The United States is exposed to several major hazards, in particular earthquakes and hurricanes, in coastal areas. As shown in figure 1, the Pacific, South Atlantic, and Gulf Coasts face the highest risk of earthquakes and hurricanes. According to the National Oceanic and Atmospheric Administration (NOAA), 53 percent of the nation’s total population, or approximately 153 million people, lived in coastal counties in 2003. Moreover, the total coastal population increased by 33 million people, or 28 percent, between 1980 and 2003. California led in coastal population change, with the number of residents increasing by 9.9 million people. Florida showed the greatest percentage population change between 1980 and 2003, increasing nearly 75 percent. The nation’s coastal population is expected to increase by more than 7 million people by 2008 (over current levels) and by 12 million people by 2015. The housing supply in coastal areas also continues to grow, despite the high risk of earthquakes and hurricanes. NOAA reported that coastal counties contained 52 percent of the nation’s total housing supply in 2000. The leading states in terms of total housing units in coastal counties were California, Florida, and New York, which together have 41 percent of the total housing supply in these counties. One study put the estimated insured value of coastal property in states bordering the Atlantic Ocean and Gulf of Mexico at $7.2 trillion as of December 2004. As shown in figure 2, properties along the Pacific and North-Atlantic Coasts and the Gulf of Mexico have some of the highest insured property values. The value of residential and commercial coastal property in Florida and New York was $1.94 trillion and $1.90 trillion, respectively, in 2004. Insurance coverage against natural catastrophes for a home may or may not be included in homeowners insurance contracts. For example, coverage against wind loss from an event such as a hurricane is typically included. However, in some areas of certain states—mostly coastal regions—wind coverage may be excluded from homeowners insurance contracts and may be available only through the surplus lines insurance market or a state-managed entity. Similarly, earthquake coverage is commonly excluded from homeowners insurance contracts and instead is sold separately by insurance companies or, in the case of California, through a state-managed program. The price of property and casualty insurance is affected by both the annual expected loss and the cost of diversifying the risk of catastrophic losses. Insurers can diversify the risk of catastrophic losses by, among other things, purchasing reinsurance, which is insurance for insurance companies, or by selling financial instruments such as catastrophe bonds. Insurance companies do not know in advance what their actual costs are going to be, because they can determine these costs only after a policy has expired. The insurer’s objectives are to calculate premiums that will make the business profitable, enable the company to compete effectively with other insurers, and allow the company to pay claims and expenses as they occur. When insurers, reinsurers, and investors in catastrophe financial instruments perceive that the expected frequency or severity of natural catastrophes has increased, they may increase the price of insurance. If a company believes that the risk of loss—for example, from flooding or earthquake—is unacceptably high given the rate that can be charged, it declines to offer coverage. While the federal government retains the authority to regulate insurance, it has given primary responsibility for insurance regulation to the states, in accordance with the McCarran-Ferguson Act of 1945. State insurance commissioners are responsible for regulating rates, monitoring the availability of insurance, and assessing insurance firms’ solvency. The insurance regulators of the 50 states, the District of Columbia, and the U.S. territories have created NAIC to coordinate regulation of multistate insurers. NAIC serves as a forum for the development of uniform policy, and its committees develop model laws and regulations that, when adopted by state legislatures or promulgated by state regulators, govern the U.S. insurance industry. Critics of state insurance regulation argue that insurance prices and terms of coverage, particularly for homeowners insurance in areas prone to natural catastrophes, are highly regulated and that the insurance industry is generally not allowed to respond freely to changing risks or market conditions. In particular, these critics say that insurance regulators do not allow private insurers in catastrophe-prone areas to charge rates sufficient to build surpluses or transfer risks to reinsurers, regulators may be subject to voter pressure and thus to legislative pressure to keep insurance premiums affordable and coverage readily available, and regulatory and political restrictions prevent markets from giving consumers accurate price signals regarding the risks of living in catastrophe-prone areas. NAIC officials told us that projected loss costs to cover the insurer’s catastrophe exposure vary widely depending on which risk-modeling firm the insurer selects to produce its catastrophe loss costs. Only future results prove whether insurance company actuaries or insurance regulator actuaries are correct. The officials said that one should not assume that insurers and their actuaries have perfect information about what catastrophes will occur during the next year and about how the economy will behave. They added that one should also not assume that actuaries working for insurance companies are always correct in their projections of the needed price for the future experience period and that actuaries working for insurance regulators are always wrong. In the aftermath of natural catastrophes, some insurers responded by limiting their exposure in catastrophe-prone areas with restrictions on underwriting, higher deductibles, and lower coverage limits. In particular, there were property insurance affordability and availability crises in the Gulf Coast states or Florida after Hurricane Camille in 1969, Hurricane Celia in 1970, Hurricane Andrew in 1992, and the 2005 hurricanes; and in California following the Northridge Earthquake in 1994. Various proposals have been put forth over the past 15 years seeking to have the federal government take a larger role—for example, as a reinsurer or by allowing insurance companies to accumulate tax-deferred reserves—in addressing the affordability and availability of natural catastrophe insurance. The federal government engages in a wide variety of insurance activities, among them providing multiperil crop insurance to farmers and flood insurance to homeowners and businesses. In addition, the federal government provides disaster assistance to individuals and households. FEMA, SBA, and HUD are the primary agencies administering federal disaster relief and recovery programs. FCIC provides insurance coverage for farmers who suffer financial losses when their crops are damaged by droughts, floods, or other natural disasters. By law, FCIC pays the premium for catastrophic coverage against losses of 50 percent of a farm’s normal yield at 55 percent of the market price. In addition, FCIC offers premium subsidies for “buy-up” coverage against crop, revenue, and prevented planting losses, with coverage for losses ranging from 50 to 90 percent of a farm’s normal yield. FCIC estimates that participation of eligible farmers is approximately 80 percent of acres planted. FEMA, through NFIP, offers insurance to homeowners and businesses for losses due to flooding and currently has 5.3 million policyholders. By law, NFIP must offer reduced premium rates for homes built in floodplains prior to the creation of flood insurance rate maps (pre-Flood Insurance Rate Map (FIRM) properties). About one quarter of NFIP policies are pre-FIRM and pay about 40 percent of the risk-based rate. According to NFIP, homes built in floodplains to an approved building code after the creation of flood maps pay actuarially sound premiums. Participation in the program is mandatory for homeowners with mortgages issued by federally regulated lenders on properties in special flood hazard areas (SFHA) where flood insurance is available. According to the RAND Corporation, about half of all homeowners who live in SFHAs purchase flood insurance. In addition to providing crop, flood, and other insurance, the federal government provides disaster assistance to individuals. FEMA provides disaster relief and recovery assistance to individual citizens through its Individuals and Households Program (IHP), which is intended to provide money and services to people in a disaster area when losses are not generally covered by insurance and property has been damaged or destroyed. IHP includes Housing Assistance (HA) and Other Needs Assistance (ONA). FEMA may provide five types of HA: financial assistance to rent temporary housing, “direct” temporary housing assistance, repair assistance, replacement assistance, and permanent housing construction in certain areas outside of the continental United States and other remote areas. FEMA may provide ONA grant funding for transportation expenses, medical and dental expenses, and funeral and burial expenses. ONA grant funding may also be available to replace personal property, repair and replace vehicles, and reimburse moving and storage expenses under certain circumstances. IHP is not intended to restore damaged property to its predisaster condition. SBA’s Disaster Loan Program (DLP) is the primary federal program for funding long-range recovery for private sector, nonfarm disaster victims. Eligible losses include under or uninsured damages and can not duplicate benefits received from another source (i.e. insurance recovery, FEMA, etc.). The Small Business Act authorizes SBA to make available the following two types of disaster loans: (1) physical disaster home loans to homeowners, renters, and businesses of all sizes, and (2) economic injury disaster loans to small businesses. Homeowners and renters can borrow up to $40,000 for repair or replacement of household and personal effects. Homeowners can also borrow up to $200,000 to repair or replace a primary residence. Businesses of all sizes can borrow up to $1.5 million to repair or replace disaster damaged real estate, machinery and equipment, inventory, etc. Small businesses can borrow up to $1.5 million for disaster related economic injury resulting from the declared disaster. The combined loans to a business for physical loss and economic injury cannot exceed $1.5 million. Homeowners and businesses must provide reasonable assurance that they can repay the loan out of personal or business cash flow, and they must have satisfactory credit and character.