A Disaster Waiting to Happen: Why Washington Shouldn’t Subsidize Disaster Insurance
This Thursday, April 23, the House Banking and Financial Services Committee will examine H.R. 219, the Homeowners Insurance Availability Act sponsored by Rep. Rick Lazio (R-NY). The bill would create a new federal Disaster Reinsurance Fund, designed to help finance losses related to natural disasters. H.R. 219 is, however, so poorly designed that it would produce a disaster of its own. The legislation has the potential to undermine the private insurance market, subsidize development in catastrophe-prone regions, and impose significant costs on taxpayers throughout the country.
The proposed program would sell reinsurance to the states, providing coverage over and above the levels of coverage that state disaster insurance programs pay out following hurricanes or earthquakes. It would also allow states to resell this reinsurance coverage to private insurance companies within the state through an auction process. This reinsurance would kick in to pay for damages of as little as $2 billion, and the federal government would be required to pay as much as $25 billion per year to reimburse disaster-related losses.
Taxpayers should be on their guard. Though the federal reinsurance coverage is supposed to be funded by the premiums that states would pay into the disaster fund for their coverage, in practice, similar programs like flood insurance have failed to meet this standard. While a disaster reinsurance program may be started with every intention of being self-funding, political factors will ultimately outweigh economic ones. In order to provide homeowners in disaster-prone states with lower insurance premiums, taxpayers in other states may have to shoulder the costs of those disasters.
Political Considerations. Unlike private insurance, government insurance is more concerned with handing out money than it is with balancing the books. Since governments do 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 actuarial or economic ones. If homeowners, under this legislation, were to have trouble obtaining new coverage after a disaster, the federal government would be heavily pressured by the states and other interests to reduce the cost of its coverage. In addition, H.R. 219 provides the reinsurance fund with a costly escape hatch. If the fund should find itself short of cash, it can just borrow money from the treasury to make up the difference. That means the federal government can simply force taxpayers in the rest of the country to subsidize the losses of homeowners in disaster-prone states. Why bother to make ends meet under these conditions?
Private Capacity Has Grown. Making federal reinsurance so readily available—paying out in the event of a disaster with damages of as little as $2 billion¾ is unnecessary and counterproductive. Private industry has already 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 these disasters, the capacity of the private insurance industry has only grown. Reinsurance availability has increased so significantly that the cost of coverage is decreasing. 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. Instead of encouraging private approaches to the funding of disaster risks, this legislation would invite more intervention by state and federal governments in the homeowners insurance market.
Risk-Based Insurance. This government insurance plan would also distort important incentives created by true risk-based premiums. Market-priced insurance correctly tells a homeowner that owning a home that’s 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 would subsidize construction and paves the way for costlier disasters in the future.
This legislation is being supported by officials in states such as Florida and California, and also by some insurance companies that have found themselves overexposed in disaster-prone states. The federal government should not, however, 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.
If Congress and the states wish to constructively address the issue of natural disasters and insurance, they should pay greater heed to the regulatory impediments that currently limit the amount of coverage the private market can offer. Rate regulation at the state level, as well as federal taxation of insurer reserves, prevent insurers from raising and maintaining the capital required to pay for natural disasters. Freeing up the private market will, in the long run, prove far more productive than creating yet another federal subsidy program.