This Liam Pleven-Ian McDonald-Karen Richardson WSJ ($) article reports on an interesting market condition in the disaster insurance business that has been reverberating in business circles around Houston since the storms of last summer — despite robust demand for disaster insurance and huge amounts of capital pouring into providing such insurance, there is nowhere near a sufficient supply of such products to meet the demand for disaster insurance.
As a result of seven costly hurricanes in two years, insurers are pulling back from the amount of risk that they will take in hurricane-prone areas such as the Gulf Coast. The shortage of supply is showing up primarily in the reinsurance market, where primary insurers buy coverage to hedge the risk of loss on the policies that they issue. Reinsurers covered over half of the estimated $40 billion in insured losses that occurred last year as a result of Hurricance Katrina. Consequently, the cost of property-catastrophe reinsurance has risen over 25% this year and, in hurricane-prone areas, the rates are increasing almost four times that amount. And all of this occurring despite the financial market’s creation of new forms of investment vehicles to induce investment of capital at reduced-risk levels.
As noted in this earlier post on federally-subsidized flood insurance in hurricane-prone areas, this tight market condition for disaster insurance is actually having a beneficial impact. Businesses in hurricane-prone areas are considering alternatives to paying huge premiums for disaster insurance, such as self-insurance and re-evaluating investment decisions. This is precisely how markets efficiently allocate risk and resources, and reflects why that efficient allocation is undermined by the federal subsidy on flood insurance.