“For we are all, like swimmers in the sea,
Poised on the top of a huge wave of fate,
Which hangs uncertain to which side to fall,
And whether it will heave us up to land,
Or whether it will roll us out to sea,
We know not, and no search will make us know,
Only the event will teach us in it’s hour.”
Mathew Arnold, Sohrab and Rustum
The above quote came to mind as I watched the latest hearing of the Connecticut Legislature’s Task Force on Sea Level Rise and Preserving Long Island Sound, dealing specifically with changes in the Biggert-Waters Flood Insurance Reform Act and its collateral damage to shoreline real estate. Yes, I’m referring to Biggert Waters, not Storm Sandy.
The Task Force, under the leadership of Rep. James Albis, has done a commendable and thorough job to date striving to understand the environmental and economic challenges facing the Connecticut shoreline, and hearing from as diverse a collection of stakeholders as possible. The January 15th hearing endeavored to get a handle on one of the most challenging issues in the portfolio: flood insurance. Much useful perspective was gathered, but through it all was a thread of magical thinking that somehow the Private Sector might intervene to make this all…better…if not good.
The hearing began with a presentation by George Bradner, Director of the Property and Casualty Division of the Connecticut Insurance Department, providing a summary of Biggert Waters provisions and a review of insurance loss history over the past forty years.
He noted that since 1978, $468 million in flood insurance premiums were collected in Connecticut, against which $484 million in claims have been filed, resulting in a loss ratio of 103% for the period. But if you take out Sandy’s contribution of $244 million in claims, the loss ratio improves to 54%, and might attract private sector insurers.
…or gamblers posing as insurers who believe that Sandy was a one-off.
As Mr. Bradner correctly notes, insurers must make money over the long-term in order to absorb those infrequent but catastrophic events that are an inherent part of the insurance industry’s raison d’etre. But it has been precisely those events that have caused insurers to retreat to safer grounds in other property and casualty lines outside of flood insurance. So why are he and others at the hearing hopeful that the private sector can be seduced into filling the coverage gap, or the affordability gap?
Well, because a couple of firms in Florida and Connecticut and other states in the Excess and Surplus markets have tip-toed into the flood insurance market to compete with our favorite Uncle. But, as Representative Rosa DeLauro’s representative, Lou Mangini, noted, persons who sign on to such policies face exposure to much higher rates if the private underwriter later chooses to bail, and forces them to go back to NFIP as the insurer of last resort, which is what the government is and does.
So, if I may translate this into the vernacular, There is no free lunch, but we’re still looking and praying. We have potentially lucrative insurance markets that should be of interest to the private sector if we can convince them to ignore the infrequent catastrophic losses that will wipe out their better days. After all, one bad season in thirty-six years ain’t so bad.
But what if the next one comes sooner?
Again, as Mr. Mangini points out, the National Flood Insurance Program was solvent as of 2004, but from then until 2011 it racked up $18 billion in debt…..before Sandy. So, what lesson on the cyclicality of catastrophic loss should the private sector draw from recent history in contemplating its future?
I suspect that the private sector insurance industry will approach flood insurance as it has managed health care. It will cherry-pick the best risks, weed out or abandon the worst, and leave them to the tender mercies of the NFIP and the US taxpayer, who is becoming increasingly unsympathetic in the face of multiple collateral challenges. Following a ‘greater fool than I’ meme so typical in business, the individual players in the insurance industry will collectively contract their market and concentrate their book of risks,…to their detriment. And ours.
That gets us back to affordability and what I referred to as Darwinian Economic Displacement in a prior post. If there is no free lunch, and no private sector sugar daddy, then a lot of folks on the shoreline will find themselves under water, physically and fiscally. One of the functions of insurance is to spread risk not only for themselves but their insureds, and to provide financial liquidity in times of crisis through timely and substantive settlement of claims. But a number of participants, most notably First Selectman Michael Tetreau of Fairfield, noted that it was not merely a case of funding the coverage, but making the mechanisms of claim processing and reconstruction responsive to need. Indeed, Sandy has reminded us that Best intentions are too often not followed by best performance, creating an endurance contest between insured and insurers as challenging as between the insured and the storm itself.
Michael Barbaro, representing the Connecticut real estate industry, but speaking from his own personal professional experience, noted that Biggert-Waters has cast a pall over any shoreline property within flood zones and potentially subject to flood insurance. To a separate comment by Mr. Mangini that the 23 bills currently before Congress are at best short-to-intermediate term solutions, and a long-term solution is not likely for four years at the earliest, Mr. Barbaro stated that such uncertainty for so long will only do further damage to an already fragile market, and by extension to municipal tax bases dependent on that market.
One might infer from that comment that if only the situation of flood insurance can be made more amenable to our wishes and means, things would settle back a little closer to normal. But that ignores the other shoe waiting to fall: what are Mother Nature’s intentions? (My working hypothesis: Mother Nature is a centipede and she’s wearing combat boots. Just my opinion. I could be wrong.)
One of the problems with the premise that modifying Biggert-Waters to our wishes will re-set the clock to better days is this: neither FEMA, nor the NFIP, nor the retail insurance industry are forward looking in their risk assessments. They are fighting the last war. They are looking backward at historical loss data, and not looking forward at possible future trends which may depart materially from recent and long term history. If future events unfold as scientists suggest, both the footprint and financial impact of future storms could escalate significantly. Translation: even today’s premiums may prove insufficient in such event, and much more property could be affected than is presently designated. And, in certain cases, raising structures will prove irrelevant, and a fool’s errand in hindsight.
Among the many pointed observations in this discussion were those offered by Mac McCleary of Connecticut’s Department of Energy and Environmental Protection. He offered that, whatever the defects and imperfections of Biggert-Waters, we would be well advised to view it as the harbinger of things to come, and prepare ourselves. He further urged the chair to engage the reinsurance industry and Connecticut’s wealth of risk assessment expertise to better assess what lies ahead for us.
Mr. McCleary, who is among the more pragmatic executives in the agency, noted that the agency is aggressively studying all suggested avenues of addressing risk exposure and loss remediation; even the half-baked-not-ready-for-prime-time possibilities, because there are no easy, obvious solutions to the multitude of thorny issues confronting us. In other words, to borrow an oft used and overused phrase: ‘no low-hanging fruit’. True statement.
Among the half-baked ideas that are still in the oven and rising is a plan to fund proactive efforts at risk mitigation for home owners and businesses: a $2 million fund intended to provide up to $300,000 per applicant to raise structures or otherwise mitigate risks from storm surge before the fact. A commendable concept, and worthy of expansion. But at $60,000 to $100,000 on average to raise a shoreline residence, the current state funded program would touch at most thirty homes. Milford had eight times that number that might have benefited from the program before Sandy, and many more that survived Sandy, but could become the next debris field with the Son of Sandy. The hope, again, is that the private sector (banks, mortgage companies, insurers) can be induced to join the fund in their enlightened self-interest, expanding its reach and impact. Keep hope alive.
But even Mr. McCleary, the pragmatist, spoke to the hope that the insurance industry might find ‘arbitrage opportunities’ in the market that will invite them in. I would suggest that such opportunities, if they are taken, will be interim advantages to the industry, but of little long-term benefit to property owners and mortgage companies and communities in the long-term in extending coverage or making it more affordable.
* * *
A few observations on the insurance industry.
Most people think of the insurance industry as being in the business of providing risk underwriting and loss financing (claim settlement) services. Not true. Insurance services are a front for the primary business of insurance companies: investing the premiums that are generated. It’s not about risk; it’s about positive cash flow and net return. The P&C business in particular has been historically cyclical, riding the waves of the economy and, yes, environmental cycles of loss that have substantial historical precedent, and therefore a degree of predictability. In fact, many P&C insurers routinely run a modest loss on the underwriting side of the house, but make it up on the investment side of the house, and therefore acquit themselves for the year with a net profit that their shareholders consider acceptable.
And what do insurers invest in? Real Estate, like Miami condos, and Kansas farm land and petrochemical infrastructure, and capital plants in Bangkok, and stocks and bonds of various blue-chips like utilities and agribusiness and home builders and municipalities and all sorts of enterprises whose performance is ultimately dependent upon—the environment. They do so successfully by carefully understanding and balancing HISTORICAL underwriting and economic (investment) cycles, balancing and diversifying their portfolios of underwriting and investment risk in order to dodge, or significantly mitigate, the BIG HIT that could render their corporate logo an artifact in the Corporate Hall of Fame.
The retail insurers, the Travelers and Cignas and All States and State Farms and other street level purveyors of protection, do have a card up their corporate sleeves: reinsurance through such global firms as Swiss Re and Munich Re and the like. The retail insurance trade ‘re-insures’ the policies the retailers sell the public to further dilute the risk they hold on their books. The re-insurers further spread their assumed risks among themselves so that no one of them is left (hopefully, fingers and toes crossed) holding the whole bag of a catastrophic loss, like maybe Fukushima?
In the past ten years of my observation, and probably longer, there has been an interesting divergence of perspective on the subject of environmental (climate change and other) issues. For the most part, the retailers have continued to perceive the CC issues as no different from traditional hazards, and within the competence of their history-oriented statistical tools. The reinsurance industry? Not so sure. ‘We’re gonna need a better business model!’
Because of their global reach and global exposure, and because they backstop their little brothers and sisters of the street trade, reinsurers must take a particularly long long-term perspective, and with good reason. It’s o.k. if Bangkok and much of southeast Asia is getting whacked in a particular year as long as North America and Europe and most other parts of the world are doing business as usual, including paying premiums. But what if the whole world is going toastados at once, And it’s not a cycle, but a trend?
Hence, the reinsurance industry’s quiet but substantive presence in the study of climate change in recent decades, and with good reason. Because reinsurers have global reach, they have global exposure. They, like their little brothers and sisters of the retail street trade, must have deep pockets to endure infrequent but catastrophic losses. Because, unlike their little brothers and sisters, there is no backstop for the reinsurers, except the government, maybe. (AIG, The Sequel?)
I don’t believe the reinsurance community shares the view of their retail brothers and sisters that it’s just another day in underwriting paradise. But they have been discrete and circumspect in expressing their views on climate change to date, even as they study it aggressively. At some point, they will make their views explicit in underwriting standards and rates, and their little brothers and sisters of the street trade will be forced to pay attention, as will we all. Economic gravity, trickle-down if you will, does work. Selectively.
This is why Mac McCleary is right about the Cassandra effect of Biggert-Waters, and overly optimistic about the potential of the private insurance industry to play the role of the cavalry. The private insurance industry will cherry pick its risks and retreat when necessary. At best, it may be the front-end servicer of government-insurer-of-last resort programs, as it currently is for NFIP. But in the intermediate to long-term, the private sector will not add capacity, and will not reduce rates. Because it can’t. At best, it will stimulate economic prioritization of private sector decision-making in defining the risk-reward prospects of personal and commercial investment–Darwinian Economic Displacement.
* * *
As for me, I’ve defined my own personal benchmark for determining when the retail insurance industry and the rest of the FIRE (Finance, Insurance, Real Estate) industry encounter a come-to-reality moment.
There is a distinction that still is not appreciated between properties that are subject to periodic storm flooding, and those that are subject to eventual and permanent routine daily inundation from sea level rise. Intermittent storm flooding may remain insurable for some at some price. But, as I have previously noted, routine inundation probably is not, according to the norms of insurance underwriting (possibility of loss is insurable; certainty of loss is not). However, there is a window of opportunity for insurers relative to properties subject to ultimate inundation in twenty to fifty years. It is conceivable that insurers might write policies (at some price) to protect such properties, and their collateral loans, from premature compromise by sea level rise ahead of projections.
Such a policy would be significant in two respects:
– It would evidence the insurance industry’s acceptance of climate change and a phenomenon (in sea level rise) the consequences of which it has yet to address to my knowledge.
– It will put a time-line to its critical impact, a prerequisite for underwriting the risk.
With the introduction of such a policy, sea level rise and climate change more generally will have transcended the debate of passionate lunies on the left and right, and will be ratified by the most staid of Establishment institutions.
End-game of debate. As for evolving reality, the beat goes on.
Meanwhile, good luck riding the wave, Dude.