Gulf Region Property Markets Still Troubled 5 Years After Katrina

Five years after Hurricane Katrina devastated the Gulf Coast, neither the federal government nor the private sector is any closer to developing effective solutions to the problems facing flood and windstorm insurance, according to a report from the RAND Corp.

The seven hurricanes that pummeled the Gulf Coast region in 2004 and 2005 caused nearly $90 billion of insured wind losses to property, with one-half of those losses caused by Hurricane Katrina alone. As a result, insurance premiums skyrocketed, numerous private insurers retreated from coastal regions and government insurance programs were expanded.

“The current constellation of institutions and regulations is not adequate for achieving the basic goals for a well-functioning residential insurance market along the Gulf Coast,” said Lloyd Dixon, one of the authors of the study and a senior economist with RAND.

“Until an improved system for mitigating and insuring hurricane risk is developed, these storms will continue to cause record-setting losses to life and property, ever-increasing federal disaster relief and major economic disruption in the Gulf Coast states,” Dixon said.

The study, “Residential Insurance on the U.S. Gulf Coast in the Aftermath of Hurricane Katrina: A Framework for Evaluating Potential Reforms,” identifies numerous obstacles to public and private efforts. For example, it has always been difficult for the private sector to insure low-probability, high-consequence events like major hurricanes and earthquakes that affect a large number of policyholders simultaneously. The large variation in annual losses can mean that insurers must hold a large amount of capital in reserve to protect against insolvency, which forces rates up.

“We found that the last round of catastrophic hurricanes has shaken the confidence of some insurers in their ability to predict wind damage risk,” said James Macdonald, a study co-author and an adjunct staff member at RAND. “Several insurers we interviewed raised doubts about whether catastrophic windstorm peril can be accurately modeled.”

While public sector programs have some advantages over private sector insurers, government programs often subsidize premiums in high-risk areas by charging less than actuarially needed. By doing so, these programs may be creating disincentives for homeowners to take the risk of hurricane damage into account when they choose where to live, or discouraging them from taking mitigation measures.

The study identifies the types of reforms that could address the ongoing problems, including:

• Changes in government regulations that reduce the cost of capital that private insurers hold to protect against large losses
• Government provision of reinsurance for wind risk
• Government provision of wind insurance
• Expanding mandatory flood insurance purchase requirements
• New policy language on loss allocation, such as addressing how losses are allocated when there is both wind and flood damage
• Privately provided flood insurance to encourage competition and innovation.