    Natural Disasters: Public Policy Options for Changing the Federal
    Role in Natural Catastrophe Insurance (26-NOV-07, GAO-08-7).

    In recent years, much attention has been focused on the roles
    that the private sector and federal government play in providing
    insurance and financial aid before and after catastrophic events.
    In this context, GAO examined (1) the rationale for and resources
    of federal and state programs that provide natural catastrophe
    insurance; (2) the extent to which Americans living in
    catastrophe-prone areas of the United States are uninsured and
    underinsured, and the types and amounts of federal payments to
    such individuals since the 2005 hurricanes; and (3) public policy
    options for revising the federal role in natural catastrophe
    insurance markets. To address these questions, GAO analyzed state
    and federal programs, examined studies of uninsured and
    underinsured homeowners and federal payments to them, identified
    and analyzed policy options, and interviewed officials from
    private and public sectors in both high- and low-risk areas of
    the United States. GAO also developed a four-goal framework to
    help analyze the available options.
    -------------------------Indexing Terms-------------------------
    REPORTNUM:   GAO-08-7
        ACCNO:   A78351
      TITLE:     Natural Disasters: Public Policy Options for Changing the
    Federal Role in Natural Catastrophe Insurance
         DATE:   11/26/2007
      SUBJECT:   Federal/state relations
    	     Financial management
    	     Flood insurance
    	     Homeowners insurance
    	     Hurricane Katrina
    	     Hurricane Rita
    	     Insurance companies
    	     Insurance premiums
    	     Natural disasters
    	     Payments
    	     Policy evaluation
    	     Prices and pricing
    	     Private sector
    	     Program management
    	     Risk assessment
    	     Risk management
    	     State programs
    	     Federal Insurance
    	     Program implementation

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    GAO-08-7

    This is the accessible text file for GAO report number GAO-08-7
    entitled 'Natural Disasters: Public Policy Options for Changing the
    Federal Role in Natural Catastrophe Insurance' which was released on
    December 26, 2007.

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    Report to the Ranking Member, Committee on Financial Services, House of
    Representatives:

    November 2007:

    Natural Disasters:

    Public Policy Options for Changing the Federal Role in Natural
    Catastrophe Insurance:

    GAO-08-7:

    GAO Highlights:

    Highlights of GAO-08-07, a report to the Ranking Member, Committee on
    Financial Services, House of Representatives.

    Why GAO Did This Study:

    In recent years, much attention has been focused on the roles that the
    private sector and federal government play in providing insurance and
    financial aid before and after catastrophic events. In this context,
    GAO examined (1) the rationale for and resources of federal and state
    programs that provide natural catastrophe insurance; (2) the extent to
    which Americans living in catastrophe-prone areas of the United States
    are uninsured and underinsured, and the types and amounts of federal
    payments to such individuals since the 2005 hurricanes; and (3) public
    policy options for revising the federal role in natural catastrophe
    insurance markets. To address these questions, GAO analyzed state and
    federal programs, examined studies of uninsured and underinsured
    homeowners and federal payments to them, identified and analyzed policy
    options, and interviewed officials from private and public sectors in
    both high- and low-risk areas of the United States. GAO also developed
    a four-goal framework to help analyze the available options.

    What GAO Found:

    The federal government and some states have developed natural
    catastrophe insurance programs that supplement or substitute for
    private natural catastrophe insurance. These programs were created
    because homeowner coverage for catastrophic events is often not
    available from private insurers at prices deemed affordable by
    insurance regulators. Large losses associated with natural catastrophes
    are some of the biggest exposures that insurers face. Particularly in
    catastrophe-prone locations, government insurance programs have tended
    not to charge premiums that reflect the actual risks that homeowners
    face, resulting in financial deficits. After a resource-depleting
    disaster, the programs have postfunded themselves through, among other
    sources, payments from insurance companies and policyholders and
    appropriations from state and federal taxpayers.

    Large numbers of Americans are not insured for natural catastrophes.
    Homeowners may not purchase natural catastrophe insurance because doing
    so is voluntary and they may not believe that the risk justifies the
    expenditure. In addition, some homes may be underinsured�that is, not
    insured for the full replacement value. GAO estimates that the federal
    government made about $26 billion available to homeowners who lacked
    adequate insurance in response to the 2005 Hurricanes Katrina, Rita,
    and Wilma. Given the unsustainable fiscal path of federal and state
    governments, they will be challenged to maintain their current fiscal
    role.

    As Congress reevaluates the role of the federal government in insuring
    for natural catastrophes, Congress is faced with balancing the often-
    competing goals of ensuring that citizens are protected and limiting
    taxpayer exposure. This report examines seven public policy options for
    changing the federal government�s role, including establishing an all-
    perils homeowner insurance policy, providing reinsurance for state
    catastrophe funds, and creating a mechanism to provide federal loans
    for state catastrophe funds. Each option has advantages and
    disadvantages, especially when weighed against competing public policy
    goals. For example, establishing an all-perils homeowner policy is a
    private sector approach that could help create broad participation. But
    low-income residents living in parts of the United States with high
    catastrophe risk could require subsidies, resulting in costs to the
    government. Similarly, federal reinsurance for state programs could
    lead to broader coverage, but could displace private reinsurance. GAO
    also identified several policy options for tax-based incentives for
    insurance companies, homeowners, investors, and state governments. But
    these options, which could help recipients better address catastrophe
    risk, could also result in ongoing costs to taxpayers. While some
    options would address the public policy goals of charging risk-based
    rates, encourage broad participation, or promote greater private sector
    participation, these policy goals need to be balanced with the desire
    to make rates affordable.

    Selected Advantages and Disadvantages of Options for Changing the
    Federal Role in Natural Catastrophe Insurance:

    Option 1: All-Perils Homeowners Insurance Policy;
    This option would create a homeowner insurance policy that would provide
    coverage against all types of natural catastrophes.
    Advantages:
    * A mandatory all-perils policy could eliminate the problems of
    uninsured property owners and adverse selection;
    * A mandatory all-perils policy would end homeowners� uncertainty about
    coverage for some perils.
    Disadvantages:
    * The all-perils option could require government subsidies for low-
    income property owners;
    * Premiums for an all-perils policy could be more expensive than
    current homeowner policy premiums, and these premium increases could be
    seen as unfair.

    Option 2: Federal Reinsurance for State Catastrophe Funds;
    This option would create federally backed reinsurance policies for state
    catastrophe funds. In one version of this option, states would create
    catastrophe funds that would be reinsured by the federal government. In
    another version, the Secretary of the Treasury would create an auction
    process for the sale of reinsurance contracts to private and state
    insurers and reinsurers.
    Advantages:
    * The federal reinsurance option could lead to greater participation
    from private insurers;
    * This option would not use tax dollars if premiums were risk-based.
    Disadvantages:
    * Federal reinsurance could compete with the private reinsurance
    sector;
    * Federal reinsurance could create inequities among states because of
    geographical differences in natural catastrophe risk.

    Option 3: Federal Lending to State Catastrophe Funds;
    This option would create a federal lending facility to provide temporary
    loans at market prices to state catastrophe funds.
    Advantages:
    * This option could help state catastrophe insurance funds with
    financing needs after a disaster;
    * The federal lending option would require states to demonstrate that
    they were doing all they could to attract private capital.
    Disadvantages:
    * The federal lending option imposes credit risk on taxpayer� the risk
    that the loans would not be repaid;
    * Political pressure could be exerted to keep the terms and conditions
    of federal loans more favorable than those in the private market.

    Option 4: Insurance Company Catastrophe Reserving;
    This option would permit private insurance companies to establish
    tax-deferred reserves for future natural catastrophes.
    Advantages:
    * With reserves, insurance companies could be more willing to
    underwrite policies;
    * Insurance regulators could be more willing to approve risk-based
    rates for consumers, because premium income could be set aside in a
    reserve fund.
    Disadvantages:
    * Allowing insurance companies to build reserves could involve tax
    benefits that favored one type of activity over another and could
    hamper economic efficiency;
    * Reserves could be costly for the federal government, because they
    would reduce federal tax revenue.

    Option 5: Homeowner Catastrophe Savings Accounts;
    This option would permit individuals to establish tax-deferred reserves
    to pay expenses related to disasters.
    Advantages:
    * Allowing homeowners to use tax-deferred dollars to pay for
    catastrophe insurance could induce more people to buy it;
    * This option might encourage more homeowner mitigation activities.
    Disadvantages:
    * Such accounts may not be enough to induce people to buy costly
    catastrophe insurance and, thus, may not broaden citizen participation
    in natural catastrophe insurance programs;
    * These accounts would reduce federal tax revenues but must be weighed
    against any reduction in post-disaster spending by the federal
    government.

    Option 6: Favorable Tax Treatment for Catastrophe Bonds;
    This option would facilitate the onshore creation of catastrophe bonds
    through tax exemptions for income from the underlying assets.
    Advantages:
    * Favorable tax treatment of catastrophe bonds would increase the
    ability of insurance markets to access capital markets;
    * Insurance companies could be more willing to underwrite catastrophe
    risk because the risk could be passed on to investors.
    Disadvantages:
    * This option creates a new class of reinsurer that would operate under
    regulatory and tax advantages not afforded U.S. reinsurance companies;
    * It is not clear how this option would encourage risk-based premiums
    or lead to more citizen participation in catastrophe insurance
    programs.

    Option 7: Property Tax Assessment for Private Insurance with Federal
    Deductible Payment;
    This option has property tax assessments paying a premium for an all-perils
    catastrophe insurance policy that would be provided by private insurance
    companies, with the federal government responsible for the deductible.
    Advantages:
    * This option would protect the tax base of a state�s economy;
    * The property tax assessment option would increase homeowner
    participation in catastrophe insurance programs.
    Disadvantages:
    * The property tax assessment option would reduce federal tax revenue;
    * This option could be expensive for taxpayers because the federal
    government would pay some portion of the homeowner deductible.

    Source: GAO.

    What GAO Recommends:

    This report does not contain recommendations. However, GAO evaluates
    seven public policy options that are discussed in the right-hand column
    and on the reverse side of this page. In written comments, the National
    Association of Insurance Commissioners (NAIC) generally agreed with
    GAO�s report findings.

    To view the full product, including the scope and methodology, click on
    [hyperlink, http://www.gao.gov/cgi-bin/getrpt?gao-08-07]. For more information, contact Orice
    Williams at (202) 512-8678 or williamso@gao.gov.

    [End of section]

    Contents:

    Letter:

    Results in Brief:

    Background:

    Government Natural Catastrophe Insurance Aims to Provide Affordable
    Protection but Often Requires Postfunding after Large Natural
    Catastrophes:

    Because Many Americans Are Inadequately Insured for Natural
    Catastrophes, Federal Programs Play a Significant Role in Recovery:

    Options for Changing the Federal Role in Natural Catastrophe Insurance
    Attempt to Address Market Issues but May Not Limit Federal Exposure:

    Agency Comments and Our Evaluation:

    Appendixes:

    Appendix I: Objectives, Scope, and Methodology:

    Appendix II: Selected State Natural Catastrophe Insurance Programs:

    Appendix III: Comments from the National Association of Insurance
    Commissioners:

    Appendix IV: GAO Contact and Staff Acknowledgments:

    Related GAO Products:

    Figures:

    Figure 1: Catastrophic Risk in the United States--Earthquake,
    Hurricane, Tornado, and Hail:

    Figure 2: Insured Property Value, by County:

    Figure 3: Estimated Federal Disaster Assistance Obligated for
    Homeowners and Renters Lacking Adequate Insurance in Five Gulf Coast
    States after the 2005 Hurricane Season:

    Figure 4: Advantages and Disadvantages of Seven Public Policy Options
    for Changing the Federal Role in Natural Catastrophe Insurance:

    Figure 5: Comparison of Selected State Natural Catastrophe Insurance
    Programs in 2005:

    Abbreviations:

    CDBG: Community Development Block Grant:

    CEA: California Earthquake Authority:

    DLP: Disaster Loan Program:

    FAIR: Fair Access to Insurance Requirements:

    FCIC: Federal Crop Insurance Corporation:

    FEMA: Federal Emergency Management Agency:

    FHCF: Florida Hurricane Catastrophe Fund:

    FIRM: Flood Insurance Rate Map:

    FWUA: Florida Windstorm Underwriting Association:

    GUA: Georgia Underwriting Association:

    HA: Housing Assistance:

    HRA: High Risk Account:

    HUD: Department of Housing and Urban Development:

    IHP: Individuals and Households Program:

    JUA: Florida Residential Property and Casualty Joint Underwriting
    Association:

    MIUA: Mississippi Insurance Underwriting Association:

    NAIC: National Association of Insurance Commissioners:

    NFIP: National Flood Insurance Program:

    NOAA: National Oceanic and Atmospheric Administration:

    ONA: Other Needs Assistance:

    PLA: Personal Lines Account:

    SBA: Small Business Administration:

    SFHA: Special Flood Hazard Areas:

    [End of section]

    United States Government Accountability Office:
    Washington, D.C. 20548:

    November 26, 2007:

    The Honorable Spencer Bachus:
    Ranking Member:
    Committee on Financial Services:
    House of Representatives:

    Dear Mr. Bachus:

    Natural disasters not only devastate communities and individuals but
    also are costly to insurers, state governments, and the federal
    government. As the 2005 hurricane season showed, costs associated with
    a large natural disaster, such as a hurricane or major earthquake, can
    be enormous. Aside from the human toll, Hurricanes Katrina, Rita, and
    Wilma caused insured losses of an estimated $56.5 billion and total
    economic losses--including both insured and uninsured losses--of more
    than $100 billion. The federal government alone has appropriated more
    than $88 billion for disaster relief and recovery from the 2005
    hurricanes. Future disasters could be even more expensive. One
    catastrophe modeling firm estimates that a large hurricane in southeast
    Florida could cause insured losses of more than $130 billion and a
    total economic loss of more than $260 billion.[Footnote 1] Similarly,
    if San Francisco's 1906 earthquake were to be repeated today, it is
    estimated that it would cause insured losses of more than $70 billion
    and a total economic loss of more than $280 billion. Also, a rupture of
    the Puente Hills fault in the Los Angeles basin could lead to estimated
    insured losses of more than $140 billion and a total economic loss of
    more than $500 billion.

    As we reported earlier in 2007, large losses associated with natural
    catastrophes are some of the biggest exposures that property and
    casualty insurers face.[Footnote 2] To remain financially solvent,
    these companies must estimate and prepare for the potential impact of
    such events. Because of the increased risk of natural catastrophes and
    the challenges of predicting losses from them, insurance companies have
    started limiting both renewals of existing contracts and the writing of
    new contracts in catastrophe-prone regions of the United States, such
    as coastal areas (from Massachusetts to Texas), earthquake zones in
    California, and the Mississippi River area of the central United States
    along the New Madrid earthquake fault.

    Such events place enormous stress on insurance markets and governments,
    carry huge costs, and have raised concerns about who ultimately bears
    the costs and receives the benefits of government disaster insurance
    programs. For these reasons, debate has arisen about the appropriate
    role for the federal government in insuring against and in recovering
    from natural catastrophes.[Footnote 3] While many public policy
    observers agree that the federal government does and should play an
    integral role in disaster relief and infrastructure recovery, some
    other public policy observers have asked whether the government's
    current role is the most appropriate and have suggested alternatives.
    Some have argued for more federal involvement, but others believe that
    the federal government may be doing too much, crowding out private
    insurance and reducing the private market's ability and willingness to
    provide insurance-based solutions.[Footnote 4] Public policy observers
    have raised moral hazard concerns, noting that generous federal
    disaster relief may discourage homeowners from purchasing natural
    catastrophe insurance.[Footnote 5] These observers have also pointed
    out that government catastrophe insurance programs are vulnerable to
    adverse selection, in that homeowners who are at the most risk are also
    the most likely to buy catastrophe insurance.[Footnote 6]

    In the context of your concerns about finding ways to ensure that the
    federal government and the private sector each play an appropriate role
    in the provision of natural catastrophe insurance, we examined (1) the
    rationale for and resources of the federal and state programs that have
    supplemented or substituted for private natural catastrophe insurance
    and their funding; (2) the extent to which Americans living in
    catastrophe-prone areas of the United States are uninsured and
    underinsured and the federal payments that have been made to such
    individuals since the 2005 hurricanes; and (3) public policy options
    for revising the federal role in natural catastrophe insurance markets.

    We reviewed or analyzed documents on federal and state catastrophe
    insurance programs, the numbers of uninsured and underinsured and
    federal payments that have been made, options to redefine the federal
    role in natural catastrophe insurance, and goals that could be used as
    a basis for designing and evaluating options for change. We interviewed
    officials from public interest groups, insurance companies, reinsurance
    companies, insurance agents, insurance brokers, insurance and
    reinsurance associations, insurance agent associations, state
    catastrophe insurance and reinsurance plans, state insurance
    departments, state economic development departments, the National
    Association of Insurance Commissioners (NAIC), the Federal Emergency
    Management Agency (FEMA), the National Flood Insurance Program (NFIP),
    the Department of Agriculture's Risk Management Agency, the Department
    of Housing and Urban Development (HUD), the Small Business
    Administration (SBA), Fannie Mae, Freddie Mac, rating agencies, risk
    modeling organizations, academia, law firms, a hedge fund, an insurance
    research organization, a private research organization, a consumer
    group, and others. To determine the mechanisms that governments use to
    supplement or substitute for private catastrophe insurance markets, we
    collected oral and documentary information from public and private
    officials in various states with high and low catastrophe risk and from
    Washington, D.C. To determine the number of uninsured and underinsured
    Americans and payments made to such individuals after the 2005
    hurricanes, we collected information from states, examined federal
    agency data, interviewed federal officials who prepared these data,
    sought information from the private sector, and interviewed state
    officials responsible for disbursing federal disaster funds. Data on
    the numbers and amounts of money going to the uninsured and
    underinsured were incomplete and had a number of limitations, which are
    described in appendix I. We determined that these data were sufficient
    for the purposes of this engagement.

    We identified various options for altering the role of the federal
    government in catastrophe insurance by looking at bills before the
    current and previous Congresses as well as other options that were not
    included in current legislative proposals--for example, a proposal
    before a committee of NAIC. After fieldwork for this report concluded,
    we were informed that additional public policy options not considered
    in this report were being discussed before a committee of NAIC. We
    sought out both supporters and critics of each option, and our
    discussion of the third objective presents mainly advantages and
    disadvantages that they have identified. We developed a four-goal
    framework that was based on challenges faced by current government
    natural catastrophe insurance programs and used the framework to
    analyze current options for changing the federal role in natural
    catastrophe insurance. We developed these goals by drawing insights
    from the following: past GAO work, legislative histories of laws that
    changed the roles of state governments and the federal government after
    disasters, bills before the current and previous Congresses, interviews
    with public and private sector officials, and refereed articles written
    by academics in insurance economics. Although we identified numerous
    possible goals that could assist our analysis, we believe the four
    goals that we chose accurately capture the essential concerns of the
    federal government. The congressional policy choices ahead involve
    striking an appropriate balance among these goals.

    The scope of our work covered hurricane and earthquake perils. We did
    not investigate tornado, hail, or other perils, such as wildfires. We
    focused on the property and casualty insurance line, especially
    homeowners insurance. In reporting on the amount of federal disaster
    assistance to individuals who lacked adequate insurance in the Gulf
    Coast states following the 2005 hurricanes, we attempted to identify
    payments to homeowners only. However, because in some instances we
    could not separate out payments to renters, we included payments to
    both homeowners and renters in some of our calculations. Judgments
    about whether market failure did or did not exist in any particular
    state's property and casualty insurance market--and whether the cost of
    doing something about it was or was not more expensive than the federal
    government's not acting--were outside the scope of this report.
    Appendix I contains additional details of our objectives, scope, and
    methodology. We did fieldwork in Alabama; California; Connecticut;
    Florida; Illinois; Indiana; Louisiana; Massachusetts; Mississippi;
    Missouri; New York; Ohio; Texas; and Washington, D.C. Our work was
    conducted between March 2006 and October 2007 in accordance with
    generally accepted government auditing standards.

    Results in Brief:

    The federal government and some states have developed natural
    catastrophe insurance programs that supplement or substitute for
    private natural catastrophe insurance. For example, the Federal Crop
    Insurance Corporation (FCIC) currently insures crops for losses from
    multiple perils, and NFIP insures against flood losses. Although these
    programs were created to provide affordable insurance coverage, by
    design they are not adequately funded--that is, the premium rates do
    not cover the government's exposure--and rely on postfunding mechanisms
    to cover catastrophic loss years. Unlike private insurers that base
    premium rates on the risk of loss associated with properties, these
    programs offer legislatively mandated premium subsidies to encourage
    participation, and Congress appropriates funds for emergency disaster
    relief as needed. Similarly, some state governments have intervened
    when private sector insurance became prohibitively expensive or was not
    widely available, offering state-sponsored catastrophe insurance
    programs. For example, California created an earthquake fund in 1996
    when private insurers significantly reduced the writing of homeowner
    earthquake coverage following the Northridge Earthquake. Likewise,
    Florida has created the Citizens Property Insurance Corporation
    (Florida Citizens)--the largest home insurer in Florida--to provide
    state-backed insurance coverage, including for wind damage, for
    homeowners who cannot get coverage in the private sector. The natural
    catastrophe insurance programs in Florida, Louisiana, Texas, and other
    states are funded through a combination of premium payments and
    postevent assessments and bonds. Like the federal programs, some state
    natural catastrophe insurance programs have been criticized for not
    charging premiums sufficient to cover risks. After the 2005 hurricanes,
    for example, some of these programs faced large accumulated deficits
    and required substantial public funding to continue operations.

    The 2005 hurricanes made clear that, even with the federal and state
    natural catastrophe insurance programs, significant numbers of
    Americans lacked adequate insurance against natural catastrophes for
    their homes. These property owners were either uninsured or
    underinsured, for a variety of reasons. Perhaps most significantly,
    buying natural catastrophe insurance is in many cases voluntary, and
    homeowners may choose not to buy it because they do not understand
    their risk exposure, do not understand the protection catastrophe
    insurance offers, or cannot afford it. In some cases, homeowners have
    insurance, but it covers less than the full replacement value of their
    property or has other policy limitations. Underinsurance can be
    exacerbated following a natural catastrophe, when rebuilding costs can
    increase substantially. Uninsured and underinsured homeowners may
    compound the challenge of providing affordable natural catastrophe
    insurance by relying on the federal government for postdisaster
    assistance to rebuild their homes. These homeowners may seek federal
    disaster relief from several federal agencies, including grants from
    FEMA and HUD, and real property loans from SBA. As we found, a
    significant portion of post-Katrina payments to Americans have gone to
    homeowners who were inadequately insured. We estimated that a quarter
    to a third of all federal emergency appropriations after the 2005
    hurricanes, or around $26 billion in grants and loans, was obligated to
    homeowners and renters who lacked adequate natural catastrophe
    insurance.

    As Congress and the industry continue to reevaluate the role of the
    federal government in insuring for natural catastrophes, Congress is
    faced with balancing the often-competing goals of limiting taxpayer
    exposure and ensuring that citizens are protected. We identified seven
    public policy options for changing the role of the federal government
    in natural catastrophe insurance, including a mandatory all-perils
    homeowners insurance policy, federal reinsurance for state catastrophe
    funds, a federal lending facility for state catastrophe funds, and
    several tax-based incentives to encourage greater participation by
    insurers and homeowners in managing natural catastrophe risks. As shown
    in figure 4, each of these options has advantages and disadvantages. As
    part of our evaluation, we weighed each of the options against four
    public policy goals that we identified for federal involvement in
    natural catastrophe insurance programs: (1) to have premium rates fully
    reflect actual risks, (2) to encourage private markets to provide
    natural catastrophe insurance, (3) to encourage broad participation in
    natural catastrophe insurance programs, and (4) to limit costs to
    taxpayers before and after a disaster. We found that a mandatory all-
    perils policy, for example, could help create broad participation and
    provide a private sector solution. But this option could also require
    subsidies for low-income residents and thus potentially create
    substantial costs for the federal government. Similarly, while federal
    reinsurance for state catastrophe funds could lead to greater
    participation by private insurers, it could also displace the private
    reinsurance market. Also, a federal lending facility could also help
    state catastrophe insurance funds with financing needs after a
    catastrophe but could also expose the federal government--and
    taxpayers--to the risk that a loan might not be repaid. Given the often-
    competing purposes of many public policy options, some options may be
    more appealing than others, but all warrant discussion as part of the
    current debate. While some options would address the goals of charging
    rates that reflect the true risk of catastrophic loss, encourage broad
    participation, or promote greater private sector participation, these
    goals must be balanced with the desire to make rates affordable.

    We provided a draft of this report to NAIC and provided excerpts from
    the draft to Alabama Insurance Underwriting Association (Alabama Beach
    Pool), California Earthquake Authority (CEA), Department of Housing and
    Urban Development (HUD), Federal Crop Insurance Corporation (FCIC),
    Federal Emergency Management Agency (FEMA), Florida Hurricane
    Catastrophe Fund (FHCF), Florida Citizens Property Insurance
    Corporation (Florida Citizens), Georgia Underwriting Association (GUA),
    Louisiana Citizens Property Insurance Corporation (Louisiana Citizens),
    Mississippi Windstorm Underwriting Association (Mississippi Windpool),
    the North Carolina Insurance Underwriting Association (North Carolina
    Beach Plan), Small Business Administration (SBA), the South Carolina
    Wind and Hail Underwriting Association (South Carolina Windpool), and
    the Texas Windstorm Insurance Association (Texas Windpool). NAIC
    provided written comments that are reprinted in appendix III. In these
    comments, NAIC officials said that our approach was thorough and that
    we had done an admirable job of evaluating the public policy aspects of
    the seven proposals. The officials also mentioned two additional
    proposals that merit consideration, including a proposal that includes
    an allocation system for determining what portion of hurricane damages
    should be attributed to wind and what portion to flood, and another
    proposal for the creation of a federal entity to oversee property
    insurance rates in coastal zones. While these options were put forth
    too recently to be included in our review and analysis, we will collect
    additional information about them, to the extent possible, during the
    course of other ongoing work involving NFIP. NAIC also commented on
    allegations made by some critics of state regulation, who have
    suggested that regulators may be suppressing rates for some catastrophe
    insurers, and cautioned against assuming widespread rate suppression by
    state insurance regulators. As NAIC noted, our report does not allege
    any such activity on the part of state insurance regulators but notes
    that it is a concern raised by some critics. We recognize that
    determining the appropriate rates for natural catastrophe insurance is
    challenging and is often a negotiated process between the insurers and
    regulators. Alabama Beach Pool, the CEA, FCIC, Florida Citizens, FHCF,
    the GUA, Louisiana Citizens, MWUA, the North Carolina Beach Plan, SBA,
    the South Carolina Windpool, and the Texas Windpool provided technical
    comments that we incorporated in this report as appropriate.

    Background:

    The United States is exposed to several major hazards, in particular
    earthquakes and hurricanes, in coastal areas. As shown in figure 1, the
    Pacific, South Atlantic, and Gulf Coasts face the highest risk of
    earthquakes and hurricanes. According to the National Oceanic and
    Atmospheric Administration (NOAA), 53 percent of the nation's total
    population, or approximately 153 million people, lived in coastal
    counties in 2003.[Footnote 7] Moreover, the total coastal population
    increased by 33 million people, or 28 percent, between 1980 and 2003.
    California led in coastal population change, with the number of
    residents increasing by 9.9 million people. Florida showed the greatest
    percentage population change between 1980 and 2003, increasing nearly
    75 percent. The nation's coastal population is expected to increase by
    more than 7 million people by 2008 (over current levels) and by 12
    million people by 2015.

    Figure 1: Catastrophic Risk in the United States--Earthquake,
    Hurricane, Tornado, and Hail:

    [See PDF for image]

    This figure is a map of the United States with depictions of the paths
    and/or landfalls of earthquakes, hurricanes, tornadoes and hail. Shaded
    areas on the map indicate risk, from low risk to high risk. Twenty-one
    different shadings are indicated on a continuum from lowest risk (1) to
    highest risk (21), with the following cities depicted: Phoenix: 2;
    Las Vegas: 3;
    New York: 4;
    Philadelphia: 5;
    Portland: 6;
    Washington, DC, Boston, Chicago: 7;
    San Diego: 9;
    Salk Lake City: 10;
    Raleigh: 11;
    Atlanta, San Antonio: 12;
    St. Louis, Denver: 13;
    Seattle, Los Angeles: 14;
    Anchorage: 16;
    Tampa, Houston, Dallas: 17;
    New Orleans, Memphis, Oklahoma City: 18;
    Charleston, San Francisco: 19;
    Honolulu: 20;
    Miami: 21.

    Source: Risk Management Solutions.

    [End of figure]

    The housing supply in coastal areas also continues to grow, despite the
    high risk of earthquakes and hurricanes. NOAA reported that coastal
    counties contained 52 percent of the nation's total housing supply in
    2000.[Footnote 8] The leading states in terms of total housing units in
    coastal counties were California, Florida, and New York, which together
    have 41 percent of the total housing supply in these counties. One
    study put the estimated insured value of coastal property in states
    bordering the Atlantic Ocean and Gulf of Mexico at $7.2 trillion as of
    December 2004.[Footnote 9] As shown in figure 2, properties along the
    Pacific and North-Atlantic Coasts and the Gulf of Mexico have some of
    the highest insured property values. The value of residential and
    commercial coastal property in Florida and New York was $1.94 trillion
    and $1.90 trillion, respectively, in 2004.

    Figure 2: Insured Property Value, by County:

    [See PDF for image]

    This figure is a map of the continental United States, depicting the
    insured property value, by county. Counties are shaded into the
    following five categories by insured property value, in billions:

    Less than 5;
    Five to ten;
    Eleven to fifty;
    Fifty-one to one hundred;
    More than 100.

    Source: Copywrite, 2007 AIR Worldwide Corporation.

    [End of figure]

    Private Natural Catastrophe Insurance:

    Insurance coverage against natural catastrophes for a home may or may
    not be included in homeowners insurance contracts. For example,
    coverage against wind loss from an event such as a hurricane is
    typically included. However, in some areas of certain states--mostly
    coastal regions--wind coverage may be excluded from homeowners
    insurance contracts and may be available only through the surplus lines
    insurance market or a state-managed entity.[Footnote 10] Similarly,
    earthquake coverage is commonly excluded from homeowners insurance
    contracts and instead is sold separately by insurance companies or, in
    the case of California, through a state-managed program.

    The price of property and casualty insurance is affected by both the
    annual expected loss and the cost of diversifying the risk of
    catastrophic losses.[Footnote 11] Insurers can diversify the risk of
    catastrophic losses by, among other things, purchasing reinsurance,
    which is insurance for insurance companies, or by selling financial
    instruments such as catastrophe bonds. Insurance companies do not know
    in advance what their actual costs are going to be, because they can
    determine these costs only after a policy has expired. The insurer's
    objectives are to calculate premiums that will make the business
    profitable, enable the company to compete effectively with other
    insurers, and allow the company to pay claims and expenses as they
    occur.

    When insurers, reinsurers, and investors in catastrophe financial
    instruments perceive that the expected frequency or severity of natural
    catastrophes has increased, they may increase the price of insurance.
    If a company believes that the risk of loss--for example, from flooding
    or earthquake--is unacceptably high given the rate that can be charged,
    it declines to offer coverage.

    State Regulation of Insurance Prices:

    While the federal government retains the authority to regulate
    insurance, it has given primary responsibility for insurance regulation
    to the states, in accordance with the McCarran-Ferguson Act of
    1945.[Footnote 12] State insurance commissioners are responsible for
    regulating rates, monitoring the availability of insurance, and
    assessing insurance firms' solvency. The insurance regulators of the 50
    states, the District of Columbia, and the U.S. territories have created
    NAIC to coordinate regulation of multistate insurers. NAIC serves as a
    forum for the development of uniform policy, and its committees develop
    model laws and regulations that, when adopted by state legislatures or
    promulgated by state regulators, govern the U.S. insurance industry.

    Critics of state insurance regulation argue that insurance prices and
    terms of coverage, particularly for homeowners insurance in areas prone
    to natural catastrophes, are highly regulated and that the insurance
    industry is generally not allowed to respond freely to changing risks
    or market conditions. In particular, these critics say that:

    * insurance regulators do not allow private insurers in catastrophe-
    prone areas to charge rates sufficient to build surpluses or transfer
    risks to reinsurers,

    * regulators may be subject to voter pressure and thus to legislative
    pressure to keep insurance premiums affordable and coverage readily
    available, and:

    * regulatory and political restrictions prevent markets from giving
    consumers accurate price signals regarding the risks of living in
    catastrophe-prone areas.

    NAIC officials told us that projected loss costs to cover the insurer's
    catastrophe exposure vary widely depending on which risk-modeling firm
    the insurer selects to produce its catastrophe loss costs. Only future
    results prove whether insurance company actuaries or insurance
    regulator actuaries are correct. The officials said that one should not
    assume that insurers and their actuaries have perfect information about
    what catastrophes will occur during the next year and about how the
    economy will behave. They added that one should also not assume that
    actuaries working for insurance companies are always correct in their
    projections of the needed price for the future experience period and
    that actuaries working for insurance regulators are always wrong.

    In the aftermath of natural catastrophes, some insurers responded by
    limiting their exposure in catastrophe-prone areas with restrictions on
    underwriting, higher deductibles, and lower coverage limits.[Footnote
    13] In particular, there were property insurance affordability and
    availability crises in the Gulf Coast states or Florida after Hurricane
    Camille in 1969, Hurricane Celia in 1970, Hurricane Andrew in 1992, and
    the 2005 hurricanes; and in California following the Northridge
    Earthquake in 1994. Various proposals have been put forth over the past
    15 years seeking to have the federal government take a larger role--for
    example, as a reinsurer or by allowing insurance companies to
    accumulate tax-deferred reserves--in addressing the affordability and
    availability of natural catastrophe insurance.[Footnote 14]

    Federal Natural Catastrophe Insurance and Disaster Aid:

    The federal government engages in a wide variety of insurance
    activities, among them providing multiperil crop insurance to farmers
    and flood insurance to homeowners and businesses.[Footnote 15] In
    addition, the federal government provides disaster assistance to
    individuals and households.[Footnote 16] FEMA, SBA, and HUD are the
    primary agencies administering federal disaster relief and recovery
    programs.

    FCIC provides insurance coverage for farmers who suffer financial
    losses when their crops are damaged by droughts, floods, or other
    natural disasters. By law, FCIC pays the premium for catastrophic
    coverage against losses of 50 percent of a farm's normal yield at 55
    percent of the market price.[Footnote 17] In addition, FCIC offers
    premium subsidies for "buy-up" coverage against crop, revenue, and
    prevented planting losses, with coverage for losses ranging from 50 to
    90 percent of a farm's normal yield.[Footnote 18] FCIC estimates that
    participation of eligible farmers is approximately 80 percent of acres
    planted.

    FEMA, through NFIP, offers insurance to homeowners and businesses for
    losses due to flooding and currently has 5.3 million policyholders. By
    law, NFIP must offer reduced premium rates for homes built in
    floodplains prior to the creation of flood insurance rate maps (pre-
    Flood Insurance Rate Map (FIRM) properties). About one quarter of NFIP
    policies are pre-FIRM and pay about 40 percent of the risk-based rate.
    According to NFIP, homes built in floodplains to an approved building
    code after the creation of flood maps pay actuarially sound premiums.
    Participation in the program is mandatory for homeowners with mortgages
    issued by federally regulated lenders on properties in special flood
    hazard areas (SFHA) where flood insurance is available.[Footnote 19]
    According to the RAND Corporation, about half of all homeowners who
    live in SFHAs purchase flood insurance.

    In addition to providing crop, flood, and other insurance, the federal
    government provides disaster assistance to individuals. FEMA provides
    disaster relief and recovery assistance to individual citizens through
    its Individuals and Households Program (IHP), which is intended to
    provide money and services to people in a disaster area when losses are
    not generally covered by insurance and property has been damaged or
    destroyed. IHP includes Housing Assistance (HA) and Other Needs
    Assistance (ONA). FEMA may provide five types of HA: financial
    assistance to rent temporary housing, "direct" temporary housing
    assistance, repair assistance, replacement assistance, and permanent
    housing construction in certain areas outside of the continental United
    States and other remote areas. FEMA may provide ONA grant funding for
    transportation expenses, medical and dental expenses, and funeral and
    burial expenses. ONA grant funding may also be available to replace
    personal property, repair and replace vehicles, and reimburse moving
    and storage expenses under certain circumstances. IHP is not intended
    to restore damaged property to its predisaster condition.

    SBA's Disaster Loan Program (DLP) is the primary federal program for
    funding long-range recovery for private sector, nonfarm disaster
    victims. Eligible losses include under or uninsured damages and can not
    duplicate benefits received from another source (i.e. insurance
    recovery, FEMA, etc.) The Small Business Act authorizes SBA to make
    available the following two types of disaster loans: (1) physical
    disaster home loans to homeowners, renters, and businesses of all
    sizes, and (2) economic injury disaster loans to small
    businesses.[Footnote 20] Homeowners and renters can borrow up to
    $40,000 for repair or replacement of household and personal effects.
    Homeowners can also borrow up to $200,000 to repair or replace a
    primary residence. Businesses of all sizes can borrow up to $1.5
    million to repair or replace disaster damaged real estate, machinery
    and equipment, inventory, etc. Small businesses can borrow up to $1.5
    million for disaster related economic injury resulting from the
    declared disaster. The combined loans to a business for physical loss
    and economic injury cannot exceed $1.5 million. Homeowners and
    businesses must provide reasonable assurance that they can repay the
    loan out of personal or business cash flow, and they must have
    satisfactory credit and character.

    HUD also provides disaster recovery assistance through several
    programs. After the 2005 hurricanes, Congress appropriated $16.7
    billion to the Community Development Block Grant (CDBG) program for
    disaster recovery. The CDBG program generally provides funding to
    metropolitan cities and urban counties that have been designated as
    entitlement communities and to states for distribution to other
    communities.[Footnote 21] Grant recipients must give maximum feasible
    priority to activities, including emergency-related activities, that
    (1) benefit low-and moderate-income families or aid in the prevention
    or elimination of slums or blight, or (2) meet urgent community
    development needs. However, HUD can waive regulatory and statutory
    program requirements to increase the flexibility of the CDBG funds for
    disaster recovery. These grants afford states and local governments a
    great deal of discretion to help them recover from presidentially
    declared disasters.[Footnote 22]

    Government Natural Catastrophe Insurance Aims to Provide Affordable
    Protection but Often Requires Postfunding after Large Natural
    Catastrophes:

    Government natural catastrophe insurance programs were created because
    certain perils are difficult to insure privately and because, when
    private insurance is available, it may not be affordable. To keep
    natural catastrophe insurance available and affordable, government
    insurance programs operate differently than private insurance
    companies. Private insurance companies generally rely on premiums
    collected from those they insure to cover operating costs and losses
    and set premium rates at levels that are designed to reflect the risk
    that the company assumes in providing the insurance. These companies
    may also accumulate reserves to cover large losses. Federal and state
    government insurance programs also collect up-front premiums, but their
    rates do not always reflect the risks that the programs assume. Because
    premiums are inadequate to cover operating costs and losses, the
    government programs generally have limited resources and often face
    deficits after disasters. However, unlike private insurers, federal
    insurers may obtain funds after a catastrophic event through emergency
    appropriations. State programs may also access postevent funding
    through various means, including assessments on private insurers,
    bonds, and private reinsurance. State programs may also be postfunded
    through state general revenue funds and federal disaster relief
    payments. This structure has several implications. First, it may
    encourage homeowners in catastrophe-prone locations to seek coverage
    from government programs, crowding out the private market and
    increasing the government's financial exposure. Second, homeowners may
    not receive appropriate price signals about the risk of living in
    catastrophe-prone locations. Third, taxpayers who live in less risky
    locations may be subsidizing those living in catastrophe-prone
    locations. Finally, the added burden of private insurers' assessment
    obligations may provide another reason for them to leave already
    stressed markets.

    Federal natural catastrophe insurance programs fill gaps in private
    insurance markets and help limit disaster relief payments. For example,
    FCIC and NFIP were created because private insurers had determined that
    multiperil crop and flood losses were uninsurable and declined to
    provide coverage. A 1937 study by the Executive Committee on Crop
    Insurance, which noted that commercial attempts to insure against crop
    losses had been unsuccessful, provided the impetus for creating FCIC in
    1938. Initially, the program was experimental and suffered heavy
    losses. The Federal Crop Insurance Act of 1980 expanded the program to
    replace free disaster coverage (in the form of compensation to farmers
    who were unable to plant crops and who suffer yield losses) with
    insurance. The flood insurance program was initiated because it had
    become clear by the 1950s that private insurance companies could not
    profitably provide affordable flood coverage because of the
    catastrophic nature of flooding and the impossibility of developing an
    actuarial rate structure that could adequately reflect the risk to
    flood-prone properties, among other reasons. One of the primary
    purposes of the National Flood Insurance Act of 1968, which created
    NFIP, was to reduce federal expenditures for disaster assistance and
    flood control.

    State natural catastrophe insurance programs were created to avoid
    homeowners insurance crises that threatened the states' housing
    markets. For example, the California Earthquake Authority was formed in
    1996 in response to a crisis in the residential property insurance
    market following the Northridge earthquake in 1994. According to the
    Insurance Information Institute, California insurers had collected only
    $3.4 billion in earthquake premiums in the 25-year period prior to the
    Northridge earthquake but had paid out more than $15 billion on
    Northridge claims alone. Moreover, insurers representing about 95
    percent of the homeowners insurance market in California began to limit
    their exposure to earthquakes by writing fewer or no new homeowners
    insurance policies, triggering a crisis that threatened California's
    housing market and stalled the state's recovery from recession. See
    appendix II for a more detailed description of state natural
    catastrophe insurance programs.

    Florida Citizens is a nonprofit tax-exempt entity that provides
    residential and commercial property insurance coverage when private
    insurance is not available. Florida Citizens was established in 2002
    after two separate insurance pools--the Florida Windstorm Underwriting
    Association (FWUA) and the Florida Residential Property and Casualty
    Joint Underwriting Association (JUA)--were combined.[Footnote 23] In
    addition, the Florida Hurricane Catastrophe Fund (FHCF) provides an
    alternative to traditional hurricane reinsurance, reducing the cost of
    coverage significantly below that of private reinsurance and lowering
    the cost of insurance to homeowners. The FHCF was established in 1993
    in response to Hurricane Andrew, which resulted in a severe shortage of
    catastrophe property reinsurance capacity, stricter policy terms and
    conditions, and sharp increases in property catastrophe reinsurance
    rates in the year following the storm.[Footnote 24] The post-Andrew
    reaction of a number of insurance companies was to attempt to reduce
    their underwriting exposure, and 39 insurers stated in early 1993 that
    they intended to either cancel or not renew approximately 844,000
    policies in Florida.[Footnote 25] Other states--including Alabama,
    Louisiana, Mississippi, and Texas--have created state funds to make
    natural catastrophe insurance available and affordable.

    Premium Rates for Government Natural Catastrophe Insurance Programs Are
    Often Determined by Factors Other Than Risk:

    Because government natural catastrophe insurance programs are often
    created to ensure the availability and affordability of natural
    catastrophe insurance, homeowner premiums for these programs--although
    risk-related--are generally not based entirely on the homeowners level
    of risk. Federal natural catastrophe insurance program premium rates
    are often set by statute and involve government subsidies. For example,
    to encourage broad participation in the crop insurance program, federal
    law seeks to ensure that the premiums are affordable to all farmers by
    requiring FCIC to pay a portion of the premium cost.[Footnote 26]
    Specifically, FCIC offers farmers varying subsidy rates for crop
    insurance, depending on the level of protection they seek.[Footnote 27]
    Crop insurance subsidies totaled about $2.3 billion in crop years 2005
    and 2006. In addition, federal crop insurance legislation directs FCIC
    to operate at a loss ratio of no more than 1.075.[Footnote 28] A loss
    ratio greater than 1.00 indicates that the program paid more in claims
    than it collected in premiums.[Footnote 29] Furthermore, we have
    previously reported that NFIP is not designed to be actuarially
    sound.[Footnote 30] Annually, flood insurance subsidies total about
    $1.3 billion.[Footnote 31]

    State natural catastrophe insurance program premium rates may also be
    set by statute. Florida Citizens historically has been required to
    maintain premium rates that were not competitive with the private
    insurance market. However, in January 2007, the Florida Legislature
    allowed Florida Citizens to charge competitive rates.[Footnote 32] Even
    by 2006, Florida Citizens was the largest property insurer in Florida.
    It receives much of its reinsurance coverage from the FHCF, which
    charges premium rates that are estimated to be about a quarter to a
    third the cost of private market reinsurance. The program can charge
    these rates because of its tax-exempt status and ability to postfund
    claims losses through bonds, among other advantages. These two state
    programs are able to charge lower premiums than private insurance
    companies, encouraging more people to seek coverage in the state
    programs and leaving the state more financially vulnerable in the event
    of a large hurricane.

    State natural catastrophe insurance program premium rates are also
    subject to approval by state insurance regulators that have generally
    resisted rate increases. The Mississippi Windstorm Underwriting
    Association (Mississippi Windpool) provides coverage against windstorms
    and hail for people in the six coastal counties of Mississippi who
    might not be able to get wind coverage in the private insurance market.
    After Hurricane Katrina, the Mississippi Windpool sought a rate
    increase of almost 400 percent, primarily to cover the increased cost
    of reinsurance. The state insurance regulator granted a 90 percent
    increase. Furthermore, the state government will use $50 million in
    federal disaster recovery funds provided by HUD to offset the increased
    cost of reinsurance in 2007 and 2008. In addition, the state government
    created a reinsurance fund that uses state general revenue funds to
    offset the increased cost of reinsurance.

    Similarly, the Texas Windstorm Insurance Association (Texas Windpool)
    offers wind and hail coverage in 14 coastal counties and other
    specified areas. By law, Texas Windpool residential and commercial
    premium rates may not increase more than 10 percent above the rates for
    noncommercial windstorm or hail insurance that are in effect at the
    time the request for an increase is filed. However, the insurance
    commissioner may suspend this rule to ensure rate adequacy in the
    catastrophe area.[Footnote 33] In May 2006, the Texas Windpool sought a
    19 percent residential and 24 percent commercial rate increase, but the
    insurance commissioner approved a 3.1 percent residential and 8 percent
    commercial rate increase. When the Texas Windpool sought a 20 percent
    residential and 22 percent commercial rate increase in November 2006,
    the insurance commissioner approved a 4.2 percent residential and 3.7
    percent commercial rate increase. In both instances, the insurance
    commissioner stated that he favored an incremental approach to
    strengthening the Texas Windpool that did not put an undue economic
    burden on coastal homeowners.

    Federal and State Natural Catastrophe Insurance Programs Have Incurred
    Large Postdisaster Deficits Because of Inadequate Resources and
    Reliance on Postfunding:

    Unlike private insurance companies, government natural catastrophe
    insurance programs often do not employ accrual accounting and are not
    always required to accumulate adequate resources to meet their
    obligations. Generally, insurance premiums are paid in advance, but the
    period of protection extends into the future. Private insurers are
    required by statutory accounting rules to establish reserves for
    incurred or known claims and for the cost of "incurred but not
    reported" claims to ensure that the premiums collected in advance will
    be available to pay future losses.[Footnote 34] Incurred but not
    reported claims are insured losses that have already happened but that
    for any of a variety of reasons have not yet been reported to the
    insurer. Most government natural catastrophe insurance programs are not
    required to have these resources, because they are structured to
    postfund losses. As we have previously mentioned, NFIP and the federal
    crop insurance program are postfunded by emergency appropriations from
    federal taxpayers. State programs are generally postfunded by several
    mechanisms, including assessments on private insurers, bonds, and
    proceeds from general revenues. In most property and casualty insurance
    lines, state assessments are often passed through to policyholders. As
    a result, homeowners living in less risky locations also contribute to
    cover the shortfall--a scenario known as cross-subsidization. In those
    states where assessments cannot be passed through in some manner,
    private insurers must pay the assessments, while at the same time
    paying large claims from their own policyholders. In such instances,
    some companies may be reluctant to continue offering coverage in the
    state or may become insolvent.

    In the wake of recent natural catastrophes, some government natural
    catastrophe insurance programs suffered losses that eliminated their
    accumulated resources. For example, NFIP reported unexpended cash of
    approximately $1 billion following fiscal year 2004, but the program
    had suffered almost $16 billion in losses from Hurricane Katrina alone
    as of May 31, 2007.[Footnote 35] Similarly, Florida Citizens' high-risk
    account had a surplus of approximately $1.1 billion prior to the 2004
    hurricane season, but the program incurred over $2 billion in losses
    from the 2004 hurricanes and almost $2 billion in losses from the 2005
    hurricanes.[Footnote 36] The FHCF had accumulated net assets of $5.5
    billion at the end of the 2004 fiscal year but had an estimated
    shortfall of approximately $1.4 billion following reimbursements to
    participating insurers after the 2004 and 2005 hurricane
    seasons.[Footnote 37] Prior to 2007, the Mississippi Windpool did not
    have resources beyond premiums and reinsurance because year-end profits
    and losses were shared by member companies. By the end of 2005,
    following Hurricane Katrina, the Mississippi Windpool had incurred a
    net loss of $473 million.[Footnote 38] In Louisiana, Citizens Property
    Insurance Corporation (Louisiana Citizens), which has a structure
    similar to that of Florida Citizens, had $80 million in cash reserves
    prior to the 2005 hurricane season but suffered more than $1 billion in
    losses after Hurricanes Katrina and Rita.[Footnote 39]

    Emergency appropriations authorizing funding for federal natural
    catastrophe insurance programs after disasters have often been
    significant. In the case of FCIC, not only are premium rates subsidized
    by almost 59 percent for the most popular coverage, but farmers may
    receive additional emergency disaster relief--for example, farmers
    received $1.6 billion following Hurricane Katrina.[Footnote 40] In the
    case of NFIP, not only are premium rates for pre-FIRM homes subsidized
    up to 60 percent on average, but after Hurricane Katrina NFIP was
    authorized to borrow over $20 billion to pay claims.

    State natural catastrophe insurance programs have also often required
    postfunding to satisfy their obligations in the wake of large natural
    catastrophes. For example, to fund its 2004 and 2005 deficits, Florida
    Citizens assessed insurance companies in most property and casualty
    lines $516 million and $205 million, respectively, and these amounts
    will be passed through to policyholders.[Footnote 41] In addition, the
    Florida Legislature appropriated $715 million from the general revenue
    fund to reduce the size of the 2005 deficit. Furthermore, to fund a
    bond issuance to cover the FHCF's shortfall, eligible Florida insurance
    policyholders incurred a 1 percent assessment that will be levied over
    at least 6 years beginning in January 2007. In June 2006, the FHCF
    issued a $1.35 billion postevent revenue bond to cover 2005 losses, and
    in July 2006 it issued a $2.8 billion preevent financing bond to
    provide liquidity for 2006 and future years.

    Similarly, Louisiana Citizens assessed all property insurance companies
    in the state $193 million after the 2005 hurricanes. It has also issued
    a postevent bond for $978 million to cover 2005 losses that will be
    financed by emergency assessments on insurers in certain lines of
    property and casualty insurance. These assessments are levied directly
    on policyholders, who may claim a tax credit against state income tax.
    The assessments will continue for as many years as needed to cover the
    plan's deficit. Both Florida Citizens and Louisiana Citizens have been
    declared to be municipalities rather than insurance companies by their
    respective state legislatures, and as a result cannot declare
    bankruptcy until the bond obligations are satisfied. In addition, the
    Mississippi Windpool funded its deficit through $525 million in
    assessments on member companies in proportion to their share of
    business in the state.[Footnote 42] At the time, these assessments
    could not be directly passed through to policyholders. At least one
    private insurance company found that its assessment liability was more
    than the entire amount of premiums it collected in the state and was
    forced to liquidate. Finally, the Texas Windpool assessed private
    insurance companies in Texas for the first $100 million in program
    losses and expenses from Hurricane Rita beyond its ability to pay from
    premiums and other income.

    Because Many Americans Are Inadequately Insured for Natural
    Catastrophes, Federal Programs Play a Significant Role in Recovery:

    The 2005 hurricanes illustrated how many Americans are uninsured and
    underinsured for natural catastrophes and the federal government's role
    in recovery from natural catastrophes. An analysis by HUD found that of
    the 192,820 owner-occupied homes with major or severe damage from
    Hurricanes Katrina, Rita, and Wilma, approximately 78,000, or about 41
    percent, did not have any insurance or did not have enough insurance to
    cover the damage incurred.[Footnote 43] Homeowners do not purchase
    natural catastrophe insurance for a variety of reasons, including
    financial reasons. Moreover, buying a natural catastrophe insurance
    policy does not guarantee complete coverage for a dwelling. For
    example, if the home's replacement value is calculated inaccurately,
    the homeowner will buy too little insurance to cover all of the damage.
    More and more frequently, responsibility for supporting the needs of
    individuals who lack adequate insurance against natural catastrophe
    risk is falling to the federal government. We estimate that the federal
    government made approximately $26 billion available for homeowners and
    renters who lacked adequate insurance in response to the 2005
    hurricanes.

    Homeowners May Not Be Insured against Natural Catastrophes for Several
    Reasons:

    Homeowners may not purchase natural catastrophe insurance because they
    face budget constraints, underestimate the risk they face, or fail to
    understand the protection such insurance affords.[Footnote 44]
    Information on the number of individuals who are uninsured against
    natural catastrophe risks is somewhat limited but helps demonstrate the
    extent to which homeowners do not purchase natural catastrophe
    insurance. About 41 percent of homes that sustained severe damage from
    any peril during the 2005 hurricanes were uninsured or underinsured.
    HUD reported that of the 60,196 owner-occupied homes with major or
    severe wind damage, almost 23,000, or 38 percent, lacked insurance
    against wind loss. Also, the Insurance Information Institute reported
    that about 86 percent of Californians did not have earthquake insurance
    on their homes in 2004. Furthermore, only about one half of eligible
    single-family homes in Special Flood Hazard Areas (SFHA) nationwide
    have purchased flood insurance.[Footnote 45] In areas outside of SFHAs,
    where flood insurance is voluntary, only about 1 percent of owners of
    single-family homes have purchased flood insurance, even though 20 to
    25 percent of NFIP's claims come from outside of SFHAs.

    Purchasing insurance to protect homes against natural catastrophes is
    mandatory for some homeowners, but often it is voluntary. For example,
    homeowners who do not have mortgages are generally not required to have
    property and casualty coverage, and in some areas certain types of
    hazards are routinely excluded from homeowners policies. As we have
    seen, wind coverage is often excluded in some coastal areas, and the
    surplus lines market or a state-managed entity may offer coverage
    separately. Although lenders may require homeowners to purchase this
    supplemental insurance, those who own their homes outright may choose
    not to buy it. A similar situation exists with earthquake coverage in
    certain areas of the country. In earthquake-prone areas, earthquake
    coverage is commonly excluded from the homeowners insurance contract
    and is sold separately by insurance companies or, as in the case of
    California, by a state-managed program. In general, lenders do not
    require earthquake insurance as a condition of extending a mortgage.

    Consumers will purchase natural catastrophe insurance on the basis of
    their perception of risk. Studies have shown that consumers often
    consider the likelihood of a future catastrophe to be much lower than
    insurance companies' estimates. According to academic research, some
    homeowners may underestimate the risk of loss, have an overly
    optimistic view of expected losses, or be unaware that insurance is
    available. One insurance expert has concluded that if people believe
    that the chance of a serious event occurring is low, they often
    consider insurance unnecessary and will not seek out information on its
    benefits and costs. Reluctance to purchase insurance protection can be
    compounded by budget constraints. For some homeowners with relatively
    low incomes, disaster insurance is considered an expense that can be
    made only after taking care of necessities.

    An insurance expert has noted that insurance trade associations,
    consumer advocacy groups, and governments can provide better
    information to consumers about risk probabilities, insurer
    profitability, and prices to motivate better insurance purchasing
    behavior.[Footnote 46] One study of those living in earthquake zones
    has identified a variety of reasons for declining to purchase
    earthquake insurance.[Footnote 47] Some consumers are unwilling or
    reluctant to pay high premiums to insure against potentially large but
    rare disaster losses. Some consumers believe that the deductible for
    earthquake insurance--the standard deductible is 15 percent of the
    value of the home--is too high, given the premium rates and amount of
    coverage provided.[Footnote 48] A study of flood insurance market
    penetration rates cites several reasons why people do not purchase
    flood insurance.[Footnote 49] For property owners in SFHAs, the
    decision to purchase insurance is affected primarily by its price.
    Outside of SFHAs, property owners are not purchasing flood insurance
    because they may not be aware of flood risk, and because flood
    insurance agents have less interest in promoting flood insurance and in
    learning how to write flood policies. Also, certain limitations of the
    coverage, such as limits on basement flooding, make the policies less
    attractive in inland areas.

    Inaccurate Home Valuations Can Result in Underinsurance:

    Text box:
    Coinsurance Clause Formula:
    Homeowners who carry less than 80 percent of the full replacement cost
    of their homes receive an amount calculated by formulas. Generally, the
    amount will be the larger of the following two amounts:
    (1) Actual cash value of that part of the building damaged (minus
    depreciation cost) or;

    (2) Amount of insurance carried divided by 80 percent multiplied by
    replacement cost, then multiply that amount by Loss.

    To illustrate, assume that a dwelling has a replacement cost of
    $400,000, but it is insured for only $240,000. The roof of the house is
    10 years old and has a useful life of 20 years, so it is 50 percent
    depreciated. Assume the roof is severely damaged by a hurricane, and
    the replacement cost of a new roof is $40,000. Ignoring the deductible,
    the insured receives the larger of the following two amounts:

    (1) Actual cash value equals $40,000 minus $20,000, which equals
    $20,000; or:

    (2) $240,000 divided by 80 percent times $400,000; multiplied by
    $40,000, equals $30,000.

    The insured receives $30,000 for the loss. The entire loss of $40,000
    would have been paid if the insured had carried at least $320,000 of
    insurance.

    [End of text box]

    Homes may be underinsured because replacement costs are not calculated
    accurately. Replacement cost has been defined as the amount necessary
    to repair or replace the dwelling with material of like kind and
    quality at current prices. Replacement cost may not be calculated
    accurately for several reasons, including the effects of inflation,
    custom home building, remodeling, high demand for contractors, and
    changes in building codes following a natural catastrophe.

    Generally, property insurance losses are partial losses rather than
    total losses. However, in catastrophe-prone areas, the prospect of a
    total loss of property is real. If a homeowner suffers a total loss of
    property as a result of a natural catastrophe and the replacement cost
    has not been properly calculated, the property will not be fully
    insured. An insurance industry consultant estimates that in 2006
    approximately 58 percent of the residential housing stock in the United
    States was undervalued for insurance purposes by an estimated 21
    percent.

    Homeowners insurance coverage can vary by type of policy and from
    insurer to insurer, but there are fundamental similarities. The
    broadest coverage generally provides that a policyholder will receive
    full replacement cost with no deduction for depreciation (up to the
    policy limit) if a policyholder maintains coverage limits of 80 percent
    or more of the dwelling's full replacement cost.[Footnote 50]
    Otherwise, the homeowner receives a lesser amount according to the
    formula in the policy (see sidebar).

    The reasons that replacement costs may not be calculated accurately,
    leaving homeowners underinsured, are complex. First, replacement costs
    must be periodically updated to account for inflation. Second,
    beginning in the early 1980s developers began building more custom
    homes, and a significant percentage of homes were remodeled, sometimes
    extensively. Historically, the methodologies that the insurance
    industry used to calculate replacement costs did not always capture
    custom features. The industry has improved its calculation
    methodologies, but an insurance industry consultant told us that a
    large number of policies had not been properly updated. Furthermore,
    homeowners whose properties were remodeled may not have understood the
    need to tell their insurers about the remodeling, possibly to avoid
    rate increases. The problem of underinsurance can be exacerbated in the
    wake of a natural catastrophe when demand for contractors and materials
    to repair homes is high and the supply is tight. This phenomenon is
    known as "demand surge." In these circumstances, the short-term costs
    of repairing and rebuilding homes can escalate substantially, and
    replacement costs become significantly higher. In addition, over time a
    community may implement improved building codes, so that rebuilding may
    have to conform to stricter standards than those that were in place
    when a dwelling was first built.[Footnote 51] This situation can also
    make replacement costs much higher, as it did in Florida in the
    aftermath of Hurricane Andrew in 1992.

    Large Amounts of Federal Postdisaster Aid Have Been Distributed to
    Uninsured and Underinsured Homeowners:

    As of May 2007, Congress approved approximately $88 billion in
    emergency appropriations to assist in relief and recovery efforts in
    the Gulf Coast states following the 2005 hurricanes.[Footnote 52] Three
    federal agencies--FEMA, SBA, and HUD--received over $60 billion, or
    about two-thirds, of this amount. As we have previously noted, these
    agencies play a significant role in distributing federal disaster
    relief funds to individual victims. We estimate that, as of June 2007,
    the agencies had obligated approximately $26 billion, or between a
    quarter and a third, of the emergency appropriations to homeowners and
    renters in Alabama, Florida, Louisiana, Mississippi, and Texas who
    lacked adequate insurance (see fig. 3).

    Figure 3: Estimated Federal Disaster Assistance Obligated for
    Homeowners and Renters Lacking Adequate Insurance in Five Gulf Coast
    States after the 2005 Hurricane Season:

    [See PDF for image]

    The following data is depicted in table format:

    Hurricane-related emergency supplemental funding, in billions:
    Total: 87.755;
    Total congressional funds to assist Gulf Coast States: 100%.
    FEMA IHP: 42.576;
    SBA DLP: 0.988;
    HUD CDBG: 17.099;
    Portion of congressional funds to FEMA, SBA, and HUD: 69%;
    Estimated amount obligated by FEMA, SBA, and HUD to homeowners and
    renters lacking adequate insurance:
    FEMA IHP: 15.115;
    SBA DLP: 0.794;
    HUD CDBG: 9.904;
    Portion of congressional funds used for homeowners and renters who did
    not have adequate insurance: 29%.

    Source: GAO analysis of FEMA, HUD, and SBA documents and interviews.

    Note: These five Gulf Coast states are Alabama, Florida, Louisiana,
    Mississippi, and Texas. The 2005 hurricane season included Hurricanes
    Katrina, Rita, and Wilma. The SBA-obligated amount represents the
    subsidy cost of disaster loans at 14.64 percent, as of January 31,
    2007. The FEMA-obligated amount includes HA, ONA, and manufactured
    housing funds as of June 18, 2007. The HUD-obligated amounts are as of
    May 16, 2007. The totals for each agency were calculated using
    different methodologies and data sources. For details, see appendix I
    of this report.

    [End of figure]

    Federal disaster assistance for homeowners and renters comes from FEMA,
    SBA, and HUD. For example:

    * For disasters declared between October 1, 2004, and October 1, 2005,
    FEMA could provide a maximum of $26,200 for housing and other needs
    assistance to an individual or household in a disaster area if property
    was damaged or destroyed and the losses were not covered by
    insurance.[Footnote 53] In total, FEMA obligated over $15 billion to
    homeowners and renters through IHP grants and manufactured housing. We
    have reported extensively on the difficulties that FEMA experienced in
    distributing disaster assistance through IHP.[Footnote 54]

    * Homeowners and renters can borrow up to $40,000 in personal property
    loans from SBA to repair or replace clothing, furniture, cars, and
    appliances damaged or destroyed in a disaster. SBA can also make real
    property loans up to a maximum of $200,000 to repair or restore a main
    residence to its predisaster condition. Any proceeds from insurance
    coverage on the personal property or home are deducted from the total
    loan amount. The interest rates on SBA disaster loans do not exceed 4
    percent for those who are unable to obtain credit elsewhere or 8
    percent for those who can get other credit. As of January 31, 2007, SBA
    approved over $5 billion in disaster loans for homeowners and renters
    after the 2005 hurricanes, at an interest subsidy cost of almost $800
    million to the federal government. We have reported on the difficulties
    that SBA experienced in distributing disaster loans.[Footnote 55]

    * The largest recovery program for homeowners and renters after the
    2005 hurricanes was HUD's CDBG program, which received $16.7 billion in
    supplemental appropriations to help homeowners with long-term recovery
    (including providing funds for uninsured damages), restore
    infrastructure, and fund mitigation activities in the declared disaster
    areas of Alabama, Florida, Louisiana, Mississippi, and Texas.[Footnote
    56] To receive CDBG funds, HUD required that each state submit an
    action plan describing how the funds would be used, but the agency
    waived some program requirements for disaster recovery purposes. For
    example, HUD granted a waiver to Mississippi so that a portion of the
    CDBG funds could be used to pay reinsurance costs for 2 years for wind
    pool insurance maintained by the Mississippi Windpool. Two of the
    states receiving the largest allocation from the emergency CDBG
    appropriations were Louisiana and Mississippi, both of which opted to
    direct the vast majority of their housing allocations to homeowners.
    Both states based the amount of compensation that homeowners received
    on the value of their homes before the storms and the amount of damage
    that was not covered by insurance or other forms of
    assistance.[Footnote 57] The grants provided up to $150,000 for
    eligible homeowners.[Footnote 58] Both programs also attached various
    conditions to the acceptance of grants, such as requiring homeowners to
    rebuild their homes above the latest available FEMA advisory base flood
    elevation levels and establishing covenants to the land requiring that
    homeowners maintain hazard and flood insurance.

    It will be a challenge for federal, state, and local governments to
    sustain their current role in natural catastrophe insurance going
    forward. The Comptroller General of the Unites States has repeatedly
    warned that the current fiscal path of the federal government is
    "imprudent and unsustainable."[Footnote 59] In addition, we reported
    that, for state and local government sectors, large and growing fiscal
    challenges will begin to emerge within the next few years in the
    absence of policy changes.[Footnote 60] The fiscal challenges facing
    all levels of government are linked and should be considered in a
    strategic and integrated manner.

    Options for Changing the Federal Role in Natural Catastrophe Insurance
    Attempt to Address Market Issues but May Not Limit Federal Exposure:

    We identified seven public policy options for changing the role of the
    federal government in natural catastrophe insurance (see fig. 4). These
    policy options have many variants and are often contained in other
    proposals, including some bills that are before Congress.[Footnote 61]
    Some of these proposals are also being debated in venues such as the
    NAIC committees. We examined the advantages and disadvantages of these
    policy options and evaluated them against four broad public policy
    goals. These goals are:

    * charging premium rates that fully reflect actual risks,

    * encouraging private markets to provide natural catastrophe insurance,

    * encouraging broad participation in natural catastrophe insurance
    programs, and:

    * limiting costs to taxpayers before and after a disaster.

    Our analysis showed that each of the seven options met at least one of
    the policy goals but failed to meet others. The first option--a
    mandatory all-perils homeowners insurance policy--would help create
    broad participation and could provide a private sector solution. But
    this option could also require subsidies for low-income residents and
    thus potentially create substantial costs for the federal government
    that would have to be balanced against money saved from reduced
    disaster relief. A second option would involve providing federal
    reinsurance for state catastrophe funds--a change that could lead to
    greater private insurance market participation but that could also
    displace the private reinsurance market. A third option, establishing a
    federal lending facility for state catastrophe funds, could help such
    funds with financing needs after a catastrophe. But this option exposes
    the federal government to the risk that a state fund might not repay a
    loan and thus might not limit taxpayer exposure. The remaining four
    options include tax-based incentives to encourage greater participation
    by insurers and homeowners in managing natural catastrophe risks. These
    incentives offer some advantages, but could also represent ongoing
    costs to the federal government and taxpayers.

    Figure 4: Advantages and Disadvantages of Seven Public Policy Options
    for Changing the Federal Role in Natural Catastrophe Insurance:

    [See PDF for image]

    Option 1: All-Perils Homeowners Insurance Policy:
    This option would create a homeowner insurance policy that would
    provide coverage against all types of natural catastrophes.
    Advantages:
    * A mandatory all-perils policy would encourage broad participation in
    natural catastrophe insurance programs.
    * A mandatory all-perils policy could reduce the number of Americans
    needing postdisaster payments and possibly limit the federal
    government�s exposure.
    * A mandatory all-perils policy could eliminate the problems of
    uninsured property owners and adverse selection.
    * A mandatory all-perils policy would end homeowners� uncertainty about
    coverage for some perils.
    Disadvantages:
    * It is not clear how the private market would be encouraged to
    underwrite all risks.
    * The all-perils option could require government subsidies for low-
    income property owners.
    * Premiums for an all-perils policy could be more expensive than
    current homeowner policy premiums, and these premium increases could be
    seen as unfair.
    * Enforcement of an all-perils policy could be extremely challenging.
    * Insurers traditionally oppose the all-perils option because of
    concern about large loss liabilities.

    Option 2: Federal Reinsurance for State Catastrophe Funds:
    This option would create federally backed reinsurance policies for
    state catastrophe funds. In one version of this option, states would
    create catastrophe funds that would be reinsured by the federal
    government. In another version, the Secretary of the Treasury would
    create an auction process for the sale of reinsurance contracts to
    private and state insurers and reinsurers.
    Advantages:
    * The federal reinsurance option could lead to greater participation
    from private insurers.
    * The federal reinsurance option would eliminate timing risk for
    insurance companies.
    * Insurance companies may be less interested in canceling policies in
    coastal regions if they have a stable source of reinsurance, their
    costs are reduced, and their liability is limited.
    * This option would not use tax dollars if the premium charged was risk-
    based.
    * The federal reinsurance option is preferable to federal disaster
    assistance.
    * This option would add stability to reinsurance rates.
    Disadvantages:
    * Federal reinsurance could compete with the private reinsurance sector.
    * Rates for federal reinsurance could be subject to consumer and hence
    political pressure to keep them below the private sector rates.
    * Federal taxpayer subsidies could favor those living in catastrophe-
    prone states.
    * Federal reinsurance could create inequities among states because of
    geographical differences in natural catastrophe risk.
    * Federal reinsurance could encourage further development and
    population growth in high-risk areas.
    * Government reinsurance that does not mimic what the private sector
    does could lead to government losses.

    Option 3: Federal Lending to State Catastrophe Funds:
    This option would create a federal lending facility to provide
    temporary loans at market prices to state catastrophe funds.
    Advantages:
    * This option could help state catastrophe insurance funds with
    financing needs after a disaster.
    * The federal lending option would eliminate timing risk for insurance
    companies.
    * Supporters of this option maintain that taxpayers would bear little
    or no insurance risk.
    * The federal lending option would require states to demonstrate that
    they were doing all they could to attract private capital, and this
    could lead to regulatory reform.
    Disadvantages:
    * It is not clear how this option would encourage risk-based premiums,
    would broaden citizen participation, or would be a cost-effective
    solution from the perspective of the federal government.
    * The federal lending option imposes credit risk on taxpayers�the risk
    that the loan would not be repaid.
    * The federal lending option could require the creation of a new
    federal agency to manage the program.
    * Political pressure could be exerted to keep the terms and conditions
    of federal loans more favorable than those in the private market.
    * This option would decrease incentives for insurers and reinsurers to
    accurately assess, underwrite, and price risk.

    Option 4: Insurance Company Catastrophe Reserving:
    This option would permit private insurance companies to establish tax-
    deferred reserves for future natural catastrophes.
    Advantages:
    * Tax-deferred reserving could mean that state regulators would be more
    willing to approve risk-based rates.
    * With reserves, insurance companies could be more willing to
    underwrite policies, thus encouraging a private sector solution.
    * This option would encourage broader-based citizen participation in
    catastrophe insurance programs.
    * Insurance regulators could be more willing to approve risk-based
    rates for consumers, because premium income could be set aside in a
    reserve fund.
    * Allowing insurance companies to build reserves could reduce pressure
    to create state catastrophe insurance programs.
    Disadvantages:
    * Allowing insurance companies to build reserves could involve tax
    benefits that favored one type of activity over another and could
    hamper economic efficiency.
    * Reserves could be costly for the federal government, because they
    would reduce federal tax revenue.
    * Tax-deferred reserves could be subject to manipulation, if they were
    used to smooth income flows across years and obscure current income.

    Option 5: Homeowner Catastrophe Savings Accounts:
    This option would permit individuals to establish tax-deferred reserves
    to pay expenses related to disasters.
    Advantages:
    * Allowing homeowners to use tax-deferred dollars to pay for
    catastrophe insurance could induce more people to buy it.
    * This option might encourage more homeowner mitigation activities.
    Disadvantages:
    * Such accounts may not be enough to induce people to buy costly
    catastrophe insurance and, thus, may not broaden citizen participation
    in natural catastrophe insurance programs.
    * These accounts would reduce federal tax revenues but must be weighed
    against any reduction of postdisaster spending by the federal
    government.

    Option 6: Favorable Tax Treatment for Catastrophe Bonds:
    This option would facilitate the onshore creation of catastrophe bonds
    through tax exemptions for income from the underlying assets.
    Advantages:
    * Favorable tax treatment of catastrophe bonds would increase the
    ability of insurance markets to access capital markets.
    * Insurance companies could be more willing to underwrite catastrophe
    risk because the risk could be passed on to investors.
    Disadvantages:
    * This option creates a new class of reinsurer that would operate under
    regulatory and tax advantages not afforded U.S. reinsurance companies.
    * It is not clear how this option is the most cost-effective for the
    federal government.
    * It is not clear how this option would encourage risk-based premiums
    or lead to more citizen participation in catastrophe insurance programs.
    * This option would only benefit larger insurers.
    * Given that catastrophe bonds were just issued by the two largest U.S.
    insurance companies, it is not clear why this tax treatment is needed.

    Option 7: Property Tax Assessment for Private Insurance with Federal
    Deductible Payment;
    This option has property tax assessments paying a premium for an all-
    perils catastrophe insurance policy that would be provided by private
    insurance companies, with the federal government responsible for the
    deductible.
    Advantages:
    * This option is market-based and designed to involve the private
    sector.
    � If risk-based premiums are required, the option is not a �government
    relief program.�
    * This option would protect the tax base of a state�s economy.
    * The property tax assessment option would increase homeowner
    participation in catastrophe insurance programs.
    * With this option, the high deductible could result in a lower
    insurance premium.
    Disadvantages:
    * The property tax assessment option would reduce federal tax revenue.
    * This option could be expensive for taxpayers because the federal
    government would pay some portion of the homeowner deductible.
    * It is not clear whether or not this option is a cost-effective
    solution for the federal government.
    * Premiums paid by homeowners might not be an effective signal of the
    risk of living in a particular location.
    * Homeowners could resist high property taxes implied by this option.

    Source: GAO.

    [End of figure]

    An All-Perils Policy Would Broaden Participation but Could Require
    Government Subsidies:

    A mandatory all-perils policy would require private insurers to provide
    coverage against all perils in a single standard homeowners policy that
    would be priced according to the risk of natural hazards each homeowner
    faced.[Footnote 62] For example, the policy would cover not only theft
    and fire but also wind, floods, and earthquakes. It would also be
    mandatory for all homeowners.[Footnote 63]

    This type of option offers several potential advantages. First, a
    mandatory all-perils policy, by definition, would encourage broad
    participation in natural catastrophe insurance programs. Moreover,
    including all American homeowners in natural catastrophe coverage could
    help reduce the number of Americans needing postdisaster payments and
    possibly limit the federal government's exposure. An all-perils policy
    would also eliminate existing gaps in coverage and remove the
    uncertainty many homeowners face in determining whether certain perils
    are covered and by whom--an issue that was spotlighted after Hurricane
    Katrina, when disputes emerged between private insurers and homeowners
    over the extent of the insurers' obligations to cover certain damages.
    Finally, because it would be mandatory and broad-based, an all-perils
    policy could lessen the problem of adverse selection that is often
    identified as the reason that some types of catastrophes, such as
    flooding, are considered to be uninsurable. This type of policy would
    spread risks geographically and potentially would make the policy more
    affordable than other options.

    However, this option is not without its disadvantages. First, it is
    unclear how private markets would be encouraged to underwrite all
    risks. Second, a mandatory all-perils policy might not be a cost-
    effective solution for the federal government, because it could create
    affordability concerns for low-income residents in certain areas and
    might require targeted government subsidies.[Footnote 64] If they did
    not sufficiently reduce postevent disaster relief, these subsidies
    could increase costs to taxpayers. Third, an all-perils policy would
    undoubtedly be more expensive than current homeowner policy premiums in
    some regions of the country. As a result, at least during the
    transition, it could lead to complaints about higher premium costs from
    residents of catastrophe-prone areas. Moreover, homeowners in
    relatively low-risk areas could wind up subsidizing the costs of
    insurance for those living in high-risk areas. Fourth, enforcement
    would be extremely challenging, as we have seen with mandatory flood
    insurance in communities in designated floodplains. Finally, this
    policy option faces opposition from the private insurance industry, in
    part because of concerns about state insurance regulators impeding
    private insurers' ability to charge premiums that reflect the actual
    risk of loss in catastrophe-prone areas. Private insurers have also
    traditionally opposed all-perils policies because of the difficulty of
    pricing flood and earthquake coverage. One insurance company has said
    that an all-perils policy would cause rates to skyrocket and could
    cause many insurers to abandon the homeowners insurance market. NAIC
    officials told us that the homeowners market was a $55 billion market-
    -not counting flood and earthquake exposure--and that most insurers
    were unlikely to walk away from a market this large.

    Federal Reinsurance Could Eliminate Timing Risk for Insurance Companies
    but Could Displace the Private Market:

    A federal reinsurance mechanism would provide an additional layer of
    insurance coverage for very large catastrophes, or megacatastrophes,
    and could be implemented in two ways.[Footnote 65] The first version of
    this option would create a federal mechanism that would serve as a
    backstop for state catastrophe funds to increase the amount of
    insurance and reinsurance available to states, expand the availability
    of catastrophe coverage, and possibly improve its affordability.
    [Footnote 66] States would create catastrophe funds and enter into
    agreements with the federal government--possibly, but not necessarily,
    the U.S. Treasury--and pay premiums for the reinsurance that would be
    used to support the reinsurance fund. Each state's payments would be
    based on risk and determined using actuarial and catastrophe modeling,
    and the states would be responsible for collecting premiums from
    insured commercial and residential property owners. The federal fund
    would provide payments to state funds for storms of a certain magnitude
    up to some predetermined level of payments. If the federal reinsurance
    fund was not adequately financed at the time of a catastrophe, it would
    issue government-backed bonds.

    A related but different version of this federal reinsurance option
    would authorize the Secretary of the Treasury to create an auction
    process for the sale of reinsurance contracts to private and state
    insurers and reinsurers.[Footnote 67] The secretary would make
    available reinsurance contracts covering both earthquakes and wind
    events. The auction process would be open to state and private insurers
    and reinsurers and would take place in at least six separate geographic
    regions, so that risks would be based on local factors and insurers in
    less risk-prone areas would not be subsidizing those in riskier areas.
    State programs would have to reach a minimum loss level before they
    would be eligible for federal funds. This version also establishes a
    disaster reinsurance fund within the U.S. Treasury to be credited with,
    among other sources of funds, amounts received from the sale of
    reinsurance contracts. The Treasury would be authorized to issue debt
    if the fund's resources were insufficient to pay claims--and
    reinsurance premiums paid to Treasury would be used to make interest
    payments to debt holders--but the fund would not receive federal
    appropriations. A national commission on catastrophe risks and
    insurance loss costs would advise the secretary.

    Both versions of this option offer advantages and disadvantages. First,
    federal reinsurance is advantageous because it has the potential to
    help insurance companies by limiting timing risk--the possibility that
    events will occur before insurers have collected enough premiums to
    cover them--potentially making insurers more willing to underwrite
    natural catastrophe insurance policies.[Footnote 68] Second, primary
    insurance companies may be less interested in canceling catastrophe
    insurance policies in coastal regions after a disaster if stable
    sources of reinsurance are available from state catastrophe funds. This
    option could also encourage the provision of catastrophe insurance via
    private insurance markets by limiting private insurers' liability for
    very large events and thus increasing their willingness to offer
    insurance for less catastrophic events. And a greater supply of natural
    catastrophe insurance could reduce the cost of insurance as competition
    for business intensified. Third, this option may also be advantageous
    because, if it were appropriately structured--that is, if program
    losses were funded by upfront premium payments--federal reinsurance
    should not require the use of taxpayer dollars. Finally, to the extent
    that this option increased the availability and affordability of
    catastrophe insurance, it would be preferable to postdisaster
    assistance and could limit the need for some types of postevent
    government payouts.

    While federal reinsurance has some appealing options, it is not without
    disadvantages. For example, neither version of the reinsurance option
    is intended to displace or compete with the private reinsurance market,
    because reinsurance contracts would not be sponsored in markets where
    private reinsurance markets offered coverage. However, federal
    reinsurance could compete with and possibly displace private
    reinsurance if the government offered coverage at levels that were well
    within private market capacity or set premium rates below what the
    private sector would charge for comparable risk. While the stated
    intent of this option is to charge a premium that fully reflects the
    risk assumed by the federal reinsurance fund, political and consumer
    pressures could be put on the federal fund to underprice premiums in
    terms of risk to keep premiums low for policyholders in high-risk
    areas. Charging a reinsurance premium that was not fully risk-based
    would expose the federal fund and the government to potentially
    significant unfunded contingent insurance risk. As a result, federal
    reinsurance could disproportionately benefit those living in high-risk
    areas. Should the fund experience losses that exceeded the premiums
    collected, the difference would have to be paid by the taxpayers,
    creating a cross-subsidy that favored those in catastrophe-prone areas.
    Also, the existence of federal reinsurance might affect market
    discipline, leading private insurers and state catastrophe insurance
    funds to loosen underwriting guidelines--that is, to insure properties
    that would not have been insurable without the availability of (low-
    cost) federal reinsurance. Such a change could be costly for the
    reinsuring federal facility. As a result, a federal reinsurance role
    could inadvertently encourage further development and population growth
    in areas with high natural catastrophe risk. Finally, government
    natural catastrophe insurance programs are not purely insurance
    programs and may have social goals. But if the government plans to
    intervene in the catastrophe insurance market, it may want to use
    mechanisms that mimic as closely as possible what operating private
    markets could have been expected to do. When federal insurance programs
    mimic private insurance, and base decisions on risk (as consistent with
    social goals), then government losses are more likely to be contained.

    A Federal Lending Facility Would Eliminate Timing Risk for State
    Catastrophe Insurance Programs but Would Face the Risk That the Loan
    Might Not Be Repaid:

    A federal lending facility would allow the federal government to use
    its borrowing power to extend temporary loans to state catastrophe
    funds. State catastrophe funds may not have the creditworthiness to
    borrow at acceptable interest rates. One proponent of this plan has
    suggested that the private insurance market could handle all or nearly
    all catastrophe exposure, but possibly not at the moment the
    catastrophe happened. Creating a lending facility in the federal
    government would allow the government to provide the capital to meet
    the temporary shortage and spread the repayment over time without
    assuming the underwriting risk held by the insurers. Under this option,
    state catastrophe funds would be required to secure private reinsurance
    and would have the ability to sell catastrophe bonds to repay the money
    loaned to them by the federal government. The loans would be made at
    market prices to guarantee that capital was efficiently allocated and-
    -given that an insurance company that has just paid out a large claim
    does not have the same quantity or quality of assets as a solvent
    insurer or bank--would be secured both by the future income stream of
    premium payments from state residents through insurance companies to
    the state catastrophe funds and by bond proceeds. The loans would be of
    short duration, perhaps 2 to 3 years at maximum, and would provide
    state catastrophe funds with encouragement and time to access the
    private capital market. State catastrophe funds would be expected to
    demonstrate to the federal lending facility that the states were doing
    all that they could to attract private capital. A proposed trigger for
    the federal lending facility would be a megacatastrophe.

    The creation of a federal lending facility would have several
    advantages. First, a federal lending facility would shift timing risk,
    which is significant in the catastrophe insurance business, from the
    insurance industry to the federal government. The federal government,
    because of its borrowing power, is uniquely able to deal with timing
    risk. Second, a federal lending facility could mean that taxpayers
    would assume little or possibly no insurance risk, because the insurers
    would be responsible for paying all of the losses from catastrophic
    events, although not necessarily in the year of the catastrophe.
    Finally, through the requirement that the states do all that they can
    to attract private capital, the option may lead to insurance regulatory
    reforms in areas such as rate regulation that have inhibited the influx
    of private capital.

    A federal lending facility would also have a number of disadvantages.
    First, it is not clear how this federal lending facility would
    encourage premiums that reflected risks, would foster broad citizen
    participation, or would be a cost-effective solution. Second, it would
    expose the facility and ultimately taxpayers to credit risk if a state
    did not repay its debt. Third, a federal lending facility could also
    require the creation of a new federal entity or structure to administer
    the system. Fourth, like the federal reinsurance option, such a lending
    facility could have a competitive advantage over the private
    reinsurance sector, particularly if the terms were too easy or if
    borrowed funds did not have to be repaid. States in high-risk regions
    would have a financial incentive to seek nonmarket terms and conditions
    in loans. Finally, this option would decrease the incentives for
    insurers and reinsurers to accurately assess, underwrite, and price
    risk.

    Tax-Deferred Reserves for Insurance Companies Could Encourage Greater
    Private Sector Coverage but Could Be Costly for the Federal Government
    and Have Other Disadvantages:

    A fourth policy option would be to permit private insurers to establish
    tax-deferred reserves for future catastrophes.[Footnote 69] This option
    could encourage some insurers to maintain or expand their catastrophe
    insurance coverage in regions with significant or projected catastrophe
    exposures. This option is also intended to provide insurers with an
    incentive to write catastrophe coverage in hazard-prone areas while
    improving their own financial strength. It would require amending the
    U.S. Tax Code, because current tax laws and accounting principles
    discourage U.S. property and casualty insurers from accumulating long-
    term assets specifically for payment of future losses by taxing these
    assets.[Footnote 70] Because the size and timing of disasters that have
    not taken place is uncertain, assets set aside for catastrophe losses,
    together with any interest accrued, are taxed as corporate income in
    the year in which they are set aside. Although there is a federal
    income tax deduction for losses that have already occurred, reserves
    for uncertain future losses are not tax deductible.

    Tax-deferred reserving has its advantages. Tax-deferred reserving could
    mean that state regulators would be more willing to approve risk-based
    rates, because premiums could now be set aside rather than flow into
    profits. Consistent with the intended purpose of this option, tax-
    deferred reserving could increase the willingness of insurance
    companies to increase capacity without risking insolvency, because the
    companies would be less dependent on the uncertain prices available in
    reinsurance markets. In this case, the option would encourage a
    solution by private insurance markets and more broad-based
    participation in catastrophe insurance programs. Finally, this approach
    could reduce the need for state catastrophe insurance mechanisms by
    increasing the willingness of private insurers to remain or enter
    certain catastrophe-prone markets, such as Florida and other Gulf Coast
    states.

    However, tax-deferred reserving also raises a number of broader issues
    that must be considered. Tax-deferred reserving would reduce current
    federal tax revenue. However, as with other options, the net cost would
    have to be determined by weighing the tax cost against potential
    savings from federal postdisaster assistance programs. Deferring taxes
    on reserves for insurance companies could also be disadvantageous if
    this system created tax benefits that favored one type of activity over
    another. For example, to the extent that tax-deferred reserving became
    prevalent, it could displace the reinsurance market or other forms of
    hedging. Finally, such reserves could also be subject to manipulation
    or abuse if insurers used them to obscure current income by smoothing
    income flows across years.

    Homeowner Catastrophe Savings Accounts Could Broaden Participation in
    Catastrophe Insurance Programs but Could Reduce Federal Tax Revenue:

    Like tax-deferred reserves, the fifth policy option would also require
    amending the U.S. Tax Code to provide a tax incentive, but this one
    would be aimed at homeowners, who would be allowed to accumulate before-
    tax funds to pay expenses related to disasters. The accounts would
    operate much like those currently in use for health care expenses,
    allowing homeowners to withdraw both savings and interest for qualified
    disaster expenses such as deductibles, uninsured losses, flood damage,
    and structural upgrades to mitigate damage from future storms. A bank
    or another designated organization would be the custodian for these
    accounts. Under one current option, homeowner contributions would be
    limited to (1) $2,000 for individuals with homeowners insurance and
    deductibles of not more than $1,000, and (2) the lesser of $15,000 or
    twice the insurance deductible for homeowner insurance deductibles of
    more than $1,000. In June 2007, the South Carolina Legislature passed
    legislation authorizing the creation of catastrophe savings accounts
    for use by state residents in paying natural catastrophe insurance
    deductibles.[Footnote 71]

    This option could induce more homeowners to participate in natural
    catastrophe insurance programs. Moreover, allowing homeowners to use
    tax-deferred savings to cover mitigation expenses might encourage more
    mitigation activities to reduce natural catastrophe risk. However,
    implementation challenges pose disadvantages that would have to be
    addressed. For example, it is unclear to what extent such a mechanism
    would encourage those who are not insured to purchase insurance. Rather
    than increasing participation, it could result in a tax benefit for
    those who are already insured. Like the tax-free reserves option, these
    savings accounts would also cost the federal government in reduced tax
    revenues. But once again, the actual net cost to the government would
    depend on the potential offsetting savings from postcatastrophe funding
    mechanisms.

    Favorable Tax Treatment for Catastrophe Bonds Could Increase Insurers'
    Access to Capital Markets, but Some Question the Need for Such Tax
    Treatment:

    The sixth policy option would create certain tax advantages for
    catastrophe bonds.[Footnote 72] Historically, catastrophe bonds have
    been created in offshore jurisdictions where they are not subject to
    any income or any other tax (i.e., in tax havens). This option would
    facilitate the creation of onshore transactions, potentially reducing
    transactions costs and allowing for increased regulatory oversight. Tax
    treatment of catastrophe bonds would be similar to the treatment
    received by issuers of asset-backed or mortgage-backed securities that,
    for example, are generally not subject to tax on the income from
    underlying assets, which is passed on to investors.[Footnote 73] More
    favorable tax treatment of catastrophe bonds would increase the ability
    of insurance markets to access capital markets by making these products
    more attractive to investors. Making catastrophe bonds more attractive
    to issuers and investors could, in turn, make insurance and reinsurance
    companies more willing to underwrite catastrophe risk and increase the
    availability of coverage, because these companies could pass on more
    catastrophe risk to investors.

    One disadvantage of this option is that it is not clear how its
    implementation would encourage premiums that fully reflect risk or how
    it would encourage broad-based participation in catastrophe insurance
    markets. It is also not clear how this option would be a cost-effective
    solution for the federal government when both predisaster and
    postdisaster costs are counted. Some reinsurers have pointed out that
    favorable tax treatment of catastrophe bonds could be disadvantageous
    because it could create a new class of reinsurer that would operate
    under regulatory and tax advantages not afforded U.S. reinsurance
    companies. Finally, recent catastrophe bond issuances by the two
    largest U.S. primary insurance companies may indicate that catastrophe
    bonds do not need a different tax treatment to make them economically
    viable.[Footnote 74] However, if market transparency and the
    development of uniform terms and conditions do not take place, only the
    largest insurers may be able to take advantage of catastrophe bonds.

    Property-Tax Assessment for Federal Reinsurance May Broaden
    Participation but May Be Costly for the Federal Government:

    The final policy option we examined was a state plan, funded by state
    property taxes, that would require mandatory all-perils natural
    catastrophe insurance coverage on residential property. All primary
    residential properties in a state would be required to have catastrophe
    insurance coverage. Participating insurers would assume the primary
    risk on the property and would have reinsurance from a qualifying
    reinsurance company. The state would pay an annual natural catastrophe
    insurance premium financed by an annual property tax assessment on all
    residential and commercial properties in the state, and homeowners
    could deduct the cost from their federal taxes.[Footnote 75] The
    insurance coverage would be provided by private insurance companies
    selected by a government administrator who would qualify them as
    providers of catastrophe insurance. To ensure that premiums were
    reasonable, the primary and reinsurance coverage would require large
    deductibles that would be paid in layers by the homeowner, the state,
    and the federal government. Homeowners would be responsible for the
    first 10 percent of the value of the home, with a state catastrophe
    fund paying the next layer of the deductible. The state would provide a
    fixed-dollar deductible--for example, $100 million--for all homeowners,
    with the federal government as the backstop provider, paying a
    deductible that was a multiple of the amount that the state put up.

    Proponents of this plan point out that it is market-based, designed to
    involve the private sector, and if risk-based premiums are required is
    not a "government relief program." Plan supporters also point out that
    the option protects the tax base of a state's economy as well as the
    creditworthiness of a state's bond rating. One possible advantage of
    this policy option for the consumer is that the premiums paid from
    property taxes are intended to be tax deductible.[Footnote 76]
    Moreover, paying the premium from property taxes could increase
    participation at the state level and create a broad-based program that
    would limit adverse selection and moral hazard. Finally, maintaining
    higher deductibles could result in lower insurance premiums.

    However, this plan also has its disadvantages. Paying the premium from
    homeowner property taxes collected by the state would reduce federal
    tax revenues, and, if a disaster occurred, the federal government would
    have to pay some portion of the deductible. Like the other tax-related
    options, this option could reduce federal tax revenue if the new
    deduction were not offset by savings from the elimination of preevent
    premium subsidies or postevent disaster relief. As a result, it is not
    clear whether this option may or may not be the most cost-effective for
    the federal government. Also, using property taxes to pay insurance
    premiums might diminish the effectiveness of using the price of
    insurance as a signal of the risk of living in a particular location.
    One critic has argued that allowing homeowners to deduct the premium
    portion of the property taxes combined with the federal deductible
    could result in a double federal subsidy. Finally, this policy option
    would raise homeowners property taxes, potentially creating homeowner
    resistance to the assessment.

    Agency Comments and Our Evaluation:

    We provided a draft of this report to NAIC for comment and provided
    excerpts from the draft to Alabama Beach Pool, the CEA, FCIC, FHCF,
    Florida Citizens, FHCF, the GUA, HUD, Louisiana Citizens, Mississippi
    Windpool, the North Carolina Beach Plan, SBA, the South Carolina
    Windpool, and the Texas Windpool. NAIC provided written comments that
    are reprinted in appendix III. In these comments, NAIC officials said
    that our draft report was thorough, and that they were pleased that we
    outlined the advantages and disadvantages of several proposals rather
    than favoring a single outcome. NAIC officials suggested that we also
    include in this report two recently proposed options, including one
    that includes an allocation system for determining what portion of
    hurricane damages should be attributed to wind and what portion to
    flooding and the creation of a federal entity to oversee property
    insurance rates in the coastal zone. While there are interesting
    features to both options, they were too recent to be included in our
    review and analysis. However, we will explore both options during the
    course of our ongoing work involving NFIP.

    NAIC officials also commented on the language in the draft report
    discussing allegations made by some critics of state rate regulation
    who suggest that state regulators may be suppressing rates for some
    catastrophe insurers. As these officials pointed out, the allegations
    in this report are attributed to others and are not presented as our
    position. We recognize the challenges involved in ensuring that
    consumers are charged appropriate premiums that reflect their risk of
    exposure to natural catastrophes. Given that premium rates requested
    are based on a variety of factors that involve a certain amount of
    judgment--including anticipated losses on claims and related expenses;
    the need to build a surplus; and other factors, including profit--the
    rate-setting process is open to interpretation and some amount of
    negotiation. That is, reasonable but different assumptions about the
    probability of future losses can result in substantial disagreements
    about rates. However, if state regulators and the insurance markets
    consistently have divergent opinions about the cost of the risk
    exposures, the implications can be far-reaching. As we discuss in this
    report, for state natural catastrophe insurance programs, if premium
    rates determined by state insurance regulators consistently result in
    financial resources that are inadequate to pay policyholder claims
    after a disaster, postfunding mechanisms must be used to pay
    shortfalls. Postfunding can result in costs to the private insurance
    market and may mean that taxpayers in low-risk areas are subsidizing
    the costs of those living in high-risk areas. Similarly, a pattern of
    regulator-approved rates for private insurance companies that are
    consistently below what the market believes to be the true risk rate
    may result in the withdrawal of healthy, diversified insurance
    companies from the market. However, if premium rates are set at a level
    reflecting the market's perception of the true risk rate, more
    competitors are likely to enter.

    Alabama Beach Pool, the CEA, FCIC, FEMA, Florida Citizens, FHCF, the
    GUA, Louisiana Citizens, Mississippi Windpool, the North Carolina Beach
    Plan, SBA, the South Carolina Windpool, and the Texas Windpool provided
    technical comments that we incorporated in this report as appropriate.

    As agreed with your office, unless you publicly announce its contents
    earlier, we plan no further distribution of the report until 30 days
    from the date of this letter. At that time, we will provide copies to
    interested congressional committees; the Chairman and Ranking Member of
    the Senate Committee on Banking, Housing, and Urban Affairs; and the
    Chairman of the House Committee on Financial Services. We will also
    make copies available to others upon request. In addition, this report
    will be available at no charge on the GAO Web site at [hyperlink,
    http://www.gao.gov].

    Please contact me at (202) 512-8678 or williamso@gao.gov if you or your
    staff have any questions concerning this report. Contact points for our
    Offices of Congressional Relations and Public Affairs may be found on
    the last page of this report. Key contributors to this report are
    listed in appendix IV.

    Sincerely yours,

    Signed by:

    Orice M. Williams:
    Director, Financial Markets and Community Investment:

    [End of section]

    Appendix I: Objectives, Scope, and Methodology:

    Our objectives in this report were to examine (1) the rationale and
    funding of the federal and state programs that have supplemented, or
    substituted for, private natural catastrophe insurance; (2) the extent
    to which Americans living in areas of the United States that are at
    high risk for natural catastrophes are uninsured and underinsured, and
    the types and amounts of federal payments to such individuals since
    Hurricanes Katrina, Rita, and Wilma; and (3) public policy options for
    revising the federal role in natural catastrophe insurance markets.

    We reviewed or analyzed documents on federal and state natural
    catastrophe insurance programs, the numbers of uninsured and
    underinsured and federal payments to them, options to redefine the
    federal role in natural catastrophe insurance, and principles on which
    change options can be based and evaluated. We interviewed officials
    from public interest groups, insurance companies, reinsurance
    companies, insurance brokers, insurance and reinsurance associations,
    insurance agents and their associations, state catastrophe insurance
    plans, state insurance departments, federal catastrophe insurance
    agencies, the Department of Housing and Urban Development (HUD), the
    Small Business Administration (SBA), Fannie Mae, Freddie Mac, rating
    agencies, a risk modeling organization, academia, law firms, a hedge
    fund, a private research organization, consumer groups, and others. To
    determine the mechanisms governments use to supplement or substitute
    for private catastrophe insurance markets, we collected oral and
    documentary information from public and private officials in various
    states with high and low catastrophe risk and in Washington, D.C. We
    sourced financial data for government natural catastrophe insurance
    programs from financial statements, bond offering documents, and other
    similar financial documents.

    To determine the number of uninsured and underinsured Americans and
    payments made to such individuals after the 2005 hurricanes, we
    collected information from states, examined federal agency data,
    interviewed federal officials who prepared these data, sought
    information from the private sector, and interviewed state officials
    responsible for disbursing federal disaster funds. We focused our
    analysis on the federal disaster assistance to homeowners and renters
    who lacked adequate insurance in the five Gulf Coast states directly
    impacted by Hurricanes Katrina, Rita, and Wilma. These five states are
    Alabama, Florida, Louisiana, Mississippi, and Texas. Data on the
    numbers and amounts of money disbursed to the uninsured and
    underinsured were incomplete and had a number of limitations. For
    instance, because we often could not separate payments to homeowners
    versus payments to renters, we generally included the entire amount in
    our analysis. Also, we generally excluded administrative and other
    expenses that federal disaster assistance programs incur in
    distributing assistance. Our analysis was limited to the major federal
    disaster assistance programs that we identified as providing relief to
    homeowners and renters. These programs are the Federal Emergency
    Management Agency's (FEMA) Individuals and Households Program (IHP),
    SBA's Disaster Loan Program (DLP), and HUD's Community Development
    Block Grant (CDBG) program. Our identification of relevant federal
    disaster assistance programs may be incomplete. Other federal agencies
    are involved in federal disaster assistance according to the mission
    assignment issued and approved by FEMA, as we reported separately in
    Disaster Relief: Governmentwide Framework Needed to Collect and
    Consolidate Information to Report on Billions in Federal Funding for
    the 2005 Gulf Coast Hurricanes, GAO-06-834 (Washington, D.C.: Sept. 6,
    2006).

    To determine the amount of federal disaster assistance appropriated by
    Congress to FEMA and the amount paid to homeowners and renters who
    lacked adequate insurance through FEMA IHP, we obtained and analyzed
    data provided by FEMA officials describing the funds obligated for the
    subcategories of Housing Assistance, Other Needs Assistance, and
    Manufactured Housing in Alabama, Florida, Louisiana, Mississippi, and
    Texas following Hurricanes Katrina, Rita, and Wilma. In analyzing these
    data, we had to make certain judgments in deciding which specific
    subcategories of funds to include in our analysis. In particular, FEMA
    noted that the Other Needs Assistance data contained funds for services
    that would not be provided by personal property coverage in standard
    private homeowners insurance, such as medical and funeral expenses.
    However, we included Other Needs Assistance data in our analysis
    because these are expenses that may have been covered by other types of
    insurance, such as health and life, and, therefore, still provide a
    reasonable approximation of insurance coverage. Also, FEMA officials
    noted that the Manufactured Housing data included expenses that would
    not be included in additional living expenses coverage provided by
    standard private homeowners insurance. For example, other expenses
    included unit purchase, haul/install, utilities, site lease,
    maintenance, deactivation, and the transition out of service. We
    included these data in our analysis because they are designed to serve
    a similar purpose as the additional living expenses coverage provided
    by insurance companies. We assessed the reliability of the data
    provided by agency officials by interviewing agency officials
    knowledgeable about the data systems; obtaining oral responses from the
    agency; and reviewing agency reports regarding (1) the agency's methods
    of data collection and quality control reviews, (2) practices and
    controls over data entry accuracy, and (3) any limitations of the data.
    It is possible that FEMA's data analysis methodology is different from
    that employed by the other agencies we reviewed. Nevertheless, we
    determined that these data were sufficiently reliable for the purposes
    of our engagement. Finally, we interviewed officials from FEMA Disaster
    Assistance Directorate, which administers IHP, and reviewed the
    document entitled Oversight of Gulf Coast Hurricane Recovery, A
    Semiannual Report to Congress, October 1, 2006-March 31, 2007, by the
    President's Council on Integrity and Efficiency and the Executive
    Council on Integrity and Efficiency.

    To determine the amount of federal disaster assistance appropriated by
    Congress to SBA and the amount paid to homeowners and renters who
    lacked adequate insurance through SBA DLP, we reviewed the previously
    mentioned document entitled Oversight of Gulf Coast Hurricane Recovery,
    and interviewed agency officials. We obtained and analyzed data
    provided by SBA that included, among other things, the amount of loan
    funds approved net of other federal disaster assistance and insurance
    proceeds to loan recipients. We multiplied this total by the subsidy
    rate of the loans--14.64 percent in 2006. That is, for every $100 that
    SBA lends, the cost to the federal government is $14.64. The subsidy
    rate is roughly the percentage of loan principal that is not repaid as
    well as the difference between the market interest rate and the rate
    charged by SBA. We believe that subsidy cost is the most accurate
    representation of the amounts made available and paid to homeowners and
    renters because the loans under DLP must be repaid by recipients at a
    subsidized interest rate. We assessed the reliability of the data
    provided by agency officials by interviewing agency officials
    knowledgeable about the data systems and obtaining from the agency
    written responses regarding (1) the agency's methods of data collection
    and quality control reviews, (2) practices and controls over data entry
    accuracy, and (3) any limitations of the data. It is possible that
    SBA's data analysis methodology is inconsistent with that employed by
    the other agencies we reviewed. Nevertheless, we determined that these
    data were sufficiently reliable for the purposes of our engagement.

    To determine the amount of federal disaster assistance appropriated and
    paid to homeowners and renters who lacked adequate insurance through
    the HUD CDBG program, we interviewed agency officials and reviewed the
    previously mentioned document entitled Oversight of Gulf Coast
    Hurricane Recovery. We obtained publicly available data from HUD and
    each of the five Gulf Coast states that received emergency CDBG
    appropriations. We reviewed GAO testimony on Gulf Coast rebuilding that
    described the CDBG programs established in the Gulf Coast
    states.[Footnote 77] Congress approved emergency appropriations for HUD
    CDBG in two installments: $11.5 billion in December 2005 and $5.2
    billion in June 2006, for a total appropriation of $16.7 billion. Our
    goal was to determine what portion of the total appropriation was
    intended for homeowners in the five Gulf States. We made certain
    judgments in deciding whether particular subcategories of funds applied
    to our calculations for each state. It is possible that we did not
    identify all of the relevant funds.

    For Florida, we used the Florida Department of Community Affairs, 2005
    Disaster Recovery Initiative Action Plan (Apr. 14, 2006) and 2006
    Disaster Program Action Plan (Dec. 19, 2006). HUD designated for
    Florida $82.9 million of the original $11.5 billion included in the
    December 2005 emergency appropriation. Florida's action plan calls for
    the funds to be distributed through entitlement communities,
    nonentitlement communities, and federally recognized Indian tribes.
    Grant recipients are required to use at least 70 percent of the funds
    for the provision of affordable housing. Therefore, approximately $58
    million of the Florida CDBG grants will be allocated to the provision
    of affordable housing. In addition, the June 2006 emergency
    appropriation included $5.2 billion to the CDBG program, and, on August
    18, 2006, HUD made $100,066,518 available to Florida for repair,
    rehabilitation, and reconstruction of affordable rental housing, and
    for the unmet needs of evacuees who were forced from their homes and
    are now living in other states. The entire amount has been made
    available for mitigation programs through the My Safe Florida Home
    Program and other programs.

    For Alabama, we interviewed officials from the Alabama Department of
    Economic and Community Affairs (DECA). We obtained and analyzed
    information from DECA officials regarding the plan for distribution of
    HUD CDBG disaster recovery funds. We learned that DECA determined to
    make $14,460,588 available for unmet housing needs. In addition, on
    August 18, 2006, HUD made $21,225,574 available to Alabama for repair,
    rehabilitation, and reconstruction of affordable rental housing, and
    for the unmet needs of evacuees who were forced from their homes and
    are now living in other states. Of this amount, $16,964,296 has been
    made available for Disaster Relief, Recovery and Restoration of Housing
    and Infrastructure, and Affordable Rental Housing.

    For Mississippi, we used the Mississippi Development Authority,
    Homeowner Assistance Program Partial Action Plan (Mar. 31, 2006).
    Mississippi's partial action plan made $3 billion available for the
    Homeowner Grant Assistance Program, which is for people who owned homes
    located outside of the federally designated flood zone, yet still
    suffered structural flood damage caused by Hurricane Katrina. In
    addition, on August 18, 2006, HUD made $423,036,059 available to
    Mississippi for repair, rehabilitation, and reconstruction of
    affordable rental housing, and for the unmet needs of evacuees who were
    forced from their homes and are now living in other states.

    For Louisiana, we obtained the Louisiana Recovery Authority, The Road
    Home Housing Programs, Action Plan for the Use of Disaster Recovery
    Funds (May 11, 2006) and the Louisiana Recovery Authority, Proposed
    Action Plan for the Use of Disaster Recovery Funds Allocated by P.L.
    109-234 (May 16, 2007). Louisiana made $3,551,600,000 available to the
    Road Home Program, which is intended to help owner-occupants repair or
    rebuild their homes, buy or build replacement homes, or sell unwanted
    properties so that they can be redeveloped or converted to open space.
    In addition, on July 11, 2006, HUD allocated $4.2 billion to Louisiana
    for the Road Home Program. Louisiana designated $2,496,150,000 of this
    funding as assistance to owner-occupants to compensate them for their
    hurricane loss.

    For Texas, we used the State of Texas Action Plan for CDBG Disaster
    Recovery Grantees under the Department of Defense Appropriations Act,
    2006 (Apr. 13, 2006, and May 9, 2006) and the Proposed Partial Texas
    Action Plan for Disaster Recovery to Use Community Development Block
    Grant (CDBG) Funding to Assist with the Recovery of Distressed Areas
    Related to the Consequences of Hurricanes Katrina, Rita, and Wilma in
    the Gulf of Mexico in 2005 (Dec. 15, 2006). Texas' action plan made
    $38,938,268 available for its "Minimum Housing Need Allocation." In
    addition, on August 18, 2006, HUD made $428,671,849 available to Texas
    for repair, rehabilitation, and reconstruction of affordable rental
    housing, and for the unmet needs of evacuees who were forced from their
    homes and are now living in other states. Of this amount, $305,238,257
    has been made available for a Homeowner Assistance Program, Sabine Pass
    Restoration Program, and Rental Housing Stock Restoration Program.

    We identified various options for altering the role of the federal
    government in catastrophe insurance by looking at bills before the
    current and previous Congresses as well as other change options that
    were not in current legislative proposals--for example, a proposal
    before a committee of the National Association of Insurance
    Commissioners (NAIC). We sought out advantages of these options from
    their supporters and disadvantages from critics. We also developed a
    four-goal framework, on the basis of challenges faced by current
    government natural catastrophe insurance programs, to analyze current
    options for an increased federal role in natural catastrophe insurance.
    We developed these goals by drawing insights from the following: past
    GAO work, legislative histories of laws that changed the roles of state
    governments and the federal government after disasters, bills before
    the current and previous Congresses, interviews with public and private
    sector officials, and articles written by experts in insurance
    economics. Although we identified numerous possible goals that could
    assist our analysis, we believe the four goals we chose accurately
    capture the essential concerns of the federal government. The scope of
    our work covered hurricane and earthquake perils--we did not
    investigate tornado, hail, or other perils. Also, we focused on the
    property and casualty insurance line--especially homeowners insurance.

    We did fieldwork in Alabama; California; Connecticut; Florida;
    Illinois; Indiana; Louisiana; Massachusetts; Mississippi; Missouri; New
    Jersey; New York; Ohio; Texas; and Washington, D.C. Our work was
    conducted between March 2006 and October 2007 according to generally
    accepted government auditing standards.

    [End of section]

    Appendix II: Selected State Natural Catastrophe Insurance Programs:

    State government natural catastrophe insurance programs, in most cases,
    have been created after disasters because homeowners insurance coverage
    for catastrophic events is often not available from private insurers at
    prices deemed affordable by state legislators and insurance regulators.
    These programs supplement or substitute for private natural catastrophe
    insurance. For example, California created an earthquake fund in 1994
    when private insurers stopped writing homeowner earthquake coverage
    following the Northridge Earthquake. Likewise, Florida created Citizens
    Property Insurance Corporation (Florida Citizens)--the largest home
    insurer in Florida--to provide state-backed insurance coverage,
    including for wind damage, for homeowners who cannot get coverage in
    the private sector. State natural catastrophe insurance programs differ
    in their details, including the percentage of homeowners covered,
    geographic locations covered, coverage limits, deductible levels, how
    the premiums are calculated, losses, and other details. The natural
    catastrophe insurance programs in California, Florida, and other states
    are funded through a combination of premium payments and postevent
    assessments and bonds. Particularly in catastrophe-prone locations,
    government insurance programs have tended not to charge premiums that
    reflect the actual risks that homeowners face, resulting in financial
    deficits. After the 2005 hurricanes, for example, some of these state
    programs faced large accumulated deficits and required substantial
    public funding to continue operations. See figure 5 for a comparison of
    the features of selected state natural catastrophe insurance programs,
    especially their losses, after the 2005 hurricanes. The text that
    follows figure 5 contains the most recent information on the state
    programs.

    Figure 5: Comparison of Selected State Natural Catastrophe Insurance
    Programs in 2005:

    [See PDF for image]

    Primary Insurance: Florida Citizens Property Insurance Corporation;
    Program availability: Hail and wind only in the high risk area; full
    coverage policy in rest of Florida;
    Coverage Limits, property: At least 100 percent of the estimated
    replacement value;
    Coverage Limits, contents: [Empty];
    Coverage Limits, other: [Empty];
    Deductible, 1%: [Empty];
    Deductible, 2%: [Check];
    Deductible, 5%: [Check];
    Deductible, 10%: [Check];
    Deductible, 15%: [Empty];
    Deductible, $: $500;
    Premium methodology: Not lower than highest average rate among
    20largest insurers in geographic area;
    Gross written premium (in millions): $1,609;
    Number of policyholders: 810,017;
    Total exposure (in billions): $165;
    Gross losses incurred (in billions): $2.6;
    Assessment structure: Every insurer licensed to write fire, industrial
    fire, allied lines, farmowners/homeowners multiperil, commercial
    multiperil, mobile homes, and residual market participants. Regular
    assessment, premium surcharge, and emergency assessment. Insurer may
    pass-through to insureds.

    Primary Insurance: Louisiana Citizens Property Insurance Corporation;
    Program availability: Coastal Plan for areas along Gulf Coast; FAIR
    Plan for noncoastal areas. Fire, hail, and wind, or homeowners;
    Coverage Limits, property: $500,000;
    Coverage Limits, contents: $250,000;
    Coverage Limits, other: [Empty];
    Deductible, 1%: [Empty];
    Deductible, 2%: [Check];
    Deductible, 5%: [Check];
    Deductible, 10%: [Check];
    Deductible, 15%: [Empty];
    Deductible, $: [Empty];
    Premium methodology: 10% above highest average rate in parish;
    Gross written premium (in millions): $33[C];
    Number of policyholders: 134,169;
    Total exposure (in billions): $14.9;
    Gross losses incurred (in billions): $1.3[F];
    Assessment structure: Every insurer licensed to write fire, allied
    lines, homeowner multiperil, and property portion of commercial
    multiperil. Regular assessment, market equalization surcharge, and
    emergency assessment. Insurer may pass-through to insureds.

    Primary Insurance: Mississippi Wind-storm Underwriting Association;
    Program availability: Hail and wind coverage only in coastal counties;
    Coverage Limits, property: $1,000,000;
    Coverage Limits, contents: $250,000;
    Coverage Limits, other: [Empty];
    Deductible, 1%: [Empty];
    Deductible, 2%: [Empty];
    Deductible, 5%: [Empty];
    Deductible, 10%: [Empty];
    Deductible, 15%: [Empty];
    Deductible, $: $500;
    Premium methodology: Subject to the commissioner�s approval and not
    discriminatory;
    Gross written premium (in millions): $14;
    Number of policyholders: 15,252;
    Total exposure (in billions): $1.9;
    Gross losses incurred (in billions): $0.6;
    Assessment structure: Every insurer licensed to write property
    insurance. Member insurers pay first 10%, can reduce second 90% by
    voluntary writing.

    Primary Insurance: Texas Windstorm Insurance Association;
    Program availability: Hail and wind coverage in Texas coastal counties;
    Coverage Limits, property and contents: $1,500,000[A] for homeowners;
    Coverage Limits, other: [Empty];
    Deductible, 1%: [Check];
    Deductible, 2%: [Empty];
    Deductible, 5%: [Empty];
    Deductible, 10%: [Empty];
    Deductible, 15%: [Empty];
    Deductible, $: Not less than $100;
    Premium methodology: Reasonable, adequate, not unfairly discriminatory
    and nonconfiscatory to any class of insurer;
    Gross written premium (in millions): $114;
    Number of policyholders: 118,413[D];
    Total exposure (in billions): $27.5[E];
    Gross losses incurred (in billions): $0.2;
    Assessment structure: Every authorized insurer licensed to write
    property insurance. Member insurers pay first $100 million; second
    assessment if losses exceed the first assessment, reinsurance, and a
    trust fund; and third assessment if losses exceed the above. Third
    assessment may be credited against state premium tax.

    Primary Insurance: California Earthquake Authority;
    Program availability: Insurers must offer coverage with homeowners;
    Coverage Limits, property: Homeowners policy coverage amount;
    Coverage Limits, contents: $5,000 up to $100,000;
    Coverage Limits, other: %1,500 up to $15,000 (loss of use);
    Deductible, 1%: [Empty];
    Deductible, 2%: [Empty];
    Deductible, 5%: [Empty];
    Deductible, 10%: [Check];
    Deductible, 15%: [Check];
    Deductible, $: [Empty];
    Premium methodology: Actuarially sound, based on best scientific
    information, location, construction type, age, and mitigation measures;
    Gross written premium (in millions): $503;
    Number of policyholders: 751,767;
    Total exposure (in billions): $240;
    Gross losses incurred (in billions): $0.0;
    Assessment structure: Participating insurers who elect to join the CEA.
    Two industry assessment layers: $2.2 billion below reinsurance and $1.5
    billion above reinsurance. First layer assessment authority ends in
    2008.

    Reinsurance: Florida Hurricane Catastrophe Fund;
    Program availability: Mandatory for all licensed property insurers;
    Coverage Limits: $15 billion[B];
    Deductible: $4.5 billion industry aggregate;
    Premium methodology: Actuarially indicated premium for each Zip code or
    other limited-geographical area;
    Gross written premium (in millions): $737;
    Number of policyholders: 205;
    Total exposure (in billions): $1,508.4;
    Gross losses incurred (in billions): $4.5;
    Assessment structure: Every insurer licensed to write property/casualty
    lines, except medical malpractice, federal flood, accident, and health.
    Emergency assessment collected from insurance companies.

    Source: GAO.

    Note: This figure is intended to show the state of the selected state
    natural catastrophe insurance programs during the 2005 hurricane
    season. Many features of these selected programs have changed since
    that time, as reflected in the narratives that follow this table.

    [A] As of June 2006.

    [B] As of May 2006.

    [C] As of September 30, 2005.

    [D] As of June 2006.

    [E] As of March 2006.

    [F] Estimated.

    [End of figure]

    California Earthquake Authority:

    Program Overview:

    The California Earthquake Authority (CEA) is an instrumentality of the
    state that sells earthquake insurance policies for residential property
    throughout California. Most standard homeowners insurance policies do
    not cover earthquake damage. However, California law requires insurers
    that sell residential property insurance in California to offer
    earthquake coverage to their policyholders every 2 years. In offering
    earthquake coverage, insurance companies can manage the risk themselves
    or they can become a CEA-participating insurance company and offer the
    CEA's residential earthquake policies. The CEA is managed by a
    Governing Board composed of the Governor, Treasurer, and Insurance
    Commissioner. An 11-member Advisory Panel advises the board.

    The base CEA policy, known as a "minipolicy," is a reduced-coverage,
    catastrophic earthquake insurance policy intended to protect a
    dwelling, while excluding coverage for costly nonessential items, such
    as swimming pools, patios, and detached structures. Dwelling coverage
    will help pay to repair or (up to the policy limit) replace an insured
    home when structural damage exceeds the policy deductible. Coverage for
    fire is not included; fire is covered in the companion homeowners
    insurance policy. The dwelling coverage limit is determined by the
    insured value of the home, as stated on the companion homeowners
    insurance policy. Personal property coverage provides up to $5,000 to
    replace items, including furniture, televisions, audio and video
    equipment, household appliances, bedding, and clothing. Policyholders
    can increase their personal property coverage to as much as $100,000.
    The CEA policy provides $1,500 of Additional Living Expense coverage to
    pay for necessary increases in living expenses incurred to maintain a
    normal standard of living. Policyholders can increase that coverage to
    as much as $15,000. In addition to providing funds for repairing or
    replacing a home, the CEA base policy includes an additional $10,000 in
    Building Code Upgrade coverage. For policies that renew or become
    effective on or after July 1, 2006, policyholders can choose to
    increase Building Code Upgrade coverage by an additional $10,000, for a
    total Building Code Upgrade coverage limit of $20,000. The CEA policy
    offers two deductible options: the standard base-limit deductible of 15
    percent of the policy of the total coverage or a 10 percent deductible
    option. Damage to personal property is not covered, unless the dwelling
    deductible is met. There is no deductible for Additional Living
    Expense/Loss of Use coverage. CEA coverage is available to homeowners
    only from the insurance company that provides their residential
    property insurance and only if that company is a CEA- participating
    insurance company. Participating insurance companies process all CEA
    policy applications, policy renewals, invoices, and payments and handle
    all CEA claims.

    CEA Was Created in the Wake of the Northridge Earthquake to Avoid
    Collapse of the Homeowners Insurance Market:

    The Northridge Earthquake jolted the San Fernando Valley in January
    1994. It caused 57 deaths and an estimated $49.3 billion in economic
    losses. California insurers had collected only $3.4 billion in
    earthquake premiums in the 25-year period prior to the Northridge
    Earthquake and paid out more than $15 billion on Northridge claims
    alone. In January 1995, insurers representing about 95 percent of the
    homeowners insurance market in California began to limit their exposure
    to earthquakes by writing fewer or no new homeowners insurance
    policies. This triggered a crisis that by mid-1996 threatened the
    vitality of California's housing market and stalled the state's
    recovery from recession. In 1995, California lawmakers passed a bill
    that allowed insurers to offer a reduced-coverage earthquake insurance
    policy that became the "minipolicy." The CEA became operational in
    December 1996.

    CEA Premium Rates Are Required to Be Actuarially Sound:

    In determining premium rates, the CEA is required by law to use the
    best science available and is expressly permitted by law to use
    earthquake computer modeling, to establish actuarially sound rates. The
    CEA will examine rating factors, such as the rating territory
    (determined by ZIP code), age, and type of construction of a home, in
    determining the premium rate. The CEA applies a 5 percent premium
    discount to dwellings that meet the following requirements: the
    dwelling was built before 1979, it is of a wood-frame construction-
    type, the frame is tied to the foundation, it has cripple walls braced
    with plywood or its equivalent, and the water heater is secured to the
    building frame. The CEA governing board establishes premium rates,
    subject to the prior approval of the Insurance Commissioner. The
    Governing Board voted to reduce the base policy rates on July 1, 2006,
    by a statewide average of 22.1 percent resulting in a rate reduction
    for approximately 85 percent of CEA policyholders. The CEA says that a
    sharp drop in the cost of reinsurance and several years without a major
    earthquake, allowing CEA insurers to build up reserves, made the cut
    possible. While consumer advocates support the cut, some industry
    experts fear that the lower rates could make the CEA financially
    vulnerable in the event of a major earthquake.

    CEA Accumulates Surplus When Premiums Exceed Claims Paid:

    No state funds and no public money are used to finance the CEA. The CEA
    is funded from policyholder premiums, contributions from and
    assessments on participating insurers, returns on invested funds,
    borrowed funds, and reinsurance. Assessments on participating insurers
    may not be directly passed through to policyholders. The CEA is
    authorized to issue bonds, and may not cease to exist so long as its
    bonds are outstanding. As of January 2006, the CEA had a projected
    total claims-paying capacity of $7.8 billion, but if an earthquake
    causes insured damage greater that the CEA's claims-paying capacity,
    then policyholders affected will be paid a prorated portion of their
    covered losses. The surplus of the CEA increases each year in which
    there is no major event.

    Participation in the CEA Is Relatively Low:

    The CEA is one of the world's largest residential earthquake insurers,
    with about 755,000 policies and $501.4 million in premiums in 2006. The
    CEA states that over 8 million households in California have homeowners
    insurance, and that about 12 percent of these households have
    earthquake insurance. The CEA states that there would not be enough
    capacity to support 100 percent participation in the program. There are
    insurance companies that offer only earthquake coverage and do not
    write homeowners insurance. Such companies physically select the
    properties that they will insure. Private insurers accounted for about
    30 percent of the earthquake insurance market in California in 2005.

    Florida Citizens Property Insurance Corporation:

    Program Overview:

    Citizens Property Insurance Corporation (Florida Citizens) is a not-
    for-profit and tax-exempt government entity that provides property
    insurance for personal, commercial residential, and commercial
    nonresidential properties when private insurance is unavailable or, in
    the case of residential insurance, unaffordable. Florida Citizens
    maintains three accounts: (1) the high-risk account (HRA) provides
    personal and commercial multiperil and wind-only coverage in certain
    high-risk coastal areas ("HRA areas");[Footnote 78] (2) the personal
    lines account (PLA) offers personal residential multiperil policies
    outside of the HRA areas, and ex-wind policies for residential
    properties inside of the HRA areas; and (3) the commercial lines
    account (CLA) offers commercial residential and commercial
    nonresidential multiperil policies outside of the HRA areas, and ex-
    wind policies inside of the HRA areas. Florida law requires Citizens to
    maintain the separate accounts until the retirement of bonds issued by
    Citizens' predecessors prior to Citizens' formation. Since these
    predecessor bonds have been retired, the separate accounts may be
    combined, but Citizens has made no decision to do so.

    Policies are sold by independent insurance agents, who receive 6 to 8
    percent commissions for residential policies and 7 to 12 percent
    commission for commercial policies.[Footnote 79] Underwriting standards
    are somewhat limited, as the company is intended to be an insurer of
    last resort. Hurricane deductibles are offered at $500, 2 percent, 5
    percent, and 10 percent for personal lines multiperil policies and at
    $500, 2 percent, 3 percent, 4 percent, 5 percent, and 10 percent for
    personal lines wind-only policies. All-other-peril deductibles are
    $500, $1,000, and $2,500. Coverage limits for homeowners policies must
    be at least equal to 100 percent of the estimated replacement value.
    Florida Citizens offers premium discounts up to 45 percent to
    homeowners who take qualifying mitigation measures. Florida Citizens
    imposes a surcharge on older homes that reaches a maximum of 20 percent
    for homes over 40 years old, while policyholders with newer homes can
    receive a premium credit of up to 10 percent.

    Florida Citizens Was Created to Consolidate Separate Residual Market
    Mechanisms and Achieve Tax-Exempt Status to Lower Costs:

    Florida Citizens was established in 2002 after two separate insurance
    pools, known as the Florida Windstorm Underwriting Association (FWUA)
    and the Florida Residential Property and Casualty Joint Underwriting
    Association (JUA) were combined. The FWUA was created by statute in
    1970 to provide high-risk, windstorm and hail residual market coverage
    in selected areas of Florida. Florida Citizens' HRA assumed the debt
    and obligations of the FWUA. The JUA was created in December 1992, in
    the wake of the capacity crisis following Hurricane Andrew, to provide
    residual market residential-property multiperil insurance coverage,
    excluding wind if the property was within FWUA-eligible areas. Florida
    Citizens' PLA and CLA assumed the debt and obligations of the JUA. A
    primary driver for the merger was that the combined entity obtained
    federally tax-exempt status, thus saving federal income taxes that
    otherwise would have been paid by the FWUA and the JUA. In addition, as
    a tax-exempt entity, Florida Citizens is able to issue lower coupon tax-
    free bonds postevent, as well as taxable preevent bonds. The merger
    also resulted in some overhead cost savings by having a single
    organization.

    Florida Citizens Premium Rates Are Required to Be Actuarially Sound,
    but Are Subject to Legislative Change:

    Until recently, Florida Citizens' premium rates were required to be
    noncompetitive with the voluntary market, using a formula that
    determined rates on a county-by-county basis, on the basis of the
    highest rate offered in the voluntary market among the state's top 20
    insurers writing in that area. Then, as part of legislation passed in
    May 2006, Florida Citizens' rates were required to be high enough to
    purchase reinsurance to cover 1-in-100-year hurricane probable maximum
    loss in the PLA and 1-in-70-year hurricane probable maximum loss in the
    CLA. Finally, in January 2007, legislation was passed that eliminated
    both of these requirements and required that Florida Citizens' rates be
    actuarially sound and not excessive, inadequate, or unfairly
    discriminatory. In addition, the legislation rescinded a rate increase
    that took effect on January 1, 2007; froze 2007 rates at the December
    31, 2006, rate level; and required Florida Citizens to make a new rate
    filing to be effective January 1, 2009.

    In the Event that Florida Citizens Has Losses That Exceed Surplus, It
    Can Levy Assessments to Recover the Deficit:

    Storms in 2004 and 2005 resulted in more than $30 billion in insured
    damage in Florida. Florida Citizens sustained deficits of $515 million
    in 2004 and $1.8 billion in 2005. To fund its deficit, Florida Citizens
    is required by statute to assess admitted insurers in proportion to the
    amount of property and casualty insurance business (except for workers'
    compensation or accident and health) they write in Florida, and also to
    assess its own policyholders and surplus lines policyholders. The
    admitted insurers have the ability to recoup regular assessments from
    their policyholders upon renewal of a policy or issuance of a new
    policy. If the amount of the deficit exceeds the amount Florida
    Citizens can collect as a regular assessment, it is required to levy
    emergency assessments on its own policyholders, on surplus lines
    policyholders, and on the policyholders of admitted insurers. Admitted
    insurers collect emergency assessments from their policyholders and
    remit the collections to Citizens.

    To fund its 2004 deficit, Florida Citizens assessed insurance companies
    and surplus lines insureds over $515 million in regular assessments. To
    fund the 2005 deficit of approximately $1.8 billion, the Florida
    Legislature appropriated $715 million from the Florida general revenue
    fund, which reduced the size of the regular assessment from $878
    million to $163 million. The regular assessment imposed to fund the
    2005 deficit was reduced from an estimated 11.2 percent to 2.07 percent
    due to the infusion of general revenue funds. The Florida Legislature
    also directed Florida Citizens to amortize the collection of the
    emergency assessment for the remaining $888 million deficit over a 10-
    year period, resulting in a 1.4 percent emergency assessment levied
    beginning in June 2007.

    Florida Citizens' resources also come from its reinsurance arrangement
    with the Florida Hurricane Catastrophe Fund (FHCF). In 2006, the FHCF
    provided coverage for Florida Citizens for 90 percent of $4 billion in
    losses above its deductible. As a tax-exempt entity, Florida Citizens
    is able to issue tax-exempt postevent bonds as well as taxable preevent
    bonds. The tax-exempt status is beneficial because in the event of a
    major disaster, Florida Citizens can finance loss payment by issuing
    bonds that carry low interest rates, thereby reducing financing costs
    over the years by hundreds of millions of dollars. In June 2006,
    Florida Citizens completed a $3.05 billion taxable pre-event bond sale.
    In February 2007, Florida Citizens closed a $1 billion tax-exempt
    postevent bond issuance. In June 2007, Citizens completed a $1.95
    billion preevent financing plan consisting of a $1 billion line of
    credit and $950 million in bonds. Under its enabling statute, Florida
    Citizens is a government entity and not a private insurance company. As
    long as Florida Citizens has bonds outstanding, it may not file a
    voluntary petition under Chapter 9 of the Federal Bankruptcy Code.

    Florida Citizens Has Had Moderate Growth in All but 2 Years, Partially
    Due to Depopulation Incentives:

    Except for 2 years, Florida Citizens' growth has been relatively
    moderate given the market dynamics. Since its establishment in 2002,
    when it had 658,085 policies, the policy count has increased to 1.38
    million policies-in-force as of September 30, 2007. Over this 5-year
    period, there has been nominal growth in Citizens' formerly wind-only
    HRA of 10 percent. Most of the growth of Florida Citizens has been in
    its PLA and has been caused by the following factors: (1) the private
    market pulling back following eight hurricane events in 2004 and 2005,
    (2) private insurers' curtailing coverage in sinkhole parts of the
    state, and (3) the July 2006 assumption by Florida Citizens of
    approximately 300,000 policies following the insolvency of a private
    insurer. Aside from 2006, the only other significant policy increase
    occurred in 2003, a 25 percent increase. By comparison, total policies
    grew by only 7 percent in 2004, decreased by 7 percent in 2005, and
    grew by 7 percent for the first 9 months of 2007--all net of
    depopulation activities.

    Prior to 2007, part of Florida Citizens' lower growth rate was the
    result of incentives to private insurers to take policies out of
    Citizens, also known as depopulation incentives. Florida Citizens had
    the authority to pay insurers a take-out bonus of up to 12.5 percent of
    premiums removed from the HRA. The incentive program required that a
    minimum of 25,000 policies or a total insured value of at least $5
    billion be removed. Insurers could earn higher bonuses, up to 10
    percent, for assuming more than the minimum. They were required to
    retain the policies for either 3 or 5 years. Take-out incentives were
    eliminated in 2007. Nonetheless, through August 31, 2007, 131,000
    policies have been removed without incentives.

    Louisiana Citizens Property Insurance Corporation:

    Program Overview:

    The Louisiana Citizens Property Insurance Corporation (Louisiana
    Citizens) is a nonprofit, tax-exempt entity that acts as a market of
    last resort for residential and commercial property insurance in
    Louisiana. Louisiana Citizens is modeled on a similar Citizens Plan
    created in Florida. Louisiana Citizens was specifically organized to
    operate the state's Coastal Plan and Fair Access to Insurance
    Requirements (FAIR) Plan. The Coastal Plan offers coverage in coastal
    areas of the state. The FAIR Plan offers coverage in the rest of the
    state. Louisiana Citizens offers coverage for fire, vandalism,
    windstorm, hail, and homeowners. Residential policy limits are up to
    $750,000 for property, and up to $375,000 for contents. Policy
    deductibles are offered at various levels, with 2 and 5 percent offered
    for wind/hail coverage. Underwriting standards are somewhat limited
    since the company is intended to be an insurer of last resort. A 15-
    member governing board supervises company operations. The company has
    very limited infrastructure in place, as it maintains an administrative
    services contract with the Property Insurance Association of Louisiana,
    a nonprofit organization of licensed insurance carriers in the state.
    The company also entered into agreements for underwriting, policy
    management, and claims management services with three service
    providers.

    Louisiana Citizens Was Created to Change Assessment Structure of
    Residual Market Mechanisms:

    Louisiana created the Louisiana Joint Reinsurance Plan (the predecessor
    to the FAIR Plan) in 1968 to provide a residual market for property
    insurance in inner cities within the state in response to damage caused
    by civil unrest. The state created the Louisiana Insurance Underwriting
    Plan (the predecessor to the Coastal Plan) in 1970 to provide a
    residual market for property insurance in coastal areas of the state in
    response to damage caused by Hurricane Camille. All insurers licensed
    to write property insurance in the state were required to participate
    in the predecessor insurance plans. Property losses caused by
    hailstorms, Hurricane Lili, and Tropical Storm Isidore resulted in
    assessments against the participating insurers that were not
    recoverable from policyholders. The insurers became reluctant to write
    insurance in the state. The legislation creating Louisiana Citizens
    gave participating insurers the ability to recoup a regular assessment
    from policyholders and gave Louisiana Citizens the ability to impose
    emergency assessments directly on policyholders.

    Citizens Rates Are Not Competitive with the Private Market and
    Necessitated Postfunding:

    Louisiana Citizens premium rates are required to be actuarially sound.
    Premium rates are not intended to be competitive with the private
    market and are set at least 10 percent above the average rate of the
    insurer that had the highest rate of the top 10 insurers by parish,
    provided they make up at least 3 percent of the market. In 2005,
    Louisiana Citizens suffered more than $1 billion in losses from
    Hurricanes Katrina and Rita, with the vast majority of the losses in
    the FAIR Plan. Citizens had not built up sufficient reserves to meet
    its obligations. It had only $80 million in cash reserves and tapped
    into its reinsurance for an additional $295 million. In October 2005,
    because there was still a deficit, Citizens assessed all property
    insurance companies in the state a one-time regular assessment of a
    maximum amount of 15 percent of premium: 10 percent for the FAIR Plan
    and 5 percent for the Coastal Plan. Insurers recoup the amount of their
    regular assessments from their policyholders in the subsequent year.
    The regular assessment following the 2005 hurricanes generated
    approximately $200 million for Louisiana Citizens. Because a deficit
    situation still existed after the regular assessment was levied,
    Citizens was authorized by law to issue bonds. In December of 2006,
    Citizens received approval from the State Bond Commission to issue up
    to $1.4 billion of tax-exempt revenue bonds. The actual bond issue in
    April 2006 was for approximately $978 million. The bond offering will
    be financed by an emergency assessment on policyholders that is
    estimated to be about 5 to 6 percent of insurance premiums per year for
    as many years as needed to cover the plan deficit.[Footnote 80]

    Mississippi Windstorm Underwriting Association:

    Program Overview:

    The Mississippi Windstorm Underwriting Association (Mississippi
    Windpool)[Footnote 81] is a nonprofit association of all insurance
    companies writing property insurance in Mississippi on a direct basis.
    It was established by the legislature to provide an adequate market for
    windstorm and hail insurance in the six coastal counties of
    Mississippi. The maximum coverage available for residential coverage is
    $1 million for the dwelling and $250,000 for contents. The policy
    contains a "named storm" deductible of 2 percent of the insured value
    of the home with a $500 minimum or, if coverage exceeds $500,000, a
    $1,000 minimum. Any structure built after June 1, 1987, in an area that
    has not adopted the standard building code must produce proof that the
    structure is built in substantial accordance with the code. Otherwise,
    it is not insurable by the Mississippi Windpool. Policies can be sold
    by any approved insurer, and agents receive a 15 percent commission on
    new business and a 10 percent commission on renewals.

    Mississippi Windpool Was Created in the Wake of Insurance Crisis
    Following Hurricane Camille:

    The Mississippi Insurance Underwriting Association (MIUA), the
    predecessor to the Mississippi Windpool, was created by the Mississippi
    Legislature in 1970 as the state struggled to recover from Hurricane
    Camille in 1969. The MIUA provided fire and windstorm coverage in the
    six coastal counties of the state, and its basic purpose was to enable
    individuals to secure a mortgage since there was no private market for
    fire and wind coverage. In 1987, the legislature found that the market
    for fire coverage had recovered, but there remained the need for
    residual windstorm coverage. Thus, the legislature created the
    Mississippi Windpool.

    Mississippi Windpool Premium Rates Are Significantly Less Than
    Requested:

    Mississippi Windpool premium rates are required to be nondiscriminatory
    as to the same class of risk, and are subject to the approval of the
    state insurance commissioner. Prior to 2007, in light of agent
    commissions and the servicing carrier agreement, the Mississippi
    Windpool recovered just over 75 percent of premium payment on new
    business and about 82 percent of premium payment on renewals. The
    Mississippi Windpool used most of the premium to buy reinsurance. In
    2004, the Windpool sought to raise premium rates by 76 percent, but the
    insurance commissioner approved a 22 percent increase. In April 2006,
    the Mississippi Windpool sought approval of a 397.8 percent rate
    increase for residential coverage. Much of the increase was needed to
    buy adequate reinsurance, which cost the Mississippi Windpool about
    $0.65 to $0.70 per dollar of reinsurance. The state insurance
    commissioner granted a 90 percent increase. To defray the cost of
    reinsurance for the Mississippi Windpool, the state requested that HUD
    allow it to allocate up to $50 million in CDBG funds. HUD gave the
    state permission to use $30 million in 2006 and $20 million in 2007 for
    the Mississippi Windpool reinsurance. In 2007, the State Legislature
    created the Mississippi Windstorm Underwriting Association Reinsurance
    Assistance Fund for the purpose of defraying the cost of Mississippi
    Windpool reinsurance. The fund will be financed using state tax dollars
    and may be used only by the state insurance department upon
    appropriation by the State Legislature. The Mississippi Windpool was
    also granted authority to issue bonds and other debt instruments.

    Catastrophic Mississippi Windpool Losses Are Borne by Participating
    Insurers:

    Following Hurricane Katrina, the Mississippi Windpool suffered about
    $720 million in losses. It received loss claims from every
    policyholder, about 18,000 total. About 700 to 800 policyholders did
    not meet their deductible, but the vast majority of claims resulted in
    payment. Prior to 2007, the Mississippi Windpool did not retain
    profits, if any, at year-end, but distributed them to participating
    insurers. The Mississippi Windpool did not have adequate reinsurance
    and capital to cover their losses in Katrina, and assessed
    participating insurers $525 million, on the basis of their level of
    participation in the state property insurance market. About 400
    companies were participating in the Mississippi Windpool at the time.
    Each could reduce their assessment liability by $1.40 for every $1.00
    of voluntarily written premium for property insurance in the coastal
    area. This credited amount came out of the second 90 percent of the
    assessment; all members were responsible for the first 10 percent of
    the assessment. No company completely wrote themselves out of the
    Katrina assessment, and some companies incurred greater direct losses
    than their assessment. However, some companies were assessed more than
    their entire direct written premium received in the state. Legislation
    passed in 2007 requires the state insurance commissioner to levy a
    surcharge on all property insurance premiums in the state to recover
    within 1 year the amount of the regular assessment for reimbursement to
    assessable insurers who paid the regular assessment.

    Texas Windstorm Insurance Association:

    Program Overview:

    The Texas Windstorm Insurance Association (Texas Windpool) offers
    windstorm and hail coverage for residential and commercial properties
    in 14 coastal counties and parts of Harris County (but not Houston).
    About 25 percent of the state's population lives along the coast. The
    membership of the Texas Windpool includes every property insurer
    licensed to write property insurance in the state. Each company's
    percentage of participation is based on their statewide sales. The
    Texas Windpool is governed by a nine-member board of directors.
    Coverage limits are adjusted annually to reflect inflation. Effective
    January 1, 2007, residential coverage for a dwelling and its contents
    is capped at $1.597 million. Policies include coverage for wind-driven
    rain, loss of use, and consequential losses. Since 2004, the Texas
    Windpool has required that residential properties that it insures
    conform to the International Residential Code. However, under certain
    conditions, the Texas Windpool will insure homes built before 1988 that
    were not built according to any recognized building code. Policies are
    sold by individual licensed agents who receive 16 percent of gross
    written premium as commission.

    Texas Windpool Was Created Due to Insurance Crisis Following Hurricane
    Celia:

    Hurricane Celia struck the Texas coast in August 1970 and caused an
    estimated $310 million in insured losses ($1.55 billion in 2005
    dollars). Many insurers decided to stop writing business in the state's
    coastal communities. In response, the State Legislature created the
    Texas Catastrophe Property Insurance Association (predecessor to the
    Texas Windpool) in 1971.

    Texas Windpool Premium Rates Are Less Than Requested:

    The Texas Windpool must file all rates with the state insurance
    commissioner for approval. The commissioner assesses whether the rates
    are reasonable, adequate, not unfairly discriminatory, and
    nonconfiscatory as to any class of insurer. Approved rates must be
    uniform throughout the 14 coastal counties. By law, the Texas Windpool
    residential premium rates may not increase by more than 10 percent
    above the rate for noncommercial windstorm or hail insurance in effect
    at the time of filing, but the insurance commissioner may suspend this
    rule after a catastrophe or series of catastrophes to ensure rate
    adequacy in the catastrophe area.[Footnote 82] In May 2006, the Texas
    Windpool sought a 19 percent residential and 24 percent commercial rate
    increase. The insurance commissioner approved a 3.1 percent residential
    and 8 percent rate increase. Again, in November 2006, the Texas
    Windpool sought a 20 percent residential and 22 percent commercial rate
    increase. The insurance commissioner approved a rate increase of 4.2
    percent for residential policies and 3.7 percent for commercial
    policies.

    Texas Windpool Claims-Paying Capacity Mixes Industry Assessments and
    Reserves:

    The Texas Windpool is authorized to assess participating insurers for
    excess losses. In addition, the State Legislature created the
    Catastrophe Reserve Trust Fund, into which Texas Windpool profits are
    deposited, rather than distributed to participating insurers. Under the
    plan, companies are assessed the first $100 million losses in excess of
    the Texas Windpool's premiums and other income. Losses in excess of
    this amount are funded by private reinsurance and the trust fund. An
    additional $200 million assessment can be levied if private reinsurance
    and the trust fund are inadequate to cover losses. In March 2006, the
    Texas Windpool had the ability to fund $1.3 billion in excess losses
    based on a combination of assessments, reinsurance, and other means.
    Losses in excess of $1.3 billion are funded through further industry
    assessments. An insurer may credit the amount paid under this top-layer
    assessment against its premium tax. Hurricane Rita produced estimated
    losses of between $160 million and $165 million for the Texas Windpool.
    The payment of some 11,506 Hurricane Rita claims in 2005 resulted in a
    deficit and a $100 million assessment on insurance companies. The pool
    grew from almost 69,000 policyholders at the end of 2001 to about
    207,000 at the end of September 2007. Texas Windpool liability, or
    exposure to loss, was about $56 billion as of the end of September
    2007.

    Alabama Insurance Underwriting Association:

    Program Overview:

    Alabama Insurance Underwriting Association (Alabama Beach Pool) is a
    voluntary unincorporated nonprofit association established to provide
    essential residential and commercial insurance coverage to the beach
    area counties of Baldwin and Mobile. Twelve percent of Alabamans live
    on the coast. Every licensed property insurer in the state is a member
    of the Alabama Beach Pool. The Beach Pool offers two types of policies:
    fire and extended coverage, and wind and hail. The Beach Pool offers
    coverage limits on residential buildings up to a maximum of $500,000,
    combined dwelling and contents. A hurricane deductible of 5 percent
    ($1,000 minimum) is applicable in the event of a named storm. Policies
    covering property located in certain areas may opt for a 2 percent
    hurricane deductible for an additional premium. The standard deductible
    for all other perils is $500. Buildings must conform to the Southern
    Standard Building Code for the Alabama Beach Pool to provide coverage.
    Any insurance agent licensed in Alabama can sell Beach Pool policies
    and receive an 8 percent commission. The Beach Pool is managed by a
    board of directors.

    Alabama Beach Pool Was Created Due to Insurance Crisis Following
    Hurricane Camille:

    The Alabama Beach Pool was created in the aftermath of Hurricane
    Camille in 1969. Insurance companies operating in Alabama voluntarily
    agreed to join the association at the behest of the state insurance
    commissioner. The Beach Pool was not created by the State Legislature,
    but is subject to regulation by the Alabama Department of Insurance.

    Alabama Beach Pool Premium Rates Have Been Subject to Political
    Pressure:

    The Alabama Beach Pool and other insurers operating in the state must
    file premium rate change requests with the Alabama Department of
    Insurance. Alabama is a "prior approval" state, meaning that insurers
    must either allow a waiting period to expire or receive approval from
    the insurance department prior to using those rates in pricing
    insurance coverage. Insurance company officials told us that they are
    not always able to get their requested rates, and that Alabama Beach
    Pool rates are too low. Prior to Hurricane Katrina, the state insurance
    department conducted a study comparing Beach Pool premium rates with
    rates charged by state-run coastal insurance programs in Florida and
    Mississippi. The study showed that Alabama Beach Pool rates were higher
    than the Florida and Mississippi programs. The State Legislature put
    pressure on the insurance department to lower Beach Pool rates. In the
    wake of Hurricane Katrina, however, coastal insurance rates in Florida
    and Mississippi are higher than in Alabama.

    Alabama Insurers May Not Pass-Through Alabama Beach Pool Assessments to
    Policyholders:

    The Alabama Beach Pool is authorized to make assessments upon all
    member insurers. The calculation of the assessment is based on the
    member's proportion of net direct premiums of property insurance in the
    state. Members can receive annual credit against assessments for
    property insurance voluntarily written in the coastal area. In the
    event of catastrophe loss requiring assessment, a first partial loss
    assessment will be limited to not exceed $2 million per member insurer.
    Members may not pass-through assessments to policyholders. The Beach
    Pool currently has about 8,500 policies, insuring about $1.5 billion in
    property.

    Georgia Underwriting Association:

    Program Overview:

    The Georgia Underwriting Association (GUA) was created by insurance
    companies licensed to write property insurance in Georgia to administer
    the state FAIR Plan. The plan insures homeowners throughout the state
    who have not been able to find certain types of insurance coverage in
    the voluntary market, and also coverage against windstorm and hail
    damage in coastal counties and off-shore islands. The coverage limit
    for any one building, including the dwelling and its contents, for
    windstorm and hail coverage is $2 million. The deductible for windstorm
    and hail coverage is at least 1 percent, subject to a minimum of $500.
    Any structure in the windstorm and hail area that is less than 10 years
    old and not built in compliance with the Southern Standard Building
    Code or its equivalent is not eligible for coverage. Replacement cost
    and loss of use coverage are available as supplemental coverage.
    Homeowners may apply for GUA coverage directly or through a state-
    licensed insurance agent. Agents receive a commission of 10 percent of
    the premium. Premium rates either may be approved by the state
    insurance commissioner and must not be excessive, inadequate, or
    unfairly discriminatory or may be advisory rates and premiums from the
    Insurance Services Office, Inc. The average premium for coverage is
    about $590. The GUA maintains reinsurance of $100 million in excess of
    $50 million, and a second-event limit covers a second loss greater than
    $25 million. The GUA is authorized to assess member insurers for
    program losses in proportion to each member's property insurance
    premiums written during the most recent calendar year. Member
    assessments may not be passed-through to policyholders. Member insurers
    also share in program profits. In June 2006, the GUA had 26,882
    policies in-force, of which 7,136 policies were on the coast. The
    exposure statewide as of June 2006 was $3.2 billion, of which $1.3
    billion was coastal exposure.

    South Carolina Wind and Hail Underwriting Association:

    Program Overview:

    The South Carolina General Assembly authorized the creation of the
    South Carolina Wind and Hail Underwriting Association (South Carolina
    Windpool) in 1971. All admitted property and casualty companies
    licensed by the South Carolina Department of Insurance are members of
    and are required to participate in the South Carolina Windpool. The
    Windpool provides wind and hail coverage in the coastal areas of the
    state, which are specifically designated by statute. The state director
    of insurance recently expanded the territory eligible for Windpool
    coverage and divided the territory into two zones. Insurance companies
    writing policies in the defined territory may either offer wind
    coverage or exclude wind coverage (for a reduced premium). If an
    insurer excludes wind coverage, that coverage may be written by the
    South Carolina Windpool (for an additional premium). Cover limits for
    one-to-four family dwellings, including mobile homes and condominiums,
    is $1.3 million. Items that are specifically excluded from coverage
    include property over water and wind-driven rain. South Carolina
    Windpool policies are actual cash value contracts. Primary residences
    are eligible to purchase replacement cost coverage. The standard
    building/contents deductible is 3 percent of the policy limit in zone 1
    with a minimum deductible of 2 percent in zone 2. Loss of use coverage
    is subject to a time deductible that is based on the underlying
    building/contents deductible. Policies may be sold by any insurance
    producer or broker licensed by the state. Premium rates must be
    approved by the state director of insurance. Premium rate increases or
    decreases of 7 percent may take effect on a file-and-use basis; rate
    increases or decreases of more than 7 percent are subject to prior
    approval. In 2005, the average premium per residential policy for the
    South Carolina Windpool was $1,385. In 2007, the State Legislature
    required the Windpool to ensure rate adequacy so as to permit it to be
    self-sustaining. The South Carolina Windpool is authorized to assess
    member insurers to cover program losses. Insurers may pass through
    assessments to policyholders through future rate filings. In June 2007,
    the State Legislature authorized the South Carolina Windpool to sell
    bonds and incur debt. The South Carolina Windpool had 36,196
    residential policies in-force as of September 30, 2007, compared with
    16,430 residential policies in-force in 2001. Windpool exposure was
    almost $13.735 billion as of September 30, 2007.

    North Carolina Insurance Underwriting Association:

    Program Overview:

    The North Carolina Insurance Underwriting Association (North Carolina
    Beach Plan) was created in 1969 to provide insurance coverage to people
    not able to buy it through the standard insurance market only on the
    barrier islands adjacent to the Atlantic Ocean. In 1998, the North
    Carolina General Assembly expanded the Beach Plan to include the
    state's 18 coastal counties for windstorm and hail only coverage. A 14-
    member board of directors acts as the North Carolina Beach Plan
    policymaking body. All property and casualty insurance companies that
    do business in North Carolina participate in funding the plan. The
    North Carolina Beach Plan provides Basic coverage, which includes most
    major perils, and broad coverage, which includes a broader array of
    perils. Coverage limits are up to $1.5 million on private dwellings.
    Coverage is provided on an actual cash value basis or replacement cost
    if certain specific criteria are met. Policies meeting plan criteria
    are continuous 1 year policies if premiums are paid. Underwriting
    standards are somewhat basic since the North Carolina Beach Plan is
    intended to be an insurer of last resort. North Carolina Beach Plan
    premium rates must be filed with the state insurance commissioner by
    the North Carolina Rate Bureau for approval prior to their use. In
    2007, homeowner rates were raised by an average of 25 percent for beach
    and coastal areas. Homeowners wind-only policies were increased 25
    percent for beach areas and 38 percent for the coastal areas. In 2006,
    dwelling extended coverage rates were increased about 25 percent. For
    commercial property maximum coverage limits are $3 million (combined
    building and contents) and $300,000 for business income. The Beach Plan
    adopts Insurance Services Office commercial loss cost filings approved
    by the state insurance commissioner. All member insurers share in North
    Carolina Beach Plan expenses, profits, and losses in proportion to
    their property insurance net direct premium written in the state.
    Member insurers can receive credit against expenses, profits, and
    losses for property insurance voluntarily written in the beach and
    coastal areas. The North Carolina Beach Plan has a "take out" program
    within its plan of operation; however, to date, this program has not
    been initiated. As of fiscal year end September 30, 2007, the Beach
    Plan had over 162,000 policies in-force with an exposure of $64.1
    billion, compared with about 88,000 policies and an exposure of $28.9
    billion at the end of fiscal year 2004.

    Florida Hurricane Catastrophe Fund:

    Program Overview:

    The goal of the FHCF has been to provide a cost-effective source of
    reinsurance to residential property insurers in the state. It is
    structured as a tax-exempt state trust fund under the direction and
    control of the State Board of Administration of Florida (State Board).
    The State Board is a constitutional entity of Florida state government.
    It is governed by a Board of Trustees composed of the Governor, Chief
    Financial Officer, and Attorney General. The State Board appoints a
    nine-member advisory council to provide the State Board with
    information and advice with its administration of the FHCF. The
    management and day-to-day operations of the FHCF is the responsibility
    of the Senior Officer. The Senior Officer currently manages eight
    professional staff. Paragon Strategic Solutions, Inc. is the FHCF
    administrator as well as the actuarial consultant to the State Board.

    The FHCF collects premiums from and provides reimbursements to insurers
    writing residential property and casualty insurance policies within the
    state. As a condition of doing business in Florida, each insurer
    writing "covered policies" is required to contract with the FHCF.
    "Covered policies" means any insurance policy covering residential
    property in the state that provides wind or hurricane coverage. This
    includes any such policy written by Florida Citizens. A limited
    exemption is available for insurance companies with less than $10
    million in covered exposure (not premium). The FHCF is obligated,
    pursuant to reimbursement contracts, to reimburse participating
    insurers for a specified percentage of qualifying losses on the basis
    of selected coverage (45, 75, or 90 percent) in excess of loss
    retention thresholds (or deductibles). Nearly 85 percent of insurers
    selected the 90 percent coverage option for fiscal year 2005-2006 (July
    1, 2005 through June 30, 2006). There were 205 insurance companies that
    contracted with the FHCF during that period.

    The aggregate industry deductible is set by law at $4.5 billion to be
    adjusted to reflect increased exposure to the FHCF. Currently, the
    aggregate deductible is $6.089 billion for the contract year ending May
    31, 2007. An individual insurer's deductible is based on an insurer's
    pro rata share of reimbursement premium due for a contract year and
    other factors. An insurer's full deductible shall apply to each of the
    insurer's largest two hurricanes. The insurer's full deductible would
    then be adjusted to one third for any other hurricanes occurring during
    the contract year.

    The insured value of property reinsured by the FHCF in contract year
    2007 is estimated to be approximately $2 trillion. The FHCF's claims-
    paying capacity in a contract year is set by law, and legislation
    passed in early 2007 will increase capacity from $15 to $38.4 billion.
    Due to actual coverage selected, the resulting capacity was $27.83
    billion. The FHCF's multiyear claims-paying capacity is over $50
    billion. The cap on capacity represents the limited liability of the
    FHCF--it is not obligated by contract if losses in a given contract
    year exceed claims-paying capacity. In contract years where there is
    growth in the FHCF's cash balance, the capacity is allowed to increase
    to the lesser of the growth in the cash balance or the growth in the
    reported insured property values.

    The projected payout for a participating company is set as a pro rata
    share of the FHCF's annual capacity. Prior to reimbursement, an
    insurer's loss reports are examined by the State Board and tested for
    reasonableness. Limited apportionment companies, which possess capital
    not exceeding $20 million, are entitled to reimbursement first. No one
    county is responsible for more than 9.8 percent of the fund's exposure.
    Dade, Broward, and Palm Beach Counties are contiguous and make up less
    than 28 percent of the fund's total exposure.

    FHCF Was Created in 1993 after Hurricane Andrew Limited the
    Availability of Reinsurance:

    On August 24, 1992, Hurricane Andrew hit the southern coast of Florida
    just south of Miami and caused economic damages estimated in excess of
    $25 billion, including an estimated $15.5 billion in insured losses.
    The major impacts for primary insurance company buyers of reinsurance
    in the year following Andrew included a severe shortage of catastrophe
    property reinsurance capacity and stricter policy terms and conditions,
    as well as sharp increases in property catastrophe cover rates.

    The poststorm reaction of a number of insurance companies was to
    attempt to reduce their underwriting exposure. In early 1993, 39
    insurers stated they intended to either cancel or not renew 844,433
    policies in Florida. The factors influencing these private insurers
    included:

    * the inability to obtain adequate reinsurance or, when available, the
    cost for reinsurance was too high;

    * new catastrophe risk models indicated that exposure levels were
    higher than previously thought, and the exposure levels were
    disproportionate to company and industry financial resources;

    * significant reductions in insurers' policyholders surplus;

    * concerns about rate adequacy, especially for coastal counties and
    certain risk categories, such as condominiums;

    * "hidden" exposures from potential assessments by various other
    insurance mechanisms, for example, residual markets and catastrophe
    funds; and:

    * fear that unfavorable catastrophe exposure would hurt ratings from
    agencies such as A.M. Best and Standard & Poor's.

    The Department of Insurance (now called the Office of Insurance
    Regulation) issued a study examining the state of the property
    insurance market and enumerating many recommendations. Among the
    recommendations was a proposal (originally suggested and supported by
    the two largest private insurers in the state--State Farm and Allstate)
    to establish a tax-free state catastrophe fund to provide reinsurance
    protection between that provided by the private market and a proposed
    federal fund. Later, the legislature created a Study Commission on
    Property Insurance and Reinsurance to look into the viability of the
    property insurance industry and the adequacy of reinsurance. Of the 40
    recommendations made by the commission, a key recommendation included
    the establishment of a state catastrophe fund "to fill the void between
    currently available private sector reinsurance and the proposed federal
    catastrophic fund program." Virtually all of the recommendations from
    the commission were enacted with minor alterations, including creation
    of the FHCF.

    FHCF Premiums Are Significantly Less Than Private Reinsurance Premiums:

    The cost of FHCF coverage is significantly less than the cost of
    private reinsurance (one fourth to one third the cost) due to the
    FHCF's tax-exempt status, low administrative costs, and lack of a
    profit or risk-load. The tax-exempt status of the FHCF removes a level
    of potential income taxation for participating insurers resulting from
    the annual buildup of contingent reserves in years when there are few
    or no hurricanes, and, thus, allows for the accumulation of funds for
    the payment of Florida losses. Another reason FHCF premiums are low is
    that a significant part of the coverage provided by the FHCF may be
    paid by long-term debt issued by the FHCF after a large hurricane event
    occurs, as discussed below.

    A company's annual reimbursement premium is based on an actuarial
    formula that considers property location, type of construction,
    deductible, and loss mitigation. Premiums have been stable over time
    due to mandatory participation but have increased significantly since
    2004 when the FHCF's capacity was increased. Growth in reported
    exposure has also factored into increased premiums. The top 10 insurers
    in the FHCF contribute 64 percent of the total reimbursement premiums
    paid. The FHCF is expected to collect $736 million in reimbursement
    premium during contract year 2006. Beginning in 2006, the FHCF was
    required to charge a rapid cash build-up factor equal to 25 percent of
    premiums, which was expected to provide $200 million annually. However,
    the Florida Legislature repealed this provision in early 2007.

    According to the FHCF, most insurers select the 90 percent coverage
    option. Insurers may purchase private market reinsurance to cover their
    hurricane losses for amounts below the retention, above their
    reimbursement limit, or for the coinsurance amount (10 percent - along
    side) that is the insurer's responsibility for the layer of coverage
    provided by the FHCF. In fact, for some large national insurers, the
    FHCF is a small part of their total reinsurance program.

    FHCF Maintains Reserves, but They May Not Be Adequate to Handle
    Catastrophe Losses:

    The FHCF is not required to have the loss reserves that are required of
    insurers or reinsurers under state law. Financial reserves of the FHCF
    accumulated steadily through fiscal 2004 due to limited hurricane
    activity. Specifically, the FHCF had accumulated net assets of $5.5
    billion at the end of the 2004 fiscal year (June 30, 2004). Following
    the 2004 and 2005 hurricane seasons, the FHCF reimbursed participating
    insurers over $5 billion, which has eliminated the reserves and created
    an estimated shortfall of $1.425 billion. Standard & Poor's states that
    this cyclical financial performance is expected, given the nature of
    FHCF funding requirements.

    FHCF Authorized to Postfund Revenue Shortfalls:

    To support the capacity of the FHCF, revenue bonds may be issued. The
    Florida Hurricane Catastrophe Fund Finance Corporation was formed in
    1996 to issue bonds and engage in such other financial transactions as
    are necessary to provide sufficient funds to achieve the purposes of
    the FHCF. The corporation is governed by a five-member board of
    directors, including the governor, chief financial officer, attorney
    general, director of the Division of Bond Finance of the State Board,
    and the Senior Officer. Revenue bonds issued are exempt from state and
    federal taxes. The corporation has authority to create preevent and
    postevent financing. In June 2006, the corporation undertook postevent
    financing of $1.35 billion to address its 2005 shortfall. In July 2006,
    the corporation undertook preevent financing of $2.8 billion to address
    2006 liquidity needs.

    To pay debt service on outstanding revenue bonds and to reimburse
    insurers for the reimbursable losses under a covered event, the State
    Board directs the Office of Insurance Regulation to levy an emergency
    assessment which insurance companies collect from their policyholders.
    Emergency assessments are levied on premiums for all assessable lines
    of business in Florida. For 2006, there are 27 assessable lines, and
    medical malpractice policies will be added in 2010. In 2004, surplus
    lines insurers were added to the emergency assessment base. Excluded
    lines include accident and health, workers' compensation, and federal
    flood insurance. The assessment base, which totaled $35 billion in
    2005, has grown at a compound annual growth rate of 14.6 percent since
    1970. Over 40 percent of the direct-written premium base is from auto
    insurance. In May 2006, a 1 percent emergency assessment was directed.

    The assessments are collected by insurance companies from policyholders
    and remitted to the FHCF throughout the year. Policyholders are
    required to pay the assessments, and insurers are required to treat the
    failure to pay the assessment as a failure to pay premium, which
    permits an insurer to cancel the policy. The maximum assessment in a
    single season is 6 percent of premium, and the aggregate limit is 10
    percent of the premium base. Emergency assessments had never been
    assessed or collected prior to the levy of assessments relating to the
    issuance of the June 2006 bonds. Statewide assessments can also be
    levied for Florida Citizens and the state insurance guarantee fund. The
    emergency assessment of 1 percent for the FHCF is expected to be in
    place for 6 years.

    [End of section]

    Appendix III: Comments from the National Association of Insurance
    Commissioners:

    NAIC: making progress together:
    National Association Of Insurance Commissioners:

    Executive Headquarters:
    2301 Mcgee Street:
    Suite 800:
    Kansas City Mo 64108-2662:
    Voice 816-842-3600:
    Fax 816-783-8175:

    Government Relations:
    Hall Of The States:
    444 North Capitol St NW:
    Suite 701:
    Washington DC 20001-1509:
    Voice 202-471-3990:
    Fax 202-471-3972:

    Securities Valuation Office:
    48 Wall Street, 6th Floor
    New York NY 10005-2906:
    VOICE 212-398-9000:
    FAX 212-382-4207:
    World Wide Web: www.naic.org:

    October 31, 2007:

    Ms. Orice Williams:
    Government Accountability Office:
    Financial Markets and Community Investment:
    441 G Street, NW, Room 2440-B:
    Washington, DC 20548:

    RE: GAO Study on Changing the Federal Role in Disaster Insurance Dear
    Ms. Williams:

    Thank you for the opportunity to review the GAO's study on the
    possibility of changing the role of the Federal Government related to
    disaster insurance.

    The review of the study was conducted by several senior staff at the
    NAIC. The NAIC staff found that the approach taken by the GAO was
    thorough and identified several possibilities for Congress to consider.
    The NAIC staff was pleased that the GAO decided to outline the
    advantages and disadvantages of each rather than giving its opinion as
    to a single outcome.

    There are seven distinct proposals considered by the GAO in its study.
    The GAO has done an admirable job of evaluating the public policy
    aspects of each. Since the project was undertaken, the NAIC has become
    aware of two more possibilities that deserve some consideration by
    public policymakers. South Carolina Insurance Director Scott Richardson
    has developed a proposal that includes an allocation system for
    determining what portion of a claim should be attributed to flood and
    what portion should be attributed to wind. Since this proposal would
    involve changes to the National Flood Insurance Program, we believe it
    deserves to be mentioned. In addition, state insurance regulators heard
    from representatives of the Travelers regarding a proposed coastal zone
    plan involving the creation of a Federal entity to oversee property
    insurance rates in the coastal zone. While regulators were generally
    not enthusiastic about the Travelers proposal, it should be mentioned
    as a possibility for study regarding its advantages and disadvantages.

    One final point should also be made. There are often allegations that
    some state insurance regulators are involved in rate suppression. Some
    statements along this line occur in the GAO study. They are all
    properly attributed by the GAO. Those who allege that regulators are
    suppressing rates often assume that insurance industry actuaries have
    perfect information about the pricing of risk. They assume if a
    regulator does not grant the industry filer all that was requested in a
    rate filing, the regulator is involved in rate suppression.

    Regulators have found wide differences of opinion among the several
    risk modelers that assist insurers with the development of the
    estimated future catastrophe loss costs. If an industry actuary selects
    a higher priced option among the modelers and the regulatory actuary
    disagrees, the regulator is labeled a rate suppressor. Since reasonable
    actuaries can and do have different opinions about the correct answer
    when it comes to pricing insurance products, particularly when covering
    perils subject to catastrophe losses, we wanted to caution readers of
    this report so they could avoid falling into the trap of assuming that
    there is widespread rate suppression by state insurance regulators.

    Sincerely,

    Signed by:

    Catherine J. Weatherford:
    NAIC Executive Vice President and Chief Executive Officer:

    cc:
    Patrick S. Dynes, GAO:
    Lawrence D. Cluff, GAO:
    Philip J. Curtin, GAO:

    [End of section]

    Appendix IV: GAO Contact and Staff Acknowledgments:

    GAO Contact:

    Orice M. Williams, (202) 512-8678 or williamso@gao.gov:

    Staff Acknowledgments:

    In addition to the person named above, Lawrence D. Cluff, Assistant
    Director; Joseph A. Applebaun, Patrick S. Dynes; Philip J. Curtin;
    Carrie Watkins; John P. Forrester; Emily R. Chalmers; Thomas J. McCool,
    Marc W. Molino; David S. Dornisch; and Tania L. Calhoun made key
    contributions to this report.

    [End of section]

    Related GAO Products:

    [End of section]

    Federal Insurance:

    National Flood Insurance Program: Preliminary Views on FEMA's Ability
    to Ensure Accurate Payments on Hurricane-Damaged Properties. GAO-07-
    991T. Washington, D.C.: June 12, 2007.

    Climate Change: Financial Risks to Federal and Private Insurers in
    Coming Decades Are Potentially Significant. GAO-07-285. Washington,
    D.C.: March 16, 2007.

    Definitions of Insurance and Related Information. GAO-06-424R.
    Washington, D.C.: February 23, 2006.

    Federal Emergency Management Agency: Improvements Needed to Enhance
    Oversight and Management of the National Flood Insurance Program. GAO-
    06-119. Washington, D.C.: October 18, 2005.

    Crop Insurance: Actions Needed to Reduce Program's Vulnerability to
    Fraud, Waste, and Abuse. GAO-05-528. Washington, D.C.: September 30,
    2005.

    Catalogue of Federal Insurance Activities. GAO-05-265R. Washington,
    D.C.: March 4, 2005.

    Catastrophe Risk: U.S. and European Approaches to Insure Natural
    Catastrophe and Terrorism Risks. GAO-05-199. Washington, D.C.: February
    28, 2005.

    Catastrophe Insurance Risks: Status of Efforts to Securitize Natural
    Catastrophe and Terrorism Risk. GAO-03-1033. Washington, D.C.:
    September 24, 2003.

    Catastrophe Insurance Risks: The Role Risk-Linked Securities and
    Factors Affecting Their Use. GAO-02-941. Washington, D.C.: September
    24, 2002.

    Insurers' Ability to Pay Catastrophe Claims. GAO/GGD-00-57R.
    Washington, D.C.: February 8, 2000.

    Budget Issues: Budgeting for Federal Insurance Programs. GAO/AIMD-97-
    16. Washington, D.C.: September 30, 1997.

    Natural Disaster Insurance: Federal Government's Interests
    Insufficiently Protected Given Its Potential Financial Exposure. GAO-T-
    GGD-96-41. Washington, D.C.: December 5, 1995.

    Federal Disaster Insurance: Goals Are Good, but Insurance Programs
    Would Expose the Federal Government to Large Potential Losses. GAO/T-
    GGD-94-153. Washington, D.C.: May 26, 1994.

    Flood Insurance: Financial Resources May Not Be Sufficient to Meet
    Future Expected Losses. GAO/RCED-94-80. Washington, D.C.: March 21,
    1994.

    Property Insurance: Data Needed to Examine Availability, Affordability,
    and Accessibility Issues. GAO/RCED-94-39. Washington, D.C.: February 9,
    1994.

    Crop Insurance: Federal Program Faces Insurability and Design Problems.
    GAO/RCED-93-98. Washington, D.C.: May 24, 1993.

    Crop Insurance: Program Has Not Fostered Significant Risk Sharing by
    Insurance Companies. GAO/RCED-92-25. Washington, D.C.: January 13,
    1992.

    Disaster Assistance: Crop Insurance Can Provide Assistance More
    Effectively Than Other Programs. GAO/RCED-89-211. Washington, D.C.:
    September 20, 1989.

    Congress Should Consider Changing Federal Income Taxation of the
    Property/Casualty Insurance Industry. GAO/GGD-85-10. Washington, D.C.:
    March 25, 1985.

    Federal Disaster Assistance:

    Gulf Coast Rebuilding: Observations on Federal Financial Implications.
    GAO-07-1079T. Washington, D.C.: August 2, 2007.

    Gulf Coast Rebuilding: Preliminary Observations on Progress to Date and
    Challenges for the Future. GAO-07-574T. Washington, D.C.: April 12,
    2007.

    Small Business Administration: Additional Steps Needed to Enhance
    Agency Preparedness for Future Disasters. GAO-07-114. Washington, D.C.:
    February 14, 2007.

    Hurricanes Katrina and Rita: Unprecedented Challenges Exposed the
    Individuals and Households Program to Fraud and Abuse; Actions Needed
    to Reduce Such Problems in Future. GAO-06-1013. Washington, D.C.:
    September 27, 2006.

    Catastrophic Disasters: Enhanced Leadership, Capabilities, and
    Accountability Controls Will Improve the Effectiveness of the Nation's
    Preparedness, Response, and Recovery System. GAO-06-618. Washington,
    D.C.: September 6, 2006.

    Disaster Relief: Governmentwide Framework Needed to Collect and
    Consolidate Information to Report on Billions in Federal Funding for
    the 2005 Gulf Coast Hurricanes. GAO-06-834. Washington, D.C.: September
    6, 2006.

    Small Business Administration: Actions Needed to Provide More Timely
    Disaster Assistance. GAO-06-860. Washington, D.C.: July 28, 2006.

    Federal Disaster Assistance: What Should the Policy Be? PAD-80-39.
    Washington, D.C.: June 16, 1980.

    [End of section]

    Footnotes:

    [1] According to the Insurance Information Institute, the term
    "catastrophe" is often used in the property and casualty insurance
    industry in a narrow way to mean a catastrophic event that exceeds a
    dollar threshold in claims payouts, which is now set at $25 million in
    insured damage to property.

    [2] GAO, Climate Change: Financial Risks to Federal and Private
    Insurers in Coming Decades Are Potentially Significant, GAO-07-285
    (Washington, D.C.: Mar. 16, 2007). Property insurance covers losses
    from damage to real estate and personal property because of perils such
    as wind or earthquake. Casualty insurance covers liability or loss
    resulting from an accident.

    [3] "Insurance" is a practical method of handling a major risk. It is
    the pooling of potential losses by transferring the risk to insurers
    that agree to indemnify those they insure against such losses.

    [4] See Justin R. Pidot, "Coastal Disaster Insurance In the Era of
    Global Warming: The Case for Relying on the Private Market," Georgetown
    Environmental Law & Policy Institute (Washington, D.C.: 2007); and
    Wharton Risk Center Extreme Events Project, University of Pennsylvania,
    Managing Large-Scale Risks in a New Era of Catastrophes: The Role of
    the Private and Public Sectors in Insuring, Mitigating and Financing
    Recovery from Natural Disasters in the United States, Report on Phase
    One of the Study (Philadelphia, Penn.: February 2007).

    [5] "Moral hazard" is an increase in the probability of loss that could
    be caused by the behavior of the policyholder. For example, providing
    insurance protection to an individual may lead that person to behave
    more carelessly than before.

    [6] "Adverse selection" occurs when insurers cannot distinguish between
    less risky and more risky properties, although homeowners can. When
    premiums do not reflect differences in risk that are known to potential
    policyholders, those who buy insurance are often at greatest risk for
    the hazards covered. Adverse selection in the market for natural
    catastrophe suggests that homeowners who are at the highest risk of
    experiencing a natural catastrophe will buy available insurance.

    [7] National Oceanic and Atmospheric Administration, Population Trends
    Along the Coastal United States: 1980-2008 (Washington, D.C.: September
    2004). We checked numerous sources for more recent data on this
    subject, but this document contained the best available data.

    [8] Population Trends Along the Coastal United States (September 2004).
    We checked numerous sources for more recent data on this subject, but
    this document contained the best available data.

    [9] Karen M. Clark, "The Coastline at Risk: Estimated Insured Value of
    Coastal Properties," AIR Worldwide Corporation. We checked numerous
    sources for more recent data on this subject, but this document
    contained the best available data.

    [10] "Surplus lines" refers to any type of insurance for which there is
    no available market within a state and which the state allows
    nonadmitted insurers to offer. A "nonadmitted" insurer is not licensed
    to do standard business in the state.

    [11] Martin F. Grace, Robert W. Klein, and Zhiyong Liu, "Increased
    Hurricane Risk and Insurance Market Responses," Journal of Insurance
    Regulation, vol. 24, no. 2 (Winter 2005).

    [12] Pub. L. No. 79-5, ch. 20, 59 Stat. 33 (1945) codified as amended
    at 15 U.S.C. �� 1011-1015. See also GAO, Ultimate Effects of McCarran-
    Ferguson Federal Antitrust Exemption on Insurer Activity Are Unclear,
    GAO-05-816R (Washington, D.C.: July 28, 2005).

    [13] "Underwriting" refers to the process of selecting and classifying
    applicants for insurance. See George E. Rejda, Principles of Risk
    Management and Insurance, 9TH ed. (Boston, Mass.: Addison Wesley,
    2005), 587.

    [14] GAO, Federal Disaster Insurance: Goals Are Good, But Insurance
    Programs Would Expose the Federal Government to Large Potential Losses,
    GAO/T-GGD-94-153 (Washington, D.C.: May 26, 1994). This report provided
    an analysis of S. 1350, 103RD Congress (1993), which would have set up
    three interrelated programs--a multihazard disaster mitigation program,
    a primary insurance program for earthquakes and volcanic eruptions, and
    a reinsurance program to limit insurer losses when a major disaster
    strikes.

    [15] The federal government operates at least 135 different programs
    that provide insurance-like benefits to individuals and businesses. See
    Council of Economic Advisors, Economic Report of the President
    (Washington, D.C.: Feb. 13, 2007). See also GAO, Catalogue of Federal
    Insurance Activities, GAO-05-265R (Washington, D.C.: Mar. 4, 2005).

    [16] Section 408 of the Robert T. Stafford Disaster Relief and
    Emergency Assistance Act, 42 U.S.C. � 5174, is the general authority
    for the President to provide assistance to individuals and households.
    Until the 1950s, the federal government assisted Americans harmed by
    disasters only occasionally on an ad hoc basis. Prior to then,
    policymakers did not typically view disaster relief as an ongoing
    federal responsibility. See David A. Moss, When All Else Fails:
    Government as the Ultimate Risk Manager, (Cambridge, Mass.: Harvard
    University Press, 2002), 260-267.

    [17] 7 U.S.C. � 1508(e).

    [18] 7 U.S.C. � 1508(e).

    [19] Previous studies have shown that 50 to 60 percent of single-family
    homes in special flood hazard areas are subject to the mandatory
    purchase requirement. Estimating the percentage of homes complying with
    the mandatory purchase requirement is difficult because of uncertainty
    about whether a home has a mortgage and whether that mortgage is
    subject to the mandatory purchase requirements. See Lloyd Dixon, Noreen
    Clancy, Seth A. Seabury, and Adrian Overton, The National Flood
    Insurance Program's Market Penetration Rate: Estimates and Policy
    Implications (Santa Monica, Calif.: RAND Corporation, 2005).

    [20] 13 C.F.R. � 123.5.

    [21] For further information about the CDBG program, see GAO, Community
    Development Block Grants: Program Offers Recipients Flexibility but
    Oversight Can Be Improved, GAO-06-732 (Washington, D.C.: July 28,
    2006).

    [22] GAO, Gulf Coast Rebuilding: Preliminary Observations on Progress
    to Date and Challenges for the Future, GAO-07-574T (Washington, D.C.:
    Apr. 12, 2007).

    [23] The FWUA was created by statute in 1970 to provide windstorm and
    hail coverage to high-risk areas of Florida. The JUA was created in
    December 1992 in the wake of the capacity crisis that followed
    Hurricane Andrew and provided residential multiperil insurance
    coverage, excluding wind coverage if the property was within FWUA-
    eligible areas.

    [24] Howard Kunreuther and Richard J. Roth, Sr., eds., Paying the
    Price: The Status and Role of Insurance Against Natural Disasters in
    the United States (Washington, D.C.: Joseph Henry Press, 1998).

    [25] Kunreuther and Roth, Paying the Price.

    [26] 7 U.S.C. �1508(e).

    [27] Specifically, for 55 percent coverage, the premium subsidy rate is
    64 percent; for 65 percent coverage, the premium subsidy rate is 59
    percent; for 75 percent coverage, the premium subsidy is 55 percent;
    and, for 85 percent coverage, the premium subsidy is 38 percent.

    [28] A "loss ratio" is calculated as claims paid divided by total
    premiums collected.

    [29] GAO, Crop Insurance: Actions Needed to Reduce Program's
    Vulnerability to Fraud, Waste, and Abuse, GAO-05-528 (Washington, D.C.:
    Sept. 30, 2005).

    [30] GAO, Federal Emergency Management Agency: Improvements Needed to
    Enhance Oversight and Management of the National Flood Insurance
    Program, GAO-06-119 (Washington, D.C.: Oct. 18, 2005); Flood Insurance:
    Financial Resources May Not Be Sufficient to Meet Future Expected
    Losses, GAO/RCED-94-80 (Washington, D.C.: Mar. 21, 1994); Effect of
    Premium Increases on Achieving the National Flood Insurance Program's
    Objectives, GAO/RCED-83-107 (Washington, D.C.: Feb. 28, 1983); and
    GAO's High-Risk Program, GAO-06-497T (Washington, D.C.: Mar. 15, 2006).

    [31] Statement of Donald B. Marron, Acting Director of the
    Congressional Budget Office, "The Budgetary Treatment of Subsidies in
    the National Flood Insurance Program," before the Committee on Banking,
    Housing, and Urban Affairs of the U.S. Senate (Jan. 25, 2006), 1.

    [32] Legislation passed in May 2006 required Florida Citizens to charge
    rates sufficient to purchase a certain amount of reinsurance, but this
    requirement was repealed by the January 2007 legislation.

    [33] Section 2210.359(a) and (b) of the Texas Insurance Code.

    [34] Policyholders' "surplus" is the difference between an insurer's
    assets and its liabilities.

    [35] Center on Federal Financial Institutions, "National Flood
    Insurance Program" (Washington, D.C.: Sept. 25, 2006). See also FEMA,
    "Significant Flood Events, 1978-May 31, 2007," available at [hyperlink,
    http://www.fema.gov/business/nfip/statistics/sign1000.shtm].

    [36] Fitch Ratings, "Citizens Property Insurance Corporation-High Risk
    Account" (New York, NY: May 26, 2006).

    [37] Standard & Poor's, "Florida Hurricane Catastrophe Fund Finance
    Corp.-Florida Hurricane Catastrophe Fund" (New York, NY: July 7, 2006).

    [38] Mississippi Windstorm Underwriting Association, "Accounting Report
    for Year Ended December 31, 2005" (Mar. 1, 2006).

    [39] Fitch Ratings, "Louisiana Citizens Property Insurance Corporation"
    (New York, NY: Apr. 11, 2006).

    [40] The most popular coverage for crop insurance is 70 percent of
    average yield. See Congressional Research Service, "Agricultural
    Disaster Assistance" (Washington, D.C.: Oct. 6, 2006).

    [41] Florida Governor's Property and Casualty Insurance Reform
    Committee, "Interim Report and Recommendations" (Nov. 16, 2006),
    available at [hyperlink, http://www.floir.com].

    [42] Mississippi Code, � 83-34-9.

    [43] U.S. Department of Housing and Urban Development, Office of Policy
    Development and Research, "Current Housing Unit Damage Estimates:
    Hurricanes Katrina, Rita, and Wilma" (Washington, D.C.: Feb. 12, 2006).
    We asked the insurance departments in several states whether they could
    provide information on the numbers of uninsured and underinsured
    homeowners, but they were unable to do so.

    [44] Federal disaster assistance is sometimes cited as a reason
    homeowners do not purchase natural catastrophe insurance. However, some
    studies have suggested that individuals may not anticipate receiving
    any federal aid following a disaster. See Howard Kunreuther, "Has the
    Time Come for Comprehensive Disaster Insurance?" in On Risk and
    Disaster: Lessons from Hurricane Katrina, ed. Ronald J. Daniels, and
    others, (Philadelphia, Penn.: University of Pennsylvania Press, 2006),
    175-201.

    [45] Federally insured or regulated lenders must require flood
    insurance as a condition of extending a mortgage in SFHAs.

    [46] Howard Kunreuther and Mark V. Pauly, "Neglecting Disaster: Why
    Don't People Insure Against Large Losses?" Journal of Risk and
    Uncertainty, vol. 28, no. 1 (January 2004), 5-21.

    [47] Risa Palm and Michael Hodgson, After a California Earthquake:
    Attitude and Behavior Change, University of Chicago Research Papers
    (Chicago, Ill.: 1992); and Paul Slovic, The Perception of Risk (London,
    England: Earthscan, 2000).

    [48] Dwight M. Jaffee, "Commentary," Federal Reserve Bank of St. Louis
    Review (July/August 2006), 381-85.

    [49] Making estimates of the number of homes in SFHAs that have flood
    insurance is difficult because it can be hard to determine whether a
    home has a mortgage and whether a mortgage is subject to the mandatory
    purchase requirement. See Dixon, Clancy, Seabury and Overton, The
    National Flood Insurance Program's Market Penetration Rate.

    [50] This contract language is also known as the "coinsurance clause,"
    which is a contractual provision that requires a property owner to
    insure the property for a stated percentage of its insurable value. The
    fundamental purpose of coinsurance is to achieve rate equity.
    Policyholders who meet the coinsurance requirement are not penalized at
    the time of loss, and the policyholder who is underinsured (i.e.,
    maintains insurance limits that are less than 80 percent of the
    replacement cost of the dwelling) is penalized.

    [51] To provide some coverage for the costs of rebuilding to new codes,
    Insurance Services Organization Form HO-3 was revised in 1994 to
    provide "ordinance and law" coverage of up to 10 percent of the
    coinsurance provision replacement cost.

    [52] On May 25, 2007, Congress approved an additional $3.4 billion in
    emergency appropriations to FEMA for disaster relief from Hurricane
    Katrina. See Pub. L. No. 110-28, 121 Stat. 169 (May 25, 2007).

    [53] The maximum amount is adjusted annually to reflect changes in the
    Consumer Price Index.

    [54] GAO, Hurricanes Katrina and Rita Disaster Relief: Improper and
    Potentially Fraudulent Individual Assistance Payments Estimated to Be
    between $600 Million and $1.4 Billion, GAO-06-844T (Washington, D.C.:
    June 14, 2006); Hurricanes Katrina and Rita: Unprecedented Challenges
    Exposed the Individuals and Households Program to Fraud and Abuse;
    Actions Needed to Reduce Such Problems in Future, GAO-06-1013
    (Washington, D.C.: Sept. 27, 2006); Hurricanes Katrina and Rita
    Disaster Relief: Continued Findings of Fraud, Waste, and Abuse, GAO-07-
    252T (Washington, D.C.: Dec. 6, 2006); and Hurricanes Katrina and Rita
    Disaster Relief: Continued Findings of Fraud, Waste, and Abuse, GAO-07-
    300 (Washington, D.C.: Mar. 15, 2007).

    [55] GAO, Small Business Administration: Actions Needed to Provide More
    Timely Disaster Assistance, GAO-06-860 (Washington, D.C.: July 28,
    2006); and Small Business Administration: Agency's Response to Gulf
    Coast Hurricanes Highlights Need to Enhance Preparedness for Future
    Disasters, GAO-07-114 (Washington, D.C.: Feb. 14, 2007).

    [56] The total emergency appropriation to HUD was $17.099 billion, and
    $16.7 billion of that amount was made available to the CDBG program.

    [57] Pursuant to federal statute, homeowner assistance provided by
    these funds may not duplicate benefits derived from any other source
    received by the homeowner as a result of damages incurred during the
    hurricanes. Thus, the granting of CDBG funds to a homeowner cannot
    duplicate insurance, FEMA, or other payments received by the homeowner.

    [58] Mississippi established a second phase of its program that offers
    grants of up to $100,000 to eligible homeowners.

    [59] GAO, The Nation's Long-Term Fiscal Outlook, August 2007 Update:
    Despite Recent Improvement in the Annual Deficit, Federal Fiscal Policy
    Remains Unsustainable, GAO-07-1261R (Washington, D.C.: Sept. 28, 2007).

    [60] GAO, State and Local Governments: Persistent Fiscal Challenges
    Will Likely Emerge within the Next Decade, GAO-07-1080SP (Washington,
    D.C.: July 18, 2007).

    [61] Combinations of public policy options could have a different
    overall effect than individual public policy options.

    [62] National Association of Insurance Commissioners, National
    Catastrophe Risk Plan: Creating a Comprehensive National Plan (Kansas
    City, Mo.: Dec. 11, 2006), 4; and Kunreuther "Has the Time Come?" Some
    countries--such as France and Spain--have government programs that
    include multiple perils like earthquake and floods. See GAO,
    Catastrophe Risk: U.S. and European Approaches to Insure Natural
    Catastrophe and Terrorism Risks, GAO-05-199 (Washington, D.C.: Feb. 28,
    2005), 33.

    [63] "Mandatory" can also mean that insurers would be required to offer
    a policy that includes all of the catastrophe perils. However, in this
    public policy option, we mean mandatory purchase by the consumer.

    [64] State governments could also be providers of premium subsidies.

    [65] Experts debate the dollar threshold for insured losses beyond
    which a catastrophe becomes a "megacatastrophe."

    [66] Elements of this proposal are contained in several bills before
    the 110TH Congress, including the Homeowners Insurance Protection Act
    of 2007 (H.R. 91), the Homeowners Protection Act of 2007 (S. 928), and
    the Homeowners Defense Act of 2007 (H.R. 3355).

    [67] See the Homeowners Insurance Availability Act of 2007, H.R. 330,
    110TH Congress. See also Christopher Lewis and Kevin Murdock, "The Role
    of Government Contracts in Discretionary Reinsurance Markets for
    Natural Disasters," The Journal of Risk and Insurance vol. 63, no. 4
    (December 1996).

    [68] "Timing risk," or the smoothing out of cash flows, is a
    significant issue for the insurance industry. Insurance ventures need
    to be able to pay annual losses out of annual premiums. It is unclear
    whether the capital of the insurance industry, or even a subset of the
    industry, would be sufficient at a given point in time to meet the
    demands of a major catastrophe. Given its taxing and borrowing
    authority, the federal government has an advantage in bearing the
    timing risk associated with disasters.

    [69] This proposal was initially developed by an NAIC committee and is
    reflected in the Policyholder Disaster Protection Act of 2005, H.R.
    2668, 109th Congress.

    [70] A "property casualty company loss reserve" is an accounting entry,
    a liability on the balance sheet, for the amount of money the company
    expects to pay out in the future to cover indemnity payments that will
    come due on policies already written for losses that have already been
    incurred and the costs of dealing with the associated claims. Loss
    reserves do not reflect the pattern of future claims payments. Premium
    payment funds that cannot be put into loss reserves must be treated as
    underwriting profits.

    [71] Omnibus Coastal Property Insurance Reform Act of 2007, South
    Carolina Act No. 78 (June 11, 2007).

    [72] Catastrophe bonds are risk-based securities that pay relatively
    high interest rates and provide insurance companies with a form of
    reinsurance to pay catastrophe losses, such as those caused by a major
    hurricane. They allow insurance risk to be sold to institutional
    investors in the form of bonds, thus spreading risk.

    [73] GAO, Catastrophe Insurance Risks: The Role of Risk-Linked
    Securities and Factors Affecting Their Use, GAO-02-941 (Washington,
    D.C.: Sept. 24, 2002); Catastrophe Insurance Risks: Status of Efforts
    to Securitize Natural Catastrophe and Terrorism Risks, GAO-03-1033
    (Washington, D.C.: Sept. 24, 2003); and Catastrophe Risk: U.S. and
    European Approaches to Insure Natural Catastrophe and Terrorism Risks,
    GAO-05-199 (Washington, D.C.: Feb. 28, 2005). Asset-backed securities,
    for example, are backed by loans or accounts receivable originated by
    banks, credit card companies, or other providers of credit.

    [74] The first catastrophe bond is a $4 billion principle at-risk
    variable rate note issued by Merna Re for the ultimate benefit of State
    Farm Insurance Company. It transfers a portion of State Farm's risk of
    natural catastrophe losses in the United States and Canada, including
    hurricane, earthquake, tornado, hail, winter storm, and brush fire. The
    second catastrophe bond is a $2 billion principle at-risk variable rate
    note issued by Willow Re for the ultimate benefit of Allstate Insurance
    Company. The first issuance under this bond is a $250 million tranche
    that covers hurricane risk in New York, New Jersey, and Connecticut.

    [75] National Association of Insurance Commissioners, Catastrophe
    Insurance (C) Working Group, "The Utah Catastrophe Insurance Plan"
    (June 3, 2007).

    [76] Property taxes are not deductible in all tax situations--for
    example, with the alternative minimum tax. This proposal would require
    changes in tax law if the intention is for property taxes related to
    catastrophe perils to be deductible in all situations.

    [77] GAO, Gulf Coast Rebuilding: Preliminary Observations on Progress
    to Date and Challenges for the Future, GAO-07-574T (Washington, D.C.:
    Apr. 12, 2007).

    [78] Legislation passed in early 2007 permits Florida Citizens to issue
    multiperil policies in the HRA.

    [79] These are the "effective" commission rates as related to the total
    policy premium. The stated rates exclude certain components of the
    premium and are lower rates.

    [80] In March 2007, Fitch Ratings issued a Negative Ratings Watch on
    Louisiana Citizens and the bond offering because of computer problems
    experienced by Louisiana Citizens making it difficult for it to
    retrieve financial data for 2005 and 2006. More recently, an official
    at Louisiana Citizens told us that the problems were being resolved,
    and that the Negative Ratings Watch had been lifted.

    [81] In 2007, the Mississippi Legislature passed House Bill 1500, "the
    Mississippi Economic Growth and Redevelopment Act of 2007," which
    changed the structure of the Mississippi Windstorm Underwriting
    Association. We attempted to reflect certain changes instituted by the
    bill in this section.

    [82] Section 2210.359(a) and (b) of the Texas Insurance Code.

    [End of section]

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