Hurricanes: Insuring the uninsurable

Q: Large windstorms seem to strike the coastline of the Southern and Eastern United States nearly every year. What impact do these storms have on property owners in the regions most affected?

A: Aside from the very real possibility of loss of life and property, these storms also affect the cost and availability of coverage. Furthermore the increasing severity of storms affects the affordability and viability of a commercial hurricane-insurance market in these areas.

On average, two hurricanes classified as Category 3, 4, or 5 have made landfall in the United States every three years since 1851, according to the National Hurricane Center (NHC).¹ With population increases in coastal areas and the effects of inflation, the costs associated with windstorms continue to rise. The 2004-2005 season, with thirteen major hurricanes, was one of the most active hurricane seasons on record, tying with 1950-1951. In seven of the twelve years between 1995 and 2006, 14 or more tropical storms were recorded.²

Data from the NHC shows that, from 2000 through 2006, property damage from nine hurricanes and one tropical storm would have totaled nearly $180 billion, expressed in 2006 dollars. ³ Those were very active storm years, with four of the five highest-cost hurricanes, including Katrina, Wilma, Charley, and Ivan, occurring in just the years 2004 and 2005 and causing more than $130 billion in damages. ⁴ In 2005 dollars, Hurricane Katrina alone topped $81 billion, $41 billion of which was insured, according to information provided by the Insurance Information Institute. The most recent hurricane, Ike, resulted in insured property damage exceeding $8 billion.

Wind damage and storm surge are two major causes of property damage from hurricanes. Storm surge is considered flooding, and is not covered by wind policies or by regular homeowners insurance. Homeowners can purchase up to $250,000 of coverage for flood and storm surge by buying a policy from the federal government’s National Flood Insurance Program. For those who did not purchase flood insurance or who had less than full coverage, the debate continues—three years later—about which damages during Hurricane Katrina were caused by wind and which by storm surge. The same debate about Hurricane Ike's damages will likely stretch well into the future. The line is often unclear, but the determination dictates the party financially responsible.

All of this means that hurricanes and other tropical storms are becoming more difficult to insure. As the expense of covering storm damage grows, insurers must raise premiums, sometimes to levels that exceed the ability of residents to pay. Even when reinsurers step in to cover excessive losses, a single storm event could potentially wipe out surplus capacity. Some coastal residents may be left without coverage.

Q: How do insurance companies do business in high-risk areas?

A: Insurance companies maintain a level of surplus to cover unexpected losses. This surplus can cover smaller catastrophic events. However, when an insurance company's exposure to catastrophic events becomes large, its response is to purchase reinsurance either from reinsurers or from catastrophe bonds (also known as cat bonds) from the capital markets. The cost of purchasing reinsurance is expensive. At some point insurers are no longer able to write additional coverage in high-risk areas because they are not able to purchase enough reinsurance to cover the additional risk of adding new policies. This leads to the availability problem in the market and the creation of government programs to offer homeowners coverage that is not available in the voluntary market. Even without adding additional policies in catastrophe-prone areas, an insurer's exposure to large catastrophic events grows each year because of inflationary pressures on the costs of rebuilding homes.

For example, Hurricane Celia struck the coastal areas of Texas in 1970, causing enormous insured losses. As a result, many insurance companies refused to write more wind and hail-damage business in the hardest-hit 14 counties of the state. In the years since Hurricane Celia, storms have continued to rage and, while Katrina resides squarely at the top of the list of most expensive hurricanes ever to strike the United States, other storms have also caused considerable property damage.

For people living and working in the areas most affected by windstorms, rebuilding their lives often depends on their ability to rebuild their properties. Insurance coverage is critical for them. But insurance companies assess their risks based on claims and statistics. If a company estimates that the risk is too high in a given region relative to the premiums paid, they may withdraw from providing coverage in that region. It may be a matter of survival for the insurance companies: One storm often destroys huge numbers of properties, and could potentially drive insurers out of business. In some cases, that means properties in high-risk areas are essentially uninsurable.

In the wake of Hurricane Celia in 1970, that's just what happened. Many insurers determined that the risk of continuing to offer wind and hail insurance to property owners in the coastal regions of Texas was just too great. But realizing the critical need for these coverages, the state legislature acted, forming the Texas Catastrophe Property Insurance Association (now called the Texas Windstorm Insurance Association, or TWIA) in 1971. Together, insurance companies and the TWIA represent the first tier of defense against the cost of damages caused by windstorms.

Another level of coverage may be necessary when damages exceed the capacity of insurance and reinsurance companies, as happened following 1992’s Hurricane Andrew. Catastrophe bonds can provide this additional layer of coverage above that offered by primary insurers.  However, the current makeup of insurance, reinsurance, government programs, and cat bonds could one day prove inadequate to a superstorm. Programs like TWIA can at least ensure that most hurricanes are fully insured.

Q: How does TWIA work?

A: TWIA provides basic wind and hail coverage for property owners who may have no other options for insuring their properties against these hazards. Surplus premiums collected by TWIA are placed into a trust fund that is used to pay future claims. Each insurance company licensed to write property insurance in the state of Texas is a member of TWIA. In the event of losses exceeding TWIA’s premiums and other revenues, each company is assessed a cost based on their statewide property market share, minus credits for writing voluntarily in the coastal counties. As with other insurance companies, TWIA also purchases reinsurance to cover claims that exceed the funds available. And for very large, costly storms, TWIA has authorization from the state of Texas to further assess the insurance companies that write business in the state. Insurers can recover some of the cost of the assessments through premium tax credits in subsequent years.

TWIA assessed insurance companies in the state of Texas $100 million for July's Hurricane Dolly, after exhausting current-year premiums of $80 million and an additional $100 million from the TWIA fund. Hurricane Ike struck soon after, hitting the coast of Texas and resulting in approximately $2.1–$2.5 billion of covered losses to TWIA. Texas insurers were assessed $230 million to augment the $370 million available in the TWIA trust fund and applicable reinsurance coverage of $1.5 billion. TWIA assessed insurers an additional $200 million to reinstate the reinsurance coverage in the event of another storm in 2008.

Insurance companies can reduce the amount of their TWIA assessment by increasing the number of properties they cover in the 14-county coastal region that TWIA protects. Essentially, companies that want to offer property/casualty insurance in any part of the state must participate in some way in covering wind and hail damage in the coastal areas, either on their own or through the TWIA. As a nonprofit, TWIA does not compete in the property/casualty insurance market. Rather, TWIA is an insurer of last resort for property owners in areas where insurance companies are reluctant to write coverage. It is a traditional insurance company in the sense that its policies are governed by a written contract specifying coverages and restrictions. It is authorized by the state of Texas to collect premiums and pay claims, and coverage is obtained through properly licensed insurance agents, brokers, and direct writers.

Q:How much does TWIA insurance cost, and what are coverage levels?

A: Homeowners insurance is expensive in Texas, in large part because of the potential for catastrophic weather-related damage. At nearly twice the national average, Texas has the highest average homeowners premium in the United States.⁵ Some insurance companies continue to write wind and hail coverage in the high-risk coastal area of Texas. Others insure properties against fire and other potential problems, but exclude wind and hail damage, reducing their premium because of this exclusion. Property owners can then purchase wind and hail coverage from the TWIA. In 2007, the average single-family property insured by the TWIA was covered for $226,000 (dwelling and contents), for a premium of $1,067, in addition to the regular homeowners insurance policy. Many homeowners also purchase flood insurance, especially in coastal areas. The result is that some properties are covered by three separate policies.

Q: What’s next for windstorm insurance coverage?

A: Debate continues about the best way to handle catastrophic windstorms. Governments can step in to offer homeowners coverage in areas where traditional insurance companies will not or cannot provide coverage, as is the case with Texas and TWIA, but that only transfers the capacity problem away from primary insurers. It does not solve the underlying problem that some storms are just too big to insure. This will continue to be the case as continued population growth and continued development in high-risk areas ensure that, some day, a storm will join Andrew and Katrina in the ranks of uninsurable storms.

Then there is the human element. Research from the NHC quotes a sociologist who says that "people only remember the worst effects of a hurricane for about seven years." Officials at the NHC worry that, because of improved forecasting ability, this kind of thinking could lull people into failing to recognize the great potential for loss of life and property in the event of another catastrophe.⁶ Selective memory also applies when insurance regulators begin to believe that another major storm is unlikely, as was the case before Hurricanes Katrina and Rita hit southern Texas. Twenty years had elapsed since the region had experienced a major storm, and insurance rates may have been too low relative to the exposure. If we remain attentive to the real possibility of larger storms, we'll go a long way toward mitigating this ultimately uninsurable risk.

1 Blake, Eric S., Edward N. Rappaport, and Christopher W. Landsea. "The Deadliest, Costliest, and Most Intense United States Tropical Cyclones From 1851 to 2006 (and Other Frequently Requested Hurricane Facts)," Table 5. NOAA Technical Memorandum NWS TPC-5, National Weather Service, National Hurricane Center Miami, April 2007.

2 Ibid., Part II, (2).

3 Ibid., Table 3b.

4 Ibid., Table 3a.

5 National Association of Insurance Commissioners.

6 Blake, Rappaport, and Landsea. "The Deadliest, Costliest, and Most Intense United States Tropical Cyclones."