More frequent and more destructive natural disasters are shaking the foundation of the U.S. homeowners insurance systems, with coverage becoming more costly and harder to procure for millions of Americans.
In vulnerable states like California and Florida, where insurers face higher costs and catastrophe exposure, many companies have drastically cut coverage over the past few years, fearing they might not be able to pay the enormous claims generally linked to extreme events.
The solution to the struggle faced by these states might have to be a radical one, according to some experts, such as centralizing the insurance system at the federal level—even if it’s likely so unpopular that it would take a cross-states disaster to make it palatable.
A Problem That’s Only Going to Get Worse
Since 1980, the U.S. has been hit by 403 weather and climate-related disasters, according to data from the National Centers for Environmental Information (NCEI),causing an estimated total of more than $2.917 trillion in damages and 16,918 deaths.
Each of the past four decades saw the number of extreme events increasing: in the 1980s, there were a total of 33 natural disasters causing an overall $219.6 billion in damages; in the 1990s, there were 57, costing $335.3 billion; the 2000s reported 67 natural disasters, for a total cost of $621.3 billion; and in the 2010s, there were 131 extreme events costing a total of $994.6 billion.
The frequency and severity of natural disasters is accelerating fast. In the last five years alone, the country was struck by 115 catastrophic events that caused total damage of $745.7 billion.
In disaster-prone states like California and Florida, pricing risk accurately and reflecting the risk with higher premiums has already become a problem for insurers. Some experts fear that, unless important reform is implemented, high-risk areas of these states might eventually become uninsurable.
How Would a National System Work?
One radical solution to the U.S. insurance crisis could be to have a federal insurance system aggregating risk at the national level instead of having state insurance regulators, Steven Haynes, assistant professor of Practice, Finance and Managerial Economics at the University of Texas at Dallas, told Newsweek.
“What we really need to do is, instead of aggregating [risk] at a local level, we need to act at a federal level, and that way, people who live in North Dakota are sharing losses in California,” he said.
The idea is to spread the risk geographically across the entire country, instead of it being focused on the most at-risk areas.
“People don’t like that idea,” Haynes added. “It’s an anti-American idea because it’s more of a social thought. But it is something that realistically has to be considered because more and more people are left with nothing, because roughly 60 percent of people who have a mortgage paid off don’t have homeowners insurance. It’s an astronomical number.”
And these people, should they be struck by a natural disaster, would stand to lose everything, Haynes said.
“That’s not acceptable. It’s just not feasible,” he added.
Nancy Wallace, a professor of finance and real estate at UC Berkeley’s Haas School of Business, told Newsweek that insurance regulators at the moment have an incentive to compete with other states by keeping their rates as low as possible. That system has not served California well, she said.
“There’s empirical evidence that California rates are lower than many other states, including, of all places, Oklahoma. And that in fact, states around us are subsidizing the cost of risk-carrying in California,” Wallace added.
“That problem would potentially be mitigated by a national system. But land in the U.S. is regulated locally. And so it’s sort of natural that some of these regulations are more state level or local; breaking through that is going to be a challenge.”
“It would literally rock the entire [insurance] world overnight, so I don’t see them doing it,” Haynes said. “Insurers would love it because there would be less complexity, but lawyers would not be so happy about suddenly losing business. You don’t need as many attorneys if you’re using the federal courts for all these types of cases. And insurance law is a big part of the caseloads in most states.”
What he thinks it more likely to happen, realistically, is that traditional risk exposure would remain at the state level while at the national level a federal cap policy might be introduced.
“You would have companies who are providing insurance for hurricane, wildfire risk, severe convective storms, and hail risk all across the country, and everyone would be paying their premium based on an underwriting category that they fall into,” Haynes said.
Charles Nyce, department chair and a Dr. William T. Hold associate professor of risk management and insurance at Florida State University, told Newsweek that a national system could work, but only if it covers the highest levels of risk in disasters.
“For example, the federal insurance system does not kick in until the losses from the event are greater than $5 billion or $10 billion, in other words only for events that are truly catastrophic,” he explained.
Nyce has done research that theoretically shows that government intervention in insurance markets is best done at the high loss levels.
“Private insurance works best at lower loss levels, where underwriting and risk-based premium setting are important. Government intervention works best when the access to cheaper capital is more important,” Nyce said, using an example where the losses are so bad that underwriting didn’t really matter.
“At that point, government access to cheaper capital—cheaper than a private insurer’s capital access—is more important,” he added.
Learning From Previous Attempts
Prior federal attempts at providing coverage “have struggled to balance their goal of increasing availability and reducing premiums against the need to base underwriting and pricing on actuarially sound principles to ensure sufficient reserves for paying claims,” Mark Friedlander, director of corporate communications at the Insurance Information Institute, or Triple-I, told Newsweek.
The National Flood Insurance Program (NFIP), established by Congress in 1968 and managed by FEMA, is a good case in point, Friedlander said.
The NFIP has two main policy goals, according to a recent document by the Congressional Research Service: “to provide access to primary flood insurance, thereby allowing for the transfer of some of the financial risk of property owners to the federal government” and “to mitigate and reduce the nation’s comprehensive flood risk through the development and implementation of floodplain management standards.”
The program counts 4.7 million policies across more than 22,000 communities in 56 states and jurisdictions across the country and provides more than $1.3 trillion in coverage while making $4.3 billion in annual premium revenue.
But as floods are the most common natural disasters in the U.S., the program has been facing rising costs in recent years.
“Created in 1968 to protect property owners for a peril that most private insurers were reluctant to cover at that time, NFIP’s ‘one-size-fits-all’ approach to underwriting and pricing has led to the program now owing more than $20 billion to the U.S. Treasury because it lacked the reserves to fully pay claims after major events like Hurricane Katrina and Superstorm Sandy,” Friedlander said.
“It also often led to lower-risk property owners unfairly subsidizing coverage for higher-risk properties. However, NFIP’s Risk Rating 2.0, implemented in 2022, is actuarially pricing risk similar to how private flood insurers price risk.”
An Uphill Political Battle
A national system would help “soften the blow” to states that are exposed to extreme events like floods, wildfires, earthquakes, severe convective storms and hurricanes, according to Nyce.
One risk in this system, Nyce warned, is that it could be seen as subsidizing high-risk areas by charging lower premiums there and higher premiums to low-risk zones.
“That is where it becomes a big political issue,” he said. “Premiums would still have to be risk-based for it to make sense with the most prone areas funding more of the losses.
“I do not think the current political landscape lends itself to the federal government expanding its insurance market participation.”
Haynes said that in order for such a system to work, you shouldn’t have people in Florida paying the same rates as someone in Wyoming who’s facing lower risk.
“So there would still be this process,” he said. “But from a pooling perspective, it ensures that you don’t have all the high risk in one categorical pool or one funding pool. And that’s really what risk pooling was meant to do.”
David T. Russell, professor of insurance and finance at California State University, told Newsweek that it remains to be seen “whether or not taxpayers would support a catastrophe program for perils such as wildfire, hurricane and earthquake, especially if it means that some taxpayers would subsidize others over and over through underpricing.”
Private reinsurance markets work relatively well for these perils, Russell said, and a federal program is not needed for most of them at the moment.
“This is especially difficult when politics at the federal level oppose support for blue states such as California which may be a perceived beneficiary,” he added.
Friedlander added: “In the current Congress, it is highly doubtful a proposal for a national property insurance program would gain any traction.”
If a national system is ever introduced, Haynes said, it will be after the country is struck by a cross-state natural disaster.
“It’s probably going to be a hurricane, because it’s going to have to transcend boundaries,” he said. “And honestly, it’s going to be Florida or Texas.”
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