A Catastrophe of a Catastrophe Bill
On January 12, Representative Adam Schiff (D-Calif.) introduced a bill, the “Incorporating National Support for Unprecedented Risks and Emergencies (INSURE) Act.” The stated goal of the bill is to “stabilize the home insurance market while ensuring vulnerable communities are not excluded from coverage.” The bill would achieve this by creating a “federal catastrophic reinsurance program to insulate consumers from unrestrained cost increases by offering insurers a transparent, fairly priced public reinsurance alternative for the worst climate-driven catastrophes.”
The underlying premise of the bill is revealed in one of the four endorsements of the proposed bill seen in Congressman Schiff’s announcement. The comment in Schiff’s release of Harvey Rosenfield, consumer advocate who engineered the introduction of Proposition 103 in California in 1988, explains “With widespread shortages and skyrocketing premiums, it is increasingly clear that the insurance industry is unwilling or unable to serve the needs of consumers and business throughout the country, and for that reason government intervention is necessary.” Because the premise of the Schiff bill, as articulated by Rosenfield, is wrongheaded, the architecture of the proposed entity is problematic as well.
Remember 2007?
The Schiff bill contains echoes of a valuable congressional hearing in 2007 chaired by Senator Chris Dodd, on availability and affordability of property insurance. In that hearing, held after a devastating two-year string of southeast hurricanes in 2004 and 2005 (hurricanes Bonnie, Charley, Frances, Ivan, Jeanne, Katrina, Wilma and Rita) there was informed, intelligent discussion on pros and cons of creating a federal insurance facility to serve as a backstop. Senator Richard Shelby made the points that the private market is more innovative than the government with new vehicles to manage risk, that the market is a better risk manager than the government, and that reinsurance schemes have a record of financial mismanagement. As with Schiff’s proposal, the premise underlying the 2007 discussions was the notion that traditional insurance market mechanisms do not adequately manage catastrophic risk. The idea of introducing such a mechanism did not advance, as the winning arguments were presented by Ed Lazear, then-Counsel of Economic Advisors Director, whose testimony expanded on Shelby’s, and has withstood the test of time. Lazear warned that a government reinsurance entity would have the following pitfalls, and its pursuit would constitute a fools’ errand:
- A national catastrophe fund is very likely to underprice the reinsurance
- A national catastrophic risk insurance plan would likely distort rates and undermine economic incentives to mitigate risk
- Replacing private reinsurance with government reinsurance is both unfair and inefficient. It is unfair because it forces taxpayers nationwide to bear the costs of subsidizing insurance in high risk areas
- When insurance premiums reflect underlying risk, they provide valuable signals to those seeking insurance about the costs of their decisions, so people have incentives to take actions to mitigate risk
- There has not yet been a catastrophe such that private insurance markets were unable to absorb the risk
Proponents of the Schiff bill identified on the release include the Consumer Federation of America, whose former head, Robert Hunter, once declared that managing an insurance company is easy. “You’d have to be pretty dumb to fail in this market. I mean the stock market just keeps going up and up and up and the bond market’s strong. It’s pretty hard to fail.” Be it also remembered that Hunter, who served as Texas Insurance commissioner for 14 months in the 1990s, also unkindly slighted insurers when he characterized new hires in the insurance industry as “dregs.”
The record shows that the federal government is not equipped to create or manage a reinsurance entity. Pace Hunter, successfully managing an insurance entity requires that over a dozen discrete functions be mastered, and executed like a well-oiled machine – distribution, underwriting, pricing actuarial, reserving actuarial, product management, loss control, loss adjusting, reinsurance, retrocession, investment management, treasury, reporting, legal, compliance, administration, data analysis, enterprise risk management, product development, risk modeling, catastrophe accumulation management, executive management, and more. It is foolish to assert that federal employees can easily create and run a well-performing insurer. The fiscal unsoundness of the National Flood Insurance Program and the federal crop insurance program, which have bled tens of billions of dollars in losses, suggest that creating another federal insurance program would constitute throwing good money after bad. And in the current context of ballooning deficits and debt, Schiff’s proposal to use the Treasury’s balance sheet as a backstop, requesting $300 billion in the course of 5 years for the facility, should send chills through the fiscal soundness community.
One reason the 2007 exploratory efforts to create a federal reinsurance program failed is because, as Shelby and Lazear declared, the market is a better risk manager than the government. In the wake of the momentous hurricane losses of 2004-05 which precipitated Dodd’s hearing, insurance capital was restored with the formation of close to a dozen new private reinsurance companies with clean balance sheets and significant financial backing from investors. What is more, approximately 50% of the losses from the hurricanes of 2004 and 2005 were borne by non-U.S. reinsurers. The reinsurance business is global – the market is concentrated in continental Europe (think Munich Re, Swiss Re, Hannover Re, SCOR Re), Bermuda and Lloyd’s. With the exception of Berkshire Hathaway, the U.S. market is a minor player, eclipsed by the non-U.S. reinsurance market. If Schiff’s program were to launch, it could crowd out the private market with underpriced insurance, resulting in socializing the cost to all taxpayers. Not a good idea.
The “Class of 2005” used its capital to write property catastrophe reinsurance. Additional private capital entered the market in the form of catastrophe bonds. The Schiff bill suggests that a market for catastrophe bonds should be created. Here’s a wakeup call — there has been a market for cat bonds for over 30 years. 2023 saw strong growth and record-high returns for investors, something to fuel further growth in the cat bond market.
Bureaucracy, More Bad Ideas
Among other things, the Schiff bill proposes that flood risk be borne by the new program. Just when the NFIP is turning the corner, with actuarially-sound Risk Rating 2.0 earning into financial results, and ample reinsurance support from the global reinsurance market and catastrophe bonds, the Schiff bill proposes transitioning the NFIP to a new proposed program.
The Schiff bill proposes that the reinsurance entity would be managed by a committee of 22 individuals, five of which are consumer advocates, five more are from the insurance industry, and 18 more are government agency leaders, who would advise the Treasury Secretary on how to manage the facility. With management by a committee of 22, a committee dominated by government bureaucrats and consumer activists who do not understand how reinsurance works, what could possibly go wrong?