The Cat fund folly

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Some families are still hoping for a solution to hurricane Sandy’s devastation, but some politicians are using the destruction as an opportunity to propose a national catastrophe fund (Cat fund). Unfortunately, that fund would have the unintended consequence of creating a new financial disaster, and it would not help the victims from Sandy. It is purely a political diversion.

Calls for a national Cat fund are about bailing out fiscally irresponsible states that have set insurance prices far below costs and are now left to wonder how their state-run insurer is going to pay homeowners their insurance claims. Using Sandy’s victims as cover for this mismanagement is just shameful. To understand this, it is important to look at one state that may be fishing for a national bailout because they are shirking fiscal responsibility — Florida.

The Florida legislature set up a government insurer called Citizens Property Insurance Corporation that offers several lines of homeowner insurance. Along with Citizens the legislature erected the Florida Hurricane Catastrophe Fund (Cat Fund) to backstop it. In theory, hurricane premiums collected by Citizens should replenish its reserves, especially if prices are set at the actuarial risk that its policyholders face.

Yet, both Citizens and the Cat fund are seriously underfunded, facing potential insolvency in the face of major storms. This financial mess comes despite Florida not incurring major hurricane damage in nearly 8 years.

The problem is that these state programs and state Cat funds are mismanaged in the sense that they subsidize coastal property insurance at the expense of everyone else in the state. Essentially, Florida’s legislature is setting insurance prices low in order to attract coastal votes, (politicians call it “affordability“) rather than encouraging a healthy insurance market.

What does this all have to do with a national Cat fund?

Early in 2013, U.S. Senator Bill Nelson (FL-D) and Representative Frederica Wilson (FL-D) introduced similar bills called the Homeowners’ Defense Act to create a national pool for catastrophic insurers. These bills require the U.S. government to make low-cost loans to any suitably structured state catastrophe fund. Not surprisingly, “suitable” is modeled after Florida’s Citizens and Cat Fund examples.

Senator Nelson says the bill “creates a framework for states to pool their resources to help pay for each other’s disaster costs.” The bills do not limit themselves to hurricane insurance. The tornados and floods that frequent some states are also covered. The benefits of mutual aid under this bill would flow disproportionately to them. But costs under this bill would be borne disproportionately by states subject to the lightest incidence of natural catastrophes. On top of this inequitable cost-benefit distribution is the cost of unchecked mismanagement. No doubt, many states will run quickly from the “opportunity” to join this mess.

The bills force taxpayers to subsidize the sloppy insurance and Cat Fund practices of any state, including bad practices, underpricing catastrophe risk, subsidies for rich coastal homeowners who contribute handsomely to political campaigns, imposing assessments to tax other consumers, and maintaining a business-hostile environment toward private insurers that actually have the capital to insure homeowners.

Through taxpayer support, this bill means that every state is dragged back to fund this folly.

There are private insurers who run a prudent business with actuarially sound prices, maintain adequate reserves, and pay claims promptly.  There is no need for politicians to pretend government provides a uniquely righteous example – it doesn’t.

Politicians should not use the devastation from Sandy as an excuse to bailout their own mismanaged state insurance programs. Moreover, if implemented, these bills would encourage further mismanagement of government insurance funds, thereby infecting states whose public and private catastrophe funds are actuarially sound.

No matter what vote-seeking politicians say, innocent consumers should never be forced to share the cost of governments driven by political folly.

Steve Pociask and Alan Daley write for the American Consumer Institute Center for Citizen Research, a nonprofit educational and research institute.