June 2007

Could More Competition Have Solved the Post-Katrina Insurance Problems on the Gulf Coast?

Insurance companies are regulated entirely by state governments. In late May, Senators Tim Johnson (D-S.D.) and John E. Sununu (R-N.H.) cosponsored legislation that would create an optional federal charter for insurance, allowing companies to organize under federal rather than state laws. Advocates of this proposal argue that an optional federal charter would enhance competition and make insurance more affordable, while opponents claim that it would make insurance even harder to obtain for people of modest incomes and result in even more complex and inefficient regulation.

This debate has drawn considerable attention in the wake of Hurricane Katrina. In many states along the Gulf Coast, homeowners' insurance premiums have risen dramatically, and many companies have either restricted coverage of--or withdrawn entirely from--certain areas. Although state governments have launched a variety of efforts to make insurance more available, some experts believe that these reforms are unlikely to create a sustainable insurance market. Would this federal legislation create a more competitive market in areas afflicted by natural disasters? Would a more competitive market solve the problems faced today by the Gulf Coast? How might an optional federal charter affect the affordability of insurance in Gulf Coast states? At a June 8 AEI conference, cosponsored by the Competitive Enterprise Institute (CEI), panelists discussed these and other questions.

Peter J. Wallison
AEI

Insurance markets in states along the Gulf Coast are now in dire straits, with many companies going bankrupt or withdrawing coverage from areas threatened by hurricanes. State-owned insurance companies have responded by picking up much of this coverage, which means that if there is another bad storm season, taxpayers in less-vulnerable areas will have to cover the losses suffered by people who live on the coast. If states did not regulate insurance rates, these problems would likely not exist, since competitive forces would lead to rates that are commensurate with the risks. While a national charter for insurance companies could help introduce competition into insurance markets, it would be ineffective so long as states continue to regulate and subsidize rates.

The Honorable Shirley D. Bowler
Louisiana House of Representatives
 
Members of the Louisiana state legislature have not responded to the insurance crisis with free-market policies. Instead, in order to secure electoral victories, they continually promise to keep rates low through regulation. Yet policies that promise "consumer protection" typically end up reducing coverage and harming Louisiana homeowners. One example of this is a law that prohibits insurers from canceling or not renewing policies or raising its deductibles if the policy has been in effect for more than three years. In the most recent session, representatives introduced other anticompetitive, anti-insurer legislation. One such bill would have the government match the surplus that insurance companies use to write new policies in Louisiana. Despite their popularity with business organizations, these subsidies are unnecessary and dangerous. Another reform package has three components: eliminating the rating commission and replacing it with a file-and-use regime, creating an office of consumer advocacy, and enacting a policyholder bill of rights. The fact that the insurance industry supports this bill--despite its anti-insurer provisions--demonstrates the hostility of the Louisiana state legislature toward insurance companies.

The interstate compact advanced by the National Association of Insurance Commissioners is bad policy because it delegates legislative authority to an independent institution that is not accountable to the people. An optional federal charter would be a better policy, since it does fall under the legislative process and would be subject to democratic supervision. However, the optional federal charter proposal should not be funded by state premium taxes, since these taxes are not even used to fund state insurance departments--they go into the state's general fund.

Carl M. Parks
National Association of Mutual Insurance Companies

While the insurance industry is not monolithic, the majority of property-casualty insurers do not support the optional federal charter. The industry supports competitive markets, an end to rate controls, and uniform regulations across states. These reforms, however, should be enacted at the state level. Passing a federal law and creating a new federal bureaucracy would only make current problems worse. Moreover, the problems afflicting the Gulf Coast states are unique to that region, and federal regulation would not be suited to deal with them. Congress can better help the troubled markets through grants and tax breaks for insurance companies that provide coverage to vulnerable markets. Even though state regulation is not perfect, the optional federal charter, which is not even politically feasible, could have flaws and other unintended consequences.

Debra T. Ballen
American Insurance Association

First, in response to Bowler's remarks, the drafters of the Sununu-Johnson bill have never tried to preempt state premium taxes, so that should not be a concern in adopting the optional federal charter. An optional federal charter can address the problems faced by Gulf Coast insurance markets but should ideally be combined with other policy measures. In the wake of Hurricane Katrina, insurance companies reevaluated the risk of covering certain areas and determined that their loss potential had increased. There has been tremendous real estate growth in hurricane-prone areas, and as Katrina demonstrated, one storm has the potential to wipe out a firm's entire profit. The reaction by states has been to prohibit insurance providers from raising premiums and deductibles and refusing to renew policies. Due to the threat of excessive class action lawsuits, insurance companies have also faced an unstable legal environment. Firms have thus been discouraged from entering vulnerable markets and offering coverage.

An optional federal charter would help counter some of these injurious state regulations by stimulating greater competition among providers and permitting risk-based pricing. As complements to the optional federal charter, the American Insurance Association (AIA) supports encouraging people to live in safer areas and improve the stability of their homes, offering tax incentives to policyholders to make insurance more available and affordable, deregulating rates by states, and tort reform. While the optional federal charter would regulate consumer protection at the federal level, residual markets and contract interpretation would remain at the state level, creating the potential for some mischief. The AIA opposes catastrophe funds and the heavy-handed regulations recently adopted by Florida and under consideration in other states.

George A. Pieler
Institute for Policy Innovation

Regulatory competition would improve the insurance industry and encourage regulation that maximizes efficiency, eliminates unnecessary costs, and increases consumer welfare. Interstate insurance compacts--in addition to an optional federal charter--would help foster this competition. There are two forms of interstate compacts: "constitutional compacts," which states present to Congress for formal ratification, and "voluntary compacts," which come about entirely through states' passing legislation. The Interstate Insurance Compact, a voluntary accord between thirty states, already exists. Although this compact does not cover property-casualty insurance or basic health insurance, it could provide a model or starting point for future regulatory reform. Bowler is right to be concerned that compacts can violate basic democratic principles, but this depends mainly on how much power the state legislatures defer to them. State compacts can also be double-edged swords, depending on which state takes the lead and sets policies for other states, since some states have better insurance regulation than others. Finally, it is legitimate to be concerned that an optional federal charter could entail heavier regulation. However, if multiple compacts and strong regulatory competition were in place, a federal charter would likely be deregulatory in nature.

Scott A. Sinder
Steptoe & Johnson LLP

The optional federal charter is a good proposal in response to the natural catastrophe insurance problems. Yet while it would enhance regulatory competition, it does not automatically equate to rate deregulation as many of its proponents argue. Reflecting on the history of insurance regulation, it is important to recognize that after the Supreme Court ruled in Paul v. Virginia (1869) that insurance regulation was the exclusive domain of states, the National Association of Insurance Commissioners (NAIC) convened and set a goal of achieving uniform standards across states. After 138 years, this has yet to occur--and it will never happen. While the NAIC can offer a model for insurance regulation, state legislatures will invariably make their own unique adjustments.

There is an enduring gap between what insurance companies believe they need to charge for premiums based on their natural catastrophe exposures and what consumers and local regulators consider reasonable. That said, there also are market shortfalls for which federal government intervention has been sought and may be inevitable. The federal flood and terrorism reinsurance programs are the two most visible examples of this. It is unconscionable that in 2007 we have a balkanized state insurance system and no unified, harmonized federal presence in the insurance world that can bring all of the threads of that system together when problems like the flood and terrorism market failures arise.

AEI research assistant Daniel Geary prepared this summary.