Archive Press Releases

STATEMENT

on
H.R. 21, the Homeowners Insurance Availability Act of 1999

before the
House Banking and Financial Services Committee

presented by
Franklin W. Nutter
President, Reinsurance Association of America

July 30, 1999

 

 

EXECUTIVE SUMMARY - REINSURANCE ASSOCIATION OF AMERICA

The Reinsurance Association of America (RAA) believes that H.R. 21 is a sound foundation for addressing a federal role in financing natural catastrophe losses. The creation of a federal reinsurance program is of great importance to our member companies. We firmly believe that federal involvement is a necessary component of any ultimate solution.

However, the RAA would like the Committee to readdress the level at which the federal Treasury assumes the cost and risk of a natural disaster. We urge the Committee to fully consider the capacity of both the primary and reinsurance marketplace to bear catastrophic risk. We propose that higher attachment levels (Atriggers@) for the government=s role be incorporated to better reflect the private sector=s risk bearing capacity. The RAA believes that such a change will help ensure that the private marketplace is not unnecessarily infringed upon and that the federal Treasury is not at risk by assuming too much of the cost of financing these disasters.

CAPACITY IS ABUNDANT IN THE REINSURANCE MARKETPLACE:

• There is currently an overabundance of reinsurance capacity in the U.S. Reinsurance broker, U.S. Re Corporation, has just released a new report reflecting the current marketplace for reinsurance. The July 28 1999, U.S. Re report states that: (1) there is approximately $13-$15 billion of Aexcess of loss@ catastrophe reinsurance capacity in place per region, per event in the U.S.; (2) an additional 40 percent of capacity is in place from other forms of reinsurance being purchased (facultative, per risk of loss and proportional); and (3) that an additional $1 billion of capacity per region is also available from capital markets products. These factors would result in approximately $20 billion of catastrophe reinsurance capacity available per region, per event. This number does not include the capacity provided by the primary industry to finance catastrophes. A Renaissance Re report reaches a very similar conclusion about the capacity of the reinsurance marketplace.

• Two state panels have determined that there is overcapacity in the reinsurance marketplace. In February of 1999, the Louisiana Property Insurance Task Force reported to the State Legislature that there is overcapacity in the reinsurance market, without even counting capital markets capacity. The report concluded that in Louisiana alone, it is estimated that it would take a market loss of over $13 billion to exceed the catastrophe reinsurance limits purchased. In February of 1999, a New York Panel on Homeowners= Insurance Coverage reported to Governor Pataki and the State Legislature that there is a current overabundance of reinsurance capacity in the marketplace and that Alosses from a 250-year storm striking New York would be in a range of $6 billion. This amount is easily within the industry=s current capacity to absorb.@

• Guy Carpenter Inc., a reinsurance broker, reported in November of 1998 that the capacity of reinsurance has risen and insurance companies can now purchase traditional catastrophe excess coverage above $500 million per event, per insurer, as compared to $200 million in 1992.

COST OF REINSURANCE: It has been suggested that reinsurance prices are too high and that is why insurance companies are unwilling to expand coverage in risk-prone areas. The cost of catastrophe reinsurance is very low and has in fact dropped for five years in a row.

• On June 1, 1999, Paragon Risk Management Services issued its Catastrophe Price Index (measure of domestic reinsurance catastrophe prices) and reported that reinsurance prices for renewals for January 1, 1999, have dropped for the ninth semi-annual period in a row. Paragon=s report concludes that global catastrophe pricing remains under pressure as reinsurance capacity exceeds demands in all regions.

PRIMARY INSURANCE MARKETPLACE: The primary industry is also well-prepared to handle the cost of a natural disaster. The Committee must consider the capacity of the primary insurers (not just reinsurers) for they are responsible for absorbing some of the cost of a natural disaster. Historically, the primary insurers have paid 2/3 to 3/4 of catastrophic claims, passing the remainder through to reinsurers. Here are some facts about the primary marketplace:

• According to a July 14, 1999, Wharton School Catastrophe Risk Management Study analyzing the capacity of the U.S. property insurance industry=s ability to finance major catastrophic losses, the insurance industry has more than adequate capacity to pay at least 98.6 percent of a $20 billion loss. For a catastrophe of $100 billion, the industry could pay at least 92.8 percent. The report concludes that the gaps in catastrophic risk financing are presently not sufficient to justify Federal government intervention in private insurance markets in the form of catastrophe reinsurance.

• According to A.M. Best, insurance industry surplus currently stands at $332.3 billion, an increase from 77.1 percent since 1994 after the insurance industry suffered losses from Hurricane Andrew and the Northridge Earthquake. Policyholder surplus for the top five homeowners insurers, controlling 49 percent of the market share (State Farm, Allstate, Farmers, Nationwide and Travelers) currently stands at $87.4 billion, more than doubling their surplus over the last five years.

CAPITAL MARKETS: Capital markets have developed and implemented products to securitize insured catastrophe risk and provide additional capacity to insurers ($2.5 billion in 1998). The potential capacity should not be ignored or underestimated during the Committee=s consideration of H.R. 21.

STATE SOLUTIONS TO THE CATASTROPHE EXPOSURE: The RAA believes that the state insurance departments play an important role in the issue of homeowners availability in disaster-prone areas. State insurance departments have been working with insurers to allow changes in policy coverages and premiums that bring premiums in line with the risk of catastrophes in their markets and give consumers options in line with their resources.

MITIGATION: The RAA believes that both the federal government and the state insurance department should encourage mitigation in disaster prone areas. Such mitigation will assist in mitigating the effects of a mega-catastrophe.

Notwithstanding these positive developments, a fundamental problem facing insurers and their policyholders remains: the threat of a mega-catastrophe that exceeds the resources of the insurance and reinsurance markets. The RAA believes that federal involvement is a critical component of any solution to this very important issue. The RAA urges the Committee to thoroughly evaluate the capacity of the primary, reinsurance marketplace and capital markets. We believe doing so will result in your support for higher trigger levels which will minimize the risk assumed by the federal Treasury and maximize the resources of the private insurance industry.

The RAA looks forward to working with the Committee as it considers H.R. 21.

***

Chairman Leach and Members of the Banking Committee, it is an honor to appear before you on behalf of the Reinsurance Association of America. We commend you, Mr. Leach as well as Messrs. McCollom and Lazio, in particular, for your leadership in promoting legislation to address the issue of natural catastrophe exposure and insurance.

The Reinsurance Association of America (RAA) represents U.S. domestic property casualty reinsurers.¹ The creation of a federal reinsurance program is of great importance to our member companies. Over the years, the RAA has supported efforts to create a federal role to address the issue of natural disaster catastrophe exposure in the United States. Our members firmly believe that federal involvement is a necessary component of any ultimate solution to this very important issue.

H.R. 21 is a sound foundation for addressing a federal role in financing natural catastrophe losses. However, the RAA would like the Committee to readdress the level at which the federal Treasury assumes the cost and risk of a natural disaster. We urge the Committee to fully consider the capacity of both the primary and reinsurance marketplace to bear catastrophic risk. We propose that higher attachment levels (Atriggers@) for the government role be incorporated to better reflect the private sector=s risk bearing capacity. The RAA believes that such a change will help ensure that the private marketplace is not unnecessarily infringed upon and that the federal Treasury is not at risk by assuming too much of the cost of financing these disasters.

RAA PRINCIPLES OF NATURAL DISASTER POLICY

The reinsurance industry has maintained a consistent position on the need for a federal backstop when the costs of a natural disaster exceed the private market capacity. Such a federal role is crucial to protect the solvency of the insurance marketplace and maintain insurance markets for consumers. Providing catastrophe insurance and reinsurance coverage should otherwise be preserved for private sector carriers. State government catastrophe funds² should only be employed as a last resort.

That position is rooted in the following principles, which we urge the Committee to adopt as its own:

(1) natural catastrophe exposures, hurricanes and earthquakes, are insurable risks in the private sector;

(2) government=s role should only be to address insurer solvency in the event of a mega-catastrophe, hereby fostering private sector coverage and preserving the claims paying ability of insurers;

(3) the risk of natural catastrophes is best insured in a diversified marketplace which avoids concentration of risk in too few insurers or state programs;

(4) the private sector=s role, including insurance, reinsurance and capital markets, should be maximized and such financing mechanisms fully exhausted before any government capacity is provided, state or federal;

(5) the government should encourage, and B where appropriate B fund pre-disaster hazard mitigation efforts; and

(6) any federal proposal should not put taxpayers= dollars at risk when the private sector is more than capable of financing the costs of a natural disaster.

These principles form the basis for the RAA=s evaluation of all disaster-related legislation, whether they be federal or state proposals. They are founded solely in the belief that the private sector is the appropriate bearer of catastrophic risk, but are tempered by the recognition that a natural event could occur, one greater than any which has occurred to date, which exceeds the resources of the U.S. insurance and global reinsurance industries.

CAPACITY TO FINANCE NATURAL DISASTERS

At the heart of the debate on H.R. 21 is what is the capacity of the insurance industry to finance natural disasters. It is critical in evaluating capacity of the industry that the Committee keep in mind that insurance capacity for natural disaster exposures is provided by insurers, reinsurers and the capital markets. The bulk of catastrophic risk is retained by primary insurers which provide coverage directly to the public. Such coverage represents the typical homeowners contract where an insurance company agrees to indemnify their customer, upon receipt of a premium, for a loss or damage to property. The primary insurance industry is in the business to pay claims and finance losses associated with a natural disaster. Reinsurers provide protection for insurers in the face of large catastrophe losses but our segment of the industry, by premium volume or surplus, is roughly one-tenth the size of the primary industry.

Although reinsurers assume the risk of a significant portion of most insurance companies= catastrophe losses, several of the largest national personal lines insurers, for example, purchase very little, if any, reinsurance, because their resources, as reflected in their capital and surplus, are large enough to retain risk and absorb shock losses. For instance, the six companies represented today on these two panels have a combined surplus of approximately $ 70 billion.³

A smaller or regional insurer, however, may rely more on reinsurance to spread its risk of loss. No insurer should, or wants to, expose its entire capital base to a threat of a single natural catastrophe or an accumulation of catastrophes. In addition, insurers have a responsibility to stockholders or, in the case of mutual insurers, policyholders, to see that their capital provides an adequate return on equity and is not exposed to a risk of ruin from natural catastrophes.

Thus, as this Committee deliberates this most important issue, it must not just look at the capacity of the reinsurance industry, but it must consider the capacity of the insurance industry as a whole to finance major catastrophes. In addition, the Committee must not ignore the ever growing capacity provided by the capital markets.

REINSURANCE CAPACITY ABOUNDS AND PRICES CONTINUE TO FALL

There is currently an abundance of catastrophe reinsurance available in the marketplace today. As Standard and Poor=s recently reported, there is currently an overabundance of reinsurance in the marketplace and the Aglut of capacity in the reinsurance marketplace will continue to hold back rate increases. Capital is very, very, strong in the reinsurance market.@

Unfortunately, during consideration of this measure last Congress, the Committee relied on a U.S. Re Corporation report as to what the reinsurance capacity is in the U.S. Again this year, the U.S. Re report is cited as evidence of the limited availability of reinsurance in any single region. That U.S. Re report concluded that there was $7 billion of reinsurance available per region. However, several considerations apply: (1) it is a 1995 report based on an analysis of the marketplace in 1994 just after the Northridge Earthquake (1994) and Hurricane Andrew (1992) and; (2) the report only took into account one form of reinsurance, Aexcess of loss⁴,@ and did not take into account the other forms of catastrophe reinsurance available for purchase (facultative, per risk excess of loss and proportional) which make up an additional 40 percent of capacity. U.S. Re has just released a new report reflecting the current marketplace for reinsurance. (See Attachment A). We urge the Committee to rely on this report as extensively as it did in its consideration of H.R. 219 last year. The July 1999, U.S. Re Report states that: (1) there is approximately $13-$15 billion of Aexcess of loss@ catastrophe reinsurance capacity in place per region, per event in the U.S.; (2) an additional 40 percent of capacity is in place from other forms of reinsurance being purchased (facultative, per risk of loss and proportional); and (3) that an additional $1 billion of capacity per region is also available from capital markets products. These factors would result in approximately $20 billion of catastrophe reinsurance capacity available per region, per event. This number does not include the capacity provided by the primary industry to finance catastrophes.

The RAA believes that this more recent and thorough data presents a much more accurate picture of the reinsurance marketplace. We urge the Committee to consider the current U.S. Re report as well as the following in its consideration of the level of which the federal government should get into the business of reinsurance. We believe the abundance of reinsurance in the marketplace warrants the raising of the trigger levels in H.R. 21.

• Consistent with the new U.S. Re report, a July 1999, Renaissance Re report (see Attachment B) analyzing the reinsurance marketplace, concludes that: (1) there is approximately $14 billion in capacity, per event, per region of excess of loss reinsurance purchased by the primary marketplace at this time; (2) reinsurers are offering additional capacity in the excess of loss market, but many insurance companies have decided to retain the risk on their own balance sheet, rather than purchase reinsurance; and (3) in addition to the $14 billion of excess of loss reinsurance available per region, there is additional reinsurance catastrophe protection currently being purchased from other forms of reinsurance agreements including, proportional, facultative and per risk excess of loss contracts. This additional protection adds approximately 40 percent more reinsurance being purchased, resulting in approximately $20 billion of reinsurance sold per region. This number does not include the capacity of the primary industry to finance catastrophes. (Renaissance Re is one of the largest catastrophe writers in the world. It maintains an exhaustive database of all catastrophe offerings and are considered to have the most comprehensive database of catastrophe cover purchased in the U.S.)

• In February1999, the Louisiana Property Insurance Task Force reported to the State Legislature that there is over capacity in the reinsurance market, without even counting capital markets capacity. The report concluded that in Louisiana alone, it is estimated that a market loss of over $13 billion alone would be needed to exceed the catastrophe reinsurance limits purchased.

• In February 1999, the New York State Temporary Panel on Homeowners= Insurance Coverage reported to Governor Pataki and the State Legislature that there is a current overabundance of reinsurance capacity in the marketplace and that Alosses from a 250-year storm striking New York would be in a range of $6 billion. This amount is easily within the industry=s current capacity to absorb.@

• Guy Carpenter, a reinsurance broker, reported in November of 1998 that the reinsurance capacity has risen and insurance companies can now purchase traditional catastrophe excess coverage above $500 million per event, per insurer, as compared to $200 million in 1992.

• Evidence of this high level coverage came in January 1999 when State Farm and Renaissance Re announced the formation of Top Line Re which will provide $3 billion in high level excess catastrophe coverage for non-U.S. business. The marketing plan, according to press reports, envisions that Top Line Re will make $500 million in high layer, catastrophe aggregate excess coverage available per insurer. Even though Top Line Re will not make the coverage available for U.S. insurers, its creation means competition is increasing in this sector.

It has also been suggested by witnesses before the Subcommittee on Housing and Community Opportunity that insurance agents are unable to sell homeowners insurance polices because Aunnamed insurance companies@ inform them that it is too expensive to buy reinsurance. The fact is, reinsurance prices are very low and have dropped for five years in a row. We urge the Committee to consider the following when addressing the catastrophe pricing issue:

• On June 1, 1999, Paragon Risk Management Services announced its Catastrophe Price Index (measure of domestic reinsurance catastrophe prices) and reported that reinsurance prices for renewals for January 1, 1999, have dropped for the ninth semi-annual period in a row. Paragon=s report concludes that global catastrophe pricing remains under pressure as reinsurance capacity exceeds demands in all regions.

• Guy Carpenter Inc, a reinsurance broker, issued a 1998 report noting that its reinsurance placements on behalf of clients continue to indicate a decline in the cost of reinsurance, noting that the cost of reinsurance is now close to Pre-Andrew levels. The report also notes that the prices for catastrophe reinsurance contracts have declined for five years in a row.

• The reinsurance contract with the California Earthquake Authority (CEA) has been cited by proponents of low triggers as evidence of high reinsurance prices. What is not pointed out is that the CEA renegotiated its reinsurance contract with reinsurers in 1999 and just completed negotiations on the 2000/2001 contract. The recent CEA contracts only highlight how low reinsurance prices currently are in the marketplace. Here are a few details of the new CEA reinsurance contract confirmed by the CEA:

For 1999, the Arate on line@(term used for the price of the reinsurance premium) will decrease from the 14.375 percent in the 1997/1998 contract to 11.0 percent in the 1999 contract. How much money does the CEA save with the new rate: a $47 million savings, a 23.4 percent reduction. For 2000/2001 the Arate on line@ will decrease to 8.5 percent, reducing the CEA=s premium cost by nearly 30 percent, thus reducing the CEA=s reinsurance costs by approximately $39 million.

The reinsurers also provided the CEA with a Ano claims bonus@ if 1999 or 2000 goes by claim free, just as 1997 and 1998 have. If the CEA treaty is loss free as of 12/21/99 or 12/31/00 reinsurers will return 12.5 percent of premiums collected in all three years (1997-1999). According to the then CEA Chief Executive Officer Greg Butler, Athe CEA was in a good position to negotiate, given the excellent loss experience (no claims), good operating performance, and excess capacity in the reinsurance markets. We asked a lot from the reinsurers, and a majority of them stepped up to the plate.@

There are record amounts of reinsurance capacity available today. Ironically, this is due in part to the unprecedented insurer losses associated with Hurricanes Andrew ($15.5 billion) and Inki ($1.6 billion) which prompted an assessment of conventional insurance and reinsurance risk. Insurers and reinsurers reviewed their insured exposures and risk management programs and decided to revise their business plans for the coming years. Since 1994, reinsurers, investment bankers, and financial market traders developed additional contingent capital, reinsurance, and derivative risk management products and added new capacity through newly capitalized companies. This has led to the over capacity in the marketplace.

It appears that the capacity will continue to grow in future years as well. In 1998 reinsurance broker Guy Carpenter made the following prognosis about the future of reinsurance during the Louisiana Coastal Task Force hearings: (1) there will be excess capacity, price reductions and continuity of market (the larger catastrophes are more easily absorbed by reinsurers without market concentration); (2) catastrophe reinsurance will continue to become more available and affordable; and (3) more sophisticated customized products will be developed and there will be lower transaction costs. The following contributing factors that cause this positive outlook on future market conditions were cited:

• Mergers and acquisitions, larger companies will assume larger amounts of risk;
• Strong investment returns;
• Entry of new players and new distribution channels including: (a) investment banks; (b)capital market investors; (c) alternative markets; and (d) strengthened Bermuda reinsurance capacity.

PRIMARY MARKETPLACE ALSO WELL PREPARED TO FINANCE NATURAL DISASTERS

Historically primary insurers have paid 2/3 to 3/4 of catastrophe losses, passing the remainder through to the reinsurance industry. The primary industry is also well-positioned to finance natural disasters. As previously stated, it is very important for this Committee to consider the capacity of the primary insurers (not just reinsurers) in its consideration of the trigger levels in H.R. 21. Although H.R. 21 is a proposal to create a federal reinsurance program, the primary industry plays just as critical of a role in financing these natural disasters.

• According to a July 14, 1999 study by the Wharton School at the University of Pennsylvania, entitled, "Managing Catastrophe Risks" which analyzed the capacity of the U.S. property insurance industry=s ability to finance major catastrophic losses, the insurance industry has more than adequate capacity to pay at least 98.6 percent of a $20 billion loss. For a catastrophe of $100 billion, the industry could pay at least 92.8 percent. The report concludes that the gaps in catastrophic risk financing are presently not sufficient to justify Federal government intervention in private insurance markets in the form of catastrophe reinsurance.

• According to A.M. Best, the insurance industry surplus currently stands at $332.3 billion, an increase from 77.1 percent since 1994 after the insurance industry suffered losses from Hurricane Andrew and the Northridge Earthquake. The policyholder surplus for the top five homeowners insurers, controlling 49 percent of the market share (State Farm, Allstate, Farmers, Nationwide and Travelers) currently stands at $87.4 billion, more than doubling their surpluses over the last five years.

• Not only have the primary market=s capital and surplus rebounded, since the disastrous effects of Hurricane Andrew and the Northridge Earthquake, most, if not all, insurers have taken steps to better assess their catastrophe exposure and put in place programs that mitigate the risk of financial impairment to their companies. These steps have included the establishment of subsidiaries devoted exclusively to high-risk markets, better management of the utilization of reinsurance, use of new capital markets products and special purposes vehicles, and catastrophe modeling to better evaluate and establish premium levels commensurate with risk.

CAPITAL MARKETS CONTINUE TO PROVIDE CAPACITY

Over the last few years, the capital markets have developed and implemented products to securitize insured catastrophe risk and provide additional capacity to insurers. (See Attachment C). The capital markets potential to provide capacity for natural disasters reaches into the trillions of dollars. Some of the nation=s most prominent investment banking and securities organizations have actively securitized insurance catastrophe risk, including the Chicago Board of Trade, Goldman Sachs, Morgan Guaranty Trust, J.P. Morgan Securities, Credit Suisse First Boston, AON Re Services, Sedgewick Financial, and Merrill Lynch. The market for capital markets funding of catastrophe natural exposures has grown from one transaction in 1994 totaling $85 million to eighteen transactions in 1998 totaling approximately $2.5 billion. While it is still in its infancy, a lot of resources are being directed by capital markets intermediaries to encourage development of the market and to complete a growing number of transactions. This development could revolutionize catastrophe insurance funding and greatly expand the capacity of the U.S. insurance market to deal with the financial risks attendant to mega catastrophes. The potential capacity from the capital markets should not be ignored or underestimated during the Committee=s consideration of H.R. 21. This is particularly important in light of the likely convergence of the financial services industries if financial modernization is enacted into law.

STATE SOLUTIONS TO THE CATASTROPHE EXPOSURE

The RAA believes that the state insurance departments play an important role in the issue of homeowners availability in disaster-prone areas. State insurance departments have been working with insurers to allow changes in policy coverages and premiums that bring premiums in line with the risk of catastrophes in their markets and give consumers options in line with their resources. Together, the overcapacity of the primary and reinsurance markets have done much to address consumer level concerns about the availability and affordability of catastrophe insurance and have provided additional security to insurers against the threat of financial impairment. Evidence of this is reflected in two recent state reports. In February 1999, the New York State Panel on Homeowners=s Insurance, chaired by the state superintendent of insurance, concluded that: the New York insurance market is resilient for the availability of homewoners= insurance in coastal communities, with few exceptions, has rebounded; and that the number of homewoners= insurance policies written by the New York Property Insurance Underwriting Association (a state-mandated market to ensure availability) has leveled off and the number of new policies is declining.

In Louisiana, after the Property Insurance Task Force issued its study, the Insurance Commissioner issued a letter to Congress noting that " . . . it is crucial that our homeowners are able to obtain affordable homeowners insurance to protect their property against a major catastrophe. In Louisiana, the private marketplace is doing just that, providing homeowners with affordable and adequate coverage to protect against such a catastrophe."

Recent developments in Florida also highlight the positive developments in the homeowners insurance markets. According to the state-run Joint Underwriting Association (JUA - insurer of last resort) in April of 1999 the number of polices dropped below the 200,000 mark. The policy count for the JUA peaked in the fall of 1996, when policies totaled nearly 937,000. The JUA issued a statement that Athe steady decline in the JUA policyholders is a sign that Florida=s property insurance market continues to grow healthier after collapsing in the wake of Hurricane Andrew in August of 1992. Insurance companies do want to write policies in Florida and believe they can. In May of 1999, three insurance companies submitted plans to the JUA that would nearly deplete the remainder of its policies. The same three companies made a proposal to slash the policy base of the Florida Windstorm Underwriting Association nearly in half. The Association insurers more than 493,000 homes in 29 coastal counties. According to a May 5, 1999 Sun-Sentinel report, "reinsurance is playing a big role in breaking the logjam of policies stuck in the pools. All three companies have pacts with large reinsurance companies."

Looking at the primary, reinsurance and capital markets, as well as state initiatives, the RAA believes that the private marketplace is more than equipped to handle losses above the levels provided for in H.R. 21.

MEGA-CATASTROPHE STILL THREATENS THE MARKETPLACE

Notwithstanding these positive developments, a fundamental problem facing insurers and their policyholders remains: the threat of a mega-catastrophe that exceeds the resources of the insurance and reinsurance markets. An insured catastrophe that, for example, exceeds 20 percent of the aggregate surplus of the industry could have a significant negative impact on the solvency of some companies and their ability to provide coverage. Currently, industry surplus stands at $332 billion. Twenty percent of industry surplus would be a $66 billion event. As previously cited, the Wharton school concluded that for a catastrophe of $100 billion, the industry could pay at least 92.8 percent of the claims, however, a significant number of insolvencies would occur, disrupting the normal functioning of the insurance market, not only for property insurance but also for other coverages.

The best approach to improve insurance affordability and availability and to prepare for the losses and devastating effects of a mega-catastrophe should include:

• Consumers who live in catastrophe-prone areas should pay a premium for insurance in direct relationship to that risk. A key component to ensure availability of insurance for these consumers is the experimentation with deductible programs. Earthquake programs have long been written with a percentage deductibles of 2 percent, 5 percent, or 10 percent of policy limits. Wind policies have typically stayed with a flat deductible. Many insurers today believe that creation of new deductible programs will provide an incentive for consumers to take steps to mitigate against property loss. Many states have taken action to approve such deductible programs.

• Consumer information programs should be enhanced. A well-publicized effort to provide consumers with information on how to obtain property insurance is necessary. If a consumer chooses not to purchase affordable insurance, there is not a lot a federal reinsurance program can do for the consumer

• States and communities working with the federal government should institute pre-disaster mitigation programs, including appropriate building codes and hazard reduction measures. Hurricane Andrew has emphasized the importance of enforcement since the Dade County, Florida, experience indicates that little or no enforcement existed for compliance with building codes. The result was billions of dollars in additional damage.

• At the federal level, a federal safety net providing protection for insurers above which they cannot absorb catastrophe losses should be put in place.

With these measures, private sector competition and capacity will continue to flourish, damage to homes and lives will diminish and, in case of a mega-catastrophe, the financial infrastructure of the industry would remain intact, thereby averting wide dislocations throughout the economy. This combination of state regulatory action and federal legislation will solve this problem.

EVALUATION OF PROPOSED FEDERAL APPROACHES

The RAA believes that H.R. 21 is a sound foundation for addressing a federal role in financing natural catastrophes. The RAA=s foremost concern in the legislation are the trigger at which the federal government would provide reinsurance. In H.R. 21, the federal government would provide reinsurance to state government-sponsored catastrophe funds once losses exceed 2 billion, a 1 in 100 year event or the claims paying capacity of the state cat fund, whichever is greater. The trigger levels for the regional contracts to be auctioned by Treasury are $2 billion or 1 in 100 year event, whichever is greater. The RAA believes that H.R. 21 would interfere with the private marketplace and encourage the creation of more state government programs. We are seeking to incorporate higher trigger levels for the federal reinsurance program to better reflect the private sector=s risk bearing capacity. As evidenced in the material above, the RAA believes these changes will help ensure that the private marketplace is not unnecessarily infringed upon and that the federal Treasury is not at risk by assuming too much of the cost of financing these disasters. We believe that low trigger levels tilt the field toward government solutions while higher trigger levels promote private solutions.

The RAA urges the Committee to consider trigger levels that preserve the solvency of the insurance industry but do not interfere with the private marketplace. Last year before this Committee, we suggested an approach which is not currently in H.R. 21, which would set the trigger level based on losses to the insurance industry or insurance company surplus. Senator Stevens= bill in the 104^th Congress, S. 1043, provided for the federal reinsurance program protection to trigger for insured losses which exceed 15 percent of industry surplus or losses by an insurer of 20 percent of its own surplus. If the industry was in a decline and surpluses were down, the trigger would be a lower number. If the industry continues to be robust, the triggers automatically rise. Therefore, the trigger level would adequately reflect the capacity of the insurance industry in good times and in bad.

If the industry surplus trigger is not a viable one, the RAA proposes that at a minimum, the trigger levels for in H.R. 21, for both the state programs and the auctions of be raised to: the greater of $5 billion, 1 in 250 year event or the claims paying capacity of the state cat fund. The RAA understands the unique situation of Florida and is willing to work with the Committee on this issue, or address any other concerns particular Members may have. The RAA is also seeking to incorporate amendments that are more technical in nature that we believe will help increase the effectiveness and fiscal soundness of the new federal reinsurance program.

Additional Concerns about Low Triggers

• The RAA believes that the lower trigger levels will encourage the creation of state catastrophe funds. More states would then be taking on more liability for catastrophe exposures, and seeking to pass the states= liability on to the federal government. Any legislation should allow the private marketplace to assume most of the liability, before a state or federal program subjects their taxpayers to the risk of these exposures.

• The RAA believes that, together with more state funds, low triggers for federal reinsurance, and the requirement that Treasury underwrite each state fund based on risk covered and the prices charged to consumers, a federal oversight mechanism would eventually have to be created. This federal regulatory entity would have to make an evaluation of underlying rates charged to consumers (required by H.R. 21 to be actuarially sound) and oversee solvency of state funds. Higher trigger levels would negate the necessity of federal insurance regulatory oversight.

• Lower trigger levels lead to higher consumer prices. The state catastrophe funds will purchase the federal reinsurance, but in order to fund the purchase of it, will have to pass the cost down to the primary companies in the case of Florida, who in turn will pass the cost onto the consumer. In Hawaii and California, the cost of federal reinsurance will have to be directly incorporated in the cost of coverage paid directly by consumers. Low triggers mean higher cost to purchasers and consumers.

CLOSING REMARKS

The RAA principles on natural disaster legislation are rooted in the belief that capitalistic incentives, operating within a flexible regulatory environment, provide ample motivation for the private sector to offer homewoners insurance in disaster-prone areas. However, they also recognize that the inherent nature of the risk associated with that coverage creates a high-capacity void that only the federal government can fill.

Those principles are further strengthened by a marketplace that has improved considerably over the last few years and is continuing to improve each passing day: insurance companies have surpluses that allow them to write more coverage; reinsurance capacity is abundant; the cost of reinsurance is at a 5-year low; and new forms of reinsurance and capital markets are enhancing the catastrophe risk management market.

Combine these dynamic developments with the guidance exhibited by Congressional leaders as yourselves, and I am optimistic that we are approaching a private/public partnership that will help ensure the availability of homeowners insurance to consumers in disaster-prone areas, while maximizing the resources of the private sector.

I urge you to thoroughly evaluate both the capacity of the primary marketplace, the reinsurance marketplace and the capital markets. I believe doing so will result in your support for higher trigger levels which will minimize the risk assumed by the federal Treasury and maximize the resources of the private insurance industry.

____________________
1. Often described as Ainsurance for insurance companies,@ reinsurance is a sophisticated transaction by which one insurer indemnifies, for a premium, another insurer against all or part of a loss that it may sustain. The fundamental objective of insurance, to spread risk of loss, is thereby enhanced by the insurer=s ability to spread that risk through reinsurance.

The key reasons a primary company purchases reinsurance are: (1) to limit liability on specific risk; (2) to stabilize loss experience; (3) to protect against large losses; and (4) to increase capacity so they can write more policies. The degree to which each insurer will utilize reinsurance for one or all of these purposes is determined by each insurer after assessing its own exposure to losses and its own capital resources.

2. A state run tax-exempt trust fund that provides reinsurance to insurance companies writing homeowners insurance in a particular state.

3. State Farm- $41.8 billion; Allstate- $13.4 billion; Farmers - $4.5 billion; Metropolitan - $95 million; Safeco $3.3 billion; Cincinnati - $3 billion. Best Week, March 29, 1999.

4. Excess of loss is one form of catastrophe reinsurance. Excess of loss provides a defined limit of coverage that indemnifies the company above a specified loss amount.