By Eli Lehrer Sr. Fellow Competitive Enterprise Institute
Under proposed plan to be heard this week state could end up in bankruptcy court
The call for elected representatives to do something" on Insurance Reform this session is understandable given that Texans have many reasons to worry about hurricanes. And last week several members of the Legislature lead by Rep. Craig Eiland (D-Galveston) introduced a proposal that would set up a state backstop" a fund that insurance companies themselves could draw on to pay claims following a major catastrophe.
Two major storms struck the Texas coast last year insurance rates have risen steadily in most coastal areas the states mandated wind insurance mechanism faces severe problems and residents have seen an ever increasing percentage of their income going to pay for property insurance.
The backstop financed through special taxes on insurance policies would theoretically help keep insurance rates down by reducing the amount that private insurers have to pay for their own reinsurance policies. (Reinsurance is insurance for insurance companies.)
It may sound good but it wont work.
In fact its likely to raise insurance rates undermine a vital private industry and quite possibly get the state into real financial trouble.
To begin with the money to pay for the backstop" will ultimately to come from insurance customers themselves so unless the insurance companies already feel their rates are too high (hint: they dont) its quite possible that rates will go up by the amount of the taxes and perhaps more.
In Florida the only state to experiment with a backstop of its own most companies filed for rate increases on top of the taxes assessed to pay for the catastrophe fund.
And as a matter of insurance policy a state-run backstop proposal wont save money.
Buying insurance makes economic sense because insurers can manage risk across a broad pool of non-correlated risks. Within the United States insurers can pool the risk of hurricanes striking Galveston or Houston with the risk of damage from severe snowstorms in Minneapolis or Buffalo. Since the two events never happen at the same time insurers can make large profits off of policies in the North at a time when they are paying lots of money for claims in the South.
Through international reinsurance arrangements likewise insurers can pool risks of hurricanes in Texas with Earthquakes in Japan and cyclones in the Southern Hemisphere.
A Texas-only backstop on the other hand will focus all its risk exclusively in Texas. Therefore in order to break even it will have to charge more than private reinsurers need to: it does nothing to pool the risk.
The result is that a backstop will either prove worthless its product will cost more than what the private market provides or more likely will impose massive liabilities on the state.
Floridas existing Catastrophe Fund does undercut the private market and has just about $3 billion in hard assets to cover its potential liability of $28 billion. It might well have to issue $25 billion in bonds all at once in order to pay for a major storm. (No state has ever sold more than $11 billion in bonds at the same time.)
With bond markets essentially frozen Texas would consider itself lucky to find buyers for $1 billion worth of bonds.
If Florida tried to pay out what it might need to cover claims following a major storm a real possibility exists that the state could end up in bankruptcy court. Already the largest Florida-only insurer has sued the state based upon the theory that the catastrophe fund coverage is essentially fraudulent.
Theres a better way.
Rather than risking the states fiscal future Texas elected representatives should take steps to help residents help themselves. It should let risk rather than political factors determine insurance rates reinforce public infrastructure against hurricanes and imitate successful Florida and South Carolina programs that help residents strengthen their homes against storms.
There are better ways to do things. Texas doesnt need a hurricane catastrophe fund. Its just a bad idea.
Eli Lehrer Sr. Fellow at the Competitive Enterprise Institute in Washington D.C. can be reached by either email or phone at
elehrer@cei.org or 202-615-0586.
