June, 2009

Policy Uncertainty and the Market for Wind Insurance

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Since Hurricane Katrina hit the Gulf Coast in 2005, critics have suggested that rising homeowners insurance costs in some areas are due to market inefficiency or herding behavior by insurers. Alternatively, insurers could be reducing exposure to hurricane losses due to new information or because of uncertainty due to enacted or contemplated regulatory or policy actions.
Herding behavior creates a policy rationale for public insurers of last resort or policies to prevent panicked exit by insurers after hurricanes. This paper tests the herding thesis empirically and finds that, while many insurers have raised premia since 2005, there is little evidence of herding behavior. Uncertainty in regulation and public policy are likely the significant drivers of rising costs and decreased availability rather than irrational herding by insurers. Policy implications of this finding are discussed.