Another government-run insurance scheme is last thing the nation needs

Reinsurance is insurance for insurance companies. If insurance is the financial first responder to disaster events, reinsurance is insurers’ shock absorber, a backstop, enabling insurers to have more stable, predictable returns by spreading the brunt of catastrophic losses to dozens of players in the global reinsurance market.

The INSURE Act, introduced by Rep. Adam Schiff (D-Calif.) in January, aims to add additional capacity to the reinsurance market with the creation of a federal reinsurance entity, with startup capital of $50 billion from the U.S. Treasury’s balance sheet. The facility would first cover flood risk, and eventually also cover windstorm, hurricane, severe convective storms, wildfire and earthquake perils. It would shut down the National Flood Insurance Program (NFIP).

The proposed INSURE Act bears the fingerprints of self-styled consumer crusaders who have demonstrated decades-long animus for the private insurance industry. To be sure, the press release from Schiff’s office announcing the act has three endorsements, all from “consumer” activists. 

Consumer Watchdog founder Harvey Rosenfield gives insurers an eye poke — “it is increasingly clear that the insurance industry is unwilling or unable to serve the needs of consumers….and for that reason government intervention is necessary.” The Consumer Federation of America declares falsely that the reinsurance industry is unregulated. The Center for Economic Justice declares the insurance industry has “market failures.”

The proposed management structure of the facility is frightening. Its advisory committee includes five consumer advocates, three insurance and two reinsurance company representatives, nine representatives from government agencies and eight assorted others. So on a 27-person advisory committee, only two would bring reinsurance expertise to the party. 

Reinsurers do much more than collect premiums for putting their capital at risk. Successful management of a reinsurer requires professional management of close to two dozen professionally managed functions, from underwriting to accounting. It is a fool's errand to believe a reinsurer can be created out of whole cloth and do all that armed with nothing but a 22-page congressional bill.

Other red flags in the proposed design of the program include price controls limiting premium growth exceeding 7 percent. This would usher in inevitable subsidies to provide cover at below-market rates, “insulating” consumers from rate increases, dulling incentives to pursue sound risk management.

The bill’s attempt to provide “stable” catastrophic reinsurance markets fails to understand that property catastrophe reinsurance is by its nature a volatile, feast-or-famine business. For example, in 2005 — the year of hurricanes Katrina, Rita and Wilma — reinsurers licked their wounds, paid their losses and lightened somewhat with reinsurance for reinsurers, known as retrocessional reinsurance. The catastrophe load in 2006 and 2007 was light, strengthening reinsurers’ balance sheets and income statements until the next catastrophe-heavy year, 2008. 

The private reinsurance market works. Property catastrophe reinsurance rates declined at the Florida-focused June 1 treaty renewals. New capacity entered the market in the form of record investment in insurance-linked securities. Even Florida is attracting capital from new companies. These are signs of a healthy market.

Insurers use the global reinsurance industry to spread their risk to reinsurers. Reinsurers, in turn, limit the risk they take on by only taking a slice of each insurer’s risk. The result is that insurers may have dozens of reinsurers on their reinsurance panel. For example, the medium-sized Pennsylvania National Mutual lists 55 reinsurers in its statutory filing. Larger insurers have many more, with each reinsurer taking only a sliver of risk from any one insurer.

Government-run insurance programs like for Federal Crop and Federal Flood Insurance have generated gaping deficits. Crop insurance is so heavily subsidized that farmers pay only one-third of actuarially-appropriate premium for a program allowed to run at a combined ratio well over 200 percent (notwithstanding misleading crop insurance accounting). 

Crop insurance has generated $37 billion in cumulative historical deficits. Flood insurance is finally on the road to reform with the recent introduction of Risk Rating 2.0, which seeks to phase in risk-adjusted rates and eliminate subsidies. It is ironic that the INSURE Act would gut the NFIP so soon after it started to recover. 

Instead of contemplating a government entity that would disrupt reinsurance markets, add to our national debt and burden consumers, Congress should pursue more dynamic strategies like encouraging nature-based solutions that have proven to mitigate the cost of recovery while protecting existing natural systems.

No subsidized, unprofessionally managed government program disguised as a reinsurance facility could replicate the value of a reinsurer. Whereas consumer advocate Rosenfield maintains “government intervention is necessary,” the history of government-run insurance is riddled with failures. Create a government reinsurer overseen by consumer activists and government agency representatives? What could possibly go wrong? 

Jerry Theodorou is policy director for finance, insurance and trade for the R Street Institute