The increased insurance rates are an unfortunate byproduct of the severe 2005 storm season, the most active since record-keeping began in 1851. It was also the most costly year on record for the insurance industry, with insured losses from Hurricane Katrina at $40.6 billion and total catastrophe losses for the year totaling $61.2 billion (source: Insurance Information Institute). As with the US in the early stages of a 15-year cycle of projected increased hurricane activity, meteorologists are forecasting another very active storm season for 2006.

The term "catastrophe" in the property insurance industry is a natural or man-made disaster that is unusually severe and that affects many insurers and policyholders. A single event is designated a catastrophe when claims are expected to reach a certain dollar threshold, currently set at $25 million. Last month's Washington Insider, by Jeanne McGlynn Delgado of the National Multi Housing Council, treated how o manage insurance hikes. I thin it's important to build on that foundation with consideration of some of the forces impacting catastrophic insurance pricing and the public policy debate surrounding this issue.

As we enter into the 2006 storm season, the nation's insurance marketplace is strained due to the number and severity of hurricanes in recent years. The availability and affordability of property insurance in coastal areas is deteriorating. The key challenges that the insurance industry faces are:

Coastal population surge. Long-term migration patterns toward hurricane-prone coastal areas have caused insurance company portfolios to swell with policies that are at-risk for catastrophic events. In fact, properties comprising 16% of total US property value are located in coastal counties along the Gulf and East Coast.

Recalibrated hurricane models. The recent increase in the frequency, severity and cost of hurricanes has caused risk-modeling companies to recalibrate their hurricane models. This recalibration has resulted in dramatically increased damage estimates upon which insurance companies rely to set insurance rates for hurricane-prone areas.

Rating agencies' assessments. Rating agencies are carefully reviewing insurance-company aggregate exposures to hurricane-prone areas and are including this data in their rating process. This has caused insurance companies to evaluate carefully their overall concentration of policies written in these areas. In order to avoid jeopardizing their current credit rating, some insurances companies have curtailed or stopped selling insurance policies in certain high-risk markets.

Reinsurance price increases. Reinsurers have dramatically increased the pricing for lines of insurance such as wind and flood that are prone to catastrophic events. Additionally, reinsurers are covering a smaller percentage of primary insurers' potential losses. The higher percentage of potential claims that "primaries" would have to pay is also reflected in the increased insurance pricing.

The unprecedented damage of Hurricane Katrina and the subsequent spotlight on the recovery efforts in the gulf region have triggered a reassessment, not just among insurers and reinsurers but also among public-policy and political leaders as to how to deal with the financial consequences of such massive property damage. The issue of catastrophic insurance is a priority in Washington, DC as well as within State capitals nationwide. Policymakers are grappling to find the appropriate role for the federal government to play in catastrophic insurance. Legislation introduced in 2005 and 2006 provides a variety of approaches for the fed's involvement in catastrophic insurance. The approaches include: federal reinsurance backstop for state catastrophe funds, federal reinsurance for reinsurers and tax-law changes to allow insurance companies to create catastrophe funds to pay for future catastrophic events.

Furthermore, at the state level, the National Association of Insurance Commissioners has developed a proposal on catastrophic insurance that involves a combination of state or regional catastrophe funds with a federal backstop for mega-catastrophes. Recently, NAIC and the National Conference of Insurance Legislators agreed jointly on the principles of a Natural Catastrophic Insurance Plan and are in the process of receiving approvals from their respective organizations. Thus, it is evident that lawmakers and state insurance regulators will continue to examine potential approaches to improving disaster-insurance protection. However, consensus on the appropriate legislative approach is unlikely in 2006.

In order to reach consensus, the Government Accountability Office has been commissioned by the House Financial Services Committee to perform a study concerning the need for federal legislation facilitating better protection for insured losses resulting from natural disasters. The study is being performed in consultation with NAIC as well as representatives of the insurance industry, including a cross-section of insurers, independent insurance agents, brokers, and policyholders. This report is due to be submitted to the House Financial Services Committee by Sep. 30, 2006. The study will include analysis of whether government legislation should incorporate any or all of the following concepts: Tax-free capital reserves, voluntary mutual reinsurance pools, distinction between sophisticated and non-sophisticated commercial purchasers for the purposes of exemption from regulation and shared public-private disaster reinsurance.

Available and affordable catastrophic insurance plays a vital role in sustaining healthy commercial real estate market conditions. Given that the majority of all commercial properties are financed by MBA members, we will continue to closely monitor both catastrophic insurance market conditions and related federal and state legislation. Additionally, for more information, a catastrophic insurance "white paper" will be published on www.mortagebankers.org this summer. Gail Davis Cardwell is senior vice president of Commercial/Multifamily at the Washington, DC-based Mortgage Bankers Association. The views expressed in this article are the author's own.

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Catastrophic Insurance--Challenges Evolve

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