THE TOPIC

FEBRUARY 2008

The term “catastrophe” in the property insurance industry denotes a natural or man-made disaster that is unusually severe. An event is designated a catastrophe by the industry when claims are expected to reach a certain dollar threshold, currently set at $25 million, and more than a certain number of policyholders and insurance companies are affected.

Catastrophe losses in 2005 totaled $61.2 billion from 24 disasters. The final tally for Hurricane Katrina losses is $41.1 billion stemming from 1.75 million claims. By contrast, losses for 2006, a year of little hurricane activity in the U.S., were $9.2 billion.

RECENT DEVELOPMENTS

• Wildfires: On October 21 wildfires broke out across Southern California, damaging thousands of homes and causing widespread evacuations. Insured losses are expected to exceed $1.6 billion, according to early estimates by the Insurance Network of California. According to the state’s insurance department, 33,000 claims have been filed, including claims for additional living expenses due to the mass evacuation of San Diego County. At least 33,000 homes were total losses.
  
  
• A scientific study that looked at the role houses play in the spread of wildfires underscores what some fire safety experts have been saying for years: that making entire neighborhoods of homes fire resistant slows down the spread of fire. The likelihood of fires spreading from one site to another is dictated in large part by the amount and proximity of fuel – flammable material such as dry undergrowth, trees that burn easily and unprotected wooded structures. When houses are not fire resistant, they add greatly to the fuel load and potential for the fire spreading because they quickly burn down to the ground. When homes are fire resistant, not only are they less likely to burn but they also act as a fire break, reducing the ultimate size of the fire and enabling it to be brought under control more easily. The study was published in the September 4, 2007 edition of the Proceedings of the National Academy of Sciences.
  
  
• Nationwide, the wildfire problem is growing as more people move into risky areas, known as the wildland urban interface, or WUI, with 2006 setting a record both in the number of forest fires and their size. A total of 96,385 fires were reported and 9.9 million acres of forest and woodland burned, a 125 percent increase over the 10-year average, according to the National Interagency Fire Center. Fifty percent of the total occurred in the southern section which stretches from Texas to Georgia. In 2005, more than 8 million acres burned. Over the past decade, the number of acres burned has increased as drought, record-setting heat and the build-up of dead trees and undergrowth together with residential development have combined to heighten the risk of fire. According to a University of Wisconsin study, in the West since 1982 more than 8.6 million new homes have been built within 30 miles of a national forest.
  
  
• The 2007 Hurricane Season and Forecasts for 2008: The 2007 hurricane season, which ended in November, produced 15 named storms, about the number predicted, with five hurricanes, two of them category 5 storms. It is highly unusual to have two category 5 storms, the most damaging, in one season. The only hurricane to make landfall in the U.S was Humberto, a Category 1 storm when it hit the eastern tip of Texas. Losses are expected to be less than $500 million. Humberto was among the fastest storms on record to develop, forming as a tropical depression only 18 hours before it hit land. The other four hurricanes caused significant damage and loss of life in the Caribbean and Central America, leaving thousands without shelter. One storm, Olga, hit the Dominican Republic causing major crop losses two weeks after the official end of the season.
  
  
• In their first forecast of hurricane activity for the 2008 season, Philip Klotzbach and William Gray of Colorado State University predict a somewhat above average hurricane season and an above average probability of a major hurricane making landfall in the United States. Similarly, Risk Management Solutions says that insured losses in 2008 are likely to be 40 percent higher than the historical average for the Gulf Coast, Florida and the Southeast and 25-30 percent higher for the Mid-Atlantic and Northeast coastal regions.
  
  
• Catastrophe Losses: Third-quarter 2007 U.S. catastrophe losses totaled $1.13 billion, according to ISO’s Property Claims Services (PCS) unit. This figure represents losses stemming from six events, many of them storms that generated severe tornadoes. The bad weather affected 11 states across the Midwest from Colorado to Pennsylvania, resulting in nearly 260,000 claims. Minnesota and Illinois were affected by three of the events and suffered the greatest insured damage. Storms in the first three quarters of 2007 generated about 997,000 catastrophe claims, with insured property damage at $4.7 billion.
  
  
• Munich Re, the world’s second largest reinsurer (an insurer of insurance companies), says that estimated insured losses from natural disasters worldwide doubled to about $30 billion in 2007 from 2006. Storms and flooding led to 15,000 deaths and $75 billion in total damage costs. The number of natural catastrophes rose to 950, the highest since the reinsurer began keeping records in 1974. Total insured losses, however, remained well below the record $99 billion in 2005, the year of hurricanes Katrina and Rita.
  
  
• Property Insurance Availability and Affordability and Insurer Profitability: The availability of property insurance in coastal counties along the eastern seaboard from Florida to Cape Cod and the cost of that coverage have become grave concerns as insurers pull back from high-risk areas to reduce future potential hurricane losses and request to raise rates to levels commensurate with the risk they are assuming. Some observers wonder why rates don’t drop significantly when the industry was highly profitable in 2006 and profitable again in 2007. Profits in an industry like insurance must be seen over the long term. In Florida a single hurricane or a string of large losses can wipe out profits from previous years or even decades. According to the Insurance Information Institute, from 1993 to 2003 the rate of return on net worth for all U.S. homeowners insurers was 2.8 percent, compared with 25 percent for Florida homeowners insurers. But when the years 2004 and 2005 are included, the picture is reversed. Over the period 1990-2006, the rate of return for U.S. homeowners insurers averaged -0.7 percent. For Florida insurers it averaged -38.1 percent, despite 2006 being a profitable year as a whole. Profits in other states cannot be used to subsidize rates in Florida or elsewhere and rates charged must be based exclusively on past trends and expected future losses in that state.
  
  
• Proposals/Legislation Stemming from 2004/2005 Hurricanes: Many proposals have been put forward for dealing with property insurance issues. Looking at legislative proposals and other public policy options, the Government Accountability Office (GAO) said in a study entitled “Natural Disasters: Public Policy Options for Changing the Federal Role in Natural Catastrophe Insurance” that it could find no perfect solution to reducing the burden of natural disasters. “Congress is faced with balancing the often-competing goals of limiting taxpayer exposure and ensuring that citizens are protected.” Each of the seven options selected was evaluated against four broad public policy goals: charging a premium that fully reflects actual risks; encouraging the private market to provide natural catastrophe insurance; encouraging broad participation in natural catastrophe insurance programs; and limiting costs to taxpayers before and after a disaster. Each met at least one goal but failed to meet others, generally related to excessive costs to the federal government or federal tax losses. According to the study, 29 percent or $25.8 billion of the nearly $88 billion allocated by Congress to help the Gulf States after the 2005 hurricane season went to people who were uninsured or underinsured. The GAO looks at state and federal programs without issuing any recommendations but says that it will be a challenge for governments at all levels to sustain their current role in natural catastrophe insurance going forward.
  
  
• The New York Insurance Department is proposing a rule that would require each property insurer doing business in the state to establish a catastrophe reserve fund to pay for catastrophe losses in New York State. Catastrophes are rare events but they result in huge losses. Under current tax and accounting rules, insurers cannot set aside reserves for an event that has not yet occurred, but each year they charge for providing the coverage. The funds to establish and maintain the state’s Catastrophe Reserve Fund will come from the profit companies make on the part of the premium charged for catastrophe coverage. The reserves will have a 20-year rolling term. At the end of the term, unused funds from the first year would be considered as income for tax and accounting purposes and the following year’s contribution added to the reserve. Insurers’ reactions to the proposal have been mixed. Some see it as a good first step in addressing catastrophe-related issues. Others say the plan requires them to tie up capital that could be employed more usefully elsewhere.
  
  
• The Homeowners Defense Act (H.R. 3355), introduced in the House by two Florida legislators, would allow states to transfer the risk of catastrophic natural disasters from undercapitalized state-run insurance entities, such as the Florida Citizens Property Insurance Corporation, to the private market. The transfer, together with a federal government loan program, would ensure that state entities have the funds after a disaster to make good on their financial commitments to property owners. To accomplish this, a consortium would be created to provide technical assistance and facilitate the transfer of risk to private markets, through for example, catastrophe bonds, see report on reinsurance. The loan program would provide liquidity and long-term financing to the state entities participating in the program. In the Senate, a similar measure (S. 2310) was introduced by Senator Clinton.
  
  
• A provision has been tacked onto a flood reform bill that would add coverage for wind. H.R. 3121, which incorporates the provisions of H.R.920, The Multiple Peril Act, and H.R 1682, the Flood Insurance Reform and Modernization Act, has been approved by the House on a 263-146 vote, nine votes short of the number needed to override the veto threatened by President Bush. The Administration opposes federal involvement in the private market for wind coverage. The measure, originally proposed by Rep. Gene Taylor, D-Miss in response to litigation over wind/flood coverage issues, would make coverage for wind damage optional and include a provision that would require claims to be paid without regard to whether damage was due to wind or flooding. Taylor’s home was hit by Hurricane Katrina and he sued his insurer for denial of his wind claim. In a hearing on the bill, insurers stressed that most government-run property insurance programs aimed at providing coverage to high-risk policyholders, such as coastal property owners, operate at a deficit. Regulators are under political pressures to keep rates down in both the private market and state-operated pools, which, in turn, leads to larger pools as private insurers withdraw from high-risk areas, and to higher deficits. If rates for wind coverage are commensurate with the risk and wind coverage is optional, as proposed, few homeowners will purchase it when they can obtain a much cheaper policy through the state. While many in the insurance industry oppose Taylor’s wind/flood coverage proposal, several large homeowners insurers support the concept. The Senate Banking Committee approved legislation that does not include wind coverage although several senators have expressed support for such an addition, see below.
  
  
• In the Senate, various bills have been introduced to create a commission. The latest, the Commission on Catastrophe Disaster Risk and Insurance Act approved by the Banking Committee, would create a 16-member expert panel to look at various proposals such as tax-deferred catastrophe accounts for insurers, tax-free catastrophe accounts for policyholders and federal catastrophe funds to back up state funds. The “blue ribbon” committee would report its recommendations to Congress by the end of 2008. In addition, Senator Dodd has sponsored measures (S. 2327 and S. 2328),which would offer an income tax credit of up to $250 to certain coastal residents whose property insurance premiums exceed a certain threshold and would provide $200 million a year for six years to FEMA to apportion to states for loss reduction grants and loans. The legislation is supported by insurance companies, including the Reinsurance Association of America.
  
  
• Another suggestion that relies on the federal government to set risk-based rules and underwriting guidelines for a specially designated “wind zone” rather than provide funding for coastal state-administered insurance entities has been put forward by Travelers Insurance Company.
  
  
• States: Most state proposals have been aimed at alleviating the property insurance availability and affordability crisis rather than solving the long-term problem that has led to it--rates that have been too low for the risk assumed and over development of coastal areas. Growth continues. In Florida, for example, where 80 percent of property lies in coastal areas, the insurance crisis is seen as a threat to the state’s economy.
  
  
• In Massachusetts a commission looking into property insurance concerns in coastal areas made public its recommendations at the end of November 2007. The report calls for the creation of a state catastrophe fund to reduce the cost of reinsurance, with the idea that any savings can be passed on to consumers in the form of lower rates; a study of the catastrophe models insurers use to help them set rates; more comprehensive educational materials so that consumers can learn more about the options available to them and the price of those options; and changes in the operation and governance of the state’s FAIR Plan. Many of the recommendations will require legislative action before they can be implemented.
  
  
• Florida has responded to the potential for increased hurricane activity by assuming greater financial risk in the event that the state is hit by a major storm. Rates for coverage from Citizens Property Insurance Corporation will be frozen until the end of 2008, making what was once the market of last resort the primary market. All homeowners will be able to obtain property insurance from Citizens, see Residual Markets paper, even if a homeowners policy is available from the private market, as long as the premium for the private policy is 15 percent or more expensive than for a comparable policy from Citizens. The legislation also allows Citizens to offer traditional homeowners insurance to its high-risk policyholders as well as wind-only policies, thus competing with private insurers in those areas. In addition, Citizens will take over the administration of the newly formed commercial property insurance pool created to offer wind and hail coverage to small businesses that cannot obtain coverage in the standard market.
  
  
• Other legislation created a three-year program that allows insurers to purchase more reinsurance from the state-run Florida Hurricane Catastrophe Fund, as long as they pass on the savings to their policyholders. Both the Citizens rate freeze and the expanded reinsurance program produce savings by increasing the amount of risk that the state is assuming, ultimately placing a greater burden on taxpayers for actuarially unsound rates. Other provisions include requiring auto insurers to write homeowners insurance in Florida, if they write it in any other state, starting in 2008, and allowing homeowners to significantly reduce homeowners insurance coverage if their mortgage holder agrees to the arrangement and they sign a document indicating that they understand the risks they are assuming.
  
  
• A study by Milliman, an actuarial consulting firm, examined the impact of the new legislation under several storm scenarios, thus quantifying the costs and consequences of the Florida property reform legislation. Among the most significant findings are the following: All homeowners will pay less for property insurance, but the major beneficiaries will be homeowners in southern coastal counties. Motorists and small business owners will see no direct benefit but will face an increase in policyholder assessments if an average-to-large storm hits the state. Assessments and surcharges could last as long as seven to eight years. By reducing premiums in high-risk areas, the legislation encourages additional development in these areas, adding to the financial burden from future storms. If Florida is hit by major storms in consecutive years, charges may exceed 20 percent of the underlying premium and continue for more than seven to eight years.
  
  
• In South Carolina, homeowners who make their homes more resistant to hurricane damage can now get sales and income tax reductions and discounts on homeowners insurance. Legislation passed in June also allows them to set up tax-deductible hurricane savings accounts to fund large deductibles in the event of damage or to use the savings to pay construction costs themselves if they go without insurance altogether. Under the same bill, insurance companies will get premium tax credits for writing full coverage homeowners insurance in wind pool areas. In addition, the wind pool’s boundaries have been expanded to cover more communities.
  
  
• In Maryland, a commission looking into what should be done to ensure that insurance coverage is available and affordable in the state’s two coastal areas, the Eastern Shore and Southern Maryland, is scheduled to report its recommendations by the end of 2007. A recent study of the state’s insurance market by the Property/Casualty Insurers Association of America (PCI) addresses the issues the task force is required to examine. The PCI study found that the homeowners market is sufficiently competitive in these areas and the residual market is shrinking as the role of reinsurance expands but that rates are not adequate in Southern Maryland. On the question of the impact of spreading property insurance costs evenly across the entire state by making everyone with the same coverage pay the same rates, the study found that 71 percent of Maryland homeowners would pay about 12 percent more and 29 percent would pay about 20 percent less. The state could do more to reduce potential storm damage, the study notes, and thus make insurance more affordable. Most jurisdictions in Maryland fail to strictly enforce building codes, according to industry data. An indication of the potential savings from upgrading building codes and stringent enforcement of existing codes comes from the National Institute of Building Sciences, which estimates that society saves an average of $3.65 for every federal dollar spent on mitigation.
  
  
• In Louisiana, legislation has been aimed at attracting more insurers to the state to increase competition, making homeowners insurance more affordable and decreasing the size of the Louisiana Citizens Property Insurance Corporation, the market of last resort. Six insurers have applied for $34 million of the $100 million in grants available to companies prepared to provide coverage, particularly to policyholders now insured by Citizens. More insurers are expected to apply in 2008. Lawmakers also eliminated the Insurance Rating Commission, a politically appointed body that approved rate increases for auto and homeowners insurance above 10 percent and made it easier and faster for new rates to be filed and used. In addition, the legislation requires insurers to provide discounts to policyholders who have improved their home’s resistance to hurricane-related damage.
  
  
• In Rhode Island, where property insurance availability in coastal areas is also a growing concern, lawmakers have formed a committee to examine the storm risks such communities face. A number of states, including Rhode Island, are considering setting up catastrophe funds, see below, but others question whether such programs could succeed without federal backing.
  
  
• Proposals for Regional and National Catastrophe Funds: The White House has criticized proposals to provide a federal backstop for natural catastrophes as totally inappropriate and characterized the insurance availability problems in coastal states as “self-inflicted,” meaning that if a state sets a ceiling on what can be charged and, as a result, insurers are unable to make a profit and leave the state, the state is to blame. Proposals for a federal backstop generally envisage a three-layer plan: 1) policies sold by individual insurance companies; 2) state or regional catastrophe pools that provide reinsurance to insurers doing business in the state; and 3) a national megacatastrophe fund. Some insurance groups are in favor of a federal role while others are not. Some say that under the current system the federal government (and hence taxpayers) pay for rebuilding in any case through government grants and low interest loans and that the funds would be better spent in an organized and predictable fashion. Other insurers say that worldwide there is enough reinsurance capacity to protect U.S. primary insurers against catastrophe losses and that people who choose to live in disaster-prone areas should not be protected from the cost of their decisions through subsidies from people who choose to live in a less risky location. They believe the solution is for Congress and state legislatures to develop more stringent building codes and tax incentives for homeowners to prepare for hurricanes. If there is a federal role, it should be limited to providing liquidity through temporary loans to state or regional catastrophe pools rather than serving as a reinsurer.
  
  
• Reducing Catastrophe Losses: A study by the Institute for Business and Home Safety (IBHS) of losses in the area hit hardest by Hurricane Charley in 2004 found that homes built after 1996 suffered much less damage on average than homes built earlier when building codes were not as stringent, underscoring the importance of enacting and enforcing strong building codes and strengthening older homes through retrofitting. According to data from the claims analysis, homes built before 1996 suffered an average loss of $24 per square foot, or $48,000 for a 2,000 square foot structure, compared with $14 per square foot for homes built between 1996 and 2004. Among the claims examined, there was a 44 percent reduction in total roof covering replacements for the newer homes, 38 percent fewer claims for window glass and/or frame damage and 32 percent fewer total garage door replacements.
  
  
• Insurers have joined a cross section of major industries in pushing for stronger building codes in individual states and across the nation. Studies have shown that the quality of building construction in an area has a significant impact on the amount of hurricane damage. As storm damage grows, flying debris can pierce a building’s outer shell allowing air pressure to build up inside which in turn can lead to catastrophic roof and wall failure. The industry has proposed that Louisiana, Alabama and other states adopt and enforce stronger statewide building codes and is calling on lawmakers and the federal government to provide funding for enforcement. In addition, they support incentives for consumers to buy into stronger building codes, retrofitting homes to be more wind-resistant and hurricane preparedness efforts. At its annual meeting in November 2006, the National Conference of Insurance Legislators discussed setting up standardized building codes in catastrophe-prone areas around the country.
  
  
• In Congress, a bipartisan bill, the Safe Building Codes Act (H.R. 3926), which would reward states that took steps to enact and enforce strong building codes, was introduced in November 2007. The legislation would offer financial incentives, including eligibility for more federal disaster aid, to states that took such preventive measures minor changes in the law. According to IBHS, 13 states would be eligible to receive such incentives and another nine and the District of Columbia could meet the criteria with minor changes in the law.
  
  
• In Florida, the insurance department has adopted the Home Structure Rating System, a scale from 1 to 100 that scores homes based on their ability to withstand damage from high winds. The system implements a bill enacted in 2006. Homeowners who make their homes more resistant to damage from hurricane force winds are now seeing a larger discount on the wind coverage portion of their homeowners insurance premium, depending on the extent to which mitigation features such as hurricane shutters, roof coverings and shape, and the way the roof is attached reduce potential wind damage. In Broward County, for example, the program has saved participants an average of $385, or 20 percent, according to the Florida Department of Financial Services. The goal is to inspect 400,000 homes before the program ends in 2009. Homeowners can request inspections at no charge for recommendations about how to reduce their home’s vulnerability. Grants are available for retrofitting, some with a matching funds feature, depending on the insured value of the structure and the homeowner’s income. Owners of mobile homes and manufactured housing are also eligible for grant money.
  
  
• Legislation enacted by Florida lawmakers during the January 2007 special session eliminates all exceptions to the Florida building code concerning wind-borne debris and requires the Panhandle region, which had been adamantly against the higher standards accepted by the rest of the state, to adopt the Florida Building Code.
  
  
• In South Carolina, legislation passed in June 2007 offers state tax credits to homeowners who retrofit their homes to make them more wind resistant and requires insurers to offer discounts for retrofitting. The state has set aside grant money for the program and expects to receive money from the federal government.
  
  
• Louisiana passed a mandatory uniform statewide building code law in November 2005. In March 2007, Louisiana received $14 million in federal money to help local authorities enforce new building codes. Now the state’s insurance department is working with insurers to set actuarially sound discount rates for compliance with the new codes.
  
  
• Increasingly, consumers are embracing the idea of living in homes that can better withstand severe windstorms. Nearly 2,500 “fortified homes,” which incorporate specific safety design features supported by the IBHS, have been completed or are in various stages of construction in 14 different states, IBHS says, including states in the Midwest. Builders of various types of wind resistant structures in several hurricane-prone states are finding that the public’s appetite for stronger homes has been stimulated by last year’s storms and forecasts of continuing hurricane activity.
  
  
• Mississippi, one of the few states without a statewide building code, the Building Codes Council adopted the 2003 International Building Code, a national building code standard. Local governments are not required to adopt a building code but, if they choose to do so, they must adopt that code. California recently strengthened its building code, incorporating international building and fire standards and state-specific codes for earthquake and wildfire-prone zones.
  
  
• In North Carolina, the insurance commissioner has asked lawmakers to introduce storm shutter legislation. He had previously proposed to building code officials and homebuilders that storm shutters be installed on all new homes sold in coastal counties, not just waterfront properties, but his proposal was rejected. The state once had a reputation for leading the nation in building code standards but amendments to the code over time have eroded their impact, allowing the use of weaker doors and windows.
  
  
• Katrina Claims Litigation/Mediation: Litigation surrounding hurricane claims centers around two issues. First, who pays claims when a home is completely destroyed by a combination of water and wind — flood damage is excluded under homeowners insurance policies, but a separate policy is available from the federal National Flood Insurance Program. Second, whether a distinction can be made between flooding according to what caused it — natural events or human negligence such as a break in a levee attributed to poor design or engineering. Both could cause widespread flooding. In the first week of August 2007, the U.S. 5th Circuit Court of Appeals overruled a lower court decision that would have forced insurers to pay for flood damage caused when levees failed in New Orleans in the aftermath of Hurricane Katrina. The three-judge panel said that even if the plaintiffs could prove negligence in the construction of the levees, “the flood exclusion in the plaintiffs’ policies unambiguously precludes their recovery”. In November 2006 a U.S. district court judge in New Orleans ruled that most flood damage exclusions in homeowners insurance policies are ambiguous because they fail to distinguish between flooding caused by natural events such as Hurricane Katrina and flooding caused by negligence. When language in insurance policies is ambiguous, it is usually construed in favor of the claimant.
  
  
• Residual Markets: Growth of state-run property insurers is shifting the financial burden of potential hurricane-related damage to all policyholders and taxpayers in these states as they devise ways to fund the claims they will have to pay. By year-end 2006, these insurers had an estimated $600 billion in exposure to loss, compared with $54.7 billion in 1990.
  
  
• In Florida, Citizens Property Insurance Corporation, the state’s insurer of last resort, has become Florida’s largest insurer. As of August 2007, it had almost 1.4 million policies in force, somewhat less than predicted, and an exposure to loss of $506 billion. More people were expected to switch to the state pool now that policyholders can move to Citizens if the premium for their current homeowners policy is 15 percent or more higher than the premium for a Citizens’ policy. When Citizens was created in 2002, it was expected to shrink by gradually transferring policies to private insurers under a depopulation program that offers companies financial incentives for assuming policies. Since 2003 nearly 500,000 have been returned to the private market. However, last year private companies took out only 68,000 policies. In October 2007, four Florida-based insurers were given approval to take 173,000 policies out of Citizens, bringing the 2007 total by the end of the year to about 200,000. Rates offered by the take-out companies will be comparable or lower than Citizens and policyholders that receive an offer have the option of remaining with Citizens. Policies tagged for take out are all west of I-95, outside the area considered highest risk. Citizens’ rates have been frozen until the end of 2008.
  
  
• In Mississippi, under legislation passed in March 2007, additional funds will be transferred to the Mississippi Windstorm Underwriting Association, along with a portion of the revenue received from state insurance premium taxes for a four-year period, so that it can build up reserves. In addition, the pool will be able to surcharge policyholders directly if it has to issue bonds or repay loans and insurers will be able to pass on to policyholders their share of assessments for deficits.
  
  
• In South Carolina, the wind pool has been expanded twice this year to additional counties.
  
  
• In Texas, where the coastal plan is run by the Texas Windstorm Association, the legislature has failed to pass legislation to help fund the residual market. Coverage is available in the 14 coastal counties, including those adjacent to Louisiana and part of Harris County, see report on the residual market. The Texas pool has grown from 69,000 policyholders in 2001 to more than 200,000 in 2007 as insurers concerned about hurricane damage reassess their exposure to losses along the Gulf coast. The Texas Windstorm Association had asked the legislature for permission to issue bonds to shore up its finances. Insurance companies must fund any shortfall but may gradually offset assessments through premium tax credits over a period of years.
  
  
• Florida Hurricane Catastrophe Fund: Chief Financial Officer Alex Sink is asking the legislature to give state officials authority to decide what reinsurance coverages the fund should provide each year and at what price in an effort to lower potential costs to the state. A bill enacted in special session in January 2007 created a three-year program that allows insurers to buy more reinsurance from the state-run reinsurer, the Florida Hurricane Catastrophe Fund, thus reducing their reinsurance costs and allowing them to offer homeowners insurance at lower prices.
  
  
• The insurance industry’s retention, or deductible, is $6 billion for the current contract year but companies can purchase coverage to reduce their share of the $6 billion. The fund now has a maximum capacity of $28 billion, $12 billion of which the state added this year. The fund can pay out $5.2 billion in claims before bonds would have to be issued. Its $28 billion maximum capacity should allow it to respond to insured hurricane-related residential losses of about $37 billion, according to the Property/Casualty Insurers Association of America. Under the legislation passed in January, each insurer is required to factor into its rates the savings produced by purchasing reinsurance from the state-run fund and pass this amount onto its policyholders, whether or not the insurer actually purchases reinsurance from the fund. The fund faced a $1.4 billion deficit after the demands made on it by the 2005 hurricane season. The deficit is being funded by homeowners insurance surcharges.
  
  
• Flood Insurance: Although the House passed H.R 3121, the new federal flood insurance reform bill that would, among other things, add wind coverage to the program, the vote was nine short of the two-thirds majority needed to override a likely veto by President Bush, see Proposals section above. Meanwhile, the Senate Banking Committee approved a bill that does not include wind coverage. The Senate bill would forgive the flood program’s debt that resulted from the unprecedented flooding associated with Hurricane Katrina, make owners of property subject to repetitive flooding pay premiums that more closely reflect the true cost of their losses and update flood maps. However, in a repeat of last year’s scenario, Sen. David Vitter (R. La) placed a hold on the bill to keep it from coming to the floor for a vote. Among his concerns were lack of an optional wind coverage provision and failure to raise coverage levels. A large portion of repetitive loss properties are in Louisiana. Flood insurance reform bills were introduced in both houses of Congress in 2006. The House bill was passed but the Senate version, which was opposed by Louisiana’s senators who feared the measure would hurt the state’s property owners, was not.
  
  
• Both bills would cut costs by gradually eliminating the flood insurance subsidy for vacation and second homes. But the House bill, unlike its counterpart in the Senate bill, would increase maximum coverage limits and add more coverage options, including additional living expenses for homeowners temporarily displaced by flooding. The House would also add business income coverage for commercial entities that could not open for business due to floods. Both bills would raise penalties for mortgage lenders that do not enforce the law requiring flood insurance on properties in flood zones, one of several provisions that lenders oppose, and allow premium increases of up to 15 percent from the current 10 percent.
  
  
• Insurers support reform of the flood insurance program but most are opposed to the addition of wind coverage. Some would also like Congress to forgive the NFIP debt, reauthorize the program for a long term and, in an effort to shore up the NFIP, change FEMA procedures to ensure that disaster payments go to flood insurance policyholders before non-policyholders.
  
  
• The National Flood Insurance Program (NFIP) has asked for a study on expanding the scope of the program to another 4 to 6 million properties in less risky areas and to properties protected by dams and levees. Nationally, only 40 to 60 percent of those who are required to purchase flood insurance actually have policies in force. According to a Rand Corporation study conducted for the NFIP, nationwide about 49 percent of single family homes in special flood hazard areas (SFHAs) are covered by flood insurance. In the South and West the percentage is higher, about 60 percent. However, outside of the high-risk areas there is a steep drop off in coverage. Only about 1 percent of homeowners in non-SFHAs purchase it.
  
  
• The number of flood policies in force is growing. In 2006, the last year of data available, there were more than 5.5 million policies in force, compared with 4.9 million the previous year. Premiums grew to $2.6 billion in 2006 from $2.2 billion in 2004. However, the number of claims dropped to 21,547 from 209,801 in 2005, the year of Hurricanes Katrina and Wilma and the cost of flood losses decreased to $553 million from $17.4 billion in 2005. Although more people are buying flood insurance, the percentage is still dangerously low.
  
  
• The Government Accountability Office is looking into the way insurers adjust flood claims. Most NFIP policies are sold through private insurers who issue the policies and adjust claims under their own names on behalf of the federal government through what is known as the “Write-Your-Own-Program.”

BACKGROUND

The insurance industry tracks catastrophes to monitor claim costs, assigning a number to each catastrophe. Each claim arising from the event is tagged so that total industrywide losses can be tabulated. The term catastrophe is often used in the property insurance industry in a narrow way to mean a catastrophic event that exceeds a dollar threshold in claims payouts. This figure has changed over the years with inflation and the increase in development of areas subject to natural disasters. Sarting in 1997 the catastrophe definition was raised from $5 million to $25 million in insured damage. As a result, the number of recorded catastrophes and the aggregate losses attributed to catastrophes has been on average lower since 1997 than in earlier years.

While $25 million is a large figure to most people, there have been four catastrophes that fall into the megacatastrophe category, greatly exceeding that amount. The first two, Hurricane Andrew (1992) and the Northridge earthquake (1994), were both watershed events in that they were far more destructive than most experts had predicted a disaster of this type would be. The third, the terrorist attack on the World Trade Center in 2001, altered insurers’ attitudes about man-made risks worldwide. Hurricane Katrina, the fourth, is not only the most expensive natural disaster on record but also an event that has intensified discussion nationwide about the way disasters, natural and man-made, are managed.

Hurricane Andrew: Hurricane Andrew, which hit the Bahamas and Southern Florida August 23-24, 1992, and then moved across the Gulf of Mexico to strike portions of Louisiana and other southeastern states on August 25-26, was the costliest natural disaster in U.S. history before Hurricane Katrina. With peak wind gusts of almost 200 mph, the hurricane flattened whole communities, leaving in its wake a wasteland of debris. Eleven property/casualty insurers became insolvent due to Hurricane Andrew (10 in Florida and one in Louisiana) and others were financially impaired. Some of the state’s largest homeowners insurance companies had to be rescued by their parent companies and others had to dig deep into their surplus to pay Hurricane Andrew claims. Allstate, for example, paid out $1.9 billion, $500 million more than it had made in profits from its Florida operations from all types of insurance and investment income on those funds over the 53 years it had been in business. In total there were 680,239 claims, including 161,400 for damage to automobiles.

The Northridge Earthquake: The Northridge earthquake measured 6.8 on the Richter scale. It jolted the San Fernando Valley, 20 miles northwest of downtown Los Angeles, on January 17, 1994, causing more than 60 deaths and 12,000 injuries and destroying some 8,000 homes. More than 114,000 buildings were damaged and some 430,000 claims were filed. In both natural disasters, Hurricane Andrew and the Northridge Earthquake, homeowners accounted for the bulk of claims and claim dollars.

The Destruction of the World Trade Center: The World Trade Center disaster impacted many kinds of insurance companies, particularly commercial lines companies. Claims were also filed with life insurance companies as well as personal lines insurers. The number of people known to have died as a result of the attacks on the World Trade Center complex has been officially set at 2,976. More than 35,000 claims were filed in New York State alone, according to the New York Department of Insurance. Broken down by type, two-thirds were commercial claims and one third personal, mostly property claims. Lost income and extra expense claims for the cost of getting the business back on track represented more than one quarter of the dollars paid out. More than 5,600 workers compensation claims were filed. Other claims were paid by insurance companies to businesses that suffered indirect losses in other parts of the country. These were not reported to the New York Insurance Department.

Other large U.S. man-made disaster losses in the last two decades include those stemming from the Los Angeles riots in 1992, at $775 million, and the World Trade Center bombing in 1993, at $510 million, see charts above.

Hurricane Katrina: Katrina, the storm that changed attitudes about managing natural disaster risk, made landfall first in Florida on August 25, 2005 as a Category 1 storm, then gathered strength as it crossed the warm waters of the Gulf of Mexico, ultimately hitting Louisiana on August 29 as a strong Category 3 storm. The hurricane generated more than 1.7 million claims, more than half of the total in Louisiana. The bulk of the claims, 1.2 million, were for personal property. There were 346,000 claims for damaged vehicles and some 156,000 commercial claims. Claims payments to businesses accounted for half of the $40.6 billion bill for insured losses.

Katrina left more devastation and a higher reconstruction bill in its wake than any previous storm, in part because of extensive commercial and residential development along the Gulf Coast; the record breaking storm surge, reported to be as high as 29 feet in some areas; and the concentration of energy related and other high value businesses in its path. Katrina’s hurricane force winds at landfall covered a wide area, extending for 250 miles, twice as far as Hurricane Andrew. Because the damage was so severe and widespread, the demand for materials and skilled labor quickly exceeded the readily available supply, pushing up construction prices and hence the cost of property insurance claims.

The 2005 hurricane season exposed many weaknesses in the nation’s preparedness for megadisasters. For example, many people in flood zones had failed to buy flood insurance and many communities in harm’s way did not have or had not enforced strong building codes, which would have reduced the amount of wind damage. In addition, the disasters drew attention to the need to reconsider land use patterns in areas most vulnerable to storm damage.

Hurricanes: A hurricane's winds revolve around a center of low pressure expressed in millibars, or inches of mercury, and the entire system moves slowly. Hurricanes are categorized on the Saffir/Simpson intensity scale, which ranges from 1 to 5, reflecting a hurricane's wind and ocean-surge intensity. Below is the Saffir/Simpson Classification System.

A windstorm becomes a tropical storm when average wind speeds reach 39 mph. The hurricane season runs from June 1 to November 30, but the height of the season is from mid-August to mid-October.

The number and severity of hurricanes seems to run in cycles. Experts now think these cycles are influenced by several factors: the amount of rainfall in the Sahel region of West Africa just below the Sahara Desert and the pressure and temperature conditions there, the direction of equatorial stratosphere winds, Atlantic Ocean and Caribbean Sea level pressure readings and the oceanic warm-water pattern known as El Nino. Between 1947 and 1969, a rainy period in the Sahel, 17 major hurricanes (Category 3 or greater) struck the East Coast of the United States, compared with 10 between 1970 and 1991, when the Sahel was experiencing a drought. Climatologists believe changing climatic conditions in the tropics signal a period of more intense hurricane activity.

Many of the most severe hurricanes have originated near the Cape Verde Islands off the West Coast of Africa. Recently, hurricane experts have been studying what has become known as the "Atlantic Conveyor Belt," a stream of warm water that moves north up the East Coast from Florida and loops around to Greenland, where it cools and turns south again. The belt of water flows at different speeds in 20 to 30 year cycles. For the past 25 years, it has flowed slowly but is now accelerating, creating conditions favorable to hurricanes. Some scientists attribute the increased hurricane activity to global warming but others say there no evidence to support this. There is some indication that higher water temperatures over the Gulf of Mexico are contributing to the overall greater intensity of the storms.

Florida is the state most vulnerable to hurricanes. Reliable records on hurricanes only go back to the 1870s. Sketchy accounts of earlier disasters exist in ship’s logs and journals. Now, geologists, supported in part by insurers, hope to add to the written record by examining sediments at the bottom of coastal lakes and marshes. During a hurricane, sand and shell debris get swept into these waters. Research so far suggests that between 1,000 and 2,000 years ago, there were five or six Category 4 and 5 hurricanes in the Florida panhandle.

Data compiled by the National Oceanic and Atmospheric Administration (NOAA) on the 30 most powerful storms over the period 1900 to 1996 show that more than 40 percent of the damage they caused occurred in southeast Florida. Of the 158 hurricanes that hit the United States, 47 hit Florida and 26 of those struck the Southeast Florida coast.

Recently, computer simulation models have been developed that can mesh long-term disaster information with current demographic data to produce potential claims losses for any given geographical location under various scenarios. This information allows insurers to better differentiate between high- and low-risk areas in states such as Florida, where formerly, in times of less sophisticated risk delineation, the entire state may have been considered high risk. In addition, computer programs designed to help underwriters evaluate a building's potential damage from windstorms allow insurers to price industrial property insurance coverages more accurately. The ability to generate such information has also led insurers to reassess their business strategies.

But quality and type of building construction are not the only factors that influence the extent of damage a windstorm can cause. Others include the number and type of trees in an area and the type of soil, both of which affect the potential for losses due to falling trees. Soft woods, such as pine, tend to have shallow roots so that they are more easily uprooted than hard woods like oak, particularly in places with sandy soil. Storm surges will cause more damage where the developed land is close to sea level rather than elevated.

Coastal Development: A study published in 2004 by NOAA, based on U.S. Census data, found that in 2003, 53 percent of the nation’s population — 153 million people — lived in coastal counties (including those that abut the Great Lakes), which in total make up 17 percent of the country’s land mass. For the purposes of the study, a coastal county must be part of a coastal watershed but it does not have to have a shoreline. These ratios have remained steady since 1970 but the number of people has steadily increased. Twenty-three of the 25 most densely populated areas are coastal. Put another way, in 1960 an average of 187 people were living on each square mile of the U.S. coast, excluding Alaska. In 1994, that figure was 274 per square mile, and it is expected to reach 327 people by 2015. The West Coast is in the highest earthquake risk zone.

Between 1980 and 2003, the population of coastal counties grew by 33 million people, or 28 percent. Florida grew 75 percent, Texas 52 percent and Virginia 48 percent. More growth is expected. Between 2003 and 2008, the study notes, coastal population in the Southeast region, the area most vulnerable to windstorms, is expected to grow by 1.1 million, or 8 percent, with the highest growth expected in the southernmost part of Florida. Coastal counties in the Carolinas and Georgia are also expected to see considerable population increases. Large increases are forecast for the Houston, Texas area and Florida’s central Gulf Coast.

Exposure to windstorms and high property values combine to make Florida the state with the highest potential for losses, and New York's Long Island the second highest. A 2004 study by AIR Worldwide put the value of insured coastal property in hurricane-prone states--states bordering on the Atlantic Ocean and Gulf of Mexico--at $6.86 trillion. The value of residential and commercial coastal property in Florida alone was $1.94 trillion. This represented 79 percent of the state’s total insured property values. In New York it was $1.90 trillion, representing 61 percent of the total. However, the value of New York’s commercial coastal property at $1.3 trillion was higher than that of any other state on the list. Other states where insured coastal property values exceeded 50 percent of the state’s total are Connecticut, Maine and Massachusetts.

The growth and concentration of property values in hurricane-prone areas has pushed to the forefront of public policy debates the issue of coastal development and hidden insurance subsidies. Subsidies exist in various aspects of the property insurance transaction. First, they exist where rates for property insurance are no longer commensurate with risk because it is politically unpalatable to raise rates to actuarially justified levels. Second, there are subsidies in the pooling arrangements that were set up to make sure people living along the coast can obtain property insurance. When these pools have insufficient funds to pay claims, the shortfall is picked up by insurance companies, which may then pass the cost on to all property insurance policyholders in the state through explicit policy surcharges, as in Florida, or indirectly in the form of higher property insurance rates.

Catastrophe Deductibles: After Hurricane Andrew, with computer-based models of storms, coastal development patterns and increasing values all indicating how vulnerable insurers were to large weather-related losses, homeowners insurers had difficulty finding the reinsurance coverage they needed to protect their own bottom line. Many homeowners insurers couldn't obtain reinsurance coverage unless they agreed to greatly reduce their potential maximum losses from such events through higher deductibles. These deductibles exist in regions prone to hail as well as hurricane damage. They are generally equal to a percentage of the structure's insured value as opposed to a straight dollar amount, such as $1,000. Eighteen states and the District of Columbia have what have become known as hurricane deductibles.

Percentage deductibles for windstorm losses, which may be mandatory in some coastal areas of a state, vary from 1 percent of the home's insured value to 15 percent, depending on many factors that differ from state to state, and sometimes from insurer to insurer, including the home's insured value and the "trigger," the nature of the event to which the deductible applies. In some states or portions of a state, policyholders have a "buy back" option — paying a higher premium in return for a traditional dollar rather than percentage deductible. The percentage deductibles may apply to the entire state or just part of it (see Hurricane and Windstorm Deductibles paper).

For hail damage, in addition to instituting percentage of limits deductibles, some insurers in some states are providing coverage for roofs on a depreciated (actual cash value) basis, rather than replacing a damaged roof with a new one. Some insurers are offering a discount for hail- resistant roofs or imposing a surcharge for roofs that are not hail resistant to encourage people to replace old roofs with new, less damageable ones.

Earthquakes: On the West Coast, earthquakes represent the greatest threat. Statistics show that since 1900, earthquakes have occurred in 39 states and have caused damage in all 50. About 5,000 quakes can be felt each year, with some 400 capable of causing damage to the interior of buildings and 20 capable of causing structural damage. A major earthquake (8.2 on the Richter scale) in San Francisco today could cause as much as $84 billion in damage. However, a major earthquake on the East Coast, though more unlikely, could cause much greater damage. Because earthquakes in the eastern part of the country tend to be thrust-fault quakes, which produce an up-and-down motion rather than the horizontal side-to-side common in California, damage could be 10 times greater, according to seismic experts. The degree of damage also depends on other variables such as the structure of the building and soil conditions (see Earthquakes: Risk and Insurance Issues paper).

A study by Dr. Haresh Shah of Risk Management Solutions and Stanford University, which draws on data from the 1994 Northridge quake and the 1995 quake in Kobe, Japan, suggests the ground shaking at a quake's epicenter can be more violent than expected. This finding has pushed up earlier estimates for loss of life and property damage in the event of a megaquake. An 8.3 magnitude quake in San Francisco, the same in intensity as the quake in 1906, could cause up to 8,000 deaths and between $80 and $105 billion in insured losses, with total losses as high as $225 billion. (Total damage from the Kobe, Japan, quake was $147 billion, of which only $4.1 billion was insured.) New estimates of the potential damage to Tokyo in a major earthquake are numbing. A quake similar to the one that destroyed the city in 1923 could cause as much as $4.3 trillion in total losses.

California insurers collected only $3.4 billion in earthquake premiums in the 25-year period prior to the Northridge earthquake and paid out more than $15.3 billion on Northridge claims alone. After the Northridge earthquake, insurers were reluctant to offer homeowners insurance because they feared additional earthquake exposure could potentially bankrupt them. In response to this crisis in the homeowners insurance market, in 1995 California lawmakers passed a two-part bill that allowed insurers to offer a new earthquake policy with a maximum deductible of 15 percent and created a privately funded, state-run earthquake pool.

Earthquake Insurance: Insurers doing business in California must offer earthquake insurance to their homeowners insurance policyholders, either a policy from the California Earthquake Authority (CEA) or, if they do not participate in the pool, a policy that they underwrite. Several dozen companies now write earthquake insurance in California in addition to the CEA. The CEA became operational in December 1996, with a $10.5 billion funding package. The CEA could now pay claims caused by a quake more than twice as destructive as Northridge since with each passing earthquake-free year, its claims paying ability increases. Passage of the CEA legislation opened up the homeowners market (see Earthquake paper). More recently, the CEA created a supplementary policy to broaden coverage. Nevertheless, only a small portion of the state’s property owners buy earthquake insurance and the percentage appears to grow smaller as the time span since the last major quake increases.

Tornadoes: Each year, about 1,200 tornadoes with gusts of wind as high as 200 mph touch down in the United States. Tornado intensity is measured by the Fujita scale which runs from 0 through 5, the most damaging, based on the maximum speed of three-second wind gusts and the potential for damage. Though generally not as costly in terms of insured values as hurricanes because they strike a more limited geographic area, tornadoes are more frequent. They can cause severe damage and, particularly before the advent of tornado warnings, many deaths. In the decade, 1965-1974, they were responsible for an average of 141 deaths each year, compared with 62 in the 10 years 1997-2006. The peak of the tornado season is April through June or July. Spring tornadoes tend to be more severe and strike the Southeast, which is more densely populated than the Great Plains, thus causing more deaths than those in the summer months. In addition, the South has more mobile homes than other regions. Mobile homes are vulnerable to tornado damage.

Since 1990 the number of tornadoes has generally exceeded 1,000 a year. In the three preceding decades, the only year in which there were more than 1,000 tornadoes was 1973, when 1,102 were reported. This increase may reflect greater ability to detect tornadoes.

Wildland Fires: Fire plays an important role in the life of a forest, clearing away dead wood and undergrowth to make way for younger trees. But for much of the last century, fire-suppression policies focused on extinguishing wildfires as quickly as possible to preserve timber and, increasingly, real estate. These policies have led to the accumulation of brush and other vegetation that is easily ignited and serves as fuel for wildfires. In an effort to reduce the incidence of wildfires, increasingly fire officials are promoting “prescribed burns” to eliminate the accumulated debris. In recent years, most of the large fires with significant property damage have occurred in California, where some of the fastest developing counties are in forested areas. However, wildfires are a growing threat in other states, particularly when there is a drought, as more homes are built in woodland areas that were once wild.

Fire damage is covered under a homeowners insurance policy whatever the cause of the fire unless the person insured under the policy commits arson by intentionally setting fire to the structure. As a result of the greater potential for fire losses where homes are built on mountainous and forested sites, insurers are increasingly requiring homeowners whose property is at risk to take precautions to slow the spread of fire. Such measures include installing fire-resistant roofs and creating a “defensible zone” around the home by removing debris, overhanging tree branches and other items located close to the building that can become fuel for a fire.

Reinsurance: Just as individuals and businesses buy insurance to protect their assets, primary insurers, the companies that sell insurance to consumers, buy reinsurance to protect their bottom line. Reinsurance is sold in layers, reaching up into the millions of dollars to protect insurance companies from possible, but statistically highly unlikely events such as a $100 million court award or an extraordinary number of homeowners claims as a result of a hurricane or a fast-spreading brush fire.

Retentions and coinsurance, through which insurers share the risk at various levels with their reinsurers, as well as coverage amounts, have increased dramatically over the past decade. It is now patently evident that the cost of catastrophes, both natural and man-made, can be in the tens of billions of dollars. Hurricane Katrina cost more than $40 billion but a hurricane hit to Miami or a major terrorist attack could cost much more.

Before September 11, terrorist coverage was provided to commercial policyholders essentially without charge because the risk of an attack was considered remote. Immediately following the disaster, reinsurers said they would no longer offer terrorist coverage to the insurance companies they reinsure because they could not price this unprecedented risk and the availability of coverage for terrorist events is still limited. Legislation that made the federal government the reinsurer of last resort for major terrorist attacks was passed by Congress in November 2002 and extended in 2005 for two more years, making it easier for insurers to calculate maximum losses and therefore to underwrite the coverage (see report on Terrorism Risk and Insurance). Congress is expected to pass an extension to the law which expires at the end of 2007.

The shortage of catastrophe reinsurance capacity in the United States following Hurricane Andrew, particularly for large national insurance companies, also prompted insurers, reinsurers, investment banks and others to look for new ways to spread the risk of natural disasters (see Reinsurance paper). Increasingly, the capital markets are being seen as a large resource that can be tapped to cover claims at the higher levels (after reinsurance has been exhausted) where there is a low probability of loss. The advantage to investors is diversification. Catastrophe losses are unrelated to the usual speculative risks, which are generally economic. While the number of transactions involving the capital markets is still relatively small, some observers expect catastrophe risk to be securitized and made available to investors on a regular basis.

Pricing: The price of an insurance policy reflects the costs of paying claims covered by that policy, as well as an insurance company's costs for such items as reinsurance. Not surprisingly, reinsurance costs as well as direct claims costs are lower where the risk is low. For example, if a community has a good fire department and ready access to water to extinguish fires, serious fires in that community will likely be fewer than in similar communities that lack a good fire department. The same principle applies to windstorms: premiums will reflect the normal level of windstorm claims in a given community.

How does the insurance industry deal with extraordinary costs such as the $40.6 billion in insured losses for Hurricane Katrina? Prior to Hurricane Andrew, insurance companies accounted for hurricanes and other catastrophes with a special premium amount known as a "catastrophe loading" to spread the risk over a period spanning 30 to 40 years. Sometimes they used data from several states subject to the same kind of catastrophes to develop the average annual cost of catastrophes. However, since the mid-1990s more sophisticated computer modeling techniques have become available. Insurers now base their rates on sophisticated computer models that combine meteorological data with their own exposure data. The meteorological data show the probability of a natural disaster occurring in a particular geographical area and the exposure data indicate how many of the company's policyholders are likely to be affected and to what extent, i.e., what the insurer's potential losses from that event are likely to be. Models can also assess the losses a specific company or building might sustain in a terrorist attack.

Special Catastrophe Programs: In the United States special pools, known as Beach and Windstorm Plans, ensure the availability of windstorm insurance for properties close to the ocean. These pools, which exist in seven states along the Gulf and Atlantic coasts in various forms, are operated by property insurers doing business in the state, and in some cases by the state itself. Hawaii created a fund but this was disbanded in December 2000.

New Zealand, Japan, France, Norway and the Netherlands also have catastrophe programs. The original program in New Zealand, the Earthquake and War Damage Commission, was enacted in 1944 to cover "uninsurable" risks. Since 1994 the program has covered not only damage caused by earthquakes but also floods, tsunamis, landslides, volcanic eruptions and hydrothermal activity. Funding comes from a levy placed on all fire insurance policies.

In France, the government created a program in 1982 to pay for uninsurable disasters such as floods. It is funded through a tax on nonlife (home, auto and commercial) insurance premiums. Insurance companies can obtain reinsurance for catastrophes from the government-owned Caisse Central de Reassurance.

The Netherlands set up a natural disasters program based on the French system after widespread, devastating flooding in 1994.

Japan has had an earthquake program covering residential properties since 1966. Primary companies sell the coverage but, since it is expensive and not mandatory, less than 10 percent of homeowners purchase it. Primary insurers insure 100 percent of the risk with the Japanese Earthquake Reinsurance Company (JER), a government entity. JER in turn cedes a portion of the risk to the private reinsurance market and to the Toa Reinsurance Company. The program requires a high level of "coinsurance" by policyholders. In the case of "half a loss," for example — damage equal to between 20 and 50 percent of the property's value — only 50 percent of the loss is covered by insurance. The total limit of indemnity payable by all insurers to claimants for any one earthquake is set annually by the Japanese government. If claims exceed the budgeted amount, payments are prorated. The government limits commercial insurance coverage for earthquakes by geographical location, according to the risk of earthquake damage.

Taiwan set up a program for earthquake losses in 2002, under which claim costs are shared among private insurers, the international reinsurance industry and the government.

Spain has a government-sponsored reinsurance pool that covers both terrorist acts and natural disasters, such as floods, but does not offer business income coverage.

Flood Insurance: Flood damage is excluded under homeowners policies, but it is covered under the comprehensive section of standard auto insurance policies and some coverage is available for floods under special commercial insurance policies. Some insurance companies provide coverage under homeowners policies for the backup of sewers and drains and some companies offer flood coverage to homeowners to augment coverage provided by the National Flood Insurance Program, see below.

Flood insurance for homeowners and businesses is available from the federal government. The private sector cannot insure widespread floods because only people concentrated in flood-prone zones would purchase flood insurance and those people would have frequent claims, making the coverage prohibitively expensive. Before Congress passed the National Flood Insurance Act in 1968, after Mississippi River flooding, the national response to flood disasters had been to build dams, levees and other structures to hold back flood waters, a policy that may have encouraged building in flood zones.

The National Flood Insurance Act was amended in 1969 to provide coverage for mudslides and again in 1973. This last amendment put constraints on the use of federal funds in flood plain areas unless the property was protected by flood insurance, a provision that was expected to make coverage in flood plains almost universal. No lenders that are federally insured or financed can lend money on a property in a flood plain zone when a community is participating in the National Flood Insurance Program (NFIP) unless the property is covered by flood insurance. However, because the initial mortgage on the property is frequently sold by the originating bank to another entity, enforcement of this law has been poor.

Flood insurance is only available where the local government bodies have adopted adequate flood plain management regulations for their flood plain areas under the NFIP. Buildings constructed in a flood plain after a community has met regulations must conform to elevation requirements. About 20,000 communities participate in the program. When repair, reconstruction or improvement to an older building equals or exceeds 50 percent of its market value, the structure must be updated to conform to current building codes. Older buildings sustain six times more damage than newer, elevated buildings built to flood-plains management standards, according to the Federal Insurance Administration. According to a 2007 NFIP study on the benefits of elevating buildings, homeowners can recover the higher construction costs in less than five years if the home is being built in a velocity zone where the structure is likely to be subject to wave damage, and in five to 15 years in a standard flood zone, through significantly lower insurance premiums.

Legislation was enacted in 1994 to tighten enforcement of flood insurance requirements. Regulators can now fine banks with a pattern of failure to enforce the law and lenders can purchase flood insurance on behalf of homeowners who fail to buy it themselves, then bill them for coverage. The law includes a provision that denies federal disaster aid to people who have been flooded twice and have failed to purchase insurance after the first flood. Another provision allows homeowners the option of purchasing flood mitigation insurance, coverage similar in concept to an ordinance or law endorsement, to help pay the cost of raising a structure above flood level to meet federal flood requirements.

Flood insurance was initially only available through insurance agents who dealt with a firm under contract with the Federal Insurance Administration (FIA), part of the Federal Emergency Management Agency (FEMA), to provide administrative services and maintain records. The "direct" policy program has been supplemented since 1983 with a program known as "Write Your Own," through which some 85 insurance companies issue policies and adjust flood claims on behalf of the federal government under their own names. The insurers receive a commission and remit premium income in excess of claims to the federal government. The FIA pays losses in excess of premiums; sets the rates, coverage limitations and eligibility requirements; and designates flood plain areas. The NFIP is expected to be self-supporting (i.e., premiums are set at an actuarially sound level) in an average loss year, as reflected in past experience. In an extraordinary year, as Hurricane Katrina demonstrated, losses can greatly exceed premiums. Hurricane Katrina losses and the percentage of flood damage that was uninsured have led to calls for a revamping of the entire flood program.

Flood adjusters must be trained and certified to work on NFIP claims. NFIP general adjusters typically reexamine a sample of flood settlements. Insurers that fail to meet NFIP requirements must correct problems; otherwise they can be dropped from the program.

Flood plain maps are redrawn periodically. As development in and around flood plains increases, run off patterns change, causing flooding in areas that were formerly not considered high risk. In addition, new technology enables flood mitigation programs to more accurately pinpoint areas vulnerable to flooding. Since the inception of the federal program, some 25 to 30 percent of all paid losses were for damage in areas not officially designated at the time of loss as flood-prone. A new report published by FEMA in 2007 suggests that development patterns should be changed to protect environmentally sensitive areas and that communities in the flood program should be encouraged or required to ban development in these locations.

Flood insurance covers direct physical losses by flood and losses resulting from flood-related erosion caused by waves or currents of water exceeding anticipated cyclical levels and accompanied by a severe storm, flash flood, abnormal tide surge or a similar situation which results in flooding. Buildings are covered for replacement cost but coverage for personal possessions is available on an actual cash value basis only. Coverage for the contents of basements is limited. To prevent people putting off the purchase of coverage until waters are rising and flooding is inevitable, policyholders now have to wait 30 days before their policy takes effect. In 1993, 7,800 policies purchased at the last minute resulted in $48 million in claims against only $625,000 in premiums.

More than 11 million U.S. homes are in flood zones. Only about one in four homeowners who live in areas vulnerable to floods purchase federal flood insurance from the NFIP, generally those in the highest risk areas, in part because people underestimate the risk of flood damage. They tend to think the risk of flooding for structures in a flood zone is about the same as the risk of fire, when in fact it is much higher. According to a FEMA probability analysis, over the life of a 30-year mortgage, a property located in a special flood hazard area would have a 26 percent chance of being flooded, compared with a 1 percent chance of suffering a fire loss.

Ninety percent of all natural disasters in this country involve flooding, the NFIP says.

Building Code Enforcement and Other Damage Mitigation Measures: In the mid-1980s, a study of the damage caused by Hurricanes Alicia (1983) and Diana (1984), two storms of roughly equal size and intensity, found that the level of building code enforcement affected the cost of claims. Hurricane Alicia hit Texas, causing $675 million in insured damage, of which close to 70 percent was attributed to poor code enforcement. By contrast, Hurricane Diana hit North Carolina, where codes were effectively enforced. Researchers found that only 3 percent of homes in that state suffered major structural damage as result of the hurricane. (Insured losses for North and South Carolina totaled $36 million.) This research and a similar assessment of losses in South Carolina after Hurricane Hugo prompted the National Committee on Property Insurance, now the Tampa-based Institute for Business & Home Safety (IBHS), to study coastal municipal building code departments in southern states. Researchers found that building officials and inspectors in about half of the communities surveyed were not enforcing the building code wind-resistance standards on their books.

In South Florida, which has one of the strongest building codes in the country, experts estimated that between 25 and 40 percent of Hurricane Andrew losses were avoidable. A Dade County, Florida, grand jury report issued in December 1992 confirmed that much of the damage was due to lax code enforcement, warning that it was a long-standing problem in the state and that the quality of rebuilding in the hurricane devastated area might be even lower.

As a result, the insurance industry began to develop a building code compliance rating system, similar to its fire protection rating system, which dates back to 1916. Under this classification program, each local fire department's firefighting capability is ranked according to various factors, such as water supply and whether its firefighters are fulltime paid employees or volunteers. The final ranking is incorporated into the homeowner premium rate structure. The ranking process takes into account such things as the size of the building code enforcement budget relative to the amount of building activity, the professional qualifications of building inspectors and past code enforcement levels, with special emphasis on mitigating losses due to natural disasters. Insurers can now offer discounts on property insurance for new construction in communities that enforce accepted building codes. Communities are regraded for building code enforcement every five years.

After Hurricane Andrew, the insurance industry created the Institute for Business and Home Safety (IBHS) to bring the same level of technical expertise to property losses as the Institute for Highway Safety has

brought to automobile losses. Through IBHS, insurers are now sponsoring building construction that better withstands natural disasters. Named "Fortified…for Safer Living," the program specifies construction, design and landscaping guidelines for homes and eventually businesses in areas subject to windstorms, hailstorms and earthquakes. The current program applies to homes now being built. There will also be a retrofitting program for existing structures. The aim is to have a fortified model home in every county in Florida and then one in every state. In Florida, such houses cost from 4 to 9 percent more to build. Surveys show that on average people are prepared to pay up to 6 percent more for a disaster resistant dwelling.

The concept behind this program is twofold: to keep the structure intact and to protect those inside from outside debris, which turns into dangerous missiles in a storm. The more secure the structure, the less storm-generated debris there will be. Some states are initiating programs to help consumers “fortify” their homes themselves, sometimes requiring insurers to offer homeowners insurance discounts for improvements. Efforts to reduce catastrophe damage are not confined to hurricane-prone regions. Homes in areas vulnerable to other types of catastrophes can be protected also and even if discounts are not offered, hail and wildfire-resistant roofs and measures taken to reduce earthquake-related damage makes structures in high-risk areas more readily insurable, and because there is generally less damage, lessen the frustrations involved in getting back on track after a disaster.

Source: Insurance Information Institute. www.iii.org