The case for national disaster insurance

By Liz Pulliam Weston

The disaster insurance system in the U.S. is broken. It's time we fixed it.

What happened on the Gulf Coast after Hurricane Katrina is a story that should be threadbare in the retelling: A huge but not unpredictable disaster strikes. Homeowners discover too late they're not covered, or not covered enough. Insurers who misjudged their risk balk at paying claims. Regulators make a show of cracking down on the industry, when their power to change anything is extremely limited.

Then a few folks, from all parts of the political spectrum, mention that there might be a better way: federal disaster insurance. But their voices are quickly drowned out by a flood of disaster aid and by assurances from the insurance industry that the system's working just fine, thank you.

So we limp along until the next Big One, and the whole dance starts again.

The problems

Here are some of the problems with the way we handle insurance today:

Insurers get to cherry-pick their risks. The insurance industry long ago decided floods were too unpredictable and expensive, which is why your homeowners policy doesn't cover them. A similar conclusion was reached about earthquakes after the 1994 Northridge temblor in California. People living along the coast in the Southeast often can't get hurricane coverage from their regular insurers. In many states, people who live near wooded or wilderness areas can't get any coverage at all and are relegated to high-cost, government-run insurance pools. This patchwork approach leaves too many people confused about their coverage and unaware that they may be at risk.

Even then, insurers get it wrong. After every major disaster, you see insurers either abandoning affected states or severely cutting back the number of policies they issue because they miscalculated the risks. Ten insurers went bankrupt after Hurricane Andrew in 1992. Many more stopped writing policies in Florida. All of the major insurers bailed on California after Northridge, and they started writing new business only after the state ended its requirement that they provide earthquake coverage. Allstate is no longer writing policies for California homeowners at all, and the nation's largest insurers have pulled out of Gulf Coast and Eastern Seaboard states. Homeowners wind up whipsawed, losing their coverage and scrambling to find some kind of (costly) replacement.

The coverage that's available is too costly. If you can't get disaster coverage from your regular insurer, your alternative typically is to buy from a high-risk pool, where the policies are limited and often expensive. Wind-damage coverage from Florida's high-risk pool, for example, averages about $1,700 a year. Flood premiums can exceed $1,000 for the largest policy, which is only $250,000 (and many things, like basements and living expenses, aren't included). The standard earthquake policy provided by the California Earthquake Authority comes with a 15% deductible, which means that if rebuilding your house costs you $300,000 (probably on the low end for a high-cost state), the first $45,000 comes out of your own pocket. Hurricane deductibles aren't as stiff, but still are formidable at 2% to 5%.

Most people won't buy disaster coverage if they have a choice. Even in the highest-risk flood plains, only one in four homeowners buys flood insurance. Fewer than one in seven California homeowners has earthquake coverage. Many people figure that they'll get government grants to rebuild, or at least a low-cost loan. The fewer people who buy the coverage, the more concentrated the risks and the more expensive the premiums. Of course, the more expensive the premiums, the fewer people who buy the coverage, leading to a vicious cycle of ever-rising costs for a shrinking number of covered homeowners.

Federal aid is a powerful disincentive. Put in its simplest terms, people don't want to be chumps. They see the feds helping people rebuild after every major disaster even as the insured fight with their companies to get claims paid. Why, folks wonder, should they pay premiums for insurance they might never need or get when the government is there to bail them out?

There has to be insurance

There are plenty of problems with this viewpoint -- most insurers pay up as agreed, and most federal aid to homeowners is in the form of loans, not grants; having cash from an insurer is a heck of a lot better than having another loan to repay. Furthermore, the disaster that affects you might not be widespread enough for you to be eligible for any aid.

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