Federal catastrophe insurance plan faces major opposition; state initiatives sprouting

Although many members of Congress, the administration, and even some parts of the insurance industry oppose the idea, House Financial Services Committee Chairman Barney Frank (D-Mass.) may bring a federal “catastrophe insurance fund” to a vote before the end of 2007. With the Florida presidential primary scheduled for Jan. 29, 2008, property insurance may yet emerge as a significant issue in the presidential campaign.

States have largely been left to their own devices in addressing the property insurance crisis that has affected coastal states in the wake of the 2005 hurricane season, and have used a combination of state-funded insurance pools, rate regulation (broadly defined), and litigation to address the issue. Traditionally, insurance regulation has been left to states — although the federal government has some role, particularly in financing a national flood insurance system. However, some congressional leaders have floated the idea of the catastrophe fund as a more comprehensive approach to addressing weaknesses in the existing system for insuring against weather risk.

Frank’s legislative push.

Frank has asked freshman Democratic Reps. Ron Klein and Tim Mahoney (both from Florida) to draft legislation.
Catastrophe risk insurance is subject to large volatility in underwriting costs, since it is difficult to model events for which there is extremely low probability but that carry the potential for extreme losses. A recent study commissioned by protectingamerica.org, a lobbying group that favors a wider federal role in the provision of catastrophe insurance, estimates that increasing federal involvement could create a more efficient system, which would supposedly save consumers more than $11 billion.

Powerful opponents.

At present, the nascent bill faces significant opposition:

•Limited support base. Although the definition of catastrophe would — in addition to hurricanes — include earthquakes and other national disasters, support for the measure remains geographically concentrated in coastal states. The legislative proposal as ultimately drafted may allow states to opt out of participating in any catastrophe pool so as to reduce the apparent cross-subsidy. However, if a significant number of states elect this option, the benefits to states that participate might not be much greater than if they continued to rely on state pools, or to create regional arrangements.

•Administration hostility. The administration of President Bush firmly opposes establishing any federal role in providing catastrophe insurance:

It rejects the need for the federal government to continue to act as insurer of last resort, and it continues to oppose extension of the Terrorism Risk Insurance Act (TRIA) beyond its scheduled expiration date of the end of this year.

In testimony before the Senate Banking Committee in April, Edward Lazear, chairman of the White House Council of Economic Advisers, rejected the need for a federal catastrophe insurance fund, arguing that such a solution would stifle the development of private market solutions.

The administration argues that absent a federal role, other mechanisms for laying off weather-related risks, such as catastrophe bonds, are slowly developing; Allianz recently announced the issuance of such an instrument.

•Industry resistance. Parts of the insurance industry remain unconvinced that an expanded federal role is necessary in providing catastrophe insurance, and instead believe the industry and other financial services firms, including hedge funds, should be left to develop mechanisms for valuing and laying off weather-related risks. Indeed, the latest industry results show record profitability levels (with operating profits of more than $31 billion in 2006, compared to $6 billion in losses in 2005), making it difficult to claim that the industry needs federal assistance.

•Katrina impetus fades. By settling many outstanding Katrina claims, insurance companies have weakened the role that state attorneys general may play on this issue (at least for the time being), and reduced pressure on national political leaders to take action.

State-level initiatives.

Despite Frank’s strong support, the most optimistic timetable for a federal initiative to emerge would be at the end of this year — and it would probably need the impetus of another difficult hurricane season. However, the absence of a clear federal solution has led some state legislatures to float their own initiatives. In addition to the existing Florida measures — the most comprehensive action to date — several other states have recently addressed the issue:

•New Jersey fund. A bipartisan measure has been introduced in the New Jersey legislature to create a privately funded state catastrophe fund, financed by a levy on insurance companies. However, its prospects for approval before the legislature’s four-month recess, beginning at the end of June, remain uncertain.

•Rhode Island commission. Rhode Island convened a special commission to study state insurance needs; two legislative proposals have recently been introduced that build on the commission’s work. One would prevent insurers operating in the state from canceling or refusing to issue policies based primarily on a property’s location. The other would define precisely the means for calculating hurricane insurance deductibles, which must be based on actuarial evidence.

•South Carolina incentives. The South Carolina Senate recently passed legislation providing tax credits to homeowners that “hurricane-proof” their properties, and allowing consumers tax benefits for creating individual personal catastrophe savings accounts. The legislation is expected to become law.

Presidential campaign impact?

Florida remains strongly affected by the catastrophe insurance crisis, which in conjunction with problems in the sub-prime lending sector has spawned a more general state real estate crisis. As the Florida presidential primary has been brought forward to Jan. 29, 2008, the state’s problems will now figure more prominently on the national agenda. In a late May campaign swing through Florida, Sen. Hillary Rodham Clinton (D-N.Y.) endorsed creating a national catastrophe insurance fund. Republican presidential candidate Mitt Romney, who due to his former role as Massachusetts governor is well aware of the problems property owners are facing in coastal states, has also highlighted the issue. Florida Gov. Charlie Crist has promised that he will push other Republican candidates to clarify their positions on catastrophe insurance.

Oxford Analytica is an international consulting firm providing strategic analysis on world events for business and government leaders. See www.oxan.com .