New Study Proclaims Savings if Federal Catastrophe Backstop Created

It’s not every year that studies performed by actuarial consultants generate so much press.

A couple of months ago, I mentioned work Tillinghast has done looking at the potential impacts on the new Florida cat facilities if a storm were to hit — the conclusions being that current cost savings is being achieved at the risk of some hefty assessments in the future if a storm hits, and that inland Floridians were effectively subsidizing the risk of coastal south Floridians.

Now, in the past couple of days, there have been several articles about two new studies. (See: Insurance Journal, Jason Kennedy’s recent blog post for the Orlando Sentinel, and this article in the Sun-Sentinel).

Both studies were put together by Milliman. One was commissioned by PCI, to look at the impact of Florida’s reforms. PCI’s press release is here. I haven’t been able to track down a copy ot the study itself, but the conclusions are similar to the Tillinghast report — renters, auto insurance customers, small business owners, and residents of northern Florida will subsidize South Floridians through assessments if a hurricane hits, and the state will potentially be burdened with a need to borrow a lot of money if we were to see a bad storm season in that state.

The other study was put together by Milliman for a group calling itself Protecting America. An executive summary of the Milliman report is available for download at the Protecting America website. The big headline coming out of this study is that Milliman believes that $11.6 billion in savings could be generated for homeowners in key states if the feds were to form a national cat fund.

Reading the executive summary, the premise behind that take-away appears to be that the federal government can underwrite risk far more cheaply than insurers and reinsurers, given that the feds are an infamously not-for-profit operation, and given the feds’ ability to borrow money theoretically risklessly.

That’s a premise I don’t necessarily disagree with…but there is a certain element of risk, of variability that the feds ought to consider in any premiums. The nature and magnitude of that element is not discussed within Milliman’s executive summary. Neither is a discussion of to what extent a federal backstrop will create unfair subsidization from less cat-prone Americans to those who choose to live in harm’s way.

I could see that some level of subsidization is appropriate, be it at the state or federal level. For example, I could believe that a consumer living in Tallahassee derives some benefit (e.g., Florida’s lack of an income tax) by virtue of the state’s having such a vibrant tourist industry fueled by all these magnificent destinations constructed in hurricane-prone areas. If that’s true, it could be argued that the inland homeowner ought to help pick up a small part of the cat-prone property’s insurance cost.

I’d love to see a study done to measure those effects.

However, the lack of details in the second Milliman study’s documentation leaves me a bit uncomfortable. Specifically, I’d love to read more about the mechanism of funding the federal pool, or the sensitivity of the assumptions made.

I am not, however, going to get too excited yet about the potential of a federal cat fund. It’s been talked about for a long time…and given the expected contentiousness of the 2008 election cycle, I doubt that too many politicians will want to be connected with a bailout of the perpetually unpopular insurance industry.