Treasury Trashes Bill Creating Backstop For State Catastrophe Covers

A Treasury Department official last week threw cold water on legislation creating a joint federal-state program to backstop state-sponsored insurance programs that provide natural catastrophe coverage for homeowners.

Indeed, the legislation would displace private markets, promote riskier behavior and be costly as well as “unfair to taxpayers,” Phillip Swagel, Treasury's assistant secretary for economic policy, told a Sept. 6 hearing before two subcommittees of the House Financial Services Committee.

An official of the Reinsurance Association of America also voiced concern about the legislation, predicting it would “unnecessarily crowd out the private reinsurance market.”

At the same time, said RAA President Frank Nutter, while his group does not support this bill, and has significant concerns about certain of its provisions, “we do agree with some of the principles in the legislation, and pledge to work with the committee to improve it as it moves through the legislative process.”

However, the Property Casualty Insurers Association of America voiced measured support. Robert Joyce, chairman and CEO of Ohio-based Westfield Group, testified that the legislation “creates a good starting point for a discussion of how to stabilize catastrophe-prone markets.”

A representative of the Independent Insurance Agents and Brokers of America called the issue of catastrophic insurance “a national problem that requires a national solution.”

However, Steven Spiro–president of Spiro Risk Management Inc., an independent insurance agency based in Valley Stream, N.Y.–speaking on behalf of IIABA, said “it is important that the day-to-day regulation of insurance remain at the state level, where state insurance departments are best equipped to serve the special needs of local consumers in local markets.”

As such, he said, “given the absence of affordable coverage and the exposure that both consumers and taxpayers face, we believe there is a very limited and appropriate role for the federal government, and we are open to supporting proposals that increase insurance availability and affordability in catastrophe-prone areas.”

According to Mr. Joyce, “one of the most promising aspects of the bill” is a provision to create a federal liquidity facility to provide financial support for qualified state catastrophe funds.

“The liquidity facility proposed in the bill has considerable merit and could play an instrumental role in a long-term solution to America's natural disaster problem,” Mr. Joyce said. “We look forward to working with the sponsors and the committee to refine this proposal so that it best serves consumers and taxpayers.”

The legislation–H.R. 3355, the Homeowners' Defense Act of 2007–would provide a federal backstop for qualifying state-sponsored insurance programs that provide natural catastrophe coverage for homeowners.

Implementation of the federal backstop would be accomplished through a National Catastrophe Risk Consortium, as well as a program to provide liquidity loans and catastrophe loans to state and regional reinsurance programs. Under the legislation, the consortium would be run jointly by the federal government and the states.

The bill appears to go beyond earlier proposals that cast the federal government as an insurer of last resort. Instead, the bill (sponsored by two Florida Democrats–Reps. Ron Klein and Tim Mahoney) appears to envision a very active federal role, via the consortium, in the natural catastrophe arena.

The bill would have the consortium not only providing a backstop for state and regional catastrophe programs, but also securitizing and selling catastrophe risks while collecting and storing catastrophe risk and coverage information.

The hearing was before the Capital Markets and Housing and Community Opportunity Subcommittees of the House Financial Services Committee.

In his testimony, Mr. Swagel of Treasury argued that the private insurance markets for natural hazard insurance “are active and effective.” He said the experiences with catastrophes in 2004 and 2005 led insurers to increase their estimates of probable losses from future hurricanes.

“As a result, insurers obtained state regulatory approval and increased their premiums to cover future losses and enhance solvency,” he said.

“Certain coastal areas have experienced increases in rates,” Mr. Swagel noted. “This can be difficult for homeowners, but this is fundamentally a reflection of the cost of risk, not a defect of the market.”

He added that “while certain coastal areas have seen reduced availability of private insurance as well, these shortages generally can be traced to state regulatory actions.”

Mr. Nutter made the same point, noting in his testimony that it is “important for the committee to understand that, notwithstanding the extraordinary losses from natural catastrophes in 2004 and 2005, the private insurance and reinsurance sector proved exceptionally resilient.”

The record losses for insurers reduced insurer earnings in 2004 and 2005, but U.S. property-casualty insurers increased capital from $359 billion at year-end 2003 (prior to the hurricane seasons) to $437 billion at year-end 2005 and $500 billion at year-end 2006, he noted.

The concern of the reinsurance industry is that H.R. 3355 will lead to creation of more programs like Florida's, which, he said, “turns sound risk management on its head” by underpricing catastrophe risk.

“A major concern the RAA has with H.R. 3355 is that it appears to provide incentives for the creation of more such state catastrophe reinsurance programs,” Mr. Nutter said. “State programs that do not collect adequate, risk-based premiums up front–such as in the case of the Florida Hurricane Catastrophe Fund–cannot afford to lay off the risk to the capital or global reinsurance markets.”

Instead, he said, “they must rely on the issuance of bonds and have the taxpayers and other insurance consumers to pay off the debt and subsidize catastrophe exposed insurers.”

Mr. Joyce said PCI supports the liquidity provisions in the legislation because they would offer solvency protection to state catastrophe funds to stabilize markets.

Still, he said, “any federal program must be carefully structured so that it does not mask the true cost of insuring against catastrophes, encourage reckless development in high-risk areas, or hinder the flow of new private capital to the market.”

He added, “We think it is critical to connect such standards to the creation of a federal financing facility in order to provide incentives for states to do everything they can to reduce their exposure to future losses and attract private capital before asking for federal assistance.”

Mr. Joyce noted that the bill's provisions do not specify how catastrophe loans would be repaid. “PCI is concerned that the costs of these loans could simply be passed on to insurers, which could create solvency problems for some companies following a catastrophic event,” he said.

In his comments, Mr. Spiro said IIABA believes that H.R. 3355 “deserves serious consideration.” IIABA especially supports a provision creating a national homeowners' insurance stabilization program, he said.

This provision “would potentially provide for a mechanism for liquidity loans and catastrophic loans for state and regional reinsurance programs, which could provide for a level of stability for such programs that is absent at this time,” he said.

However, Mr. Spiro cautioned, IIABA “also feels that assistance from the federal government should be limited, if at all possible, to reinsurance to help the private market participants, and not to direct state insurers of last resort.”