Those who think the federal government needs even more debt and more responsibilities will love Florida Democrat Ron Klein’s Homeowners’ Defense Act. Everyone else should treat the bill—currently moving forward in the House of Representatives—with a great deal of skepticism. The proposal, intended to reduce homeowners’ insurance premiums, turns the federal government into the insurer of last resort for many of the most disaster-prone homes in the country. Since the great bulk of the bill’s potential beneficiaries and current advocates live on or near hurricane-prone beaches, it’s quite fair to think of the bill as a bailout for them—a beach house bailout.
The Homeowners’ Defense Act sets up a Fannie Mae-style “private” consortium, with a board made up of government officials, to underwrite catastrophic natural disaster losses for private homeowners’ insurers, requires Treasury to lend money to states that suffer natural catastrophes, and provides loan guarantees to a Florida hurricane catastrophe fund and to California’s government-mandated earthquake insurer. According to the bill’s supporters—Klein, an assortment of other politicians, and a small handful of big insurance companies—all of this would cost taxpayers nothing, as the legislation requires the consortium to break even and states to pay back loans they receive.
Attractive as it may seem on paper, the idea cannot possibly work, because it violates the risk-pooling principles at the heart of insurance. “Primary” insurance companies like Allstate, Nationwide, and CNA buy insurance of their own, called reinsurance, to manage and pool risk. The reinsurers that sell this type of coverage invariably operate around the globe. A large reinsurer like Warren Buffett’s Berkshire Hathaway might simultaneously underwrite the risk of an industrial accident in Japan, a flood in the U.K., a hurricane in Florida, and a cyclone in Australia. Since there’s almost no chance that all of these events will happen at the same time, the reinsurer can profit from the premiums it earns on one type of coverage even when it pays out mammoth claims on another.
All other things being equal, a broader, more diversified pool results in lower premiums. Klein’s bill actually narrows down the pool by encouraging states to concentrate risk here in the United States under the aegis of federal guarantees. Thus, to break even, the government would have to charge higher premiums and interest rates than the private sector for any coverage or guarantee it provides. This means that if it hopes to sell any coverage at all, the government will have to under-price it and thus leave taxpayers with nearly limit-less liabilities.
The federal government’s one similar existing effort—the National Flood Insurance Program—shows how Klein’s proposal would probably work in practice. Since it began selling homeowners’ flood coverage in 1968, the flood program has repeatedly violated the statutory mandates that it break even on most coverage it sells. It has run up debts of around $19 billion and, even after a four-year run of very mild flood seasons, has made almost no progress in paying them back. Congress has always lifted debt caps and spending limits attached to the flood program since they get exceeded following major disasters, when the only other choice would be to let the program run out of cash. As a result, nearly everyone who has taken a look at the program agrees that the federal government will eventually have to forgive the debt.
Like the flood program, furthermore, the catastrophe insurance programs Klein favors would lower insurance costs and decrease credit risk for developers and real estate agents interested in building in currently wild coastal and floodplain areas. (Building in these areas both puts more people in harm’s way and, since wetlands absorb storm surge from hurricanes, potentially increases inland damage.) As a result, real estate agents and homebuilders have joined some insurers in support of the bill, while environmental groups like the National Wildlife Federation and Sierra Club have joined forces with small-government bedfellows, including Grover Norquist’s Americans for Tax Reform, Dick Armey’s FreedomWorks, as well as a larger number of insurers and a variety of insurance industry groups, to oppose it.