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It has become conventional wisdom that America's coastal regions from Galveston, Tex., to Cape Cod, Mass., are at growing risk from megastorms like 2005's Hurricane Katrina. Global warming, the theory goes, will cause nastier hurricanes as ocean temperatures rise. On Apr. 3, meteorologists from Colorado State University predicted five intense Atlantic hurricanes in the storm season beginning on June 1, twice the long-term average.
You would think the cost of insuring homes and businesses would be heading sky-high. But that's not the case. In most of the country, property insurance rates for homeowners and businesses are actually lower than they were before Katrina. And amazingly, insurance rates have been falling recently in many parts of Florida and the Gulf Coast that stand to suffer severe losses from hurricanes, encouraging continued construction in low-lying areas.
What's happening is that one powerful force, the weather, is being overwhelmed by two even more powerful forces: finance and politics. In a world of abundant liquidity, traditional insurance companies and new investors alike are trying to make a buck by underwriting risk, and the competition is pushing down rates. And in super-risky places that aren't attracting much private capital, particularly Florida, regulators are reacting to howls of pain from policyholders by capping or lowering rates by edict.
Nationally, according to the Bureau of Labor Statistics, prices for tenant and homeowner's insurance were down 1% in March from two years earlier, before Katrina. And according to a survey by the Council of Insurance Agents & Brokers, property and casualty rates paid by large companies fell 11% over the same period. "We're generally in a softening market," says Chris Boone, chief marketing officer of BancorpSouth Insurance (BXS
), an insurance broker in Tupelo, Miss.
Can it last? Regulators and the insurance industry are only beginning to grapple with the problems of pricing coverage in an era of potentially big storms. By some calculations, actuarially correct premiums would be so high as to freeze economic development in places such as Miami and New Orleans.
In Louisiana, Insurance Commissioner James J. Donelon put on hold rate increases for companies that had justified their rates using a scientific risk model that focuses on forecasts of heavy storm damage over the next five years. Donelon said that, pending results of a Florida study, insurers should take into account the possibility that hurricane activity is at a cyclical peak, and could be lower in the medium-term future. Expect more such fights. The more accurate the models get, "the less the general public will like the results they give," says Andrew Castaldi, a senior vice-president of Swiss Reinsurance Co. "The rates all just get worse."INDUSTRY WINDFALLIt's true that in the aftermath of Katrina, insurers sharply boosted rates, or even withdrew coverage, in the most vulnerable coastal areas. This year, Allstate Floridian Insurance Co. (ALL
) is notifying 120,000 Florida residents that their homeowners' policies will not be renewed.
But even in these areas, many people are seeing better rates and a wider choice of insurance carriers than they did a year ago. One reason is that the insurance industry is enjoying an abundance of capital. No hurricanes struck the U.S. last year, so the nation's property-casualty industry posted a $31 billion net gain on underwriting in 2006—a sharp swing from the $6 billion net loss in 2005. Add investment income, and insurers had net income after taxes of nearly $64 billion, giving the industry its highest rate of return in 20 years. All that money expands the industry's underwriting wherewithal, driving down the price.
In addition to internal funds from profits, the industry has been receiving a flood of outside investment, much of which arrived on the heels of the 2005 hurricanes. In 2005 and '06, $44 billion in capital was raised for property-casualty insurance, according to figures from Morgan Stanley (MS
). About one-third was raised privately for startup insurers and so-called sidecars, which are temporary pools of capital backing insurance policies.
Yield-hungry hedge funds and private-equity investors have pumped money into catastrophe bonds, which return little or no principal to investors if a hurricane in a certain location causes losses above a set threshold. In return for that risk, the so-called cat bonds pay 5 to 10 percentage points above interbank lending rates. "This asset class is paying a fairly wide spread relative to similarly rated investments," says Gary Martucci, a Standard & Poor's analyst.
But financial forces, as important as they are, don't account for all of the rate reductions. Politics plays a big part. State regulators aren't content to rely on the market in places such as Florida, where insurance rates have spiked the most. They're trimming rate increases requested by insurers and in some cases broadening the availability of state-subsidized insurance for highly exposed property owners who can't get coverage from the private market.ON THE STATE'S DIMEUnder Governor Charlie Crist, Florida has gone the furthest in challenging market forces. In January, the state legislature massively increased government involvement in the insurance business in hopes of rolling back homeowners' rates. It blocked rate hikes by the state-controlled Citizens Property Insurance Corp., which insures people who can't get coverage in the private market. That allowed Citizens to undercut private insurers. To keep private companies from bailing out of Florida, it intends to make available an additional $16 billion in highly subsidized reinsurance from a state fund.
Trouble is, if a series of big hurricanes empties out the Citizens reserve fund and the reinsurance fund, the state will have to raise the money to pay claims via a special assessment of thousands of dollars apiece on all policyholders in the state. "It'll function just fine until the next storm. Then we'll see," says Joshua D. Shanker, an equity analyst at Citigroup Investment Research.
The political fix temporarily alleviates the financial pain, but it worsens the underlying problem. Developers continue to erect condos in vulnerable parts of Florida in part because of the availability of state-subsidized insurance. Florida already has $2 trillion in coastal exposure and remains one of the fastest-growing states. That will raise the cost of the next Big One. "People have the expectation that insurance is a commodity and should be flatly priced," says Robert Muir-Wood, chief research officer of Risk Management Solutions Inc. But in an actuarially ideal world, he says, the rate for the South Florida beachfront should be perhaps 50 times higher than the rate for an elevated property in northern Florida. "The wealthiest people tend to benefit the most from this aberration," Muir-Wood says.
Meanwhile, the Florida state government's decision to fight the market and absorb more hurricane risk is benefiting other parts of the country. As private insurers and reinsurers are being driven out of Florida, they are writing more policies elsewhere, which is helping to lower rates in other places, like Mississippi.
The dip in rates is not likely to survive another year like 2005. Insurers are being more rigorous in setting rates and paying closer attention to their risk models than in the past, says Timothy R. Gardner, global head of the property specialty practice of Guy Carpenter & Co. The influx of capital could ebb. And if another Katrina-type hurricane hits, regulators and politicians will find it harder to defy nature and enforce unrealistically low rates for coastal property. By Peter Coy and Adam Aston, with Emily Thornton in New York