Thursday, July 3, 2008

A Buffet/Berkshire Bailout with Bonds? I feel a bit like Dr Seuss!

It appears that Berkshire Hathaway has guaranteed to buy $4 billion in bonds from Florida in the event of a large scale event (> $25 billion). For this service, the state of Florida has agreed to pay Berkshire $224 million up front. From the News Journal Online:

The deal would partly shore up the Florida Hurricane Catastrophe Fund, a state program that sells low-cost reinsurance to property-insurance companies. Reinsurance is a type of coverage that insurers buy to help pay claims after hurricanes.

With the nation's financial markets in disarray, state officials have grown increasingly concerned the catastrophe fund would not be able to borrow enough money to meet its obligations after a Hurricane Andrew-type storm.

The Herald Tribune describes the situation well:

In order to attract insurers, the state-run Florida Hurricane Catastrophe Fund was formed after 1992's Hurricane Andrew to reimburse insurers for major claims paid to residents.

The so-called Cat Fund has $8 billion in reserves collected from assessments on insurance policies in the state. But after Crist led the charge last year to deepen the state's risk in order to lower insurance premiums, the fund is on the hook for up to $29 billion in reimbursements to insurers this year in case of catastrophic storm damage.

This move may have been necessary due to current conditions, but there needs to be a better long term policy to address this type of risk. In a previous post, I discussed private insurer's attempt to provide flood insurance (here). This would likely give more homeowners access to flood insurance.

Howard Kunreuther of the Risk Management and Decision Processes Center at the Wharton School argues for a system with risk based premiums where policies are long term contracts tied to the property itself rather than individuals. In this proposed system premiums would be tied to mitigation measures, thus creating an incentives for these types of measures. As it stands now, people tend to under invest in these measures. He states
By mitigating existing and new homes with structural measures (e.g., better
designed roofs) one could reduce future disaster losses significantly. If all residential
homes in Florida were fully mitigated, the damage from a 100‐year hurricane would
be reduced from $84 billion to $33 billion, a decrease of 61 percent.

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