Monday, August 28, 2006

Insurance Groups Disagree on Catastrophe Insurance

As we look back at Katrina with a year of perspective and new information on what can happen in a major hurricane, the insurance industry continues to hash out what needs to be done to try to make the next such event 'less awful'. And they don't agree among themselves. I read an interesting article recently about one of the major points of disagreement.

I think most non-insurance people would probably think that ALL the insurance carriers would immediately agree to what would amount to a Federal government bailout the next time there is a major catastrophe whether natural (a la Katrina) or man-made (think 9-11-2001). But the reality is quite different.

The American Insurance Association (AIA), which represents over 400 insurance companies writing $120 billion in premiums, came out with a National Catastrophe Agenda that contains specific steps they believe are necessary to prepare. They have recommendations for government officials, individuals, businesses, and insurance carriers. They believe that if we all work together doing things like strenghtening and enforcing building codes, giving tax incentives for retro-fitting changes to existing homes, improvements in the FEMA Flood Insurance program, and numerous other areas, we can greatly improve our overall readiness and restoration afterwards.

The one piece they don't necessarily want, believe it or not, is a federal backstop for major insurance losses. Their feeling is that, so far anyway, the private reinsurance market has been able to take care of 'backstopping' catastrophes through the standard industry practice of insurance companies buying their own insurance, in the form of reinsurance, for the large losses. They know there is work to be done with State insurance departments about how reinsurance costs are passed along (or not) to the consumer, but still overall they believe that there are sufficient resources in the private sector and prefer not to increase government costs and regulation.

On the other side of this issue, is a major player. This player is, first of all, quite large enough to be entitled to their own point of view. They also have gone along for many years with NO reinsurance protection, believing they were large enough to spread their catastrophe losses over their huge client base across the country. Unfortunately, four hurricanes in a couple of weeks in Florida, followed by Katrina a year later, pointed out a weakness in their plan.

That player is Allstate. Now that they have found just how badly they could be hurt because they wrote as much insurance as they possibly could in coastal areas, (not just right on the water, the danger zone goes 10 miles inland. That's why Long Island is having a particularly nasty time with homeowners insurance right now. Pretty much everything on Long Island is within 10 miles of a shore) they are in full-blown panic mode. Their management has a clear obligation to their stockholders to do something about this situation, hence all the canceled homeowners insurance policies all over Long Island and the downstate New York area.

Anyway, Allstate says the AIA proposal is badly lacking in that one key area - a Federal government 'backstop' that would basically bail out Allstate and maybe a few of the other really big players in a major catastrophe. This basically amounts to getting reinsurance that they should have been buying all along, but guaranteed by the government. They also figure that if it's a government program, even though they would probably have to put large amounts of money into the program, they would also probably be allowed to include those costs in their rates. Currently in New York, insurance companies are NOT allowed to include reinsurance costs in calculating rates. Rates have to be based on loss history that can be demonstrated with historical data. Reinsurance doesn't come in to play as far as the State Insurance Department is concerned.

These programs always get SOME funding from within the industry. The most common example is FDIC insurance for bank accounts. Banks pay a percentage of their income into a fund that is then used to cover insured accounts at failed banks. But when something really bad happens, like the Savings and Loan debacle of the 1980's, the taxpayer ends up footing most of the bill. In addition, the S&L bailout showed that big companies (in that case, banks, but it applies to big insurance companies too) tend to be a lot less prudent and careful when they know their mistakes will be covered by taxpayer dollars.

It's all very interesting. And it will affect our daily lives here on Long Island in the form of higher homeowners and flood insurance costs going forward, no matter how you slice it. As always, for more info you can contact us through our web site at