June 24, 2013 The Honorable Michael McRaith Director, Federal Insurance Office United States Department of the Treasury 1500 Pennsylvania Avenue, N.W. Washington D.C. 20220 Re: Solicitation for Comment on the Study and Report to Congress on Natural Catastrophes and Insurance Dear Director McRaith: On behalf of the Risk and Insurance Management Society, Inc. (RIMS), these comments are submitted in response to a request published in the April 24, 2013 Federal Register. This request was published pursuant to Section 100247 of the Biggert- Waters Flood Insurance Reform Act of 2012 requiring the Director of the Federal Insurance Office to conduct a study and submit a report to Congress on the current state of the market for natural catastrophe insurance in the United States. The solicitation for comments includes a series of questions which respondents are invited to address. Our comments will be largely confined to those questions that pertain to its membership, interests, and policy positions. RIMS is a not-for-profit organization dedicated to advancing the theory and practice of risk management for the benefit of our membership. Our discipline is vital to the creation and protection of physical, financial, and human resources. RIMS is the largest organization of risk management professionals, representing over 11,000 members worldwide from more than 3,500 entities. Membership includes both public and private entities and spans the entire economic spectrum from the high-tech sector, real estate, financial, healthcare, energy, transportation, education, and defense. While RIMS member organizations are highly diverse, they do share a common characteristic: they are predominantly large consumers of property and casualty insurance. For many of our members natural catastrophe insurance is a major component of their overall risk management portfolio. This holds especially true for those members located in high risk areas such as Florida, California, or those within tornado prone areas; however, as Hurricane Sandy in the northeast has shown, natural catastrophes can hit any region or any business. The destruction from these events can be devastating if an entity is not properly covered for these catastrophes. Readily available natural catastrophe coverage at affordable rates is critical to the financial stability of an organization, but also to the economy as a whole.
I. Current Condition of the Natural Catastrophe Market A. Volatility of the Marketplace More than many other lines of insurance, the natural catastrophe market tends to be highly volatile. This volatility in the market can make it very difficult for an entity to effectively plan and manage its risks as prices for the same amount of coverage may fluctuate greatly from year to year. In some cases prices may triple from one year to the next for the same amount of coverage. This type of fluctuation may lead some entities to non-insure for natural catastrophe risk, thus placing their businesses at risk of bankruptcy in a natural catastrophe event. There are many factors which lead to the type of volatility seen in the natural catastrophe market including the type of insured property; the location of that property; the aggregation of risk an insurer has in a certain area; the overall attractiveness of risk presented to an insurer; and the number of catastrophic events within any given year. All of these play a factor in the overall availability and pricing of natural catastrophe coverage. At the time an insured seeks to obtain or renew its natural catastrophe coverage, the insurer will make an assessment of these factors in order to determine pricing. If the insurer experienced significant losses from catastrophic events in the previous year, then a surcharge on all policies may be charged as a percentage on all policies. If the insurer determines that it has too much risk in a given area, then it may be required to purchase reinsurance in order to place more coverage, which leads to a higher price for the insured. The results of this insurer assessment can differ greatly from year to year, thus leading to an inability for the insured to predict the pricing and availability from one year to the next. One possible way to stabilize natural catastrophe rates would be to rely less on modeling of a specific property to assess risk. Modeling was originally intended to model a large portfolio of risk over a broader area. As the modeling zooms in to a specific building, school, etc. then the reliability of that modeling lessens, which can lead to a higher risk factor, and thus higher rates for that specific property. Another possible solution would be the creation of a mechanism, or pool, to allow insurers to aggregate part of their premiums to fund future losses. In a year with no, or relatively few, losses from natural catastrophes, a portion of premiums could be placed into the pool to cover future events. This would lead to greater stability in premium rates from year to year as rates charged in low loss years could be rolled over to help hold down rates in higher loss years. B. Availability and Pricing As mentioned, the availability and pricing of natural catastrophe coverage can vary greatly depending on the type of coverage and location where that coverage is needed. Members in hurricane prone areas, such as south Florida, have reported inadequate capacity and very high prices for the coverage that is available. One large public entity in Florida has reported being able to obtain only $250 million in windstorm coverage, despite models predicting that a Category 5 hurricane could result in losses in excess of $800 million. Obtaining even this inadequate amount of coverage required input from the worldwide marketplace, most of which is non-domestic or excess surplus coverage. Any entity in such a position, public or private, will be reliant on the federal government in the event of a major loss.
While the recent weather events on the east coast have directly impacted the market in those regions where they occurred, they have also had repercussions on the market more generally. Hurricane Sandy proved that natural catastrophes could hit areas not traditionally considered high risk zones. This has forced insurers to reassess and broaden special pricing zones for catastrophe risks. Therefore, while pricing and availability of earthquake coverage on the west coast has eased, zones of special pricing for earthquakes have broadened along the west coast. C. Consensus Definition of "Natural Catastrophe" Insurers provide a very important service to consumers of both personal and commercial lines of insurance. Proper coverage allows consumers to protect themselves in the event of a catastrophic event that would otherwise destroy an individual s or organization's financial well-being; however, this benefit is often lost in complex policy language that leads to a confusing claims process for many consumers. This can lead to the perception that insurers look only to pay as few claims as possible through exclusions or other confusing policy language. RIMS believes that universal acceptance of what it means to have natural catastrophe coverage would help consumers and their communities to see and value the importance of adequate natural catastrophe coverage. Doing away with carve outs or exclusions for things such as "storm surge" would give the consumer a higher sense of security that they are fully covered regardless of whether flood damage is caused by wind or "rising flood." In turn, insurers may see a higher take-up rate from consumers who currently non-insure due to poor perception of the insurance industry or confusion over exactly what is, and is not, covered. A broadened base of insureds would lead to lower rates for consumers, while more easily understood natural catastrophe definitions would lead to a simpler and more cost-effective claims process for the insurer. II. Land Use Policies and Building Codes RIMS believes in the importance of properly assessing and then effectively mitigating any potential risk, including risks posed by natural catastrophes; however, we also recognize the cost associated with mandatory improvements of existing property. While stricter building codes and land use policies should be considered and discussed, particularly in high risk areas, there are other mitigation steps that can be taken. Mandating improvements to existing properties will prove more challenging, as newly constructed commercial buildings tend to be more state of the art. One potential solution is to incentivize property owners to improve their property, without making those improvements mandatory. An existing example of this would be the Florida Residential Construction Mitigation Program which provides subsidies, grants, demonstration projects, direct assistance, and cooperative programs for the purpose of improving wind resistance of residences. While this program is for homeowners or residential property owners only, similar incentives could be considered for existing commercial properties in high risk areas.
IV. Current Financial Condition of State Catastrophe Funds Perhaps the most highly publicized and monitored state-based fund is the Florida Hurricane Catastrophe Fund (FHCF) which was created in 1993 following Hurricane Andrew and the threat that the windstorm property market would collapse. The fund is set up to provide reinsurance to insurers at reduced rates with the hope that those reduced rates would then be passed on to the consumers; however, questions over the financial solvency of the fund have crept in and it is now believed that the fund could not cover its liabilities in the event of a major hurricane above Category 3. Jack Nicholson, Executive Director of the Cat Fund, recently told Florida lawmakers that "we have looked over the Cat Fund s claims paying capacity and in four of the last six years we could not have funded the coverage we sold the insurance companies." While we appreciate the FHCF's original intention of finding a cooperative public-private solution to issues negatively impacting the Florida natural catastrophe market following Hurricane Andrew, we believe the issues currently affecting the fund show some of the pitfalls that should be considered in any similar future endeavor. While the creation of the trust did prevent the windstorm market from completely collapsing, it also encouraged thinly financed companies to enter the market due to the guaranty of low cost state reinsurance. If a major storm occurs, some of these companies may go under leaving consumers vulnerable. In addition, because the state fund is underfunded for a major storm, the state will be forced to recoup its losses from such an event through policy assessments, thus driving up consumer rates. In recent months, Florida lawmakers have sought to reform the FHCF by gradually reducing its obligations, thus allowing the market time to adjust. However, these efforts have met resistance as opponents argue that the proposed reforms would drive up consumer rates. It appears that rates have become more controlled by the government rather than a true market assessment of risk followed by pricing based on that assessment. VI. Current Approaches to Insurance Natural Catastrophe Risks in the U.S. A. Current and Potential Future Public-Private Partnerships While the example of the Florida Hurricane Catastrophe Fund is evidence of some of the problems that can arise when the government enters the private insurance market, it is not indicative of every publicprivate partnership. The reality is that the government is always involved when there is a natural catastrophe in both disaster cleanup and recovery. It is better for all parties involved, including consumers, for the government to take a proactive rather than reactive approach to natural catastrophes and to have an effective plan in place to deal with natural catastrophes when they occur. It may be beneficial for these government plans to include cooperation with the private sector in a way that allows for disaster recovery to move along efficiently while allowing consumers to rebuild as quickly as possible.
While not related to the natural catastrophe market, the Terrorism Risk Insurance Act (TRIA) is an example of a partnership between the government and private insurance market that benefits all parties and allows for an established mechanism and process to be in place should a terrorist attack occur. In this case the government serves as a backstop, or reinsurer of last resort, in the event of a large scale terrorism event. This has allowed private insurers to offer adequate terrorism coverage at affordable rates without requiring the government to be directly involved as the insurer. Consumers have seen stabilization in capacity and rates without the government making any expenditures to this point. The TRIA program is evidence that the government can work with the private insurance market on effective solutions that work to the benefit of the consumers, the industry, and the economy as a whole. B. Potential Privatization of Flood Insurance in the U.S. RIMS supported the long term extension of the National Flood Insurance Program which was signed into law on June 29, 2012. A failure to reauthorize the NFIP in 2012 would have left many commercial property owners without adequate flood coverage, thus threatening the stability of the real estate market. Reforms were enacted as part of the extension that will gradually bring premium rates up to actuarial rates; that will improve the accuracy of flood maps over time; and that will establish minimum annual deductibles for policyholders. While we understand concerns over the program's current financial instability, we believe that these reforms should be allowed to go into effect before any further changes are made to the program. On behalf of RIMS, I want to thank the Federal Insurance Office for the opportunity to comment on the current state of the natural catastrophe market and some of the current issues associated with it. Should you require additional information, or have any questions, please do not hesitate to contact RIMS Senior Government Affairs Manager, Nathan Bacchus, at 212-655-6215 or nbacchus@rims.org. Sincerely, John R. Phelps RIMS 2013 President