Principles for Reform of Catastrophic Natural Disaster Insurance

Along with the winds, rain, and storm surges of Hurricane Katrina came a cacophony of voices urging Congress to adopt a catastrophic hurricane fund (CAT fund). A CAT fund, like the bankrupt and highly inefficient National Flood Insurance Program (NFIP), would provide government insurance to homeowners and businesses to protect against the next catastrophic hurricane. Lost in the chorus of doomsayers is the inconvenient fact that Hurricane Katrina—the most expensive natural disaster in American history—did not bankrupt the insurance industry. Unlike the cur­rent Wall Street financial crisis, the industry did not even require a federal bailout.

From 1970 to 2006, America experienced 23 insured catastrophic losses due to natural disasters or terrorism ranging from $45 billion down to $1.993 billion (in 2005 dollars). These included 15 hurri­canes, one earthquake, and the terrorist attacks on September 11, 2001. Only four caused insured losses greater than $15 billion. Over the past 18 years, only five years have seen insured catastrophic losses in excess of $15 billion: $22.9 billion in 1992 (Hurri­cane Andrew); $16.9 billion in 1994 (Northridge earthquake); $26.5 billion in 2001 (9/11 terrorist attacks); $27.5 billion in 2004 (Hurricanes Frances, Charley, Ivan, and Jeanne); and $61.9 billion in 2005 (Hurricanes Katrina, Rita, and Wilma).[1]

As one expert noted, the insurance "industry held about $400 billion in equity capital and collected pre­miums of about $440 billion" in 2004.[2] While only 12 percent of those funds represented premiums from homeowners insurance, that still amounts to $52.8 billion in yearly premiums.[3] Assuming that actuari­ally unsound state rate caps are lifted and insurance companies take a tighter approach to paying home­owners claims, insurance companies appear easily capable of dealing with all but the most catastrophic natural disasters—they have already dealt with the most catastrophic disaster to date.

Despite these inconvenient facts, proponents of a CAT fund continue to push for another federal pro­gram that would further distort the property and casualty (P&C) insurance market. As with many federal proposals, a CAT fund started small as a hur­ricane-centric idea, but California's congressional delegation would likely seek to add earthquakes to any proposed legislation. Yet no matter what is cov­ered, a CAT fund would federalize even more of America's natural disaster response and spread the risks willingly accepted by a minority of taxpayers to a majority of taxpayers who live far away from routine hurricane and earthquake activity. Common sense demands a different approach.