However, that would be following a natural disaster with a fiscal one.
The concept is similar to what Florida did when it created Citizens Property Insurance, a state-owned “insurer of last resort” that has become the state’s largest insurer, and the Florida Hurricane Catastrophe Fund, which requires insurers to purchase reinsurance. The idea is that applying that principle on a national scale would spread the costs of rebuilding areas hit hard by hurricanes, tornadoes or blizzards and thus stabilize the insurance markets.
It sounds deceptively appealing on a communal level. But it ignores the financial problems already experienced by such programs and the costly incentives they provide.
In Florida, political pressure to keep property insurance affordable for consumers forced rates to be set artificially low, so that they don’t reflect the true amount of risk. That meant that Citizens and the Cat Fund were unable to raise sufficient revenues to cover real losses.
According to recent estimates, Citizens will have a $5.7 billion surplus by the end of this year, with the ability to recover $6.591 billion in Cat Fund reimbursements and $575 million in private reinsurance to pay claims after a storm. However, if a 100-year storm — another Hurricane Andrew — hits, it would have a maximum loss estimated at $22 billion.
Florida has been fortunate not to have suffered a hurricane since 2005 (knock on wood — there are still three months left in the 2011 season). That has allowed it to build up reserves that can withstand a “normal” storm strike. The longer its luck holds out, the better that situation gets. Basing fiscal policy on the whims of weather, though, is about as smart as using that money to play the slots in Vegas.
If the state gets walloped by multiple storms in one year or a big Category 5 hurricane, Citizens and the Cat Fund could be overwhelmed — which means Florida would have to rely on bonds or tax increases to pay insurance claims.
It’s not difficult to imagine Congress applying the same kind of pressure on a national catastrophe fund to keep insurance rates affordable. It would be comparable to the role Fannie Mae and Freddie Mac played in the housing market meltdown, where politicians encouraged the quasi-governmental agencies to underwrite more and more risky mortgages to help inflate the housing bubble.
Washington already operates a cash-strapped national catastrophe fund — the federal flood insurance program, created in 1968 and administered through the Federal Emergency Management Agency. It charges rates that substantially underprice the risks it insures; like Citizens, it is not actuarially sound.
It is also some $18 million under water.
Federal flood insurance, like Citizens and similar entities, subsidizes risk, thus encouraging people to construct homes in flood- and storm-prone areas. That’s a big reason why damages from hurricanes and floods have skyrocketed in recent decades — more, and more expensive, property is being developed in vulnerable regions. The potential costs to taxpayers are staggering.
In 2010, USA Today investigated the program and concluded its financial problems “reflect a broader government reluctance to restrain benefits. FEMA leaders and some lawmakers have tried to end the premium discounts and the multiple insurance payments, ‘but there’s always been a few in Congress that have had enough political muscle to hold that back,’ ” one former FEMA assistant administrator told the newspaper.
Given the nation’s dismal financial situation — a mountain of debt coupled with rising entitlement costs in the coming years — the last thing it needs is to shoulder another costly responsibility. The cost of insurance should reflect the full risk, and not be used subsidize one class of property owners at the expense of others.