Flirting With Disaster

Congress is again exploring new ways to undermine the private market for homeowners insurance in disaster-prone parts of the country.

On February 4, the House Banking subcommittee on Housing and Community Opportunity marked up H.R. 219, the Homeowners’ Insurance Availability Act, sponsored by subcommittee chairman Rick Lazio (R-NY). The bill would create a new federal Disaster Reinsurance Fund, designed to support state-level insurance programs.

While H.R. 219 is designed to assist homeowners in these states, the bill is poorly designed and would produce a number of unintended problems. This legislation has the potential to weaken the private insurance market, subsidize development in catastrophe-prone regions, and impose significant costs on taxpayers throughout the country.

The proposed program would sell individually priced reinsurance contracts to qualifying states. This federal reinsurance would provide coverage over and above the levels of coverage that state disaster insurance programs pay out in the aftermath of hurricanes or earthquakes. This reinsurance would kick in to pay for damages of as little as $2 billion, and the federal government would be obliged to spend as much as $25 billion per year to reimburse states.

Potentially, this program could cost the taxpayers a great deal. The coverage provided by the federal government is supposed to be fully funded by the premiums that states pay into the disaster fund for their coverage. In practice, similar programs like flood insurance have failed to work this way. Though a disaster reinsurance program may be started with every intention being self-funding, political considerations will ultimately outweigh economic ones.

Unlike private insurance, government insurance is more concerned with “helping people” and providing money than it is with balancing the books. Because the government does not have the same financial pressures that private companies have, the pricing of government insurance is often influenced more by political considerations than it is by economic ones.

For example, if homeowners were to have trouble obtaining new coverage after a disaster, under this legislation the federal government would be heavily pressured the states and other interests to reduce the cost of its coverage. Conveniently, the bill provides the reinsurance fund with a costly escape hatch. If the fund should find itself short on cash, it need only borrow money from the Treasury to make up the difference.

If a private company can not meet its obligations, it goes out of business. If the federal reinsurance fund can’t meet its obligations, it can simply force taxpayers in the rest of the country to subsidize homeowners in disaster-prone states. Why bother to make ends meet under these conditions?

Only California, Florida, and Hawaii would currently benefit from this proposal. That is because only states that have pseudo-government disaster insurance pools can qualify for federal reinsurance. Other states that wanted such coverage would have to institute their own programs. This legislation therefore has the effect of encouraging other states to increase the role of government in the insurance market, in order to qualify for federal subsidies.

Making federal reinsurance so readily available creates a number of problems. As noted, the reinsurance would pay out in the event of a disaster with damages of as little as $2 billion. Private industry alone has handled much more costly events. According to the Insurance Information Institute, the 1994 Northridge earthquake cost $12.5 billion, while Hurricane Andrew in 1992 had a price tag of $15.5 billion.

Since Andrew, the capacities of the private insurance and reinsurance industries have only grown. Reinsurance availability has increased so significantly that the cost of coverage is decreasing. In addition, innovative financial products, such as new securities and bonds are being developed to allow insurers to tap into wider capital markets for needed funds in the event of a major disaster. These private market developments would all be put in jeopardy by H.R. 219. Private companies would not be able to compete with subsidized government insurance.

Such government insurance distorts important incentives created by true risk-based premiums. Market-priced insurance correctly tells a homeowner that owning a home in the path of a hurricane can be an expensive proposition. By artificially making it cheaper to insure property in high-risk areas, H.R. 219 instead subsidizes construction and paves the way for costlier disasters in the future.

This legislation is being supported by states such as Florida and California, and also by some insurance companies that have found themselves overexposed in disaster-prone states. However, the federal government should not relieve insurance companies, state governments, or homeowners of the consequences of their risk-management decisions. There is no justification for passing along their costs to taxpayers in the rest of the country.

Ironically, this proposal was pushed through the subcommittee by Republicans, over nearly-unanimous Democratic opposition. Before this legislation goes any farther, they might want to reconsider such an intrusive and potentially expensive government program. While many in Congress (particularly those from high-risk states) may see a need for federal involvement in financing disasters, this legislation would create more problems than it would solve.

If Congress truly wishes to constructively address the issue of natural disasters and insurance, they should look to the regulatory impediments that currently limit the amount of coverage the private market can offer. State rate regulation and federal tax policies both prevent insurers from raising and maintaining the capital required to pay for the extraordinary costs associated with natural disasters. Freeing up the private market will, in the long run, be far more productive than creating yet another federal subsidy program.