Monday, February 9, 2015

Ratemaking for North Carolina Hurricanes... just like everyone else


While I am settling in at work and developing a new web site.  I will keep notes here.

Some history:
Back in 1968, Congress passed a ginormous collection of laws better known as the Housing and Urban Development Act of 1968.  Within this stack of legislation were two important insurance items: 1) The National Flood Insurance Program (NFIP) and 2) FAIR plan legislation.

Both of these programs were considered key to ensuring the stability and continued growth of the housing market.  Several flood/hurricane events led insurers to pull out of coastal areas (example Hurricane Betsy).  Also during this time, there was a great amount of civil unrest.  Insurers began 'redlining' or rather pulling out of urban areas considered too high risk for riot (and therefore fire, vandalism, etc).

Collectively, legislators considered this a serious economic problem threatening the ability of a great many homeowners to maintain their mortgage.  Also, any inability to access insurance in certain areas stymied real estate growth in those areas.   The ultimate goal for policymakers was to ensure continued access to "essential property insurance" which included extended coverage (that is, the part of homeowners that covers windstorm).

The compromise between Congress and the States was a federally backed riot reinsurance and state run Fair plans.  The deal was that if a state wanted to partake in the riot reinsurance program then they had to provide Fair Plans which would "make essential property insurance more readily available in, but not necessarily limited to, urban areas."

To exemplify what happens in areas that cannot get insurance take a look at google satellite photos of COBRA zones.  My understanding is that it's not that people can't build in these areas it's that they can't get insurance or federal funding of any kind in these areas.  In general, they remain undeveloped.

This enabled and/or led the way for states to create Joint Underwriting Associations and ultimately, "Beach Plans" or rather, joint underwriting associations that covered legislatively defined coastal areas.  While the statute creating the Riot Reinsurance program expired in or around 1983, the state organized JUAs continued on.

North Carolina still has both a FAIR plan and a beach plan the North Carolina Insurance Underwriting Association (NCIUA).  I'm interested in the latter.

The guiding mandate (STAT. 58-45-1) of the NCIUA is as follows:
It is hereby declared by the General Assembly of North Carolina that an adequate market for essential property insurance is necessary to the economic welfare of the beach and coastal areas of the State of North Carolina and that without such insurance the orderly growth and development of those areas would be severely impeded; that furthermore, adequate insurance upon property in the beach and coastal areas is necessary to enable homeowners and commercial owners to obtain financing for the purchase and improvement of their property; and that while the need for such insurance is increasing, the market for such insurance is not adequate and is likely to become less adequate in the future; and that the present plans to provide adequate insurance on property in the beach and coastal areas, while deserving praise, have not been sufficient to meet the needs of this area. It is further declared that the State has an obligation to provide an equitable method whereby every licensed insurer writing essential property insurance in North Carolina is required to meet its public responsibility instead of shifting the burden to a few willing and public-spirited insurers. It is the purpose of this Article to accept this obligation and to provide a mandatory program to assure an adequate market for essential property insurance in the beach and coastal areas of North Carolina. (emphasis mine)
So, there should be no mistaking that NC has every intent of developing its coastline with property in some way shape or form and the state has taken a leading role in ensuring that coastal risk is spread, shared or otherwise "insured."

It's not that NCIUA causes development.  But, the historical precedent is set that it will not be the cause of limiting property development.  No residual market stemming from this era would.

Some info about NCIUA ratemaking...
NCIUA rating statutes is 58-45-45.  It is really this that I find interesting.  It starts out same old, same old:  "Rates shall not be excessive, inadequate, or unfairly discriminatory. Except as provided in subsections  (a1), (a2), and (b)." (emphasis mine)

I am not fully knowledgeable of rating regulation throughout the nation, but I think the "except" is noteworthy.  For those that think "insurer of last resort" a meaningful battle cry, then this is probably a cherished piece of legislation.  The surcharge ensures that NCIUA can never undercut the regular private market.

Section (a1) is most notable:
The Association's rates shall be the North Carolina Rate Bureau Manual Rates plus a surcharge of five percent (5%) of the applicable North Carolina Rate Bureau Manual Rate for wind and hail coverage and a surcharge of fifteen percent (15%) of the applicable North Carolina Rate Bureau Manual Rate for homeowners' insurance including wind and hail coverage. It is the intent of the General Assembly that these surcharges ensure that the Coastal Property Insurance Pool is the market of last resort over and above the manual rate.
The thing is, and likely reasonably so, the Bureau and the Commissioner still control the basic rate prior to the surcharge.

Even granted the surcharge, we can argue about the underlying rate AND a commissioner or some other can mess around with the coastal rate to make sure the surcharge isn't burdensome- (kinda like what they do in Florida with assessments).

One can see a little of this messing around in the Bureaus' January 2014  to the Insurance Commissioners' order (I believe a request for more information).

There the Bureau discusses their hurricane rate making practices.  They use the AIR model.

Quite comical is the challenge to the scientific integrity of the model.  For instance,
The AIR hurricane model has allegedly been extensively peer reviewed..."  (emphasis  mine).
Really?!  Come on now.  So many other bones to pick with a model and the model decision process then whether or not it is actually peer reviewed.  Most certainly, the model has been peer reviewed and is built on peer reviewed literature.  Now whether that matters for what someone is trying to do or say is a separate issue.

Elsewhere, the Bureau challenges the integrity of John Rollins' review of the model because he
"... is a former employee of AIR making his "independence" somewhat questionable."  
Indeed, he is a former employee, Vice President actually.  But also one of the best in the business on cat models and residual markets.

But, this is of no help in examining the interface of ratemaking and public politics.

Anyway...
While the Bureau plays the very NC card of questioning the legitimacy of the science, they outlines reasoning for all these decisions and they describe all of their own decisions they had to make in determining how best to come up with their rate requests.

For instance, they ran the AIR model using the standard catalog not the warm water catalog.  This seems fairly standard for residual markets but is contrary (and one of the biggest gripes) to the private insurance and reinsurance industry.

The Bureau  also excluded experienced historical losses (kinda of a weird move, I think) from the process of developing rates.  There are a bunch of other decisions too no doubt steeped in expert judgement.

So, just to wrap up...
Despite an effort to keep up appearances about a NCIUA that doesn't run counter to the private market, great effort is put towards ensuring that hurricane insurance rates are 'just so' or rather, just politically acceptable.

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