Hurricanes and the Insurance Market

I've been reading a little about property insurance markets for Gulf Coast property after Katrina. I don't think it surprised anyone that insurance rates increased after the most destructive hurricane anyone can remember. But the magnitude of some of the increases was staggering. Reliable sources for one commercial hotel/condo renovation project, for example, tell me that a budget of $60,000 per year for insurance turned out to be inadequate, even though the budget was 50% more than the proper owner was paying for insurance prior to the renovation. The quote they got back was $600,000 per year!

In an efficient market for property insurance, the remote possibility of a hurricane as destructive as Katrina would already be priced into insurance premiums, and though there would be a modest spike in premiums right after such an event, it wouldn't be dramatic and long lasting. This raises the question of why rates were so LOW prior to Katrina, and why the insurance companies have overreacted afterwards. Insurance is highly regulated; it is at least possible that the regulation has interfered with the efficient functioning of the insurance markets. I don't have good evidence to support that inference, and other culprits may be to blame. Certainly, it's clear that our government's subsidies of flood insurance for risky properties has played a counterproductive and destructive role.

There's a good economics paper in all this; possibly several careers to be made by young economists.