Reinsurance is insurance for insurance companies. If insurance is the financial first responder to disasters, reinsurance is the shock absorber, the backstop, for insurance companies, allowing them to earn more stable and predictable revenues by spreading the brunt of catastrophe losses across dozens of players in the global reinsurance market.
of INSURE MethodA bill introduced in January by Rep. Adam Schiff (D-Calif.) seeks to add additional capacity to the reinsurance market by using $50 billion in capital from the U.S. Treasury balance sheet to create a federal reinsurance agency that would initially cover flood risk and eventually also cover windstorms, hurricanes, severe convective storms, wildfires and earthquake perils. National Flood Insurance Program (NFIP).
The proposed INSURE Act bears the hallmarks of self-described consumer advocates who have demonstrated hostility toward the private insurance industry for decades. press release Schiff's office announced that the bill has three sponsors, all of whom are “consumer” activists.
Consumer Watchdog founder Harvey Rosenfield has harshly criticized insurance companies, stating, “It is becoming increasingly clear that the insurance industry is neither willing nor able to serve the needs of consumers, which is why government intervention is necessary.” The Consumer Federation of America has falsely declared that the reinsurance industry is unregulated. The Center for Economic Justice has declared that there is a “market failure” in the insurance industry.
The proposed governance of this facility is frightening: The advisory committee would include five consumer advocacy groups, three insurers and two reinsurers, nine government agencies, and eight others, meaning that only two of the 27-member advisory committee would bring reinsurance expertise to the table.
Reinsurance companies do much more than put capital at risk and collect premiums. Running a successful reinsurance company requires expert management of some 20 professionally managed functions, from underwriting to accounting. It would be foolish to believe that you could start a reinsurance company from scratch and do it all armed with only a 22-page congressional bill.
Other red flags in the program’s proposed design include price controls that would limit premium growth to 7 percent or less, which would inevitably invite subsidies to offer below-market premiums, “protecting” consumers from premium increases and reducing incentives to pursue sound risk management.
While this bill seeks to provide a “stable” catastrophe reinsurance market, it fails to understand that property catastrophe reinsurance is an inherently volatile, bountiful-or-bust business. For example, in 2005 (the year of Hurricanes Katrina, Rita, and Wilma), reinsurers licked their wounds, paid losses, and found some relief with reinsurance for other insurers (retrection). Catastrophe burdens in 2006 and 2007 were light, strengthening reinsurer balance sheets and income statements until the next catastrophe year of 2008.
The private reinsurance market is functioning. Catastrophe reinsurance rates have fallen With the June 1st treaty renewal focused on Florida, new capacity entered the market in the form of record investments in insurance-linked securities. Even Florida is attracting capital from new companies. These are signs of a healthy market.
Insurance companies use the global reinsurance industry to spread their risk across reinsurance companies. Reinsurance companies, in turn, limit the risk they take on by writing only a portion of each insurer's risk. As a result, insurers can have dozens of reinsurers on their reinsurance panels. For example, mid-sized Pennsylvania National Mutual lists 55 reinsurers on its legal filings. Larger insurers have many more reinsurers, with each reinsurer writing only a small portion of the risk from any one insurer.
Government-run insurance programs such as Federal Crop Insurance and Federal Flood Insurance generate huge deficits: Crop insurance is so heavily subsidized that farmers pay only one-third of the actuarially fair premium, and the programs allow overall ratios to be well over 200% (despite misleading crop insurance accounting).
Crop insurance has generated an accumulated deficit of $37 billion. Flood insurance is finally on the path to reform with recent reforms. Introducing Risk Assessment 2.0seeks to phase in risk-adjusted rates and eliminate subsidies. It is ironic that the INSURE Act would gut the NFIP just as it was beginning to recover.
Instead of considering a government agency that would disrupt reinsurance markets, increase the national debt, and burden consumers, Congress should pursue a more dynamic strategy, including incentivizing nature-based solutions that are proven to mitigate recovery costs while protecting existing natural systems.
Subsidized, unprofessional government programs disguised as reinsurance facilities cannot replicate the value of reinsurance companies. Consumer advocate Rosenfield argues that “government intervention is necessary,” but the history of government-run insurance is riddled with failure. What would happen if we created a government reinsurance company overseen by consumer activists and government agency representatives? What would go wrong?
Jerry Theodorou is director of finance, insurance and trade policy at the R Street Institute.
