At that time, for the whole insurance industry, the maximum loss, including the one that a hurricane could cause, was estimated at 8 billion USD.
Andrew brought the situation back into focus. After this natural disaster, all forecasting, pricing and loss estimation models have been readjusted upwards. Insurers and reinsurers reconsidered their coverage needs. The Bermuda market and European reinsurers were called upon to support the American market, which lacked capacity.
Coverage of natural disasters in the U.S: Homeowner's insurance
Coverage for natural disaster [4] is generally included in the comprehensive homeowner's policy. However, in the United States, this optional homeowner insurance policy systematically excludes earthquakes and water damage caused by floods, hurricanes and cyclones from its scope.
The standard homeowner's policy therefore only covers damage caused by wind including tornadoes, cyclones and hurricanes. The damage caused by water following a cyclone is excluded.
The pricing of this guarantee, which has an average ceiling of 100 000 USD, varies according to the type of contract, the value of the insured property and the geographical area.
Flood insurance
In the United States, the water damage coverage exclusion has caused a great deal of harm to hurricane victims, particularly after Katrina and Rita in 2005.
According to the National Flood Insurance Program (NFIP), 90% of all natural disasters in the United States involve flooding.
Despite the frequency and severity of flooding, few Americans are covered against this event. At the federal level, only 27% of households have specific insurance against this risk.
Individuals and businesses wishing to protect themselves against flood damage are no longer required to purchase specific coverage from an insurer or the federal National Flood Insurance Program fund, as was previously the case. In 2019, federal regulators announced a reform requiring regulated financing institutions to accept private flood insurance policies comparable to NFID.
In recent years, insurers have become increasingly comfortable with implementing sophisticated models to underwrite risk, and modeling firms are getting better at predicting flood risk, resulting in more companies covering the risk. Insurance companies can also offer more coverage than FEMA's NFIP policies, which are currently capped at 250 000 USD for residential buildings and 500 000 USD for non residential buildings. In 2020, 58 private companies provided flood insurance. The number of these companies was 41 in 2019.
In the event of a natural disaster in the United States [5], the bulk of losses are covered by the Federal Emergency Management Agency FEMA and the NFIP program.
Premium pricing
The US market is governed by the principle of contractual freedom. As a result, insurance companies have total freedom to set the amount of the premium.
This system has created inequalities between policyholders faced with either a denial of coverage or exorbitant premiums. In high-risk areas, premiums have continued to soar.
In 2021, FEMA updated the National Flood Insurance Program's rating methodology so that policyholders would be able to make decisions that are better suited to their needs and take appropriate preventive measures.
The new methodology allows for an equitable distribution of premiums among all policyholders based on the value of their home and the flood risk specific to their property. The new rating tools incorporate more flood risk variables.
These include flood frequency, different types of flooding (river overflow, storm, coastal erosion and heavy rainfall), distance from a water source and property characteristics such as reconstruction costs.
Reinsurance of natural catastrophes in the U.S
The high volatility of natural catastrophe [6] risk inevitably led to an increased need for reinsurance. It was after the occurrence of Hurricane Andrews in 1992 that foreign reinsurers, particularly those from Bermuda, made a big breakthrough in the U.S. market. Following this unprecedented disaster, American insurers were faced with financial difficulties caused by the large losses they had to deal with.
Currently, the U.S. reinsurance market is strengthening and many U.S. reinsurers have emerged. In 2021, 25 reinsurers have assumed 58 billion USD of losses. Underwriting results within the reinsurance market have been negative for five consecutive years, mainly due to the increase in the frequency and severity of natural disasters in recent years.
The United States governmental coverage programs for natural disasters
To deal with recurring catastrophic risks, the federal government has introduced government programs to provide appropriate coverage to policyholders, individuals and companies.
The Florida Hurricane Catastrophe Fund (FHCF)
The FHCF was created in 1993 after Hurricane Andrew. This disaster, which at the time caused considerable damage, led to the bankruptcy of a dozen insurance companies [7] and caused significant financial problems for some thirty others.
The purpose of the FHCF is to protect the policyholders of the State of Florida and to make reasonably priced insurance products available to them. Fed by Florida's direct insurance companies, the fund acts as a natural catastrophe risk mutual. A portion of the claims is paid by the insurers, with the fund only paying above a certain threshold. As at 31 December 2021, the fund had a capacity of 11.3 billion USD.
The California Earthquake Authority (CEA)
The California Earthquake Authority operates as a non-profit, publicly managed and privately funded entity. This program was established in 1996 by the California authorities following the 1994 Northridge earthquake.
As the primary provider of earthquake coverage for the State's residents, the CEA distributes its products exclusively through private insurers who are members of the program. To date, the program has 25 member insurance companies and over 1 million insured households. The CEA fund manages a capacity of 19 billion USD.
The National Flood Insurance Program (NFIP)
The NFIP is a federal flood insurance program. Established by the U.S. Congress in 1968, this program is managed at the national level by the Federal Emergency Management Agency (FEMA) and is funded by the federal State. The NFIP allows homeowners residing in local communities that are members of the program to purchase flood insurance.
The NFIP provides an alternative to the lack of adequate insurance coverage in many States. Premiums are set according to the severity of the risk at the local level.
For the year 2021, the average annual premium was about 766 USD. However, it can reach thousands of dollars in high flood risk areas. The coverage limit is up to 350 000 USD. At the end of December 2021, the fund had a capacity of 16.6 billion USD and 22 534 local government members. Unfortunately, the NFIP solution is not widely used by all States.
Despite the abundance of capacity in the insurance market, natural catastrophe remains underinsured in the US. The frequency and severity of damage from catastrophic events has increased over the years, and the corresponding economic and insured damages have increased by an average of nearly 5% per year since 1999.