The private market should continue to play a principal role in protecting Americans from mega-catastrophes, but the unpredictability and scope of potential catastrophes are beyond the means of the private sector alone. The federal government as well as state governments should provide a backstop that will allow private companies to insure against catastrophic loss. Just as the Federal Deposit Insurance Corporation protects depositors from losing money when banks are insolvent, the federal and state governments should act to guarantee that claims are paid after a true catastrophe and that private companies are able to continue providing insurance. While structural changes are needed, the Florida Hurricane Catastrophe Fund is conceptually sound and could be replicated on both the state and federal levels.
Catastrophe funds would only be needed in the event of a major catastrophe when a threshold established by lawmakers is exceeded. A portion of property insurance premiums would be deposited into the funds, where they would grow tax-free. No tax dollars would be used to support the Fund, and insurance companies could not use these funds for any purpose other than to pay claims from a catastrophe that exceed a certain threshold. In Florida, for example, the threshold is $4.5 billion.
A catastrophe fund helps stabilize the market after a catastrophic event. There is no debate that both the underlying and reinsurance market collapsed after Andrew hit Florida in 1993. Many companies went insolvent, and many others left the market. Reinsurance was very hard to come by, and if it could even be had, it was extremely expensive. This is the environment in which the Florida Hurricane Catastrophe Fund (FHCF) was created. The fact that it works was just borne out by the unprecedented four-storm season in 2004. There was no mass exodus, there were no mass insolvencies, and the reinsurers are still there because the FHCF helped stabilize the market.
The money paid by insurers into a catastrophe fund stays in the fund. The same cannot be said of money paid to reinsurers. Much of the reinsurance money flows to Bermuda, London, Tokyo or Paris. After a season with no hurricanes, that money is gone. With a catastrophe fund, the money stays in the fund, and it grows tax-free to help pay for future catastrophic losses. A catastrophe fund is a far more efficient way to combat the devastation of catastrophe than watching money disappear offshore year after year after year.
A catastrophe fund allows insurers to continue writing business in disaster-prone areas and this allows for continued growth and development. Insurance is the oxygen of free enterprise – without it our economy cannot prosper and grow. Florida is a perfect example: There has been unprecedented growth in Florida since Andrew devastated that state, which would not have been possible without a vibrant and healthy insurance market. The FHCF kept insurers in the state, which made continued growth and prosperity possible.
The catastrophe fund provides a lower cost alternative to some layers of private reinsurance. This directly translates into lower costs for consumers. Private reinsurance premiums have increased significantly in Florida following the 2004 hurricane season. These costs are passed along to customers in the form of higher homeowner insurance rates. Catastrophe funds help reduce these costs by providing coverage at the lower levels. However, Catastrophe Funds do not eliminate the need or the market for private reinsurance; rather, properly constructed catastrophe funds enhance the private reinsurance market as reinsurer capacity can be shifted from the expensive lower layers to the less costly top layers. This is an efficient use of their finite capacity and helps protect consumers.
States have the flexibility to create catastrophe funds based on the realities of that state. Since the entire state of Florida is subject to the devastation of hurricanes, it is appropriate for the entire state to share the risk. In California, however, the risk of earthquake varies among different geographic areas. Although a true catastrophe would affect the economy of the entire state, catastrophe funds can be structured to balance the costs based on the risk. In other words, those who live in areas more prone to catastrophes would pay more into the fund.