In the aftermath of a disaster, most people immediately think of the government as being the source of recovery assistance. However, government assistance is actually quite limited and focuses primarily on the immediate need for temporary repairs. The true funding for disaster recovery comes from the insurance industry.
The concept of insurance is relatively simple. Policy holders pay into a fund that is then reinvested by the insurance company to increase the size of the fund and generate a profit for the company. As needed, people affected by a disaster are paid from the fund. The assumption is, of course, that the number of people paying into the fund will always exceed those taking out and that there will always be sufficient liquidity in the fund to pay claims and generate profit.
But what if the system starts to fail? A policy analysis by the Cato Institute shows that U.S. insurance losses from natural catastrophes went from $16.1 billion in 2003 up to $71.3 billion in 2012. In 2012, the combination of Hurricane Sandy and drought meant that more than 90% of the worldwide insured losses occurred in the United State (the normal average is about 65%). Increasing population density and property values mean that the cost of disasters will continue to increase.
Insurance companies react to these rising costs in several ways. The most obvious is to raise premiums, either by increasing the cost for policies in general or by raising rates for those who have filed a claim. Depending on which state you live in, the cost of filing a single claim can increase your policy cost by 9% to over 30%.
Anyone who has ever filed a claim of any sort knows that another method of reducing costs is to limit the amount paid on the claim. Insurance adjusters are very adept at quick settlements and requiring extensive inventories and documentation that are difficult to produce before paying out claims.
More disconcerting, however, is the decision not to insure against loss in the first place. Following one of the worst fires seasons on record here in California, a number of homeowners have begun to receive letters of non-renewal due to “unacceptable risk for wildfire.” Insurance companies cannot discriminate in providing coverage and must request rate increases but they are allowed to dictate the conditions under which they will ensure your home.
California homeowners do have a number of protections provided by law, including an insurer of last resort in the California Fair Plan, but the increasing costs of natural disasters will inevitable result in a change in how insurance is traditionally provided. We may well see the emergence of a new form of insurance, possibly one dependent on government. The California Earthquake Authority and the National Flood Insurance Program were created to address risks that insurance companies were unwilling to underwrite. Following September 11th, the Terrorism Risk Insurance Act of 2002 created a temporary reinsurance program to help subsidize private sector insurance. Clearly, though, things cannot continue as they are without an increasingly heavy burden falling on the individual homeowner.