Also flying in the face of theory is the fact that USAA paid premiums that were, according to the author's calculations, 9.1 times the actuarially fair premium. During the era of frequent citywide fires, many fire insurance companies failed when all of their insured houses went up in smoke at the same time. Although today's catastrophic losses are more likely to result from a category 5 hurricane along the Florida coast, the risk of failure from the simultaneous loss of an entire class of insured objects continues to bedevil modern insurance companies.
Insurance companies buy reinsurance to protect themselves from catastrophic losses.
He considers USAA, one of the 10 largest automobile and home insurers in the United States. It has large numbers of policyholders in California and Florida. After hurricane Andrew created the largest catastrophic loss in the United States in 30 years, USAA began developing a bond based alternative to traditional reinsurance programs. After examining the structure of USAA's reinsurance program, Froot concludes that, contrary to theoretical predictions, USAA's reinsurance program protects it from smaller losses and leaves it relatively uncovered in the event of the largest ones. This raises two questions.