The newly reintroduced Homeowners' Defense Act (HDA) is a
dangerous step toward a federal government subsidy of property
insurance coverage for natural disasters. The bill would also make
it easier for individual states to create unrealistic disaster
insurance programs--with underpriced property insurance
policies--by creating a federal reinsurance fund to cover losses
suffered by those programs. Attempts to place the risk of property
losses due to natural disasters on the federal government are
exceptionally bad policy and should be avoided.
Passing the Cost to Taxpayers
The Homeowners' Defense Act would establish a consortium of
state-sponsored natural disaster insurance funds that would be able
to issue bonds to jointly finance these programs. There is nothing
inherently wrong with this practice, and states are already
empowered to create such consortiums. However, the HDA would
especially benefit the several states that have reacted to
increasing property insurance rates by setting up state property
insurance and reinsurance systems. In many cases, these state
systems provide coverage at artificially low rates that are more
influenced by short-term political considerations than actuarial
estimates of risk.
Additionally, the HDA would make it easier for states with the
most unrealistic insurance rates to pool their risks with more
responsible states and issue bonds that reflect the overall pool
risk level rather than their own high risk level. This would allow
these high-risk states to issue bonds at lower interest rates than
they would otherwise be able to do.In addition, the HDA would grant
this consortium a federal charter, making it appear that the bonds
issued by the group have a federal guarantee when in fact no such
guarantee would exist. This false federal imprimatur could
increase pressure for a federal bailout following any disaster.
What is worse, while bonds issued by the consortium would not
have a federal guarantee, the legislation would also create both a
federal guarantee of bonds issued by state catastrophe insurance
programs and a new $200 billion federal reinsurance program for
these state programs. Together, these two programs are nothing less
than a blatant attempt to have the taxpayers assume much of the
risk for property losses caused by hurricanes and similar
disasters. In essence, under the HDA taxpayers across the country
would be subsidizing the owners of large beach houses.
Those Who Fail to Heed History's
Lessons Are Doomed to Repeat Them
The HDA ignores the history of the National Flood Insurance
Program (NFIP). Started in 1968, the NFIP aimed to provide flood
insurance to people living in known flood plains. From 1968 to
2005, the NFIP paid roughly $15 billion in claims. However, its
losses have exceeded revenues, and the program has received several
federal bailouts, the most recent being in 2005 after the Hurricane
Part of the problem was that some policyholders paid premiums
covering only 35 percent to 40 percent of the expected costs. NFIP
also covered many "repetitive-loss properties," which are legally
defined as properties that had claims in excess of $1,000 twice
over a 10-year period. In fact, some properties have been flooded
and rebuilt a number of times, although reforms passed in the last
10 years have gradually reduced the number of these properties,
which represent almost 30 percent of all claims. Furthermore, in many
flood plains the vast majority of individuals lack flood
The HDA would repeat the mistakes of the NFIP by creating
another federal program via the National Catastrophic Risk
Consortium and Federal National Catastrophe Reinsurance Fund that
would guarantee that the American taxpayer will be on the hook when
state property insurance and reinsurance programs inevitably go
broke or get expanded.
Additionally, the HDA fails to define what "catastrophic" means,
thereby raising the possibility that this term could be applied to
virtually any disaster. For example, one of the deficiencies of the
1988 Robert T. Stafford Disaster Relief and Emergency Assistance
Act is that it did not contain strict enough limits on what can
qualify for a federal declaration by ambiguously defining disaster
as something "of such severity and magnitude that effective
response is beyond the capabilities of the State and the affected
local governments and that Federal assistance is necessary." As a
result, since 1993, the Federal Emergency Management Agency has
routinely ignored the Stafford Act's pliable requirement and
treated even comparatively small disasters as requiring a federal
response. Although very few disasters that occur in America are
truly beyond the capabilities of state and local governments, this
reality does not aid those who see natural disasters as "very
If the point of the HDA is to create a "national backstop" to
deal with a 1-in-200 year truly catastrophic event, then it strains
credibility to define disaster in a way that includes those
disasters that are actuarially predicted to occur every year. Such
an approach ensures only that taxpayers could be called on to pay
for even more of the natural disasters that happen each year.
There Is a Better Way
Earlier this year, The Heritage Foundation developed principles
for reform of catastrophic natural disaster insurance.
Comparing these principles to the HDA makes it clear that the bill
contains serious policy mistakes.
Specifically, policy errors in the HDA include:
- Catastrophic should mean nationally catastrophic.
As noted above, the HDA fails to define "catastrophic" and thus
permits an expansionary application of the program that will cover
non-nationally catastrophic natural disasters that predictably
occur in the United States each year.
- Those who assume the risk should bear the risk. Contrary
to the claims of HDA supporters, the majority of Americans actually
live in areas that have a low risk of nationally catastrophic
disasters. Rather than to require those who choose to live in risky
areas to bear most of the cost of their decision, the bill seeks to
spread the risk to those who do not live in such areas.
- State eligibility should depend on meeting five
requirements: (1) no rate caps; (2) sound building codes; (3)
no redevelopment of disaster-prone areas; (4) tort reform; and (5)
mandated P&C insurance. Although the bill does include some
language on actuarially sounds rates and mitigation actions, that
language contains little to no enforcement aspects but merely
"encourages" such rates. This means the artificially low arbitrary
rate caps in place today will persist, thereby preventing private
sector insurers from actually charging actuarially sound rates.
Similarly, the requirement for building codes standards is met
based on the opinion of the secretary of housing and urban
development, which means that politics--like with the
Stafford Act--will determine outcomes. The bill does not contain
any tort reform or mandated property and casualty insurance
requirements, thereby leaving states at the mercy of plaintiffs'
lawyers and moral hazard.
- State participation should be opt-in only. The program
does allow the states to opt in, yet the taxpayer guarantee ensures
that the taxes or premiums paid by the citizens of states that do
not opt in will directly or indirectly fund the program.
This means that states that do not opt-in receive none of the
benefits of the program, but their taxpayers still bear the costs
- Tax and accounting policies must permit insurance and
reinsurance companies to retain sufficient capital reserves.
The bill does not address this issue, so private insurance and
reinsurance companies will not be able to build up sufficient
capital reserves to deal with a catastrophic natural disaster.
State governments are free to develop irresponsible property
insurance programs as long as they and their citizens understand
that they and only they must bear the consequences. The HDA,
however, creates a way for those states to make taxpayers in other
states share in the inevitable losses. This bad policy should be
John is Senior Research Fellow in Retirement Security and
Financial Institutionsin the Thomas A. Roe Institute for
Economic Policy Studies at The Heritage Foundation. Matt A. Mayer
is a Visiting Fellow at The Heritage Foundation and an Adjunct
Professor at The Ohio State University. He has served as Counselor
to the Deputy Secretary and Acting Executive Director for the
Office of Grants and Training in the U.S. Department of Homeland
Security. He is author of Homeland Security and Federalism:
Protecting America from Outside the Beltway (June 2009).