Worst Idea of the Year

Later today [1:00 p.m. Thursday 7-9-9] former FEMA administrator James Lee Witt and former Coast Guard head James Loy –America’s two most trusted emergency managers–will assemble a great gaggle of reporters and other interested parties at the National Press Club to voice their support for something called the Homeowners’ Defense Act and release a new study supporting it. They’re wrong. In fact, the proposed law, proffered by Rep. Ron Klein (D-FL), ranks as one of the worst ideas with serious support in Congress.

The HDA  (H.R. 2255), which passed The House of Representatives last year but stalled in the Senate, would instantly transform the federal government into the largest player in the reinsurance (insurance for insurance companies) market. Under the HDA, a “National Catastrophe Consortium”– a “private” entity with a government-official dominated board — and a system of Treasury loan guarantees, would create a federal “backstop” to replace some of the catastrophic risk coverage that insurers now buy on the private market.  Proponents of the bill argue that these programs would cost less than the private sector alternatives, produce consumer savings, and protect taxpayers from liabilities by charging rates high enough to break even.

Unfortunately, the fundamental workings of insurance strongly suggest that this scheme can’t succeed. Insurance is based on managing risks across large pools of similar but non-correlated risks. Through international transactions, insurers and reinsurers pool the risk of hurricanes hitting Florida with the risk of cyclones striking Indonesia. Because the storm seasons happen at different times of the year, reinsurers will always make money covering one type of event while losing money on another. This pooling reduces the overall cost of insurance. But reinsurance focused on the U.S. narrows the risk pool and thus, will cost more than international reinsurance.

Thus, if it hoped to offer any coverage at all a government-run reinsurer would end up under-pricing the risk and sticking taxpayers with the liability. Klein’s home state of Florida, which has only $3 billion in assets to pay for the nearly $30 billion in potential hurricane risk the state legislature has already sloughed on its taxpayers, would take the lion’s share of the benefits with most states getting no benefit at all.

The one major current federal player in the property insurance market, the National Flood Insurance Program operates under statutory language requiring “adequate premiums” on most properties but the program is $19 billion in the red and has no practical way of paying it off.

All that said, the problem that Witt, Loy, and Klein seek to confront is real. For many people—particularly those who live a mile or two from the beach—ending the cross subsidies that most states mandate for beach-dwellers through control of insurance rates would ease premiums overnight.  For those who do face the most severe risks, proposals to encourage home retrofitting, preserve wetlands (which absorb the storm surge from most hurricanes), and even relocate housing away from risky areas make more sense. Finally, overhauls of the system for regulating insurance through changes to tax law and regulatory authorities might help attract more capital into private reinsurance markets.   Whatever the case, however, Rep. Klein’s proposal just won’t work.