WASHINGTON (Aug. 6, 2012) — Legislation that proposes federal debt guarantees for state earthquake insurance facilities like the California Earthquake Authority would not drive down premiums or increase take-up of coverage to anywhere near the degrees projected by the measure’s supporters, according to new analysis published today by the R Street Institute.

Under S. 637, introduced in the 112th Congress by Sens. Barbara Boxer and Dianne Feinstein, both D-Calif., the U.S. Treasury Department would guarantee up to $5 billion of debt issued following an earthquake by the CEA or other eligible state earthquake insurance programs. A companion measure has been introduced in the U.S. House as H.R. 3125 by Rep. John Campbell, R-Calif., along with 23 bipartisan cosponsors, all from California’s House delegation.

But while proponents of the bills project that they would immediately reduce earthquake insurance premiums by 33 percent, and increase the take-up of earthquake insurance by 85 percent, R Street Associate Fellow Lars Powell, the Whitbeck-Beyer Chair of Insurance and Financial Services at the University of Arkansas-Little Rock, finds much smaller effects.

According to Powell, the best case first-year effects of the program would be to reduce premiums by 8 percent and increase take-up by 3.5 percent. Assuming the program suffers no losses in the first five years after it is instituted, the maximum cumulative premium savings would be 16.5 percent and the maximum increase in take up would be 7.9 percent. Only about 12 percent of Californians in seismic zones currently purchase earthquake insurance.

Moreover, Powell finds that the primary effect of the legislation would be to shift the cost of earthquake insurance premiums forward in time, with post-event assessments on policies used as the mechanism to repay any federal loans. Given that such assessments are likely to make the CEA or similar state programs uncompetitive with private underwriters of earthquake insurance, the result would almost certainly be default on the loans, with the cost absorbed by federal taxpayers.

“Given the federal government’s record of inadequate pricing for catastrophe risk, it is natural for one to doubt even its intention of charging risk-based rates,” Powell wrote. “In fact, for the CEA to actually pay adequate fees for debt guarantees would be identical in promise, but unique in delivery among government-sponsored insurance programs.”

Powell also cites research commissioned by CEA from the RAND Corp. which demonstrates proponents’ claims that the legislation would reduce future federal spending on disaster relief is highly exaggerated. Even taking the CEA’s own claims of a roughly one-third reduction in premiums for granted, RAND found the legislation would reduce spending on uninsured disaster assistance by only about $3 million to $7 million for every $10 billion in total earthquake loss. Powell adjusts for more realistic reductions in premiums, and finds the expected savings in disaster assistance would be between $920,000 and $1.98 million for every $10 billion total earthquake loss.

A copy of Powell’s research may be found here: http://redesign.rstreet.org/wp-content/uploads/2012/08/R-Street-Policy-Study-No-3.pdf

R Street is a non-profit public policy research organization that supports free markets; limited, effective government; and responsible environmental stewardship. It has headquarters in Washington, D.C. and branch offices in Tallahassee, Fla.; Austin,Texas; and Columbus, Ohio. Its website is www.redesign.rstreet.org.

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