Federal Disaster Legislation Could Have Unintended Consequences

It is certainly no surprise that in the aftermath of Hurricane Isabel, there is a renewed effort by some in the industry to establish a federal backstop for insured losses caused by natural disasters.

Thankfully, Hurricane Isabel, while very destructive, does not appear to threaten the insurance industrys financial base. The early reports are that the losses are manageable and will not cause any serious fallout in the property insurance marketplace.

But this fact does not eliminate what many industry groups see as the genuine need for some type of federal action on natural disaster losses. The next hurricane, or the one after that, could have far more serious consequences than Hurricane Isabel.

Unfortunately, the issue of what role the federal government should play in financing natural disaster losses is one of the most controversial in the insurance industry. The industry has tried, but failed, to reach a consensus on a politically viable approach.

Indeed, there may not be a politically viable approach. If the Congressional action on asbestos litigation reform and the terrorism insurance bill is any indication, it may be very dangerous for the industry to seek a federal role in financing natural disaster losses, even if an industry-wide consensus is reached.

Looking first at the terrorism insurance bill, a joint industry proposal to create a private reinsurance pool backed up by the federal government was hardly given the time of day by either Congress or the Bush administration.

Instead, Congress went in a different direction, insisting that the insurance industry be required to repay the federal government for at least some portion of terrorism-related claims paid by the federal government, a system which some in the industry say is unworkable.

On asbestos, a strong consensus in the industry supporting a $45 billion payment to an asbestos claims resolution fund did not prevent the Senate from creating legislation that would subject the industry to virtually unlimited liability and at the same time face ongoing litigation.

The natural disaster issue holds similar dangers. Currently, two legislative models are on the table. One model would have the Treasury Department auction excess-of-loss reinsurance contracts to insurance companies and reinsurers covering catastrophic losses associated with once-in-100 year events.

But this approach has problems. For one thing, establishment of a federal government program could supplant private reinsurance coverage. Second, anytime the industry asks for federal government involvement, it is inviting federal government regulation.

The second model on the table would alter the nations tax code and allow the insurance companies to establish long-term tax-deferred disaster reserves.

But again, this approach has dangers. Asking Congress to change the tax code on disaster reserves could also invite a broader investigation of property-casualty taxation, something that many in the industry would probably like to avoid.

In the current deficit environment, any tax deferral must be offset by a tax increase somewhere else. Congress will be very tempted to pay for any catastrophe reserve tax deferral by increasing industry taxes elsewhere.

The point here is not to dismiss the need for legislation on financing catastrophic losses. Rather, it is important to be aware of the dangers.

Proposals that look good in theory have a way of turning bad once Congress gets through with them.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 26, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.