Wednesday, January 22, 2014

"The Collins Report"

In 1995, the Florida legislature created the Academic Task Force on Hurricane Catastrophe Insurance and directed the South Florida think-tank, Collins Center for Public Policy, to assist in the endeavor.

The legislature created the Task Force with the following directive (as reported in the final report):
The purpose of the Task Force shall be to comprehensively review the system of Florida residential property insurance markets, the Florida Hurricane Catastrophe Fund, the Florida voluntary residential property insurance market and the international reinsurance market, and make recommendations as to how said system can be best coordinated and/or restructured to meet the following needs: 
    1. To ensure that adequate hurricane catastrophe insurance coverage is available to Florida residents at an affordable price; 
    2. To ensure that in the event of a hurricane catastrophe adequate public and/or private sector insurance and reinsurance is available to pay the claims of Florida residents;
    3. To provide necessary incentives for private insurers and reinsurers to increase residential property underwriting in Florida; and
    4. To ensure that the Florida system of residual residential insurance markets and the Florida Hurricane Catastrophe fund do not act as disincentives for insurers and reinsurers seeking to underwrite residential property insurance.
The result of the $500k ($ 1995) appropriation was the "Final Report by the Academic Task Force on Hurricane Catastrophe Insurance: Restoring Florida's Paradise," or more commonly, the "Collins Report."

The Report outlined 15 policy options intended to work together as components of "A Balanced Equation for Florida's Future" which in turn were intended to produce a "healthy, competitive private insurance market."

The Report then established criteria for identifying a "healthy, competitive private insurance market":
  1. Coverage by financially strong private companies of most of Florida's homeowners for hurricane risks;   
  2. Affordable, competitive rates consisted with widespread coverage of homeowners by private companies;  
  3. Low numbers of the "truly uninsurable" in a single remaining Windstorm JUA; 
  4. A strong Hurricane Catastrophe Fund; and 
  5. Reasonable maximum market shares for any one company in high- risk regions of the state.
Now, there is much that can be said about the way the report turned out.  For instance, a) I'm not entirely convinced that the Task Force responded to legislative objectives; b) The idea of a truly uninsurable is a matter of much opinion and the criterion offers little direction; and c) Given the abundance of economic literature on competitive markets why did the Task Force create their own criteria???

But these are not the points I wish to take up here.

For the breadth of issues and analysis covered by the Collins Report I find it remarkable that the Task Force did not cover nor touch on the pivotal issue of the time- the introduction of catastrophe models for insurance pricing.

The models introduced dramatic changes to the flow, acquisition and availability of information about hurricane risk in the insurance market.  So significant was the issue that in the same year that the Florida legislature created the appropriation for the Task Force it also created the FCHLPM to regulate how, what and when information about the hurricane risk could be used in ratemaking.

Nobel Laureate, Joseph Stiglitz, known for his work on information asymmetry, argued that it is quite common for issues surrounding information to lead to absent or imperfect markets.  Though information flow may result in market power for some it may also come at the expense of social well being.  In his award acceptance speech Stiglitz explained,
One of the arguments for unfettered capital markets was that there were strong incentives to gather information; if one discovered that some stock was more valuable than others thought, if you bought it before they discovered the information, then you would make a capital gain. This price discovery function of capital markets was often advertised as one of its strengths. But the issue was, while the individual who discovered the information a nano-second before any one else might be better off, was society as a whole better off: if having the information a nano-second earlier did not lead to a change in real decisions (e.g. concerning investment), then it was largely redistributive, with the gains of those obtaining the information occurring at the expense of others. 
He continued to explain that this presented an opportunity for the state to intervene and protect the public,
There are potentially other inefficiencies associated with information acquisition. Information can have adverse effects on volatility. And information can lead to the destruction of markets, in ways which lead to adverse effects on welfare. We described earlier how the existence of asymmetries of information can destroy markets. Individuals sometimes have incentives to obtain information (creating an asymmetry of information), which then leads to the destruction of insurance markets, and an overall lowering of welfare. Welfare might be increased if the acquisition of this kind of information could be proscribed. Recently, such issues have become sources of real policy concern, in the arena of genetic testing. Even when information is available, there are issues concerning its use, with the use of certain kinds of information having either a discriminatory intent or effect, in circumstances in which such direct discrimination itself would be prohibited.
By proposing that Florida could have a "healthy, competitive insurance market" without acknowledging that struggles with new information and technology undermined competitive market ideals, the Task Force established a false pretense.

But, what does it matter what is written in a 20 year old report by a now defunct think-tank?

The Florida Catastrophic Storm Risk Management Center at FSU was created by the Florida legislature in 2007 to produce research that amongst other things, "are expected to have an immediate impact on policy and practices related to catastrophic storm preparedness."

The Center uses the Collins Report as a basis for its continued existence and for judging the state of Florida's property insurance market.  Because of the Collins Report shortcomings in addressing the information challenges facing Florida's insurance market it is no wonder that the Center routinely finds Florida as failing to meet the Task Force's criteria of a healthy competitive market.

Furthermore, using the Collins Report in this way narrows the scope of research activity, improved understanding and potential solutions to the challenges facing Florida and its management of catastrophic hurricane risk addressed by the Storm Risk Center.

Overlooking the effect information has on Florida's insurance market leads to research outcomes that consistently stack the deck in favor of those that would rather not go into detail about how the models are used, misused and the extent of uncertainty involved in their production and output.

Omitting of consideration of the role of information in Florida's insurance market failures also overlooks the scope of issues that legislatures were hoping to address with the creation and management of Citizens.

For example, with the roll-out of near term models onto the market in 2006 information asymmetry worsened in Florida because knowledge about the risk became controversial (more on this perhaps some other time).

The following year, during deliberation of the controversial HB1A (which placed Citizens into a competitive position in the marker), Rep. Denise Grimsley, a co-sponsor of the bill, argued that the proposed changes responded to a “competitive disadvantage” policyholders’ had when dealing with their insurance providers due to information asymmetry and industry folly:
Policyholders have too few options, too few protections, and too little information. Today, policyholders no longer stand on a level playing field with their insurers. The purpose of this legislation is to restore balance and common sense to the market
(Hearing recording, House Policy and Budget Council, FL HR, January 17, 2007).
For all the insights and ideas that the Collins Report brought to light it really failed to acknowledge a very important issue facing the Florida insurance market.  Yet, the report continues to have an impact by structuring how researchers evaluate and understand Florida's insurance market.

Ultimately, this restricts the tools available to policy makers to improve conditions.