Partners (Summer 1996)
Partners (Summer 1996)
The Cost of Starting Over is Prohibitive for Many
by Jennifer Grier
Hurricane Andrew wrought catastrophic damage on southeastern Florida in 1992 with total costs estimated at $30 billion and $15.5 billion in insurance claims. The property damage inflicted by the hurricane was the worst in American history - quadruple that of any previous calamity. Four years later, the storm's impact on the construction and insurance industries is still being felt by the hundreds of residents trying to rebuild in the area.
Insuring the Risk
In the aftermath of the storm, the insurance industry has had to reevaluate the way it assesses risk in hurricane-prone, coastal areas. The cost to the insurance industry was the largest of any previous natural disaster, causing many Florida insurers to withdraw from the market completely or place caps on the number of new policies written. Eight small Florida insurance companies went out of business when faced with paying huge storm claims.
However, even insurance giants such as Allstate and State Farm greatly reduced their coverage in south Florida. The Florida Depart-ment of Insurance imposed a six-month moratorium from May to November of 1993 on cancellations of existing homeowner policies in reaction to several insurance companies announcing plans to drop thousands of homeowners in the wake of losses caused by Hurricane Andrew. During the most recent legislative session, the moratorium was extended to November 1999, and for the first time insurance companies were given the authority to transfer business to other companies, effectively limiting their liability.
Joint Underwriting Associations
In an effort to provide coverage to homeowners unable to obtain insurance in the private market, the State of Florida began selling policies from its Florida Residential Property and Casualty Joint Underwriting Association (JUA), a publicly run insurer of last resort supported by premium dollars collected from property casualty insurers in the state.
Although the JUA was intended to be a stop-gap measure until private insurers came back into the market, it is currently the third largest insurer in the state with 895,000 residential policyholders. The size of the JUA has posed serious concern about its overexposure in the event of another big storm. State regulations allow the JUA to recoup any deficit incurred by assessing its member companies on a pro rata basis based on market share.
Industry executives admittedly underestimated the potential damage possible from a severe hurricane. Consequently, many different approaches to measuring this risk are being examined to prevent the industry's overexposure to losses in the future.
One possible method of measuring risk being proposed is to evaluate building codes across the country and the extent to which the codes are enforced. Residents in communities with good, well-enforced codes will pay lower premiums while communities with inadequate or unenforced codes will pay higher premiums. Experts say that at least 25 percent of the $16 billion in insured losses from Hurricane Andrew were caused by construction that did not meet local building code.
More Stringent Building Codes
After receiving criticism for permitting the construction of homes that could not withstand high winds, local governments throughout the Southeast have strengthened the building codes. For the first time, the changes have set standards for protecting structures against flying debris. Also, the new standards on building construction require more concrete, steel, nails, straps and shutters to be able to withstand sustained 110 mile-per-hour winds.
Hurricane Andrew exposed the immediate need for tougher window standards in storm-prone areas. Approx-imately one-fourth of the damage incurred during the storm was due to rain pouring in through damaged or destroyed roofs. The insurance industry contends that intact windows decrease the likelihood that a home's roof will be blown off during a hurricane. According to the insurers, hurricane-resistant windows would have significantly reduced the $5 billion in claims resulting from water damage during the storm.
Overall, the more stringent local building codes enacted in the wake of Hurricane Andrew have significantly raised the cost of building new homes. Since the new code took effect on September 1, 1994, the average price of a new home in Dade County has risen by about $14,000, according to a 1995 Price Waterhouse market survey.
Gap in Homeowners Insurance Policies
Many homeowners who purchased their homes before the changes to the building code are faced with having to insure for the full cost to replace the home, including the requirements under the strict code. A common clause in homeowners insurance policies provides that an insurer only has to rebuild a home damaged in a natural disaster to its previous condition. Consequently, the homeowner is responsible for the additional cost to meet the newer and often more expensive building standards.
Homeowners do have the option to purchase code-upgrade coverage from insurers at a nominal cost. Also, Florida passed a law requiring that all homeowners policies sold or renewed in the state include code-upgrade coverage worth at least 25 percent of the dwelling coverage, unless the consumer explicitly declines it.
Impact on Affordable Housing
The affordable housing market has been significantly affected by the increase in construction and insurance costs in south Florida. Habitat for Humanity (Habitat), a nonprofit housing organization, was able to build houses in Miami for $41,000 before Hurricane Andrew. Since the storm, the cost to comply with the new building codes has increased their construction expense by 31.7 percent or a total of $54,000. Most of these increased costs can be attributed to the more expensive hurricane shutters and windows that meet the building code's new wind resistance requirements.
However, the homes built by Habitat before the changes to the building code incurred minimal damage during Hurricane Andrew. A total of 27 homes built by Habitat's Miami Chapter fared well during the hurricane. Habitat attributes the sturdiness of their homes to the organization's practice of going beyond the stated building code by using extra studs and braces, plywood instead of weaker substitutes, and hand-driven nails instead of staples in their construction. Accordingly, one of the changes in the new building code since the hurricane was to require nails in all new construction.
The cost and availability of homeowners insurance is also an issue for low- and moderate income homeowners. Like all new homeowners in south Florida, Habitat for Humanity's homebuyers utilize the JUA to obtain insurance because no private carriers are writing new homeowner's insurance policies. The cost of insurance through JUA has increased $150 in one year to $539 in 1996 for a 6 month basic homeowners policy on a Habitat home, which would provide for the structure, the contents, and liability coverage. Accordingly, the homeowner's monthly escrow payments for taxes and insurance have had to increase.
Habitat for Humanity has been able to minimize the payment shock to its homeowners due to the increase in home prices and insurance costs by extending the terms of its principal payments from 20 to up to 30 years in certain cases.
There have been many national and regional policy implications for the insurance and construction industries as a result of the unprecedented losses incurred from Hurricane Andrew. Hurricane scientists and other experts concluded that much of the destruction from the storm was caused not only by severe winds, but also by low quality construction, faulty designs, and flimsy materials of many dwellings. These factors brought much attention to the adequacy and enforcement of the building code in south Florida. Consequently, significant changes were made to the building code that, while ensuring the hurricane-resistance of new construction, have also increased the cost to build new homes in the area.
The insurance industry was not only unprepared to absorb the catastrophic losses incurred from Hurricane Andrew, but failed to adequately assess and price the risk in storm-prone areas. Many insurance companies have chosen to withdraw from or reduce their presence in those markets. However, many different approaches to managing the risk have been explored, such as requiring an inspection of homes before providing insurance or limiting insurance to only those homes within a certain distance from the shore.
For example, there are no insurers providing wind coverage to homes located east of US-1 in Miami. The Florida Windstorm Underwriting Association, which was established in the 1970s to provide wind coverage in limited areas near the coast, expanded its scope after the hurricane to include Dade and Broward County residents affected by these restrictions.
However, the most far-reaching plan being instituted by the insurance industry is to tie property insurance rates to the adequacy and level of enforcement of building codes. There is a national assessment of building codes underway that will evaluate the number of inspectors relative to building activity, the frequency of inspections, and examinations of some existing buildings to see if the code was enforced in the past.
Florida Hurricane Catastrophe Fund
The State of Florida has also instituted measures to prevent an insurance crisis in the wake of another storm. In 1993, the Florida Hurricane Catastrophe Fund (Fund) was established to provide additional reinsurance capacity in the marketplace. The Fund's reinsurance capacity is currently estimated to be $6.4 billion, which represents $1.4 billion in cash from premium dollars collected from participating companies and $5 billion of bonding capacity. In 1996, the Fund was granted the authority to issue bonds directly or through local municipalities.
Essentially, the Fund assesses an insurance company's exposure to losses, which is used to determine its deductible on an occurrence basis. Participating companies choose the amount of coverage needed above their deductible or retention. The Fund is intended to serve as additional reinsurance to supplement coverage already provided through private reinsurance companies.
Rebuilding in the aftermath of Hurricane Andrew has become an arduous and complex task for builders, insurers, and homeowners. Florida officials continue to face challenges in determining the most equitable policies that will ensure the safety of its residents while preventing housing from becoming cost prohibitive.