addition to

¹⁸^T^h^{e Natio}ⁿ^a^{l Ocean}^{ic an}^d^A^t^m^o^s^p^h^e^{ric A}^d^mⁱⁿⁱ^stratioⁿ⁽^NOAA^{) al}^so^rep^o^r^te^d^t^h^{at th}^{ere w}^a^{s su}^b^t^{ropical sto}^r^m
^Nⁱ^c^o^le^a^{nd te}^{n tr}^opic^a^l^de^pr^e^s^sⁱ^oⁿ^s^.
¹⁹^T^h^{ese 1}²^st^at^{es are:}^A^l^ab^a^m^a,^De^l^a^ware,^F^l^o^rⁱ^d^a,^G^e^o^r^gi^a,^L^o^uⁱ^si^an^a,^Mⁱ^ssi^ssi^ppⁱ^,^New^Jerse^y^,^Ne^w^Yo^rk,^No^rt^h
^C^a^r^o^lina^,^P^e^nns^y^l^v^a^nia^,^Sout^{h C}^a^r^o^lina^,^a^nd^Vi^r^g^inia^.
²⁰^F^o^{r m}^o^{re i}ⁿ^f^o^rm^atⁱ^oⁿ^on^t^h^eⁱ^m^p^act^o^f^t^h^{e f}^o^u^r^h^u^rri^can^{es o}ⁿ^F^l^o^rⁱ^d^{a see In}^su^ran^{ce S}^e^rvi^{ces Off}ⁱ^c^e^,^In^c.^,^P^r^ess
^Rel^ease,^“^A^IR^Aⁿ^al^y^sⁱ^s^Coⁿ^c^l^u^d^e^{s 2}⁰⁰⁴^H^u^rri^can^{e S}^easoⁿ^Is^No^t^A^s^Un^u^s^u^a^l^,^{” avai}^l^a^b^l^{e at}^h^t^t^p^:^/^/^www^.ⁱ^so^.^c^o^m^/
^pr^e^s^s^_^r^e^le^a^s^e^s^/²⁰^04/¹¹^_0^3_⁰⁴^.ht^m^l.
²¹^Ma^{tt Bra}^d^y^,^“^I^nsure^r^s^P^o^{st Re}^c^o^r^d^First-Ha^lf^P^r^of^its,”^N^a^ti^on^{al U}ⁿ^de^r^w^r^ite^r^:^Pr^ope^r^t^y^a^{nd C}^a^s^u^alty^{, O}^c^tobe^r^25,
²⁰⁰^{4, p. 32}^.
²²^F^o^recast^e^{rs at}^t^rⁱ^b^u^t^{e t}^h^{e recen}^t^ri^{se i}ⁿ^A^t^l^aⁿ^tⁱ^c^b^a^siⁿ^h^u^rri^can^{e act}ⁱ^vⁱ^t^y^oⁿ^l^oⁿ^g^-t^erm^clⁱ^m^at^{e p}^a^t^t^e^rn^s^,ⁱⁿ^cl^u^dⁱⁿ^g
^coⁿ^tⁱⁿ^u^a^tⁱ^oⁿ^o^f^w^a^r^m^er-t^h^aⁿ^-ⁿ^o^r^mal^o^cean^t^e^m^p^erat^u^r^{es a}^c^ro^{ss t}^h^{e t}^r^o^pⁱ^cal^A^t^l^aⁿ^tⁱ^c^.^T^h^{e w}^a^r^m^er^wat^e^{rs are asso}^ci^at^ed
^wⁱ^t^h^ci^rcu^l^atⁱ^oⁿ^p^a^t^t^e^rn^{s t}^h^at^f^o^r^m^an^ab^o^v^e-a^v^era^g^{e h}^u^rri^can^{e seaso}ⁿ^.
²³^“^D^aⁿ^g^e^r^ous^P^l^aⁿ^e^{t: L}ⁱ^vⁱ^ng^on^B^o^r^r^o^w^e^{d T}ⁱ^m^e^,^”^Re^ac^tion^,^J^u^ly²⁰⁰^{4, p}^.¹⁸^.
²⁴^Ro^b^e^rt^{P. Hartw}ⁱ^g^,^Ca^ta^strop^h^e^s^:^In^su^ran^{ce Issu}^es⁽^Iⁿ^s^u^r^a^nc^e^Iⁿ^f^o^r^m^a^{tion I}ⁿ^s^tit^ute^:^Fe^br^ua^r^y²⁰⁰⁵⁾^{, a}^v^a^ila^ble^a^t
^http:^//www^.iii.org^/^m^e^dia^/^ho^tto^pic^s^/insura^nc^e^/^x^x^x^.
²⁵^S^w^{iss Re,}^N^a^tur^a^{l C}^a^t^a^s^t^r^o^p^h^e^s^and^M^an-^M^a^de^Dⁱ^sa^{sters in 20}⁰⁶^{: L}^o^{w I}ⁿ^su^red^L^o^sses^{, ht}^tp:/^/swⁱ^ss^re^.c^om^/
^r^e^s^our^c^e^s^/c^e⁸^f⁶^a⁸⁰⁴⁵^5c^6b^9f^8b2^b^bb8^0a⁴⁵^d^76a^0-^sⁱ^g^m^a^2_20⁰⁷^_e^.p^df^.

insurance pay-outs, Congress passed two emergency supplemental appropriations statutes that ²⁶
provided a total of $17.535 billion to hurricane victims.
Property and casualty insurance typically incur an underwriting loss on their business and make
up these losses on the investment of premiums and loss reserves. Despite record catastrophe
losses, the year 2004 was the first time the industry managed an underwriting profit in 26 years.
Policyholders surplus, a measure of claims-paying capacity, increased to a record $521.8 billion ^rd
in 2007 (3 Quarter), compared to $427.1 billion at year end 2006.
Unlike Hurricane Andrew that led to 11 insurer insolvencies and 63 insurers announcing plans to
withdraw from the Florida market or significantly curtailing of new business, only one small
insurer—American Superior Insurance Company—became insolvent as a direct result of last
year’s hurricanes. The 11 insolvencies were the largest number of hurricane-related insolvencies ²⁷
in U.S. history. Several insurers did have their financial strength rating downgraded by various ²⁸
rating agencies, and at least four insurers have started canceling insurance policies in Florida. In
addition, several insurers have announced that they will no longer seek new business in the state.
American Superior Insurance Company wrote homeowners insurance coverage for nearly 60,000
Floridians and had a premium volume of $34 million, representing less than 1 percent of total ²⁹
homeowners insurance premiums collected in Florida. The company voluntarily consented to be
placed into rehabilitation by the Florida Department of Financial Services, Division of
Rehabilitation and Liquidation. Under a plan of receivership, a state-appointed official takes over
the company’s operations and, in the event the insurer cannot be rehabilitated, could liquidate its
assets to pay policyholder’s claims. If the liquidated assets cannot pay all claims the Florida
Property and Casualty Insurance Guaranty Fund will pay the shortfall in claims up to $300,000,
and impose an assessment on all property insurers operating in Florida to pay claims on behalf of
the insolvent insurer. Insurers, in turn, can write off the guaranty fund assessments against their
state income taxes, thereby shifting some of the cost of the insolvency to all taxpayers in the state.

There is little doubt that property insured losses from the 2005 and 2004 hurricane seasons would
have been even higher were it not for actions taken by insurers, regulators, and state legislators to
both protect the industry’s balance sheets and stabilize the property insurance markets in the ³⁰
aftermath of Hurricane Andrew in 1992. After Andrew, Florida faced a “capacity gap”—the

²⁶^Se^e^C^R^S^R^e^por^{t R}^L³²⁵⁸¹^,^S^u^p^p^l^e^m^e^{ntal Ap}^pr^o^p^rⁱ^at^io^ns^for^the²⁰⁰⁴^H^u^r^rⁱ^c^a^ne^s^an^{d O}^t^he^r^Dⁱ^s^a^s^t^e^r^s^{, by}^K^e^{ith Be}^a
^a^{nd R}^a^lp^{h M}^.^C^hⁱ^t^e^.
²⁷^T^h^e^num^be^r^of^pr^ope^r^t^y^/^c^a^s^ua^lt^y^ins^o^lv^eⁿ^cⁱ^e^s^{in a}ⁿ^y^gⁱ^v^eⁿ^y^e^a^r^dif^f^e^r^ba^s^e^{d on a}ⁿ^or^g^a^niz^a^tion’^s^s^p^e^cⁱ^fⁱ^c^c^r^ite^rⁱ^a^f^o^r
^inc^l^u^d^ing^a^c^o^m^p^aⁿ^y^{in the}^ins^o^lv^eⁿ^cy^c^ount.^T^h^e^N^a^tiona^{l A}^s^s^o^cⁱ^a^tion^of^Iⁿ^s^u^r^a^nc^e^C^o^m^m^is^sⁱ^one^r^s^{, f}^o^r^e^x^am^ple^,^lis^t
^anⁱⁿ^su^{rer as i}ⁿ^so^l^v^en^t^w^h^en^{a com}^p^an^y^t^rⁱ^g^{gers so}^m^e^f^o^r^m^al^regu^l^a^t^o^ry^actⁱ^oⁿⁱⁿ^t^h^{e cal}^en^d^a^{r y}^{ear b}^ecau^{se o}^f
^sigⁿ^if^ic^aⁿ^{t f}ⁱ^na^nc^ia^{l i}^m^pa^ir^m^e^{nt. Othe}^{r org}^a^niz^a^tio^{ns lik}^e^A^.^{M. Be}^{st list a}ⁿⁱⁿ^sure^{r a}^sⁱⁿ^solv^eⁿ^{t w}^h^eⁿ^the^y^m^e^e^t^the
^s^a^m^e^c^r^ite^rⁱ^a^,^{but the}^y^c^ount^{each co}^m^p^an^yⁱⁿ^{a gro}^u^p^.
²⁸^P^a^ig^e^{St. Jo}^hn,^“^F^lori^da^Ins^u^re^rs^Sta^r^t^P^u^lling^Ou^{t of}^Sta^t^e^,^”^T^h^{e F}^t^.^{Myers News-Pre}^ss^{, J}^a^nua^r^y^{7, 2005}^{, p}^.^A¹^.
²⁹^T^h^eo^F^r^an^ci^s,^“Hu^rri^can^{es Cl}^ai^m^T^h^ei^{r F}ⁱ^rst^Vⁱ^ctⁱ^mⁱⁿ^In^su^raⁿ^{ce F}ⁱ^el^d^,^”^T^h^{e Wa}^l^l^S^t^reet^Jo^u^r^na^l^,^Se^pte^m^be^r^30,
²⁰⁰^{4, p.}^B²^.
³⁰^T^h^eo^F^r^an^ci^s,^“T^hⁱ^{s Year’s S}^t^o^r^{ms F}^aⁱ^l^t^o^Bl^o^w^Do^wⁿ^In^su^rers,^”^The^W^a^ll^Str^e^e^t^J^our^nal^{, Se}^pte^m^be^r^28,²⁰⁰⁴^{, p}^.
⁽^c^onti^nue^d.^..)

difference between the amount of capital (insurance) available and the demand for coverage—and
a sudden shortage of reinsurance for hurricanes. This situation meant major primary insurers
operating in coastal high-hazard Gulf and Atlantic Coast areas could not adequately spread their
catastrophe risks, which, in turn, forced many of them to stop writing new policies in hurricane-
exposed states or to shut down operations altogether for fear of over-exposure, financial
impairment, or even insolvency.
Insurers were caught off-guard by the $15.5 billion (1992 dollars) in insured losses associated
with Hurricane Andrew because of significant errors in actuarial estimates of potential hurricane-
related losses. Prior to Hurricane Hugo in 1989, the insurance industry never suffered any loss
over $1 billion from a single hurricane. Further, most insurance industry experts estimated the
probable maximum loss (PML) for a single hurricane in the United States at between $8 and $10
billion, and that such an event would occur only once in a century. Hurricane Andrew took
insurers and forecasters by total surprise. In hindsight, because of the lull in hurricane activity
during the 1970s and 1980s, insurance policies were underpriced and insurers accepted far more
hurricane exposure than could be supported by their capital resources (including reinsurance).
Also, there were deficiencies in the storm-resistant capabilities of homes in Florida as well as
poor enforcement of building codes in the region.
In response to post-Andrew insurance market disruption, state insurance regulators undertook
several steps to restrict insurers’ products, pricing, underwriting decision and claims settlement ³¹
practices for disaster coverage. In addition, the South Florida Building Codes were extended
statewide and the state legislature established the Florida Commission on Hurricane Loss
Projection Methodology to review hurricane catastrophe models used for rate filings. These two
major changes were instrumental in defining how insurers process and analyze hurricane risk.
Insurers prospectively evaluated their catastrophe exposures in coastal areas for the first time and
discovered that the magnitude of risk was both unexpectedly high and unacceptable, given the
risk tolerances of management and the expected long-term return on the business written in ³²
hurricane-prone areas in coastal states. The concern was that insurers with excessive catastrophe
exposures would have difficulty achieving or maintaining profitability and balance-sheet strength,
and this could lead to rating downgrades, insurer insolvencies, and insurance availability ³³
problems.
One major outcome of insurers’ assessment of catastrophe risk exposure was that large national
property insurers began forming single-state affiliate insurers to protect the capital of the holding
company. Also, with the approval of state regulators, insurers began shifting the risk of
windstorm losses away from overexposed insurers to all property owners and other consumers
(through assessments from state-sponsored pools). This decision allowed consumers and insurers

^(...c^on^tin^ue^d)
^C3^.
³¹^For^e^x^a^m^ple^,^r^e^g^u^la^tor^s^s^oug^{ht t}^o^{: (}¹⁾^is^s^u^e^m^o^r^a^torⁱ^um^s^dis^a^llowⁱ^ng^c^aⁿ^c^e^lla^tions^aⁿ^d^no^n-^r^e^ne^w^a^ls^of^hom^e^o^wⁿ^e^r^s
^ins^u^r^a^nc^e^p^o^lic^ie^s^;⁽²⁾^s^u^ppr^e^s^s^h^o^m^e^o^w^ne^r^s^ins^u^r^a^nc^e^r^a^te^s^{in r}^e^s^pons^e^t^o^poli^tic^a^l^pr^e^s^s^u^r^e^,^but^la^t^e^r^a^ppr^ov^e^d^r^a^te
^hⁱ^{kes an}^d^sp^eci^al^hu^rri^can^{e o}^r^“wⁱⁿ^d^”^d^e^d^u^c^tⁱ^b^l^es;^an^{d (3}⁾^op^en^up^t^h^{e m}^a^r^k^et^t^o^{excess an}^d^su^rp^l^u^s^lⁱⁿ^e^{s i}ⁿ^su^{rers and}
^s^t^a^t^e^-^s^pons^or^e^d^ins^u^r^a^nc^e^.
³²^Ru^d^e^M^u^su^lⁱⁿ^,^“^P^ro^p^e^rty^In^su^ran^{ce Mark}^{et Crisis,”}^Pre^s^eⁿ^tation^b^e^fore^the^Insti^t^ute^f^o^{r In}^te^rnati^oⁿ^a^{l Re}^se^arc^h^{, Ma}^y
^14,¹⁹⁹⁶^{, N}^e^w^Y^o^r^k^{, N}^Y^.
³³^J^e^a^nne^H^.^D^u^nle^a^v^y^,^D^a^nie^l^{, L}^.^R^y^aⁿ^{, a}^{nd C}^.^B^r^e^{tt L}^a^w^l^e^s^s^,^“^C^a^t^a^s^tr^ophe^s^:^A^Ma^jor^P^a^r^a^dⁱ^g^m^Shif^t^f^o^r^P^/^C
^In^su^rers,”^B^e^st^{Week P}^r^o^p^e^rt^y/^Casu^a^l^t^y^S^u^p^p^l^emen^t^:^A^Sp^eci^a^l^R^e^po^rt^,^Ma^r^c^{h 25}^,¹⁹⁹⁶^{, p. 1.}

to withstand hurricane-related losses in 2005 and 2004 with limited market disruption in terms of policy ³⁴
cancellations, non-renewals and insurer insolvencies.
The economic rationale for shifting the risk of windstorm loss to property owners through state-
sponsored insurance and reinsurance pools was that these pools have a cost of capital advantage
over private insurers. State-sponsored insurance pools can offer coverage at a price below what
the risk would normally require a private insurer to charge. The pooling arrangement works
because state insurance pools can largely avoid the accounting and tax rules governing the private
sector. A state-sponsored insurance facility is able to defer part of the cost of capital to the future
by virtue of the government’s authority to issue public sector debt to pay losses, and favorable tax
treatment. But, as economists and financial analysts note, there are limits to the ability of states to
fund/capitalize insurance pools in advance of catastrophe losses. That is, many consumers could
face unpaid claims.

Insurers responded to Hurricane Andrew in 1992 by taking action in four areas: hurricane
insurance deductibles, a capital market for catastrophe securities, building code regulation and
construction standards, and catastrophe modeling and forecasting tools. Collectively, these four
marketplace changes allowed private insurers, reinsurers, and state-sponsored insurance pools to
withstand significant losses from the 2004 hurricane season and to continue operating in disaster-
prone states.
Seventeen states and the District of Columbia now require property owners to pay hurricane or
windstorm deductibles from 1% to 15% of the insured value of the property, depending on the
type of home (e.g., mobile homes carry a higher percentage deductible) and where the property is
located, rather than traditional dollar deductibles used for other types of claims, such as fire ³⁵
damage and theft. According to the Insurance Information Institute, the hurricane insurance
deductibles have had the beneficial effects of making insurance coverage more available in high-
risk areas, and getting customers more motivated to invest in disaster mitigation, such as ³⁶
hurricane shutters, damage resistant windows, and homes fortified to withstand severe storms.
By imposing a higher deductible for windstorm-related losses, property owners assume a greater
share of the risks associated with living in high-risk areas, and, therefore, they presumably take
steps to mitigate potential losses.

³⁴^Oⁿ^A^u^g^u^s^t¹⁸^,²⁰⁰⁴^{, F}^l^or^ida^im^ple^m^eⁿ^te^{d a}^m^o^r^a^torⁱ^um^pr^ohi^bitⁱ^ngⁱⁿ^s^u^r^a^nc^e^c^o^m^p^aⁿ^ie^s^f^r^om^no^n-^r^e^ne^wⁱ^ng^or^c^aⁿ^c^e^lli^ng
^the^pol^ic^ie^s^of^h^o^m^e^ow^ne^r^s^hit^by^this^y^e^a^r^’^s^hur^rⁱ^c^aⁿ^e^s^{. U}^nde^r^the^m^o^r^a^torⁱ^um^{, r}^e^sⁱ^de^nt^ia^{l i}ⁿ^s^u^r^e^r^s^ha^v^e^be^eⁿ^k^e^{pt f}^r^om
^d^r^op^piⁿ^g^aⁿ^y^p^o^lⁱ^cⁱ^e^s,^{even i}ⁿ^{cases i}ⁿ^vol^viⁿ^g^non^p^a^ym^en^t^o^f^p^r^emⁱ^u^ms.^F^l^o^rⁱ^d^{a T}^r^easu^r^{er T}^o^m^G^a^l^l^a^gh^{er an}^no^un^ced^oⁿ
^No^vem^b^{er 1}⁶^,²⁰⁰⁴^,^t^h^at^h^e^w^aⁿ^t^ed^t^o^ext^e^nd^t^h^e^o^r^d^e^r^b^e^y^oⁿ^d^t^h^{e e}ⁿ^{d of}^No^ve^m^b^{er b}^ecau^{se t}^h^o^u^s^aⁿ^d^s^o^f^ho^m^e^o^wⁿ^e^rs
^w^a^iting^on^ins^u^ra^nc^e^c^h^e^c^k^{s w}^oul^d^not^be^a^b^le^t^o^c^o^m^p^le^te^re^pa^irs^by^th^a^t^tim^e^a^{nd t}^h^e^r^e^f^oreⁿ^o^t^be^a^b^le^to^g^e^{t c}^o^v^e^ra^g^e
^e^l^se^w^h^e^r^e^until^the^re^pa^{irs a}^r^e^fⁱ^nis^h^e^d^.
³⁵^T^h^{ese 1}⁷^st^at^{es are:}^A^l^ab^a^m^a,^Coⁿⁿ^ectⁱ^c^u^t^,^F^l^o^rⁱ^d^a,^G^e^o^r^gi^a,^Hawaⁱⁱ^,^L^o^uⁱ^si^an^a,^M^aⁱⁿ^e,^M^a^ry^l^aⁿ^d^,^M^a^ssach^u^s^et^t^s^,
^Mis^sⁱ^s^sⁱ^ppi,^N^e^w^J^e^r^s^ey^{, N}^e^w^Y^o^r^k^{, N}^o^r^t^{h C}^a^r^o^lina^,^R^h^o^d^e^I^s^laⁿ^d^,^So^{uth C}^a^r^o^lina^,^T^e^x^a^s^,^a^{nd Vir}^gⁱⁿ^ia^.
³⁶^{For m}^o^re^inf^o^rm^a^{tion o}ⁿ^wⁱ^ndsto^rm^de^duc^tible^{s se}^e^Ne^w^York^-ba^s^e^d^Insura^nc^e^Inf^o^rm^a^tion^Institu^te^{’s pre}^{ss re}^le^a^s^e^,
^da^te^{d Se}^pte^m^be^{r 20}^{, 2}⁰⁰⁴^{, “}^I^nsur^aⁿ^c^e^De^duc^tible^{s A}^pply^f^o^{r Ea}^c^h^Claⁱ^m^,^”^a^v^a^ila^ble^a^t^http://w^ww^.iiⁱ^.org^/^m^e^d^ia^/
^upda^te^s^/^pr^e^s^s^.⁷³⁷⁸^90/^.

The requirement that Florida homeowners pay a per-occurrence versus a seasonal (aggregate)
windstorm deductible emerged as an important state legislative issue following the 2004 ³⁷
hurricane season. Some108,000 homeowners were struck by two or more hurricanes, and
approximately 36,000 policies had multiple deductibles applied and the cost to policyholders of ³⁸
second and subsequent deductibles may total about $70 million. Residential hurricane
deductibles are typically 2% of policy limits and may be as high as 5% of policy limits, or even ³⁹
higher for certain policies. For this reason, the multiple deductible can result in significant out-
of-pocket expense for many policyholders.
After the 2004 hurricane season, the Florida Legislature passed legislation—Hurricane
Deductibles for Residential Insurance Policies (HB 9-A)—that established a program to
reimburse policyholders for financial hardships suffered due to multiple hurricane deductibles
being applied to their insured losses in 2004. Under HB 9-A, policyholders of residential property
insurance policies who paid two deductibles in 2004 were eligible for reimbursement from the
Department of Financial Services up to $10,000 per storm, per policy, per structure, and up to
$20,000 if they paid three or more deductibles.
The Multiple Deductible Reimbursement Program is funded with $150 million borrowed from the
Florida Hurricane Catastrophe Fund (Cat Fund) to reimburse residential property insurance ⁴⁰
policyholders . The borrowed funds would be repaid over five years starting in 2006. The Cat
Fund estimates that there was a statewide average increase of 0.5% in homeowner rates to cover ⁴¹
the payments.
While insurers were generally pleased with the new law because they will not have to reopen
thousands of already settled claims, they had lobbied to make it easier for insurers to be
reimbursed by the Cat Fund. Currently, there is a $4.5 billion threshold trigger before insurers can
be reimbursed for losses under the Cat Fund’s reinsurance agreement. Florida’s Chief Financial
Officer, Tom Gallagher, had recommended a plan to the Legislature’s Joint Select Committee on
Hurricane Insurance to reduce the Cat Fund retention to $4 billion for each of the two hurricanes ⁴²
and $1 billion for the third and subsequent events in a season.
Insurers have traditionally used reinsurance to manage a portion of their catastrophe risk.
Insurers, reinsurers, and an increasing number of corporations came to the realization beginning
in the late-1980s that the traditional reinsurance mechanisms were limited in their ability to

³⁷^A^a^r^{on D}^e^Sla^tte^{, “}^C^a^t^a^s^tr^ophe^F^u^nd^Stir^s^D^e^ba^te^,”^T^h^e^Florⁱ^d^a^To^day^,^Decem^b^e^{r 9}^,²⁰⁰⁴^,^p.^1.
³⁸^F^o^{r m}^o^{re i}ⁿ^f^o^rm^atⁱ^oⁿ^see,^Offⁱ^ce^o^f^t^h^{e F}^l^o^rⁱ^d^{a S}^t^at^{e S}^eⁿ^a^t^e^S^ecret^ar^y^,^“S^u^mmar^y^o^f^L^e^gi^sl^atⁱ^oⁿ^P^a^ssed^:²⁰⁰⁴^-^A
^S^p^eci^al^S^e^ssi^oⁿ^,^{” avai}^l^a^b^l^{e at}^h^t^t^p^:^/^/^www^.^f^l^s^en^at^e.^go^v.
³⁹^{It sho}^u^l^d^be^note^d^t^h^a^t^$⁵⁰⁰^h^u^rri^c^aⁿ^e^de^duc^ti^ble^s^a^r^e^{still pre}^v^a^l^eⁿ^{t f}^o^{r hom}^e^s^a^{nd m}^obile^hom^e^s^v^a^l^u^e^d^u^nde^r
^$10^0,⁰⁰^0.
⁴⁰^F^o^{r a s}^u^mm^ar^{y o}^f^l^e^gi^sl^atⁱ^oⁿ^p^a^s^s^ed^b^y^t^h^{e F}^l^o^rⁱ^d^{a L}^e^gi^sl^at^u^r^{e d}^u^rⁱⁿ^{g t}^h^e²⁰⁰⁴^-^A^S^p^eci^al^S^e^ssi^oⁿ^,^s^ee
^http:^//f^ls^eⁿ^a^t^e^.^g^o^v^/^Pu^blic^a^tio^ns^/^2004A^/Seⁿ^a^t^e^/^r^e^por^ts^/^s^um^m^a^rⁱ^e^s^/^pdf^/s^e^s^s^u^m^04A^.pdf^.
⁴¹^Fraⁿ^k^Ma^ts^{o L}^y^sⁱ^ak^{, “}^B^{ill Fre}^e^s^Ca^ta^s^t^rophe^F^uⁿ^d^t^o^Re^im^burs^e^Florida^D^e^d^u^c^tib^le^s^,^”^B^e^st^{’s R}^evi^ew,^J^a^nua^r^y²⁰⁰⁵^,
^v^o^{l. 1}^05,^p.¹⁰^.
⁴²^NA^M^I^{C On}^lⁱⁿ^e,^“F^l^o^rⁱ^d^a^:^S^eⁿ^a^t^o^{rs Hear T}^e^stⁱ^m^oⁿ^y^oⁿ^Ho^w^Hu^rri^can^{e Affect}^ed^t^h^{e In}^du^st^ry^,^h^t^t^p^:^/^/^www^.ⁿ^a^mⁱ^c^.^o^rg/
^P^rⁱⁿ^t^P^a^g^e^.^a^s^p?^A^r^tic^le^I^D⁼^7510.

provide coverage for catastrophic risk.⁴³ Recognizing the limits of their ability to finance
catastrophe risk, the high cost of reinsurance, and the sheer size of the capital markets, insurers
and investment banks became more active in offering capital market instruments linked to
catastrophe risk. Investors are attracted to innovative financial instruments form natural disaster
risk management for several reasons, including their above-average risk-adjusted rate of return
versus the typical fixed income instruments and the fact that the rate of return is not correlated
with the returns associated with stock and bond portfolios.
The first risk-linked securities (called “catastrophe bonds”) were introduced in 1994, but it was
not until 1997 that they gained some acceptance as catastrophe risk financing alternatives. Total
cat-bond issuance in 2005 is estimated at around $6 billion. Investors in these securities continue
to demand a high-risk premium because of their lack of familiarity with catastrophe risk and ⁴⁴
uncertainty about the likelihood that these instruments will be triggered. The full acceptance of
this new asset class for securitization has been limited by: (1) the tax, cost and regulatory
treatment of the financial instruments—the so-called “special purpose reinsurance vehicles”
(SPRVs)—underlying the securitization; (2) the lack of standardization in risk measurements; (3)
lack of a generally-accepted index on which to base payouts; and (4) high transaction costs
relative to traditional reinsurance coverage.
Disaster risk reduction requires effective enforcement of building codes, land-use planning,
environment risk and human vulnerability monitoring and safety standards. In hurricane-prone
coastal states like Florida, homeowners insurance rates are now based on new building code
standards and the structure’s ability to withstand damage by high winds. In the 1980s, the
insurance industry came to the realization that the level of building code enforcement affected the
cost of claims. It was not until Hurricane Andrew in 1992, however, that a new organization, the
Insurance Institute for Property Loss Reduction (IIPLR), launched a study to develop better wind
and seismic building codes so structures could better withstand the force of storms and
earthquakes. The work of the IIPLR led to the development by Insurance Service Office (ISO) of
a building code compliance rating system. The ISO Building Code Effectiveness Grading
Schedule (BCEGS) assesses the building codes in effect in a particular community and the
community enforcement of these codes. The BCEGS takes into account factors such as the size of
the community’s building code enforcement budget relative to the amount of building activity, the
professional qualifications of building inspectors, and past code enforcement levels. By
incorporating the BCEGS into the underwriting and pricing process, communities now have the
incentive to undertake mitigation activities such as requiring property owners to use certain
roofing material, the installation of hurricane shutters, and the identification of appropriate load
combinations for buildings.
With the availability of BCEGS, insurers and state insurance regulators combined forces under
the auspices of the National Association of Insurance Commissioners (NAIC) to develop and
encourage states to adopt model insurance laws, regulations and guidelines that link insurance

⁴³^P^a^{ul R}^.^K^l^eⁱ^nd^or^f^e^r^a^{nd H}^o^w^a^r^d^K^unr^e^u^t^h^e^r^{, “}^C^ha^lle^ng^e^s^Fa^cⁱ^ng^t^h^e^Iⁿ^s^u^r^a^nc^e^Iⁿ^d^u^s^t^r^y^{in Ma}^na^gⁱⁿ^g^C^a^ta^s^t^r^ophe
^Risks”,^In^The^Fi^na^ncⁱⁿ^{g o}^f^C^a^t^a^s^t^r^ophe^Rⁱ^s^k^{, e}^d^.,^K^e^nne^th^A^.^Fr^oⁿ^{t (}^C^hⁱ^c^a^g^{o, U}ⁿ^iv^e^r^s^ity^of^C^h^ic^ago^P^r^e^s^s^,¹⁹⁹⁹⁾^,^p.
¹⁴⁹^.
⁴⁴^M^a^rtin^G^r^{ace, Ro}^b^e^{rt W}^.^Klein^,^an^d^Rich^ar^d^D.^Ph^ill^ip^s,^“Aⁿ^Ecoⁿ^o^m^{ic A}^p^p^r^{aisal o}^f^Secu^ritizin^g^In^su^ran^{ce Risk}^Vⁱ^a
^On^sh^o^r^e^S^p^eci^al^P^u^r^p^o^s^{e V}^e^hⁱ^cl^e^s^,^”^Rⁱ^{sk Ma}ⁿ^a^g^e^men^t^an^{d In}^su^r^a^{nce R}^evi^ew^,²⁰⁰^2,^v^o^{l 4, p. 33}^.

practices to building codes. The Florida legislature requires insurers to reflect BCEGS in their
rates. Insurers now offer discounts on property insurance premiums to property owners and
businesses located in communities with enforced, up-to-date building codes that conform to
BCEGS standards. Communities with a BCEGS grade of 1 (reflecting exemplary commitment to
building-code enforcement), for example, can demonstrate better loss experience, resulting in
lower insurance premiums. Insurers may also impose surcharges in communities where
enforcement is lax. The BCEGS program was initially implemented in states with high exposure
to wind (hurricane) and seismic exposure, but now is available throughout the rest of the country.
Before Hurricane Andrew in 1992, most insurers had not used electronic information processing
systems to keep track of their potential hurricane loss exposure and to help them make informed ⁴⁵
insurance underwriting decisions. After the Andrew disaster there was a widespread use of
catastrophe simulation modeling—a type of modeling that allows insurers and regulators to better
predict future windstorm losses on the basis of current demographics and construction techniques,
rather than historical loss experience. Actuaries had gained access to sophisticated statistical
databases and computer modeling techniques that could integrate long-term weather data, ⁴⁶
engineering studies of storm loss potential, and population trends. By combining mathematical
representations of the natural occurrence patterns and characteristics of hurricanes, tornadoes,
severe winter storms, earthquakes, and other catastrophes, with information on property values,
construction types, and occupancy classes, these computer simulation models provide information
concerning the potential for large disaster losses before they occur.
There are significant limitations to these types of computer modeling techniques. For example,
loss models work best when they are used to develop a relative understanding of potential
damage rates rather than absolute losses. Despite the comparative wealth of data and knowledge
about hurricanes and the sophistication of insured loss models for these events, some experts
believe that these models are often wrong by an order of three, even if all the important event
characteristics are known. Thus, a model may predict that a given storm will produce $300
million of insured losses, but the actual insured losses would vary from $100 million to $900
million.

Most existing structures in hurricane-prone areas are susceptible to hazard risks, such as strong
winds, storm surges, heavy rains, and flooding. Insurance as a risk transfer mechanism can play a
key role in helping to minimize disaster losses and reduce the financial and economic impacts of
disasters. The problem is that multiple-peril insurance policies held by homeowners exclude
damages caused by wind and water damage. To fill this gap in coverage, state catastrophe funds,
such as the California Earthquake Authority and the Florida Hurricane Catastrophe Fund, provide
coverage for windstorm and earthquake hazards. In a similar fashion, flood-related damages

⁴⁵^T^o^m^O^’^B^r^ie^{n, “}^C^a^t^a^s^tr^ophe^Mo^d^e^ling^f^o^r^C^o^r^p^or^a^t^e^Rⁱ^s^k^Ma^na^g^e^r^s^,”^Ris^k^M^ana^ge^m^e^{nt M}^a^g^a^zⁱ^ne^{, Ma}^y^{2004, p. 18.}
⁴⁶^Mⁱ^ch^ael^Ha,^“Cat^ast^r^o^p^h^e^M^o^d^e^lⁱⁿ^g^,^F^o^recastⁱⁿ^{g T}^o^o^l^s^M^o^{re S}^o^phⁱ^s^tⁱ^cat^ed^,^”^N^a^tⁱ^o^{nal U}^nde^r^w^r^ite^r^:^Pr^ope^r^t^y^&
^Casual^ty^/Risk^&^Be^ne^{fits M}^ana^ge^me^{nt Edit}^ioⁿ^{, Se}^pte^m^be^r^23,²⁰⁰⁴^{, p}^.¹⁷^.

associated with hurricanes may be insured through a separate policy offered by the federal
National Flood Insurance Program (NFIP).
Hurricane Katrina demonstrated the importance of the NFIP for protecting many families from
financial ruin, but participation rates in flood-prone areas are under 30%. Many homeowners
appear not to be insured despite a mandatory purchase requirement as a condition of being
eligible for a federally insured loan.
Insurance against flood hazard is generally not available in the private insurance market because
flood risk is generally considered uninsurable: only people living in flood zones could be
expected to purchase flood insurance (adverse selection), and these people would have frequent ⁴⁷
claims, thus making the coverage prohibitively expensive. In addition, insurers generally lack
the ability to spread risk sufficiently to safeguard their assets against catastrophic flood losses. ⁴⁸
Therefore, as part of the National Flood Insurance Act of 1968, Congress authorized the
National Flood Insurance Program (NFIP) to serve as an insurance alternative to disaster relief
and to meet the escalating costs of damage to buildings and their contents.
Prior to 1968, the federal government responded to flooding on a national scale through the
building of flood control structures that restricted the flow of waters (e.g., dams, levees, and
dikes) and providing disaster relief to flood victims. After decades of federal expenditures for
structural flood works and expanded disaster relief, the focus shifted to flood insurance as a
policy tool for reducing loss and for spreading the risk of loss among individuals and businesses.
It was expected that homeowners and businesses would pre-fund their own losses by purchasing
federal flood insurance. At the same time, the program would encourage preventive and
protective measures to reduce future losses. A key mechanism for doing so was the development
of flood plain maps and the requirement that local communities restrict development in areas
most subject to flooding.
The NFIP provides subsidized, low-cost flood insurance to homeowners and small businesses in
flood-prone communities that have agreed to adopt and enforce floodplain management and
building code standards. Federal flood insurance is available in each of the 50 States, the Virgin
Islands, Puerto Rico, Guam, the District of Columbia, and American Samoa to meet the escalating
costs of repairing damage caused by flood to buildings and contents.
The NFIP operates under a statutory mandate that premium charges for Pre-FIRM risks—i.e.,
structures built before the issuance of a Flood Insurance Rate Map (FIRM) or before 1975,
whichever is later—must be reasonable. The subsidy is provided by charging premium rates
discounted from full risk rates. In order to make up the premium shortfall from subsidizing
premiums, the NFIP establishes a target level of premium income for the program as a whole that
accommodates the combined effect of the portion of NFIP business paying less than full risk
premiums and the portion of the business paying full risk premiums.

⁴⁷^Som^e^ins^u^r^e^r^s^pr^ovⁱ^d^e^c^o^v^e^r^a^g^e^unde^r^hom^e^o^wⁿ^e^r^s^ins^u^r^a^nc^e^polⁱ^c^ie^s^f^o^r^ba^c^k^{up of}^s^e^w^e^r^s^a^{nd dr}^aⁱ^ns^{. C}^o^v^e^r^a^g^e
^m^a^y^a^l^s^o^be^pr^ov^ide^d^f^o^r^f^l^ood^da^m^a^g^e^unde^r^the^c^o^m^p^r^e^he^ns^iv^e^s^e^c^tion^of^s^t^a^nda^r^d^a^u^{to i}ⁿ^s^u^r^a^nc^e^p^o^lic^ie^s^a^{nd s}^o^m^e
^c^o^v^e^r^a^ge^is^a^v^a^ila^ble^unde^r^s^p^e^cⁱ^a^l^c^o^m^m^e^r^c^ia^{l ins}^u^r^a^nc^e^pol^ic^ie^s^.
⁴⁸^P^.^L^.^90-⁴⁴^{8; 83}^Sta^t^{. 47}^6.

Hurricane Katrina will ultimately cost the NFIP approximately $21 billion in insured losses. In
addition, both FEMA and the NFIP are under attack by property owners and the insurance
industry to improve the program to more appropriately protect property values in flood-prone
areas. Some members of Congress have called for changes in the NFIP that include:
• expanding the mandatory flood zones from their current 100-year flood zone
level to the 500-year level;
• increasing the building and contents limits of flood coverage from $350,000 for
residential and $ 500,000 for commercial properties;
• adding business interruption insurance coverage.
Faced with the growing costs of federal expenditures on flood-related disaster relief assistance,
including insurance claim payments, and the cumulative impact of low-intensity hurricanes on
local economies (in terms of property damage and subsequent reconstruction activity) Congress ⁴⁹
has continuously sought to strengthen the operational and financial aspects of the NFIP. On June
30, 2004, President Bush signed legislation to reauthorize the NFIP until September 2008 and to
provide states and local communities with an additional $40 million a year for mitigating (i.e., ⁵⁰
buyouts, elevation or move the home) severe repetitive loss properties (SRLPs).
On September 27, 2007, the House approved H.R. 3121, the Flood Insurance Reform and
Modernization Act of 2007 to reform the program while retaining its original intent to keep rates
affordable for people to buy the insurance. H.R. 3121 would also increase the NFIP’s Treasury
borrowing authority from $20.775 to $21.5 billion. On November 1, 2007, Senator Christopher J.
Dodd introduced S. 2284 to restore the financial solvency of the program and to forgive the debt.
In the absence of federal government intervention into the disaster insurance market, several
states—Florida, California, Hawaii, Louisiana—have had to address the issue of “uninsurable
risks,” meaning risk that cannot get coverage from private insurers in the “voluntary market.”
States with a high risk of natural disasters have created catastrophe funds or residual markets to
deal with the unavailability and unaffordability of property insurance. The residual market
initiatives take on various forms, such as: (1) Fair Access to Insurance Requirement (FAIR) Plans
that are used to cover “hard to insure” exposures; (2) Beach & Windstorm Plans that operate by
spreading the risks among insurers operating in the state; (3) Marketing Assistance Plans (MAP)
that address short-term insurance availability and affordability problems in a state; and (4)
provision for the operation of surplus lines. Both the property insurance residual markets and
catastrophe funds as state-sponsored loss-sharing mechanisms will be discussed in the next
section.
In states where insurers in the private market have reached the limits of their willingness or
ability to provide coverage for homes and businesses in high risk areas, the state has created
catastrophe funds and property residual insurance markets ( i.e., Fair Plan and Beach &
Windstorm Plans), marketing assistance plans, and provisions for surplus line operations that

⁴⁹^Ro^b^e^{rt T}^.^B^u^rris^et^al^,^“^I^m^p^a^c^t^of^L^o^w^-^Iⁿ^te^ns^it^y^H^u^r^rⁱ^c^aⁿ^e^s^{on R}^e^gⁱ^ona^{l Ec}^o^nom^ic^A^c^tiv^it^y^,^”^Na^tu^ra^{l Ha}^z^a^rd^s
^R^evi^ew^{, A}^u^g^u^s^t²⁰⁰²^{, p}^.¹¹⁸^.
⁵⁰^P^.^L.¹⁰⁸^-²⁶^4;¹¹^{8 S}^t^at^.⁷¹²^.

serve to stabilize the property insurance market—without the involvement of the federal
government. Following is a brief discussion of these state residual insurance markets.
The District of Columbia and 34 states have Fair Access to Insurance Requirement (FAIR) plans
that make property insurance available to applicants on eligible property located in coastal areas
who have been unable to secure such insurance in the normal insurance market. FAIR Plans are
syndicated associations of property insurers doing business under the auspices of the state
insurance regulator. Although the FAIR Plans act as a single insurer, participating companies
actually share on a pro rata basis all of the premiums as well as the profits or losses and expenses
incurred.
The concept for FAIR Plans emerged in response to urban riots and civil disorder in the 1960s
and the withdrawal of insurers from the property insurance market in communities with a high ⁵¹
potential for loss. Congress enacted the Housing and Urban Development Act of 1968 which
sought to ensure the availability and affordability of fire, crime, and other property insurance in
high-risk urban areas by offering federal riot reinsurance to property insurance companies ⁵²
operating in states that voluntarily adopted a FAIR Plan.
In 1969, following Hurricane Camille, the first Coastal or “Beach” Pool was created to address
the shortage of windstorm insurance in areas vulnerable to hurricane losses. Today, nine states
have formed Beach and Windstorm Plans which provide coverage for the wind peril alone in ⁵³
designated risk-prone coastal areas. In some states the FAIR Plan serves as the windstorm plan.
Under a state-sponsored windstorm pool, the wind coverage is isolated, and a separate policy is
issued for this peril by the private insurer. Windstorm pools typically purchase reinsurance to
cover future losses.
On July 1, 2002, the Florida Legislature passed a law that created the Citizens Property Insurance ⁵⁴
Corporation (Citizens) as a market of last resort for residential and commercial residential
coverages in high-risk areas where the property owner is unable to procure insurance in the open, ⁵⁵
private insurance market. Citizens was created with the merger of the two existing property

⁵¹^P^.^L^.^90-⁴⁴^{8; 83}^Sta^t^{. 47}^6.
⁵²^T^h^e^Fe^de^r^a^{l R}ⁱ^{ot R}^eⁱⁿ^s^u^r^a^nc^e^P^r^og^r^a^m^w^a^s^te^r^m^ina^t^e^d^{on Se}^p^t^e^m^be^r³⁰^{, 1}⁹⁸⁴^,^due^{to t}^h^e^s^m^a^{ll nu}^m^b^e^r^of^ins^u^r^e^r^s
^buy^ing^the^re^insura^nc^e^.
⁵³^T^h^{ese n}ⁱⁿ^e^st^at^{es are:}^A^l^ab^a^m^a,^G^e^o^r^gi^a,^F^l^o^rⁱ^d^a,^Haw^aⁱⁱ^,^L^o^uⁱ^si^an^a,^Mⁱ^ssi^ssi^ppⁱ^,^N^o^rt^{h Caro}^lⁱⁿ^a^,^S^o^u^t^h^Caro^lⁱⁿ^a^,
^a^{nd T}^e^x^a^s^.
⁵⁴^Com^m^e^r^cⁱ^a^l^re^side^ntia^{l sim}^p^l^y^re^f^e^{rs to s}^m^a^{ll busine}^{ss loc}^a^t^e^dⁱⁿ^a^r^e^a^s^prim^a^r^il^y^z^one^{d re}^side^nt^ia^l.
⁵⁵^R^e^sⁱ^de^ntia^{l c}^o^v^e^r^a^g^e^inc^l^ude^s^b^o^t^{h pe}^r^s^oⁿ^a^l^li^ne^s^r^e^sⁱ^de^ntia^{l c}^o^v^e^r^a^g^e⁽^w^hic^h^c^ons^is^ts^of^the^ty^pe^of^c^o^v^e^r^a^g^e
^prov^ide^d^by^hom^e^o^wⁿ^e^r’s,^m^obile^hom^e^ow^ne^{r’s, dwe}^lling^,^te^na^nt^{’s, c}^oⁿ^dom^iniu^m^unit^ow^ne^{r’s, a}ⁿ^{d sim}^ila^{r polic}^ie^s)
^a^{nd c}^o^m^m^e^r^cⁱ^a^l^line^s^r^e^sⁱ^de^ntia^l^c^o^v^e^r^a^ge⁽^w^hic^h^c^ons^is^ts^of^the^ty^pe^of^c^o^v^e^r^a^g^e^pr^ov^ide^d^by^c^ondo^mⁱ^nium
^a^ssocⁱ^a^{tion, a}^p^a^r^tm^eⁿ^{t b}^u^ild^ing^,^a^{nd sim}^ila^{r polic}^ie^s).

residual markets: Florida Residential Property and Casualty Joint Underwriting Association
(FRPCJUA) and the Florida Windstorm Underwriting Association (FWUA).
Citizens operates under the authority of a seven-member Board of Governors, approved by the
State Treasurer. The State Treasurer also appoints a technical advisory Board of Governors to
provide information and advice to the seven-member Board of Governors. All revenues, assets,
liabilities, losses, and expenses of Citizens are divided into three separate accounts: (1) a personal
lines account for personal residential polices issued by Citizens or the FRPCJUA, and renewed by
Citizens ,that provides comprehensive, multi-peril coverage on risks which are not located in
areas eligible for coverage in the FWUA (and for such policies that do not provide coverage for
the peril of wind); (2) a commercial lines account for commercial residential policies; and (3) a
high-risk account for personal residential policies and commercial residential and commercial
non-residential property policies.
Citizens is authorized by statute to issue bonds and impose emergency assessments on all licensed
property insurers in the state. For the most part, these assessments are eventually passed onto
consumers. In order to maximize the financial resources to pay claims following a catastrophic
hurricane, Citizen’s income and the interest on the debt obligations issued by the corporation are
exempt from federal income taxation.
Although the presence of Citizens in the market has stabilized the availability and pricing of
insurance in coastal areas of Florida, legislators and regulators have concerns about the growth in
the number of policies issued during the past few years as well as the fact that all insurance ⁵⁶
customers statewide are responsible for a significant deficit.
On January 22, 2007, the Florida Senate and House passed a final bill which goes to the Governor
for signature. The Governor has not indicated whether he will sign the bill. In general, the Florida
legislature has (1) expanded Florida Citizens exposure and decreased rates, (2) expanded the
Florida Hurricane Catastrophe Fund, (3) expanded the assessment authority of FIGA, and (4)
rolled the Commercial Lines JUA into Citizens.
In 1993, the Florida Legislature created the Florida Hurricane Catastrophe Fund—”Cat Fund”—
in response to insurers’ concerns about actual and threatened catastrophic losses to property in the
state from hurricanes, and their unwillingness or inability to provide property insurance coverage
to the extent sought and needed. The Cat Fund was therefore established as a tax-exempt source
of reimbursement to property insurers for a selected percentage of hurricane losses above the
insurer’s retention (deductible).
The reinsurance provided by the Cat Fund is designed to stabilize the residential property
insurance market in the event of a major hurricane by offering relatively inexpensive reinsurance
to property insurers and the state’s insurers of last resort—Citizens. The cost of this reinsurance is
below what the private reinsurance market charges because the Cat Fund is not only exempt from
federal income tax, but also the state’s income tax and premium tax. The Cat Fund was the first
program in the United States in which a state provided for tax-exempt accumulation of private
cash to pay for major disasters. The relatively inexpensive reinsurance sold by the Cat Fund to

⁵⁶^Da^vⁱ^{d Se}^dore^,^“^C^it^iz^eⁿ^m^a^y^{Bill $60}^f^o^{r De}^fⁱ^c^it,”^{Palm Be}^ac^{h P}^o^s^t^{, Fe}^br^ua^r^y^{16, 2}⁰⁰⁵^,^{p. C}¹^.

Citizens (and other residential property insurers) allows them to write more residential property
insurance in the state—than otherwise would be the case—and also acts to lower premiums for
consumers.
On June 1, 2004, the Florida Legislature expanded the overall claims paying capacity of the Cat
Fund from $11 billion to $15 billion. The $15 billion amount is financed primarily through
reinsurance premiums paid by primary insurers (based on their exposure to hurricane losses) and ⁵⁷
investment income. Retained earnings are held in a reserve fund account that accumulates,
along with investment earnings, on a tax-free basis. In the event cash reserves are insufficient to
pay claims, the Cat Fund could issue state government revenue bonds or other debt instruments to
raise billion of dollars for claims payout.
Under the Cat Fund’s reinsurance arrangement, private insurers and Citizens are reimbursed for
as much as 90 percent of insured hurricane losses in excess of a $4.5 billion per storm deductible,
up to a total of $15 billion each year. Insurers can choose from three reimbursement coverage
options—45 percent of losses over the retention, 75 percent or 90 percent—depending on their
risk tolerance levels and how much they want to pay for reinsurance. The $4.5 billion is an
industry deductible. Each insurer has an individual deductible, which is its proportionate share of
the $4.5 billion industry aggregate. This individual insurer deductible allows smaller insurers that
suffer unusually heavy losses to qualify for reimbursement, while the industry overall might not.
Insurers also have an individual maximum coverage which is their individual share of the $15
billion maximum industry aggregate collected by the Cat Fund. Insured losses above $15 billion
would be covered by the insurer’s high layer reinsurance and their surplus or reserves.
On January 1, 2004, the Louisiana legislature merged the Louisiana Joint Reinsurance Plan (FAIR
Plan) and the Louisiana Insurance Underwriting Plan (Beach and Windstorm Plan) to create the
Louisiana Citizens Property Insurance Corporation as an insurer of last resort for property owners
unable to obtain insurance in the state. Policies in force at the time of the merger were to be
handled by their respective plans. New insurance business is being placed with Louisiana’s
Citizen. This new entity can build up reserve funds on a tax-free basis to pay claims after a
natural disaster. In the event the fund falls short, the state can issue revenue bonds to pay claims.
Private insurers are responsible for retiring the bonds, but can pass on the costs to policyholders
in the form of a surcharge.
After Hurricane Iniki struck in 1992, the Hawaii legislature created a Hawaii Hurricane Relief
Fund (HHRF) to provide windstorm coverage for residential properties in Hawaii. Under the
state-sponsored insurance scheme, insurers are allowed to sell homeowners insurance with a

⁵⁷^T^h^{is d}^e^b^t^m^a^y^b^e^serv^ic^ed^w^ith^fu^tu^{re rei}ⁿ^su^ran^ce^p^r^emⁱ^u^m^s^co^l^l^e^ct^ed^b^y^t^h^{e Cat}^F^uⁿ^d^aⁿ^d^/^o^r^po^st^-^h^u^rri^can^e
^a^s^s^e^s^s^m^e^nts^le^vⁱ^e^d^{on a}^ll^pr^o^p^e^r^t^y^a^{nd c}^a^s^ua^lty^ins^u^r^e^r^s^a^nd,^he^nc^e^r^e^f^l^ec^te^{d in f}^u^tur^e^pr^ope^r^t^y^a^nd^c^a^s^ua^lt^y^ins^u^r^a^nc^e
^p^r^emⁱ^u^m^s^.^In^t^h^{e even}^t^t^h^at^p^r^emⁱ^u^m^s^an^d^p^r^o^ceed^{s t}^h^at^can^b^e^rai^s^ed^t^h^r^o^u^g^h^t^h^{e i}^ssu^an^ce^o^f^t^a^x-ex^e^m^p^t^reven^u^e
^bon^ds^a^r^e^ins^u^f^fⁱ^cⁱ^eⁿ^{t to a}^ddr^e^s^s^a^c^a^t^a^s^tr^ophic^l^o^s^s^,^c^l^aⁱ^m^s^s^ubm^itt^e^d^by^ins^u^r^e^r^s^to^the^C^a^{t F}^uⁿ^d^a^r^e^pa^id^on^a^pr^o-^r^a^ta
^b^a^si^s.^Becau^{se t}^h^{e an}^nu^al^po^st^-hurri^can^{e assess}^men^t^{s are su}^b^j^ect^t^o^{a cap}^,^l^o^{sses gen}^e^rat^e^d^b^y^a^m^a^j^o^{r cat}^ast^r^ophe
^c^ould^be^pa^id^ov^e^r^a^num^be^r^of^y^e^a^r^s^f^o^llowⁱ^ng^the^e^v^eⁿ^{t. T}^h^e^C^a^t^Fun^d^is^ne^v^e^r^oblig^a^t^e^d^t^o^pa^y^m^o^r^e^thaⁿ^its^a^s^s^e^ts
^an^d^bo^rro^wⁱⁿ^g^cap^aci^t^y^p^e^r^mⁱ^t^.^T^h^{e st}^at^{e i}^sⁿ^o^t^lⁱ^a^bl^{e f}^o^{r u}ⁿ^p^aⁱ^d^cl^ai^ms.

hurricane exclusion. Each participating insurer in the state then acts as a servicing insurer for the
HHRF, issuing the insured a separate hurricane policy and collecting a separate premium that is
then forwarded to the HHRF.
The HHRF receives ongoing revenue from hurricane premiums, and insurance companies post-
hurricane assessments on property business and mortgage recording fees. The plan provides
coverage for losses up to approximately $2 billion in residential damages from hurricanes.
Homeowners are responsible for the first 10% in losses from a major hurricane. Private insurers
participating in the HHRF would be responsible for the next loss layer after the insured’s
deductible. The Fund uses some of the hurricane premium revenues to buy reinsurance, which
covers the third loss layer. The last layer of coverage comes from lines of credit, which are
secured by future surcharges on all property and casualty premiums. If losses exceed the total
coverage amounts, claims are paid on a pro-rata basis.
Four states—Florida, New York, New Jersey, and Texas—have established Marketing Assistance
Plans (MAPs) as service organizations designed to assist consumers in obtaining property and
casualty insurance coverage from authorized insurers in the private market. These organizations
are voluntary mechanisms coordinated by private insures and agent groups in cooperation with
the state insurance regulators to provide insurance when there is a “temporary” market failure.
The MAPS collect and maintain information on agents and insurers writing certain coverages.
MAPS are typically administered by insurance agents’ associations that will assign insurance
applicants who are declined coverage in the voluntary market to participating insurers that agree
to accept applicants on a proportional market-share basis. Some states have created “Property
Protection Programs” in conjunction with MAPs to provide insurers with financial incentives
(e.g., state premium tax credits) to underwrite basic residential insurance coverages which can be
tailored to fit the specific needs of residents in a particular community exposed to catastrophe
risk.
Any risk for which insurance is not available through a company licensed in the applicant’s state
(an “admitted” insurer) may be covered by a surplus lines insurer. The business is placed with a
“non-admitted” insurer in accordance with surplus or excess lines provision of state insurance
laws. Regulators allow catastrophe insurance or “hard-to-place” coverage such as insurance for
antique cars to be sold in a less regulated environment on a surplus lines basis because of the
unusual nature of the risks, and the need for greater flexibility in policy terms and pricing. Also,
coverage may be offered on a surplus lines basis if the voluntary or involuntary markets will not
write expensive homes in a high-risk community.

In 2005, despite the ability to better predict and manage individual insurance-company hurricane
exposures, the property insurance industry, as a whole, still faces the long-term challenge of
maintaining viable insurance markets following a mega-catastrophe that could threaten the
solvency and claims-paying ability of the insurance industry. Complicating this challenge is the

recognition that the country is increasingly exposed to greater hurricane-related losses as a result
of three major ongoing developments: (1) rapid expansion of the population into areas that are
susceptible to natural disasters; (2) rising property values in coastal areas; and (3) climatological
and environmental changes.
With a significant percentage of our population now living in hurricane-exposed areas, even ⁵⁸
larger insured property losses from hurricanes are possible. The American population is
migrating toward the coasts at a rapid rate, placing people and property investments at risk of
loss. In the last three decades, the nation’s shorelines have come under increasing pressure from
population growth and development, and this has profound consequences for the insurance
industry (through higher losses) and the federal budget (through emergency supplemental
appropriations). As an illustration, according to the 2000 U.S. Census data, 55% of the U.S.
population live within 50 miles of a coastline (including Great Lakes shorelines). The National
Oceanic and Atmospheric Administration (NOAA) reports that the population density per square
mile in hurricane-prone Southeast coastal areas increased 129%, versus 38% in the total U.S., ⁵⁹
during the 30-year period from 1960 to 1990. The Insurance Services Office (ISO) found that
from 1970 to 1990, the Southeast Atlantic Coast had a nearly 75% increase in population density, ⁶⁰
far surpassing the countrywide increase of more than 20%.
Given this trend in population growth and coastal development, policymakers have become
increasingly aware of the erosion risks facing homeowners and communities due to high intensity ⁶¹
storms and coastal flooding. It is not uncommon, for example, for a hurricane or severe coastal
storm to cause the coast to erode 100 feet or more in a single day. This situation has led to debate
over the economic consequences of erosion and the use of federal programs, such as the National
Flood Insurance Program (NFIP), to address the coastal erosion problem. The principal concern is
that while the NFIP covers erosion damage that occurs in connection with floods, it does not
account for erosion in setting flood insurance rates in coastal areas.
The insurance industry and FEMA have both taken steps to address coastal erosion. Insurers
responded to coastal erosion risk by making policyholders vulnerable to windstorms pay more of
the cost of living in hurricane prone areas. For example, insurers now impose hurricane
deductibles equal to a percentage of the structure’s insured value and establish rates for
windstorm coverage based on the structure’s ability to withstand damage from high wind. FEMA
has begun to prepare and disseminate maps showing areas subject to erosion, created and
imposed a mandatory surcharge for erosion on flood insurance in Coastal High Hazard Zones,
and, with the passage of the Flood Insurance Reform Act of 2004, provided relocation assistance
and/or buyouts.

⁵⁸^Ru^d^e^T^.^Mu^su^lⁱⁿ^,^“W^o^u^l^d^{a F}^e^d^e^ral^Ro^l^eⁱⁿ^Di^sast^{er P}^r^o^t^ectⁱ^oⁿ^Be^{a Cat}^a^st^ro^p^h^e?”^C^o^ntin^ge^nc^ie^s^,^N^o^v^e^m^b^e^r^29,
²⁰⁰^{3, p. 28}^.
⁵⁹^C^oⁿⁿⁱⁿ^{g & C}^o^m^p^an^y^,^Lightⁱⁿ^g^C^and^le^s^{in t}^h^e^Wⁱⁿ^d^:^Iⁿ^dus^tr^y^Re^s^pons^e^t^o^t^h^e^C^a^t^a^s^t^r^o^p^h^e^Pr^o^b^le^m^.^Hartf^o^rd^,
^C^onne^c^tic^u^t^{. N}^o^v^e^m^b^e^r¹⁹⁹^4,^p.^27.
⁶⁰^Ibid^.
⁶¹^T^h^e^N^a^tiona^{l Fl}^oo^{d I}ⁿ^s^u^r^a^nc^e^R^e^f^o^r^m^A^c^{t of}^{1994 r}^e^quir^e^{d tha}^t^F^E^MA^s^ubm^{it a}^r^e^por^{t e}^v^a^l^ua^ting^t^h^e^e^c^onom^ic
^im^pa^c^t^of^e^r^{osion on}^c^o^a^s^ta^{l c}^o^m^m^unitie^{s a}^{nd t}^h^e^NFI^P^{. T}^h^e^st^udy^{, w}^h^ic^{h w}^a^s^w^r^itte^{n by}^the^He^inz^Ce^nte^r^,
^reco^mmen^d^e^d^t^h^at^F^E^M^A^d^e^vel^o^p^m^a^p^s^t^h^atⁱ^d^en^tⁱ^fy^co^ast^a^l^ero^sⁱ^oⁿ^h^azard^{areas an}^dⁱⁿ^cl^u^d^e^t^h^{e c}^o^st^o^f^exp^ect^ed
^e^r^os^ion^los^s^e^s^w^h^eⁿ^s^e^tting^f^l^ood^ins^u^ra^nc^e^ra^te^s^f^o^{r c}^o^a^s^ta^{l a}^r^e^a^s^.

The National Coastal Zone Management Program (CZMP) is a federal-state partnership ⁶²
authorized by the Coastal Zone Management Act to encourage coastal states to develop and
implement coastal zone management plans. Some 34 states and territories participate in the ⁶³
CZMP. The CZMP is designed to encourage the states to work with the federal government in
finding a balance between protecting the coast and preserving the human uses that depend on the
environment. The CZMP supports states through financial assistance and technical services and
information. In addition, the NFIP is managed in a manner that is consistent with the criteria and
standards established for the federally approved state coastal zone management plans.
Along with rising coastal population growth, there has been a tendency for coastal development ⁶⁴
to consist of relatively more expensive properties. Table 1 shows that $6.9 trillion of the
estimated $19 trillion of insured coastal properties are vulnerable to hurricane risk. Whether
provided by an insurer’s surplus, reinsurance agreements, or securitized insurance instruments,
capital is needed to underwrite property insurance covering potential losses from weather and
climate events. It became obvious after Hurricane Andrew that exposures in disaster-prone areas
were far beyond the capital that was available from existing sources before the event.
Insurers have responded to the urgency of strengthening their capital position with reforms of
insurance systems. They have also played an active role in encouraging the development of better
wind and seismic building codes so future construction could better withstand the force of
hurricanes and earthquakes. It takes time, however, to implement and realize the results of
construction standards nationwide. Because most of the building in coastal areas were constructed
in the 1970 through 1990 period, when these building standards did not apply, most homes
remain vulnerable to damages from natural disasters. In addition, insurers have shifted more
responsibility for catastrophe damages to the property owners. They have accomplished this by
requiring higher deductibles and employing computer-generated rates—rates which are based on
a simulation of various scenarios involving a structure’s ability to withstand damage by high
winds and from water damage.
There is a growing body of scientific evidence suggesting that the global climate may be
changing (i.e., global warming), with more frequent extreme weather events occurring, thereby ⁶⁵
increasing the incidence and severity of natural disasters such as hurricanes and floods.
According to Dean John Dutton of Pennsylvania State University and the National Oceanic
Administration Agency (NOAA), up to $2.2 trillion of the U.S. economy are believed to be
affected annually by weather and climate events. At the core of the global warming debate is the
belief that human-derived so-called “greenhouse gases” emissions have risen in recent decades,

⁶²^P^.^L^92-⁵⁸^{3; 86 Sta}^t^{. 12}^80.
⁶³^F^o^{r m}^o^{re i}ⁿ^f^o^rm^atⁱ^oⁿ^on^Co^ast^a^l^Z^oⁿ^e^M^aⁿ^a^ge^m^eⁿ^t^,^{see Nat}ⁱ^oⁿ^a^l^Ocean^A^d^mⁱⁿⁱ^st^ratⁱ^oⁿ^A^g^en^c^y^’^s^Offⁱ^c^e^o^f^Oce^aⁿ
^an^d^Co^ast^a^l^Resou^r^{ces M}^aⁿ^a^ge^men^t^,^“Cel^eb^ratⁱⁿ^{g 30}^{Years o}^f^Co^ast^a^l^Z^oⁿ^e^M^aⁿ^a^ge^m^eⁿ^t^Act^,^{” avai}^l^a^b^l^{e at}
^h^t^t^p^:^/^/^www^.^o^cr^m^.ⁿ^o^s^.ⁿ^o^aa.^go^v/^cz^m^.
⁶⁴^Mus^u^lin,^p.³⁰^.
⁶⁵^Ke^lly^Quirk^e^{, “}^G^loba^{l W}^a^r^m^ing^aⁿ^d^In^creasiⁿ^{g Cat}^a^st^ro^ph^{e L}^o^sses,^”^J^ourⁿ^a^{l o}^f^Iⁿ^s^u^r^anc^e^Re^gul^ati^oⁿ^{, Sum}^m^e^r
¹⁹⁹^{4, p. 45}^1.

resulting in a dramatic rise in both the temperature at the earth’s surface and the frequency and
severity of hurricanes, windstorms and floods.
The basic assumptions underpinning the pricing of insurance against hurricanes does not take into
account changes in the global climate. Moreover, insurers traditionally assume that the average
insured losses over a recent historical period accurately reflect future losses over some arbitrary
future period. This assumption works well with automobile insurance and other widely
distributed, independent risk, but is less appropriate for low-frequency/high consequence events
like hurricanes. In other words, the average activity in any arbitrary period of the past is not
necessarily a good predictor of future activity. The inability to predict future disasters will impact
the capacity for disaster financing as part of a comprehensive disaster management approach.

The devastation caused by Gulf Coast hurricanes in 2005 has stimulated an important public
dialogue about the efficacy of our current system for managing and financing natural catastrophe ^th
risk. A central challenge facing members of the 109 Congress is determining what public and
private initiatives are needed to mitigate and finance losses stemming from future mega-
catastrophes. Is there a need to improve the nation’s ability to finance catastrophe risk and, if so,
how? More specifically, Congress might be called upon to determine the appropriate roles and
policies of the public and private sectors in addressing disaster risks, how they affect hurricane
risk, and how they might be restructured to better achieve social objectives.
Three points of view usually emerge when debating the catastrophe funding problem. One view is
that catastrophes (e.g., hurricanes) are “uninsurable” in the private sector and the federal
government should directly take over underwriting insurance. This view is not widely supported
because the private sector has access to capital market resources that can be used to fund the cost
of a catastrophic hurricane.
A second point of view argues that catastrophe risk is fundamentally uninsurable and federal
involvement in the catastrophe insurance market is needed before a really “big” event occurs only ⁶⁶
at the higher layers of coverage. A consensus among insurance and public policy experts seems
to have emerged that a public-private partnership in financing a mega-catastrophe over the $60-
100 billion threshold might eventually be needed. As demonstrated by the 2005 and 2004
hurricane seasons, insurers and reinsurers are able to handle a series of catastrophes with insured
damages as high as $60 billion. Some insurance market analysts believe the industry can even
handle a single insured event approaching $100 billion in claims.
A public-private catastrophe insurance partnership would leave the private sector responsible for
underwriting property insurance, and the federal government responsible for providing capital
only where consumers and the private insurance and capital markets are unable to do so. The
government could facilitate more effective risk-spreading, which can be achieved by more
effective pooling of losses over time and broader pooling of losses among risks. A more effective
pooling of losses over time could be achieved by borrowing mechanisms and tax deferral of loss

⁶⁶^{For m}^o^re^inf^o^rm^a^{tion o}ⁿ^th^{is a}^r^g^u^m^e^{nt, se}^e^;^Ja^m^e^{s E. Rutro}^u^g^h^{, “}^F^un^ding^Ma^j^o^{r Disa}^ste^r^{s w}^{ith T}^r^a^d^itio^na^l
^In^su^ran^ce,^{” i}ⁿ^Fin^ancⁱ^a^{l R}ⁱ^s^k^M^anage^m^e^nt^for^N^a^tur^a^{l C}^a^tas^t^r^o^p^h^e^s^:^Pr^o^ceedⁱⁿ^g^s^o^f^a^Con^f^eren^{ce S}^p^oⁿ^s^o^r^{ed b}^y^A^oⁿ
^G^r^{oup Aus}^t^r^a^{lia Lim}^ite^d^,^Nei^l^R.^Bri^t^o^{n an}^{d Jo}^hn^Olⁱ^v^er,^ed^.^,^(Bri^s^b^an^e,^A^u^stra^lia^{: G}^rⁱ^f^f^{ith Uni}^Print^,²⁰⁰²^),^{p. 1}^.

reserves for natural disasters. Broader pooling of losses among risks could be facilitated by
requiring property owners to purchase insurance against natural hazards. Economists note,
however, that any scheme that imposes a mandatory insurance requirement for all property
owners could create economic distortions, such as cross subsidization of risks, where low risk
individuals subsidize high risk individuals.
A third point of view presupposes that the financial resources available in the private sector are
sufficient to make federal involvement unnecessary at this time.
There have been many proposals considered by Congress during the last three decades to address ⁶⁷^th
various types of catastrophic losses. Members of the 109 Congress could pursue any one or all
of the following policy options if it could be shown that potential losses from hurricane-related
hazards are beyond the capacity of private markets to diversify such risks:
• establish an emergency reserve fund to provide timely financial assistance in
response to domestic disasters and emergencies;
• provide financial backstop or guarantees to innovative financial instruments and
activities involving insurance interstate compacts between states set up to address
regional exposure to catastrophic losses involving hurricanes in the Gulf and
Atlantic coast states, and earthquakes in the Pacific northwest states and other
areas exposed to similar hazard risks;
• develop a large regional pool for hurricane insurance with potential benefits of
spreading the risks across impacted states. Currently, each state relies on its own
financial resources to develop a substantial pool of funds for insurance. Some
supporters of this policy option have even suggested pooling risks with the same
characteristics as hurricanes, such as earthquakes, volcanos, and tsunamis, into a
single national hazard insurance program designed to solve the catastrophe
funding problem;
• establish a federal hurricane program to provide reinsurance to state-sponsored
insurance programs;
• establish an explicit federal windstorm insurance program, similar to the National
Flood Insurance Program;
• focus on tax policy to allow insurers to create tax-deferred reserves to fund future
catastrophe losses from natural disasters;
• encourage innovative new financing mechanisms of insurance, reinsurance and
capital markets to mitigate and diversify disaster risk; and
• implement a comprehensive national disaster mitigation policy strategy for
reducing future losses.
These approaches have been debated in previous Congresses and some have enjoyed bipartisan
support; however, no consensus emerged, largely because of concerns that such approaches
would (1) encourage home construction in high-risk areas, (2) serve as a tax giveaway to rich

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insurers, (3) expose the federal treasury to large contingent costs at a time of budgetary deficits,
or (4) give a competitive advantage to certain segments of the insurance industry.

During the 2005 hurricane season, Hurricanes Katrina, Rita, and Wilma demonstrated both the
destructive nature of natural disasters and the importance and shortcomings of insurance as a
major financial source for post-disaster economic recovery. As demonstrated by the 2005 and
2004 hurricane seasons, the industry can readily handle a series of events with insured damages
as high as $60 billion. Insurers are expected to easily cover the $66.1 billion in insured losses
from the 2005 catastrophes, including Hurricane Katrina, without threatening the industry’s
solvency or claims-paying ability. Many questions, however, have been raised about the
industry’s continued willingness and ability to sell property insurance coverage in hurricane-
prone states. While some insurance market experts believe insurers and reinsurers can even
handle a single insured event approaching $100 billion, this amount of protection might not be
enough for the potential mega-catastrophe. For example, catastrophe modeling firms note that a
repeat of the 1938 Category 3 hurricane that hit the Northeast could cause over $300 billion in
possible damages. As development increases in coastal areas, a mega-catastrophic hurricane
could result in huge government outlays for disaster assistance and present insurers with
significant financial hazards, such as the risk of insolvency, a rapid reduction of earnings and
statutory surplus, forced asset liquidation to meet cash needs, and ratings downgrade.
To the extent property insurance markets fail to offer adequate levels of coverage after a
catastrophic hurricane, and the federal government avoids the disaster insurance market (with the
exception of terrorism risk insurance), the states will likely continue to offer various, loss-sharing
mechanisms that provide catastrophe insurance or reinsurance coverage at subsidized rates. In a
similar manner, the federal government will continue to offer flood insurance under the National
Flood Insurance Program (NFIP) to offset repair and rebuilding costs in flood-prone regions.
Members of the 110^th Congress will likely be called upon to determine whether there is a need to
improve the nation’s ability to finance catastrophe risk and, if so, how. Previous Congresses
responded to similar concerns by considering legislation to create a federal catastrophe
reinsurance program for residential property. But, despite broad support for several bills over the
past few Congresses, the full Congress did not authorize a federal reinsurance program until the
enactment of the Terrorism Risk Insurance Act of 2002.
Finally, most observers would agree that for the very highest layers of catastrophe risk, the
government (and consequently the taxpayer) is now, by default, the insurer of last resort. In the ^th
110 Congress, any one of a number of policy options could be pursued, but passage will likely
be based on whether it can be shown that potential losses from hurricane hazards are beyond the
capacity of private markets to diversify catastrophe risks. Members will likely be grappling with
several policy questions. For example, will reinsurance and securitization be enough to maintain
insurance solvency after a catastrophic hurricane? How can the various funding sources available
for catastrophe insurance be expanded and refined to cope with a catastrophic hurricane? And
lastly, what role, if any, should the federal government play in catastrophe insurance?

^R^a^w^l^{e O. Ki}ⁿ^g
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^Asse^s^s^m^eⁿ^t
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