Academic journal article Risk Management and Insurance Review

The Use of Postloss Financing of Catastrophic Risk

Academic journal article Risk Management and Insurance Review

The Use of Postloss Financing of Catastrophic Risk

Article excerpt

ABSTRACT

Catastrophic risk financing is a critical issue for many states. At the epicenter of the debate is the role of the state government in helping homeowners finance catastrophic storm risk. In general, states have used a variety of preand postloss strategies, including rate regulation, residual markets, guaranty funds, and postloss assessment structures. However, several states, including Florida, Louisiana, Mississippi, and Texas have used strategies that involve potentially large postloss funding of hurricane risk. In some cases, the structure of the postloss financing mechanism is likely to create significant assessments and subsidies. This article examines the role of state government in catastrophe financing, focusing primarily on postloss financing methods. Specifically, the article provides a discussion of the advantages and disadvantages of the postloss catastrophe financing as well as the political forces that motivate the use of this approach. Further, given the potential magnitude of postloss assessments and related subsidies, we use the Florida homeowners market to illustrate the implications of the state's decisions. This allows for a concrete discussion of the impact and viability of postloss financing mechanisms.

INTRODUCTION

Catastrophic storm risk is a critical issue for many states. Storms such as Katrina in 2005, Andrew in 1992, and Wilma in 2005 are some of the costliest catastrophes in U.S. history with $43 billion, $23 billion, and $11 billion in damage, respectively. In fact, 8 of the 10 most costly U.S. catastrophes involving property damage were the result of hurricanes. These large losses have often had dramatic impacts on regional and state economies, population displacement, federal expenditures on aid, and state property insurance markets. For example, after Andrew, 11 insurers became insolvent and numerous other insurers lost enough capital to affect their ability to maintain operations in Florida (Snyder, 1993). The Florida property insurance market also was severely disrupted again after the 2004 and 2005 hurricanes. Following Katrina, significant disruptions occurred in the Louisiana and Mississippi insurance markets (Milligan, 2007).

The last few years have brought about significant legislation in a variety of coastal states that have focused on how to fund hurricane risk (Cole et al., Forthcoming; Marlett, 2009). For example, in part due to the impact of Ike in 2008, the Texas Legislature has made significant changes to its windpool in an effort to improve the method used to replenish the account following a major hurricane (Shannon, 2009). Specifically, the legislature established policy surcharges in combination with assessments on insurers to fund post-hurricane bonds (House Bill 4409). The legislation also instituted a 10 percent cap on the Texas Windstorm Insurance Association (TWIA) rates (House Bill 4409).

Recently passed legislation in Louisiana requires the state residual market entity (LA Citizens) to charge rates 10 percent greater than the private market and rate by zip code rather than the entire parish (Senate Bill 130). Also in 2009, the Mississippi Legislature continued to subsidize rates by appropriating $40 million to protect residential and commercial insureds of the Mississippi Wind Underwriting Association (MWUA) from rate increases. The funds are tobe used to purchase reinsurance for the MWUA (Insurance Journal, 2009). This subsidy is an open and transparent effort designed to promote economic activity in the coastal areas where the MWUA provides property insurance.

Some states with hurricane exposure that have not experienced any recent storm damage have also seen changes in the functioning of their insurance markets as well as legislative changes. For example, recent legislation in North Carolina would allow property insurance premiums in the entire state to increase by up to 10 percent to cover the Coastal Property Insurance Pool (Pool) deficits when the Pool exhausts its funds and the insurer's limit is reached. …

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