Do Not Flood Yourself with Bad Insurance Decisions

As a new survey from RAND Corp. points out, five years following the devastating Hurricane Katrina, neither the federal government nor the private sector has moved closer to forming effective solutions to the problems facing windstorm and flood insurance.

The seven hurricanes that lashed the Gulf Coast area in 2004-2005 resulted in an unprecedented amount of damage, leading to close to $90 billion of insured wind losses to property, with 50 percent of those losses a result of Katrina alone. Due to this, insurance premiums went through the roof, many private insurers left the coastal regions and government insurance programs were expanded.

Taxpayers and policyholders residing in low-risk areas have many times subsidized the premiums offered by public insurers, leading to concerns that these programs provide inadequate incentives to avoid high-risk areas or otherwise decrease risk.

Also, thousands of residents whose homes were victim to damage or total destruction by the storms resorted to the courts to settle disputes regarding whether their insurance policies covered the losses.

According to one of the authors of the study, until the time an improved system for mitigating and insuring hurricane risk is put in place, these storms will continue causing record-setting losses to life and property, therefore ever-increasing federal disaster relief and major economic disruption in the Gulf Coast states.

According to the RAND study, there are four goals to direct any reform effort:

First, insurance premiums should form appropriate incentives to mitigate risk. Secondly, decisions by households and residential developers should factor in wind and flood risk, the insurance system should pay legitimate claims efficiently and expeditiously, and the insurance market should encourage innovation and price competition. The researchers added that a national commission be formed to assess reforms.

The study names a number of obstacles for public and private efforts to achieve these goals.

For one, it has always been very challenging for the private sector to provide insurance for low-probability, high-consequence happenings such as major hurricanes and earthquakes that impact a large section of policyholders simultaneously.

Given there is a high amount of variation with annual losses that can mean insurance companies holding a large amount of reserved capital to protect against insolvency. That therefore increases rates for consumers.

Even though public sector programs have a number of advantages over private sector insurance companies, government programs many times subsidize premiums in high-risk areas by charging less than actuarially required. In doing so, these programs may be leading to disincentives for homeowners to take the risk of hurricane damage into account when they select where to live, or discouraging them from taking mitigation measures.

The study names the kinds of reforms that could address the ongoing issues facing the Gulf Coast residential insurance market and talks about the trade-offs of different approaches.

Among the policy approaches that researchers believe demand consideration include: Changes in government regulations that decrease the cost of capital that private insurance companies hold to protect against major losses; government provision of reinsurance for wind risk; government provision of wind insurance; increasing mandatory flood insurance acquisition requirements; new policy language on loss allocation like addressing how losses are dispensed when there is both wind and flood damage; federal – as opposed to state- regulation of wind and privately provided flood insurance to enhance competition and innovation.

For homeowners who live in areas that frequently flood or have the potential to, are you properly covered?