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.
The fundamental unfairness of the bill has attracted centrist organizations like the American Consumer Institute and Taxpayers for Common Sense to join the opposition as well. In fact, two parts of the bill—intended to provide a federal backstop for existing state catastrophe funds—would benefit only Florida and California. (Other states don’t have the legal structures to receive the guarantees the bill provides.) Likewise, the main beneficiaries would be people who live near the beach, and, as Dan Sutter of the University of Texas Pan-American has shown, coastal counties in hurricane prone states are generally wealthier than inland counties. In Klein’s hometown of Palm Beach, in fact, the State of Florida provides subsidized insurance through the Florida Citizens Property Insurance Corporation for waterfront mansions worth up to $2 million—many of them second homes.
While some California and Florida Republicans support Klein’s effort, most of its supporters come from the Democratic caucus mainly because the House Democratic leadership—interested in boosting the vulnerable Klein—has gotten strongly behind the bill. On the other hand, a similar bill to add wind coverage to the national flood insurance program went down to a 74-19 defeat in the Senate in 2008. And although Barack Obama supported a different version of Klein’s measure on the campaign trail and in the Senate, his administration has come out against the wind proposal and remains silent on Klein’s current bill.
For all of the manifest flaws of Klein’s proposal and its uncertain future in the Senate, it passed out of committee last week and seems likely to move towards the House floor. The bill presents a classic case of a public policy with diffuse, difficult-to-calculate costs and concrete, easy-to-measure benefits. On one hand, the U.S. Treasury will end up owing billions of dollars (that it will eventually have to collect in taxes)—but only after a major storm hits. On the other hand, the proposal will deliver immediate increases in profits to some insurance companies, open up new opportunities for developers, and shave a few dollars off the insurance premiums for owners of hazard-prone properties—i.e., beach houses.
The Homeowners’ Defense Act is one of the very worst pieces of public policy with serious support in the current Congress, and that’s saying something.
Eli Lehrer is national director of the Center on Finance, Insurance, and Real Estate at the Heartland Institute.