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September 24, 2007

Industry skeptical, while Treasury opposes natural disaster pool

Federal legislation that encourages states to pool their catastrophe pool risks and then transfer them to the private market has been greeted with a lukewarm insurance industry reaction at best and outright opposition from the Bush Administration.

The bill, H.R. 3355, the Homeowners’ Defense Act of 2007, introduced by Representatives Ron Klein, D-Fla., and Tim Mahoney, D-Fla., on Aug. 3, aims to address the availability and affordability of homeowners insurance by providing an opportunity for states to plan for disasters ahead of time, while also offering emergency relief for those states that may be in lower-risk regions.

Insurance industry representatives testified on the proposal this month before a joint hearing of the House Committee on Financial Services Subcommittee on Housing and Community Opportunity, and the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises.

Agents suggested that the legislation, while it has some commendable provisions, is not the answer.

The Independent Insurance Agents & Brokers of America, the nation’s largest insurance association, said that the bill deserves serious consideration when addressing the growing problem of natural disaster risks, but did not offer its full support of the legislation as is.

Steve Spiro, an independent agent and president of Spiro Risk Management Inc., in Valley Stream, N.Y., testified on behalf of IIABA, saying proposals such as this bill could potentially be a part of a comprehensive solution to the problem of natural catastrophe insurance. But he also pointed out that the key to the success of any solution is how the private market will react and whether it will result in increased coverage.

“We strongly believe our industry must come together with policymakers to find a common solution that will encourage participation in at-risk markets,” Spiro said.

Robert Joyce, chairman and CEO of Ohio-based Westfield Group, who testified on behalf of the Property Casualty Insurers Association of America (PCI), said 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,” Joyce said. “The liquidity proposal would offer solvency protection to state catastrophe funds in order to stabilize markets.” However, Joyce also said that 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.

Including the liquidity proposal, the bill has three parts.

According to the sponsors, the bill sets up a consortium for state-sponsored insurance funds to voluntarily pool their catastrophe risk with one another, and then transfer that risk to the private markets through the use of catastrophe bonds and reinsurance contracts. Sponsors maintain that following the risk transfer, state-sponsored insurance funds would be better protected and increasingly able to provide services for those who are not able to find insurance on their own.

The second part, the “liquidity loan” program, contains a provision that would make credit financing available to qualified state catastrophe funds.

The third part would make loans to state or regional catastrophe funds that are not qualified reinsurance plans or to state residual market entities.

Joyce noted that the bill’s provisions do not specify how catastrophe loans would be repaid.

Opposition

The U.S. Treasury Assistant Secretary for Economic Policy Phillip Swagel testified that the Treasury strongly opposes H.R. 3355 because its provisions are at odds with its goal to ensure that there is a stable and well-developed private market for natural hazard insurance and reinsurance.

Allowing private insurance and capital markets to fulfill their roles is the best way to maintain the economic sustainability of communities at greatest risk of natural catastrophes, Swagel testified. “Federal government interference in a functioning natural hazard insurance market would crowd out an active and effective private market, increase the incentive for people to locate in high-risk areas, result in potentially large federal liabilities, and be unfair to taxpayers.”

The Reinsurance Association of America (RAA) also testified that the reinsurance industry does not support the Homeowners Defense Act of 2007 citing concerns with provisions of the legislation that would unnecessarily disrupt private reinsurance market dynamics.

“We cannot support this legislation as introduced because of the emphasis on encouraging the creation of state catastrophe reinsurance funds,” said Franklin W. Nutter, president of RAA. “Notwithstanding the extraordinary losses from natural catastrophes in 2004 and 2005, the capital markets and the insurance and reinsurance industry have shown their ability to meet natural catastrophe risk transfer needs of insurers and consumers when market dynamics are allowed to work.”

Nutter added that the legislation appears to provide incentive for states to replace or compete with the private sector by under-pricing catastrophe risk. “These programs,” he said, “serve to concentrate catastrophe risk in a state, rather than spread it to the global private reinsurance markets, turning sound risk management on its head.”

Nutter said that while RAA could not support the legislation as introduced, he expressed the desire to work with the committee to improve HR 3355 as it moves through the legislative process.

Topics Catastrophe Agencies Legislation Reinsurance Market

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