Comments to The Property and Casualty Insurance© Committee

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Dear Chairman
McCarty and Members of the Property and Casualty Insurance (C) Committee:

I write to you on the behalf of the Competitive Enterprise
Institute, a Washington, D.C.-based
think tank devoted to classical
liberal economic policies. We advocate these policies because we believe in
freedom for both individuals and business enterprises. We want a market where
consumers can purchase the insurance products they want and where companies can
sell these products.  To that end, we
oppose all price controls and insurance-company subsidies. Our permanent
interest is simple: we believe in the Free Market. 

We agree with much
of NAIC’s recent plan “Natural Catastrophe Risk: Creating a Comprehensive
National Plan.”

[1]

We
heartily endorse the calls for retrofitting of homes, more flexible policy
terms, and a concerted response from federal policy makers. We also agree with
the implication that the current problem requires a national-level response and
the calls for a National Catastrophe Commission.

We do, however, have
concerns about the Committee’s call for “public/private partnerships” for backstops and its call for the establishment of a
“National Catastrophe Insurance Mechanism.” On these issues, we wish to make four related points:

·        

The
C Committee should strongly discourage the creation of state catastrophe funds
rather than suggesting principles to
make them work better.

·        

The
Committee should not endorse H.R. 3355 (as it implicitly does) or any level of
public involvement with the financing of reinsurance. Such efforts will not
work.

·        

The
Committee should focus on efforts that would encourage greater capital
investments in insurance and reinsurance.

·        

Risk-Based
insurance rates, coupled with mitigation programs, will do the most to make America safer.

Discussion
of these points follows:

The C Committee should strongly
discourage the creation of state catastrophe funds rather than suggesting
principles to make them work better.

            State level catastrophe funds, which
the plan before the Committee refers to
under its discussion of Layer 2, clash with fundamental principles of good
insurance risk management.  Insurance
works best when authorities manage risks across broad pools of non-correlated
risks. State level catastrophe funds and wind pools attempt to reduce costs by managing risks across narrow
pools of heavily correlated risks. In all cases, the actuarially adequate rates
necessary to sustain such pools will
be higher than the rates that would
exist in a private, voluntary market.

Rather
than proposing principles for running catastrophe funds, the committee should
discourage their creation in the first place. They simply do not work. States
where the “private market does not have the capability to
provide” affordable insurance are invariably responsible for the messes they
have created through systems of price controls.

[2]

            Thus, any system that encourages
states to set up catastrophe
funds—even implicitly—deserves condemnation. Right now, a full-scale
catastrophe fund exists only in Florida (although
Hawaii and California have mechanisms that might be
considered Cat Funds.) Guidelines for Cat Fund creation, therefore, do not make
sense. Rather than adopting guidelines for the prudent administration of
catastrophe funds, the C Committee should consider issuing a statement
discouraging their creation.

The C Committee Should Not Endorse H.R.
3355 (as it implicitly does under layer 3) or any level of public involvement
with the financing of reinsurance. Such efforts will not work.

The
Homeowners Defense Act of 2007 (which “layer 3” endorses by implication) is
misguided in just about every way. The proposed consortium cannot work, the
idea of liquidity loans to state cat
funds will only displace private investment, and post-event backstopping will only benefit one state. Moreover, the
entire system will cost more than anticipated and, ultimately, will require a
federal bailout. 

            The
“voluntary” nature of the system envisioned under H.R. 3355’s consortium of
“layer 3” seems destined to failure.
The States most likely to join are
those with the worst insurance environments and the least stable markets. The
demands placed on private insurers in consortium participating states will only
exacerbate the negative environment pushing all but a few private insurers to flee those states, decreased availability of
private insurance and increasing the state’s reliance on federal assistance.

            For similar reasons of adverse
selection bias, proposed liquidity loans to
state wind pools are also a bad idea. A soundly run wind pool can always access
private capital and, indeed, even the unstable Florida Hurricane Catastrophe
Fund recently managed to convinced
Berkshire-Hathaway to provide what
is essentially a $4 billion retrocession facility. The federal government does
not need to involve itself in such
lending.

            Finally, direct post-event Cat Fund
backstops make no sense at all. Only
one state—Florida—currently
has a Cat Fund that would qualify. We think the NAIC should encourage Florida to come up with a plan for transferring this
liability to the private market
rather than attempting to transfer
it to the nation’s taxpayers.

In
any case, the entire plan lacks a workable funding mechanism. Although HR 3355
contains some apparently reassuring language requiring the Secretary of the
Treasury to accept nothing less than
full repayment and simultaneously forbidding the use of federal funds for
repayment, we don’t believe it can work.

[3]

  A corporation headed by the Treasury
Secretary and made up largely of government officials will have an implicit
guarantee the same way Fannie Mae and Freddie Mac did and still do. (In fact,
because it won’t have private stockholders,
the guarantee will be even more explicit.) The structure of the proposal makes
it clear that the federal government will bail out the Consortium and Florida. If
it saves money on receives lower interest rates it will only be because of this
promise of a bailout.

We
also are extremely skeptical of the bill’s claim that it will be require only a
few million dollars–$20 million the first year–for administration because it
will charge actuarially adequate rates.

[4]

The National Flood Insurance Program was supposed to
operate on an actuarial basis. Instead, it currently owes over $17 billion to the United States Treasury.

[5]

We don’t know what the cost of the Consortium will be but we expect it will be
at least as twice large as the $32 billion in potential liability that the
Florida Hurricane Catastrophe Fund imposes on its state. In fact, no major
government run insurance program in charges truly adequate rates. A major study
conducted by a former Clinton administration official
has, in fact, concluded that taxpayers in at least 20 states would face burdens
over $1 billion as a result of these programs.

[6]

In
short, the structure proposed in H.R. 3355—or any other national reinsurance
mechanism—simply cannot work on an actuarial basis because government is not the best manager of risk.

The Committee Should Focus
on Efforts that Would Encourage Greater Capital Investments in Insurance and
Reinsurance.

            Rather than proposing the creation
of “level three” (discussed above) the C Committee should encourage greater
investment in insurance and reinsurance markets. We heartily endorse the
paragraph ideas expressed under “additional consideration.” In particular, we
agree with the passage that says:

The NAIC
should continue to address perceived
roadblocks within the U.S. Tax Code and within SEC regulations that are
impediments to the private market’s
ability to fully utilize financial
market structures to transfer
catastrophic insurance risk from the insurance industry to
other willing and informed investors.

[7]

 

            In fact, we believe that this course
of action—rather than the creation of a national backstop—will
do the most to encourage a stronger,
wealthier, more resilient insurance market.  This is the root solution to the nation’s insurance woes and NAIC should focus
its attention there.

Risk-Based Insurance Rates,
Coupled with Mitigation Programs Will Do the Most to
Make America
Safer

            We
are deeply disturbed that the report, as currently written, does not once
mention the concept of risk-based rates. Basing rates on risk alone—something
many state regulators seem reluctant
to do—appears the one sure way to make insurance available to
all Americans who desire it.

            We believe that the committee should
encourage NAIC members to transition
their insurance regulatory systems to those that allow insurers and consumers to make robust use of all relevant risk factors. With risk taken into
account, market forces alone will strongly encourage the levels of mitigation
necessary order to make insurance
affordable for everyone. In particular, we believe that the committee should
call for the dismantling of all prior approval regulatory
systems and price controls that currently exist.

            Although we strongly encourage the
committee to endorse a system that
bases rates entirely on risk, we also acknowledge that the transition to such a system will take time and could cause
significantly dislocations if undertaken too
hastily. Therefore, we encourage the committee to
continue its advocacy for strong state and national level efforts to encourage programs that assist with mitigation,
relocation and other efforts to
reduce the harm from catastrophic events.

Concluding Thoughts

            The proposed plan contains a number of
well-thought out points that we agree with. We feel, however, that the overall tone of the report betrays a strong distrust in
market forces. Our message is simple: the free market will work if the
government will let it.

Respectfully
Submitted,

 

Eli
Lehrer

Senior Fellow
The Competitive Enterprise Institute

 

Michelle Minton

Policy Analyst

The Competitive Enterprise
Institute