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Gale Force Foolishness

Congress pushes for a federal windstorm insurance program.

12:00 AM, Sep 24, 2008 • By ELI LEHRER
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AS CONGRESS WINDS down its current session, there's little doubt that plenty of bad ideas will pop out of the woodwork as members put the finishing touches on legislation. Unfortunately, one of the worst ideas to come down the pike in quite some time--federal windstorm insurance--has gained some momentum. A federal wind insurance program has already passed the House and, although overwhelmingly rejected in the Senate, could end up attached to National Flood Insurance Program renewal that Congress has to pass between now and September 30.

In a way, it's easy to see the reasons for the program's appeal. Under a bill from Mississippi Democrat Gene Taylor that has passed the House of Representatives, the federal government would add wind coverage to the existing National Flood Insurance Program (NFIP). In theory, the move would cost the taxpayers almost nothing nothing because the program would charge "actuarially adequate" rates, encourage policyholders to do a better job making their homes more resistant to windstorms, and make communities adopt anti-hurricane zoning codes. Most importantly for politicians and their constituents, the proposal would provide some welcome relief from insurance premiums that have more than doubled in many coastal areas.

But all this simply won't work. Federal wind insurance could potentially run up enormous bills for the Treasury, would do almost nothing to make the country safer, and would drive the private sector out of a large part of the insurance market.

Despite all the talk of actuarial adequacy, the program would--at minimum--result in an enormous transfer of wealth to a few coastal states. This is because efforts to require "adequacy" simply aren't practical because the government's definition of adequacy really doesn't jibe with the one that private companies use (it discards a number of risk and overhead factors). Likewise, efforts to stop the program from writing policies when it goes into debt seem destined to be overturned: If enforced, they would require the program to stop issuing new policies following a major disaster when, for perfectly understandable reasons, interest in wind insurance would spike. Congress would repeal them in a heartbeat.

Former Clinton administration official Robert Schapiro, who studied the proposal, found that during a single hurricane season as bad as the 2005 season that brought Katrina, a wind program could cost the federal government as much as $160 billion in 2009. And costs would rise over time. By 2017, Schapiro and his co-author Aparna Mathur say, a wind program could impose a $332 billion cost on Federal taxpayers.

On top of this, the program would make the country less safe. Hurricane-prone areas already have decent incentives to adopt stringent building codes, and risk-based insurance rates offer the best sign of all that a place is dangerous to live. By suppressing rates below their free market levels, something the program would almost certainly do, federal wind insurance would encourage development in places that it shouldn't happen. A house on a sand dune that has hurricane shutters and roof tie-downs is still much more likely to fall apart during a hurricane than is a perfectly ordinary house built several miles inland.

Finally, the program simply isn't needed. Although real insurance affordability problems exist for some people of modest means who live in coastal areas, the overall insurance and reinsurance system has proven it can deal with major catastrophes. Hurricane Katrina, the country's largest-ever natural disaster, cost over $80 billion--private insurance payouts were almost exactly half that--but didn't drive a single major insurer or reinsurer out of business. In fact, the only entities that got into serious trouble were state-mandated wind insurance programs.

Federal wind insurance, quite simply, violates sound insurance principles. It's a terrible idea that Congress should leave by the wayside.

Eli Lehrer is a Senior Fellow at the Competitive Enterprise Institute.