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Who Will Pay for the Next Hurricane?

Copyright: The New York Times Company
Source: New York Times Full Feed
Wordcount: 873

Philadelphia

AS the second anniversary of Katrina approaches, residents in
hurricane-prone areas are still concerned that they cannot obtain insurance
to cover damage to their homes from future disasters. Specifically, the
decision by State Farm, Mississippi's largest insurer, to discontinue
selling new policies on homes and small businesses there has sent shock
waves beyond the state. Banks that normally require homeowner's insurance as
a condition for obtaining a mortgage are also not sure what impact this will
have on their clients' ability to buy such coverage.

The insurer's motivation is economic. Rates are regulated by the states, so
insurers are often restricted in the premiums they can charge. In addition,
State Farm faced a lawsuit contending it was liable for flood losses from
Hurricane Katrina. Homeowners' policies cover only losses caused by wind in
such storms; flood coverage is provided by a separate policy as part of the
National Flood Insurance Program. The state of Mississippi, however, charged
that insurers were responsible for hurricane damage from Katrina because
surging floodwaters were caused by the wind. State Farm eventually won the
case, but it was a costly process and led to its decision to discontinue
selling new policies.

State Farm's decision is only the tip of the iceberg of a much broader
problem: how this country can reduce future losses from natural disasters
and aid victims in their recovery efforts. Because of increasing development
in hazard-prone areas and the effects of climate change, we are in a new era
of catastrophic losses from natural disasters. Ten of the 20 most costly
natural disasters have occurred during the past five years -- all 10 of them
hurricanes, typhoons or tropical storms.

The four hurricanes in Florida in 2004 (Charley, Frances, Ivan and Jeanne)
collectively totaled more than $29 billion in insured losses; Hurricane
Katrina is estimated to have cost insurers and reinsurers $45 billion.

At the same time, victims have complained about receiving substantially less
than the actual costs of rebuilding or repairing the damage. Many have
turned to the Small Business Administration for low-interest loans; however,
a property owner is eligible for a loan only if he or she can show the
ability to repay it. Hence, low-income residents must find other assistance.

We need a new approach to financing the costs of natural disasters and to
encouraging individuals in hazard-prone areas to undertake mitigation
measures. Two principles, which appear to conflict with each other, are
guiding a large-scale research study being undertaken by the Wharton Risk
Center in conjunction with Georgia State University and the Insurance
Information Institute (as well as with firms and organizations from the
public and private sectors, some of whom pay for this research).

Principle 1: Risk-Based Premiums. Insurance premiums should be based on risk
to encourage individuals to reduce their vulnerability to catastrophes.

Principle 2: Dealing With Equity and Affordability Issues. Any special
treatment given to lower-income residents in hazard-prone areas should come
from general public funding and not through artificially low rates.

Principle 1 is important because it provides a clear signal of relative risk
to those living in areas subject to natural disasters, as well as those who
are considering moving into these areas. Risk-based premiums also enable
insurers to give discounts to homeowners and businesses who invest in
cost-effective loss-reduction measures. If the premiums are not risk-based,
insurers have no economic incentive to offer discounts. In fact, insurers
forced to charge artificially low premiums prefer not to offer coverage
because it is a losing proposition in the long run. More generally, those
living in hazard-prone areas should have safer structures and buy enough
insurance to cover their losses from a future disaster.

Principle 2 reflects a concern for low-income residents in high-hazard areas
who will face large premium increases if Principle 1 is followed. Today, in
many Gulf Coast states, premiums in regions subject to hurricane damage are
highly subsidized because of rate regulations imposed by state insurance
commissioners. If insurers are permitted to charge risk-based premiums,
homeowners in hurricane-prone areas will pay considerably more for coverage
than they do today.

To deal with the affordability issue, the state or federal government could
provide some type of insurance vouchers to low-income residents. It could
work like the food stamp program, in which families are given vouchers to
buy food based on income and size of family. A homeowner in a hazard-prone
area would pay an insurance premium that reflects risk, and then get
reimbursed by the state for part of the increased cost. The amount of
reimbursement would be determined by income and the premium charged. Under
such a voucher system, insurance could reward individuals for undertaking
risk reduction measures by lowering premiums.

Principle 1 gives us a better chance of making our hazard-prone areas safer
and affordable. Principle 2 implies that we as a society need to recognize
that all taxpayers will have to bear a share of this cost. Rather than
waiting for the next catastrophe, we can take constructive steps now to
protect those in harm's way. In the process we will reduce the likelihood of
having to deal with another Katrina-like disaster.

August 25, 2007, Saturday Late Edition - Final
Section: A Page: 15 Column: 0 Desk: Editorial Desk Length: 931
words