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by Consumers Union Washington D.C. Office
After disasters struck Hawaii and Florida in 1992 and California in 1994, insurance companies began a campaign to limit their exposure to catastrophe losses. In addition to increasing prices and deductibles, dropping or nonrenewing policies or withdrawing completely from markets, the industry pushed for state catastrophe programs designed to transfer the risk away from insurance companies and onto policyholders, consumers, other private sources and the public. Below is a general description of state insurance programs states have used for years to address availability problems followed by a description of the specific programs that states set up after the private market withdrew or restricted sales in high-risk disaster-prone areas.
Why are there State insurance programs? In response to availability and affordability problems in the market, states establish programs to provide insurance to consumers who are unable to obtain insurance in the voluntary or standard private insurance market. These programs are referred to as the "residual market". Often these programs are designed to address specific problems such as high risk drivers who cannot get insurance from the standard market or insurers not writing homeowners insurance in certain urban areas. The programs vary but the purpose is the same to provide coverage where it is otherwise unavailable for consumers.
How do these programs work? Assigned risk plans, common in the auto insurance market, involve a state plan that assigns drivers who have been turned down by the voluntary to a specific company. Companies are assigned a certain percentage of the drivers according to their market share. These plans may provide only limited coverage and at higher rates than available through the voluntary market. State Funds are basically state-owned insurance companies in which the state underwrites the risk when the private market refuses to do so.
A Joint Underwriting Association (JUA) involves a limited number of insurers who sell and service the policies but the premiums and losses of the pool are shared by all insurers based on their market share. As with other state programs, JUAs typically provide limited coverage at high rates. Reinsurance Facilities allow insurers to "cede" or give over to a reinsurance facility premiums from those policies they do not want, subject to a limit to prevent "dumping" of policies into the reinsurance pool. Since the insurer decides which policies to cede, the applicants typically have no idea that they were put into the residual market. The insurers all share in the reinsurance facility.
What are the State catastrophe programs? In the three states hardest hit by catastrophic disasters in the first half of the decade, the insurance industry pushed for programs that would relieve them of a large portion of their liability.
To address the problem of availability, the state established a JUA program in 1992 as a temporary measure. The program exploded with policies and Florida has been trying to depopulate it since its high of almost one million policies. Florida also has a Windstorm Underwriting Association that had been designed to provide permanent insurance for high risk areas but after Andrew, also began to explode. As evidence of an improved market and light hurricane season, as of December 1997 the JUA's enrollment dropped substantially as a result of more private insurers taking back policies.
To deal with catastrophic hurricanes, Florida set up the Florida Hurricane Catastrophe Fund, which acts as reinsurance to insurers for hurricane losses. This fund is tax-exempt, enabling it to accumulate funds at rapidly. The industry is responsible for losses up to a certain level; the premiums they pay for the reinsurance can be passed onto policyholders. In addition to premiums, these programs can use bonding and other financing arrangements if they have a shortfall. The policyholders, however, would have to foot the bill for the financing through assessments on their policies. If the funds are not adequate, claims are paid on a pro-rated basis so policyholders have no guarantee claims their losses will be covered. The estimated capacity for all these programs is approximately $10-12 billion.
Despite estimates that this would fix the market problems, the industry continued in its effort to shirk responsibility for earthquake coverage through a state earthquake facility. The California Earthquake Authority (CEA) is a privately financed, state-run insurance program that provides a limited earthquake policy (15% and limited living expense coverage). It is funded through premiums, a one-time contribution of $700 million from participating insurance companies (and an additional $3.5 billion if needed to pay claims), reinsurance, debt authority and capital from private investors. Its current capacity is $7 billion. If losses from an earthquake drain the fund, the CEA will be out of business and claims will be paid out on a pro-rated basis.
The CEA is struggling to provide for the earthquake insurance needs of Californians. As policies underwritten by private insurers expire, homeowners can opt to purchase a CEA policy. Currently, 70% of insurance companies participate in the CEA, 30% continue to offer their own earthquake coverage. Due to the high cost and limited coverage, many homeowners have declined to purchase policies from the CEA and sales are reportedly "dismal." Ironically, at least two new insurers have entered the earthquake insurance market, offering a more comprehensive and affordable alternative to the CEA policy.
While these state programs provide hurricane and earthquake coverage, the National Flood Insurance Program is an example of the federal government providing insurance for losses from floods the private market refused to cover. The federal government established the program in 1970 to provide flood insurance to homeowners in flood-prone areas. Taxpayers carry the risk and are on the hook for any losses that exceed the premiums that have been paid in by the policyholders.
