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TUESDAY, JUNE 24, 1997
House of Representatives,
Subcommittee on Housing and Community Opportunity,
Committee on Banking and Financial Services,
Washington, DC.

    The subcommittee met, pursuant to call, at 10:12 a.m., in room 2128, Rayburn House Office Building, Hon. Rick Lazio, [chairman of the subcommittee], presiding.

    Present: Chairman Lazio, Representatives Ney, Bereuter, Kelly, Metcalf, and Jackson.

    Also Present: Representative McCollum.

    Chairman LAZIO. The hearing shall come to order. I want to welcome everybody this morning and hope that everybody is staying cool in what are going to be two very hot days here in Washington.

    Today, we begin the first of a series of hearings to examine the availability and liquidity of homeowners' insurance in disaster prone areas. All too frequently, we hear stories of homeowners unable to obtain insurance in areas subject to hurricanes and earthquakes. And this, of course, affects not just risk management, but even the liquidity of the real estate market itself.
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    In the worst of the cases, the high cost of homeowners' insurance in these areas effectively prohibits its purchase, leaving homeowners at risk of homelessness in the event of a catastrophic loss.

    More and more evidence indicates that the rising toll from natural disasters is placing a significant strain on homeowners' insurance markets in many parts of the country. Most recently, Hurricane Andrew in Florida, and in California, the Northridge Earthquake, have led many insurers to withdraw from these two vulnerable areas.

    In some cases, insurers have stopped writing underwriting business in these areas entirely, leaving homeowners with very little opportunity for protection against catastrophic loss. These trends, of course, are disturbing and represent a real crisis for homeowners across the country.

    Three States have created their own programs to address an insurance availability crisis. They are California, Florida, and Hawaii. In the face of the growing threat of natural disasters, a number of other States are considering similar proposals. Forecasters predict that both the East and Gulf Coasts of America may be entering a long anticipated prolonged siege of more frequent and more destructive hurricanes that may last up to 2 decades.

    More frequent and more forceful storms coupled with the increase in population and development in coastal areas means that disasters resulting in multibillion dollar losses could become increasingly common.

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    Between 1988 and 1994, the Federal Government spent over $45 billion on natural disaster assistance. That should grab the attention of all of us who are desperately working toward deficit reduction. Experts note that it may only be a matter of time before a single storm exacts $50 billion in damages.

    To address these issues, particularly those affecting homeowners' insurance in vulnerable areas, I have introduced H.R. 219, the Homeowners' Insurance Availability Act of 1997. And my good friend, Mr. McCollum of Florida, has also introduced a piece of legislation.

    Members of Congress from both sides of the aisle will be working in partnership with the Administration, the industry and State insurance program administrators to arrive at the most appropriate Federal solution to this growing problem. And I might note that I have been particularly working with Deputy Secretary of Treasury Lawrence Summers.

    In these efforts, I must acknowledge my great respect for the late Congressman Bill Emerson, whose valiant efforts over the last several years to bring this issue to light have allowed for a real opportunity to solve this problem. And, frankly, we would not be here at this point considering several pieces of legislation that I am very hopeful of moving, if not for his dogged efforts. It is certainly my great pleasure today to have Congresswoman Jo Ann Emerson before us to testify.

    I intend to hold a number of field hearings on possible legislative solutions over the next few months and conclude with the final hearing here in Washington, DC. It is my hope that we will have markup by the full committee some time during the fall and a bill on the floor sometime this year.
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    If I may, just for a moment, I want to just make a personal comment to express my appreciation to Vicky Luna, who has been a staff assistant for the Majority staff of this subcommittee. And she has done just a remarkable job. Vicky's husband, Marlon, I understand, is in the audience somewhere. He is with the Air Force, stationed at Andrews Air Force Base, and is being transferred for important duty to Grand Forks, North Dakota, which I recently visited. And as a consequence, Vicky, Marlon, and their young son, Justin, will be moving within just a couple of weeks. And I want to recognize Marlon and Justin who are in the audience. And if you would, just stand.

    Finally, I just want to say she has been with us for only a short period of time, but she has impressed the whole staff. And it is important, I think, to acknowledge the good work that is done by people and the sacrifices they make on behalf of the country. So, I thank the entire family.

    With that, I would like to turn to my good friend, Mr. Bereuter from Nebraska.

    Mr. BEREUTER. Thank you, Mr. Chairman. I look forward to these hearings. I am glad that you have scheduled them. I appreciate the leadership that you and Congressman McCollum have provided in offering us legislation to consider. I have had concern about some of the previous versions. I think that you and industry people have made some attempt to try to assure that cost for the Federal Government's involvement in disaster insurance will not be spread across the country in an inequitable fashion.

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    I look forward to the comments of our colleague, Congresswoman Emerson, not only because of the quality representation she provides, but because she represents New Madrid, which has quite a representation in our part of the country, and because of the work of Congressman Bill Emerson in the past. So, I think these hearings are important, and I look forward to working with you on crafting legislation eventually. Thank you.

    Chairman LAZIO. I thank the gentleman.

    Mr. Jackson.

    Mr. JACKSON. Thank you, Mr. Chairman, for the opportunity to welcome our colleague and other witnesses this morning as we address the critical issue of the inadequacy of homeowners' insurance in the face of severe property damage caused by natural disasters. I look forward to hearing the views of our witnesses on the proposed plan to provide Federal reinsurance for State insurance and reinsurance programs for such disaster prone areas.

    I am thankful that my home State of Illinois is not among those that are directly affected by natural disasters that we will speak of today. In recent days, however, I have had the unfortunate occasion to personally experience unexpected property damage which, as it turned out, was not covered by my homeowners' insurance plan. While my case is not one which would be covered by the proposed legislation, I am acutely aware of the sense of helplessness shared by families who are unable to receive compensation for the damage they incur. Thus, both from a public policy and personal perspective, I am thankful for you, Mr. Chairman, for your leadership in this area. It was part of the reason why I was so disillusioned last week during the Banking marking, because I was dealing with flooding, unparalleled flooding, in my basement, a foot-and-a-half of water.
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    In light of the proliferation of natural disasters and the rising total of damage they have caused, I agree that there is a need for a Federal role in fortifying the private market and State insurance programs when necessary.

    Again, Mr. Chairman, thank you, and I look forward to reviewing the proposed legislation.

    Chairman LAZIO. I thank the gentleman. Other opening statements? I would like to make a unanimous consent request that Mr. McCollum be permitted to make an opening statement and to participate in questioning as a full committee Member without objection. It is so ordered.

    Mr. Metcalf.

    Mr. McCollum.

    Mr. MCCOLLUM. Thank you very much, Mr. Chairman, and thank you for granting me the privilege of being here today with the subcommittee. I just want to, first of all, compliment you on pressing this issue forward. It is an issue of great concern, as you know, to my State, as it is to yours. And I am a cosponsor of your bill, H.R. 219, as you are of mine, H.R. 230. I have no pride of authorship.

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    Both bills will solve the Florida problem. We just need to get to the bottom line of what is the best version to do it and do what the late Bill Emerson would have wanted us to have done, and that is get a bill enacted into law.

    In Florida, we had this Hurricane Andrew we talk about all the time that Mr. Sumner, our General Counsel for our Department of Insurance is going to discuss today with us. Sixteen billion dollars in losses in that hurricane, total losses, huge amount of money. Hurricane category four. I am told if that hurricane had gone through Fort Lauderdale, the losses would have been close to $40 billion. And if it had gone through Miami, gosh knows how much it would have been. I think Dr. Gray may say $50 billion or more.

    It is a very important thing that we find a reinsurance market. The experts that I understand also are testifying here today before our subcommittee are going to relate studies to show that about 89 percent of insurance agents believe that the lack of affordable reinsurance was one of the principal reasons given by companies for withdrawing from disaster prone markets and why in that indirect fashion, but a very significant and direct fashion, the insurance premium rates in Florida and elsewhere have been going up, and will continue to go up until we find a reinsurance scheme nationally that will work.

    And so I, again, thank you for holding the hearings. I ask further unanimous consent that my entire statement be put in the record, Mr. Chairman.

    Chairman LAZIO. Without objection.

    Mr. MCCOLLUM. And I thank you again for holding these hearings. And I look forward to them.
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    Chairman LAZIO. I thank the gentleman. I also have a statement intended for the record by Congresswoman Christian-Green, a delegate from the Virgin Islands. And without objection, that will be included in the record as well.

    Chairman LAZIO. Now, it is my pleasure to introduce one of the outstanding Members of our House, and that is Jo Ann Emerson, who represents the great State of Missouri. Congresswoman Emerson.


    Mrs. EMERSON. Thank you, Mr. Chairman. And I want to first commend both you and our colleague, Mr. McCollum, for the tremendous leadership that you have shown in carrying forth on this very, very important issue. It is something that we really must get solved. And I know that between the two of you, you are going to get it done.

    So, anyway, I do appreciate also having the opportunity to testify before you today and you know I am by no means a policy expert on the various proposals presented and introduced this year. So, I don't have a silver bullet to give to you. But I am very much aware of the impact that disasters have on this country, its citizens and communities, both small and large, in which they strike.

    The 8th Congressional District, which I represent, is home to a potentially devastating earthquake fault line known as the New Madrid Fault. It last shook the Nation in the winter of 1811–12, and the effects were absolutely devastating to a very large region of the mid-United States. Fortunately, we didn't have a lot of people living there at the time, so consequently the loss of life was relatively low. Especially when you consider, based on today's technology, that the earthquake and its aftershocks ranged from 8.0 to 8.6.
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    The scary thing is that most credible scientists who have studied this fault line say there is a greater than 50 percent chance that we will experience another major catastrophic event within the next 50 years. And now the area is populated with major urban areas like Memphis to the south, St. Louis to the north. And the potential destruction could easily cost $100 billion and thousands of lives lost.

    So, Mr. Chairman, and Members of this subcommittee, I strongly believe that Congress has a moral obligation to help homeowners and every citizen to prepare for these major disasters. We can't prevent them, so preparedness is crucial. Financial preparedness in the way of available insurance and preparedness through the proper mitigation techniques, response and recovery and education to make people more aware about some small, but important steps they can take to limit damage and possibly save their lives.

    We also know that, not only has it become harder to get adequate insurance coverage in some disaster prone areas of the country, but there is mounting evidence that the aftershocks of a major disaster larger than Hurricane Andrew or the Northridge Earthquake would devastate the insurance and financial markets and our Nation's economy.

    It seems to me that this is a Federal problem that requires a Federal solution at a level beyond the private sector's capacity to handle a mega-catastrophe. We must find an approach that addresses the affordability and availability of homeowners' insurance for folks who live in high-risk areas and build toward a consensus to enact legislation in this Congress. It will definitely be a challenge, but I think it is achievable.

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    My husband worked very hard in the last Congress to move this issue forward and came very close. And believe me, I was well aware of the frustrations that he felt throughout the whole process, and I just am convinced that you are going to be successful. No one can prevent natural disasters, but we can plan intelligently to minimize the financial and physical damage they cause. This Congress and the American public are in no mood to continue to spend the vast amounts of taxpayer dollars to pay for natural disasters without having done our level best to prepare for these events.

    Just to add to your figures, Mr. Chairman, I guess, since 1983, we have spent over $75 billion. Taxpayers have directly spent $75 billion to cover all these catastrophes. I think it is time that we take the responsible approach to getting a handle on uncontrolled cost of natural disasters. However, just as important, there must also exist an ability for homeowners to be able to purchase affordable insurance.

    I am hopeful that, together with your leadership, Mr. Chairman, and the participation of all of those people in the private sector, as well as the public who have a stake in this issue, we can sit down and find a solution to what I consider a very complicated challenge.

    I commend you for your introduction of H.R. 219 and Mr. McCollum's introduction of H.R. 230. They are both great starting points. And I am proud to be a cosponsor of both. Thanks for allowing me to testify. And I stand ready to help all of you in any way I can. Thank you.

    Chairman LAZIO. Thank you very much. Do Members have questions? If not, let me just thank the Congresswoman for—you know, in New York, and I don't mean this in any way, but affectionately—you would be known as sort of a ''nudge'' on insurance. Because you grabbed me on the floor and said, ''How are we doing on that insurance bill?'', which is very important. I want to thank you for your continuing interest in one of the first things that, I think, we spoke about when you first came here, and this year again in particular. So, thank you for your leadership on the issue.
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    Mrs. EMERSON. Thanks. Let me know what I can do to help.

    Chairman LAZIO. OK. You are doing it.

    Mr. JACKSON. Mr. Chairman.

    Chairman LAZIO. Yes, Mr. Jackson.

    Mr. JACKSON. I would like to ask a question, if you don't mind, of the Chairman and Mr. McCollum, for your two respective bills. Is there any analysis available of the cost associated with either of your bills that could be made available to the Members?

    Chairman LAZIO. I think we have not yet had them scored by CBO. But we can. What I will do is make sure, if you don't have it already, that you have all the side-by-sides and the section analysis that we have, which should give you some idea as to potential exposure to the taxpayers.

    Mr. MCCOLLUM. Would the gentlemen yield on that?

    Mr. JACKSON. I would be glad to.

    Chairman LAZIO. I would be happy to.

    Mr. MCCOLLUM. They are being scored by CBO. They have had, at least our bill and I think yours, too, Mr. Chairman, for several weeks, several months actually. And, frankly, we probably ought to prod them.
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    Chairman LAZIO. Yes.

    I want to ask Bill Gray, Dr. Gray, please, to come forward. I welcome you this morning, Dr. Gray. Professor Gray has worked in the observational and theoretical aspects of tropical meteorological research for more than 35 years specializing in the global aspects of tropical cyclones for his entire professional career.

    Professor Gray joined the Department of Atmospheric Science at the Colorado State University in 1961. In addition, he has served as the United States representative to the WMO working group on tropical meteorology since 1975. He has received numerous awards, including the Man of Science Award by the Colorado Chapter of Achievement Award, College Scientist, as well as the Neil Frank Award of the National Hurricane Conference for pioneering research into long-range hurricane forecasting.

    Dr. Gray, I might add, from a public standpoint, is very well known in his field. And I have seen and heard from him before, though, virtually I think on television as a matter of fact. And it is a pleasure to have you here.

    There is a statement, as I understand it, Dr. Gray, that we have. I just wanted to remind you that all the written testimony is included in the record. So, if you could summarize your comments and try to keep it within 5 minutes, that would be appreciated.

    Dr. GRAY. Thank you very much, Mr. Chairman.

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    Chairman LAZIO. Thank you, Doctor.


    Dr. GRAY. I am honored to be asked to present information to your subcommittee on the prospects for increased hurricane destruction in the coming 2 or 3 decades. I am a Professor of Atmospheric Science at Colorado State University. I spent a large portion of my career analyzing global hurricane and typhoon activity and its causes.

    The last 14 years, I and my colleagues have been making annual predictions as to how active the coming Atlantic Basin hurricane season is going to be. These predictions are based upon precursor global ocean and atmospheric signals. For instance, the stratospheric and upper tropospheric wind anomalies, prior rainfall in West Africa, prior surface pressures, and temperature data in the oceans and so forth. There are a surprising number of precursor climate signals which can be used to give information on the coming amount of hurricane activity that will occur in the Atlantic Basin.

    If I and my Colorado State University colleagues' interpretation of recent climate trends bear out, it is to be expected that the U.S. is on the brink of an unprecedented level hurricane spawn destruction such as never before seen.

    This assessment is based on two considerations. First is a great increase in population and property values along the U.S. Southeast Coastline since the last active period for major landfalling hurricanes, which was roughly the mid-1940's through the late 1960's. By contrast, there has been a large downturn in the major U.S. landfall hurricanes during the quarter century from 1970 to 1994.
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    Even though these major hurricanes—Saffir/Simpson category 3–4–5—account for only about 25 percent of the total number of named storms, they cause, on a statistical basis, about 75–80 percent of all hurricane-spawned destruction. If you take into account property values, insurable durable goods, and inflation, there has been a great downturn in hurricane-spawned destruction between 1970–1994, even though Andrew caused massive destruction.

    The very large increase in hurricane activity in 1995 and 1996 is probably an indication of the coming era of increased major hurricane activity. In records going back to 1870, there have never before been 2 consecutive years with more hurricane activity than occurred in 1995 and 1996. During this 2-year period, there were 32 named storms, 20 hurricanes and 11 major storms. This is roughly about three or four times the long-term average. If our projection for the 1997 hurricane season is not too far off, then the 3-year period of 1995–1997 will have been the most active consecutive 3-year period on record.

    Fortunately, most of these storms to date have missed the large urban population centers. But no one can be sure that this will continue. The State of Florida has been particularly lucky the last 32 years. Before Andrew came in in 1992, the last major hurricane to hit Peninsular Florida was Hurricane Donna in 1960, although Hurricane Betsy, category 3, caused much damage in the Florida Keys in 1965. So, Peninsula Florida went 32 years with no major hurricane strikes. Historical records show that this is unprecedented. There are two explanations. One is luck. The other is the downturn in Atlantic Basin major hurricane activity due to global circulation change. But this downturn in major hurricane activity now appears to be changing.

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    The levels of hurricane activity, particularly that of major hurricanes, Safir/Simpson category 3–4–5, are very closely linked to naturally-occurring global circulation changes driven by long period ocean wind changes, particularly the Atlantic Ocean. Warm surface water in the Atlantic moves northward. It then sinks to near bottom levels in areas of east of Greenland and north of Newfoundland. This near bottom water then moves southward. This north-south ocean circulation is called the thermohaline, or conveyor belt circulation.

    The thermohaline circulation moved faster than normal in the period from the mid-1940's to the late 1960's when Atlantic major hurricane activity was high. And it flowed slower in the quarter-century from 1970 through 1994. This thermohaline ocean circulation appears to have increased beginning in 1995. It looks like we are entering a new era of Atlantic Basin major hurricane activity. If history and longer-period geological records are any guideline, this new era may last 2 or 3 decades into the future.

    I am confident in saying that in the next 2 or 3 decades we are going to see many more landfalling major category 3–4–5 hurricanes than we have seen in the last 2 or 3 decades. I must emphasize again that it is the major hurricane which brings about 80 percent of the hurricane-spawned destruction. When we look at the decadal changes, the weaker hurricanes and tropical storms show much smaller multi-decadal changes.

    It now appears that we are going to see hurricane destruction along the U.S. coastline like we have never previously seen it. This will be due to the combined influences of the coastal population increases, to the return of more landfalling major hurricanes, due to future global circulation changes.

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    When we account for the increase of U.S. coastal population, inflation, and durable goods increases per capita, a large increase in economic loss appears unavoidable.

    In other words, the potential for hurricane-spawned destruction along the Southeast Coast is very much higher than it was in the previous active period from the mid-1940's to late 1960's. During the quarter-century period of 1970–1994, hurricane-spawned destruction has been masked by the downturn of the climate cycle.

    There appears to be little realization among the U.S. Government and the general public as to the likely magnitude of future hurricane-related problems. This hearing about the problems of insurance availability appears to me to be a positive step toward facing up to this problem.

    If consumers are not adequately insured against these storms, which we believe are headed our way, the consequences could be enormous for U.S. taxpayers. I should add that just as Congress to date has not fully addressed this issue, neither has the U.S. research community. I know of no programs within the Federal Government that are explicitly directed to the combined study of decadal hurricane variability as related to the global climate changes.

    So, Mr. Chairman, let me close by stating the bottom line of my remarks this morning. The U.S. will see more landfalling major hurricanes in the coming few decades than we have seen in the last few decades. The consequences of this are enormous for homeowners, the insurance companies, State and local governments and the U.S. taxpayers. We should be doing much more to anticipate these events to ensure that the property values are covered as best they can be.
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    Thank you very much.

    Chairman LAZIO. Thank you, Professor. I think you confirmed for many of us what we believe, advice really that we are in an upswing of hurricane activity, and of course the consequences have already been devastating in some States like Florida and California, earthquake being one case, hurricane the other. But you clearly believe that we are at the beginning point of an upswing, or an uptrend, for a particular period of time. Do you have any sense of how long that might be?

    Dr. GRAY. No, we don't. But if the historical records and the recent Greenland ice core drillings of multi-decadal changes are indicative of the future changes in the North Atlantic Ocean temperatures, then we should see increases in major hurricane activity. We take the North Atlantic temperature changes to be indicative of the strength of the Atlantic Ocean thermohaline circulation. We have also observed a downturn in major hurricane activity in the early decades of this century. There was then a neutral period from 1920 to the middle 1940's, then the swing up from the mid-1940's to late 1960's, and then the very large swing down from 1970–1994. So, the best estimate would be that we are probably in a new era of more intense hurricanes that may last for 20–30 years or so.

    Chairman LAZIO. Is there any way of assessing what the likelihood is of a storm hitting a major metropolitan center?

    Dr. GRAY. No, there isn't. There is just no way to tell where these storms will make landfall. We have started research to develop probabilities of U.S. landfall. These probabilities would rely on the global climate signals. They would indicate in the coming year whether that probability of hurricane landfall might be 1 1/2 times larger, or 50 percent as much than the long term average. One can never tell for sure when a hurricane is going to come ashore, but you can certainly give probabilities of landfall based on the changing climate signals.
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    Now, I forgot something in my testimony here that I wanted to say. Hurricanes are probably our greatest national threat that our country faces. More than earthquakes, tornadoes, floods and so forth. If you look at the number of people killed by earthquakes versus hurricanes and a similar comparison of damage in this century, hurricanes have killed 10 times as many people as have earthquakes, and done three or four times as much damage. Hurricanes are our country's greatest immediate natural hazard, more important than global warming, which is a longer term prospect and may have been much exaggerated.

    Chairman LAZIO. Let me ask you finally, Professor, if the technologies and methodologies that are used now have improved, and I take it they have improved over the last 30 years or more, could you characterize what this means in terms of your ability to assess the probability of hurricane activity and the probability, therefore, of a major loss to a population center?

    Dr. GRAY. The new technology has very little effect on these multi-decadal climate signals. New technology has come from new developments in the improvements by the satellite, the airplanes, and radar, and from improved hurricane track modeling. These new technologies have added improvements on the 1 to 5 day predictive time scale. But for the long-term prediction of a season, a year, or a decade into the future, new technology has not had much influence. There just hasn't been Federal resources available to study the longer term time scales of hurricane variability. There is much more to be learned on this subject. So, the new technology can do nothing, really, with regard to multi-decadal hurricane changes.

    Chairman LAZIO. So, the best we can do is protect against what is the inevitable?
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    Dr. GRAY. Yes, I think so.

    Chairman LAZIO. Thank you very much.

    Questions on our side? Mr. Bereuter.

    Mr. BEREUTER. Thank you, Mr. Chairman. Dr. Gray, thank you for your testimony. I do have some comments at least, and I want to thank you for the testimony that you have been providing here. I have been trying to bring to my colleagues' attention the prospect that we are going to have many more hurricanes in the next 5 to 10 years than we have had previously. I have been trying to do this now based upon scientific information made available to me for at least 4 or 5 years. And the Democratic-controlled Congress—and this Congress, Republican-controlled—has not taken adequate steps to reform our flood insurance program.

    We operate with a myth that it is a self-supporting program. And, of course, there are huge subsidies from the American taxpayer directly periodically. There is a huge regional cross-subsidization for many parts of the country for the hurricane prone Atlantic and Gulf Coasts. These V zones, or residents of V zones, are not paying actuarially-sound insurance rates. And, yet, we are still encouraging physical development in some of the most hurricane-prone parts of the coast, such as the barrier islands. So, the American Government experience with insurance programs, a small crime insurance program and the flood insurance program, are not so encouraging, and that we are going to take on an additional responsibility as well. I do think that Chairmen Lazio's bill seems to recognize that the predominant share of the cost should be borne by States initially that are more likely to be hurricane prone, or in this case, earthquake prone.
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    Just about 3 weeks ago, I went to the House floor and reminded my colleagues, as hurricane season approaches, that they need to make sure their constituents are alerted to the fact that there is a 30-day delay after they pay their premiums before they go into effect.

    In the past, particularly in the flood-prone areas, not subject necessarily to hurricane causes, they have waited until they see the flood coming down the Mississippi, or the Missouri, and then—with only 5 days delay being required under previous law—they quickly got flood insurance for the first time.

    Obviously, that kind of a loophole in the law makes it very difficult for us to have actuarially-sound rates assigned to property owners.

    But your emphasis today about the scientific evidence suggesting many, many more hurricanes, and pointing out how we have populated our coastal areas to a dramatic extent, and how that population growth continues, I think, is a very important contribution to sober us up here as we look at our responsibilities before we enlarge the Federal Government's role in disaster insurance-related legislation. So, thank you very much.

    Dr. GRAY. Well, thank you. May I respond to that?

    Mr. BEREUTER. Please do.

    Dr. GRAY. You know, the Florida and the Southeast Coast is a very nice place to live. I love going there. And the probability of a hurricane striking any one place is very low. So, I would not recommend people not living in these areas if they so desire. But they must realize that they must pay more in insurance if they do. There may be some positive aspects to more and more people moving into the coastal areas. There are more people to pay into an insurance pool. However, if you had a major storm striking a heavily populated area and destruction of $50 or $100 billion occurs, there is no way that the people living in that concentrated population could have taken out enough insurance to rebuild. So, it appears that for these very major storms, the Federal Government may have to step in.
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    Mr. BEREUTER. Thank you very much. I just point out a couple of examples. There are residences in North Carolina, for example, that are worth somewhere slightly over $200,000, where we have, by repetitive loss payments, the flood insurance programs have paid $750,000 on repair, time after time after time.

    Unless we—Congressman McCollum thinks we are picking on Florida. Since you mentioned Florida, the areas with the highest repetitive loss are Louisiana and East Texas, where repeatedly people wait every third or fourth year. In fact, it is called ''new carpet money'', because they get to replace their carpet every 3 years because of flooding there. So, we have some major problems, and we want to help those citizens, but we also expect them to pay an actuarially-sound premium.

    Dr. GRAY. Yes.

    Mr. BEREUTER. I thank you.

    Chairman LAZIO. Mr. Metcalf.

    Mr. METCALF. Thank you, Mr. Chairman. You focused in on the Southeast part of the country. Of course I am from the Northwest, so I have got a couple of questions relative to that. The big changes in temperature that occured, the cold, the warm area that was around the year 1000 to 1200 or 1300, and then the cold area from about 1500, 1600, 1700, 1800's, those are worldwide. I have always felt that the storms then tended to be more worldwide. Do you see anything about that? In other words, what was your prediction for the West Coast?
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    Dr. GRAY. The Atlantic is a special hurricane basin. It is a marginal area for hurricanes. And when the climate conditions are good, you will get a lot of storms. When they are not, you won't get many. It is different than the six other global tropical cyclone basins. We don't have what we call ''monsoon trough-generated'' hurricanes in the Atlantic, whereas, most of the storms around the globe develop out of a monsoon trough. The Atlantic has more variation in year-to-year tropical cyclones up and down than any of the other major tropical storm regions do.

    Mr. METCALF. So, I see what you are saying. So that is a special area?

    Dr. GRAY. That's right.

    Mr. METCALF. Generally, around the world, though, then the storms don't tend to fall back?

    Dr. GRAY. That's right. There is some multi-decadal variation in the other tropical cyclone basins, but it tends to be much less in the Atlantic.

    Mr. METCALF. Thank you.

    Chairman LAZIO. Thank you very much. Any other questions? If not, I want to thank you, Professor.

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    Dr. GRAY. It has been a pleasure to testify before this subcommittee.

    Chairman LAZIO. I appreciate it very much. It is, as I described before, a wake-up call for all of us. Thank you.

    Dr. GRAY. Thank you.

    Chairman LAZIO. I want to ask the next panel to come forward, please. That would be Dr. Robert Klein, Greg Butler, and Daniel Sumner. In the meantime, I am going to introduce them.

    Dr. Robert Klein is an Associate Professor of Risk Management Insurance and Director of the Center of Risk Management Insurance Research at Georgia State University in Atlanta. His current research is focused on the economics of insurance markets and insurance regulation, including the insurance market and public policy issues associated with the management of catastrophic risks from natural disasters. He has also served 8 years as Director of Research for the National Association of Insurance Commissioners.

    Mr. Greg Butler was appointed CEO of the California Earthquake Authority in November of 1996. As CEO, he is responsible for the effort to start up the CEA and manage the day-to-day operations of the Authority. He previously served as Deputy Insurance Commissioner for Policy, Research, and Special Projects where he focused efforts on California's growing homeowners' insurance availability crisis.

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    And, finally, Daniel Sumner currently serves as General Counsel for the Florida Department of Insurance. He has also served the Florida Treasury and Insurance Commissioner as Assistant General Counsel, Director of Legal Services, Director of Insurance Rating, and Deputy State Treasurer. Mr. Sumner has been with the department for the past 16 years with the exception of a brief period when he served as Executive Director of the original Florida Property and Casualty Joint Underwriting Association.

    I want to welcome and thank the three of you gentlemen for coming forward and for your written testimony, which, again, has been submitted for the record, which has been very helpful. And I would ask that you summarize your statements. And, again, I will begin from my left with Greg Butler.

    Mr. BUTLER. Good morning, Mr. Chairman.

    Chairman LAZIO. Good morning.


    Mr. BUTLER. Thank you for having me here today. And I'll try to summarize my written testimony. As you know, in California, after the Northridge Earthquake, we suffered a huge problem with availability of homeowners' insurance in the State mainly due to State law that requires that every time an insurance company sells a homeowners' policy, they also offer an earthquake policy. And, after a $12.5 billion loss in Northridge, and concerns by rating agencies and increased knowledge about the potential loss of earthquake, they simply walked away from the market.
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    Rather than risk an increase in earthquake exposure, they just stopped selling homeowners' insurance. When we were at the peak of the crisis, 95 percent of the homeowners' insurance market had shut down. It was nearly impossible to find insurance for a new home buyer, a driving economic force behind our economic recovery.

    The legislature took two very difficult steps to address that problem. The first was recognizing that we could not cover the full cost of earthquakes anymore. No longer could we afford to fix the cracks in a swimming pool or replace grandma's china. Our focus needed to change to, ''We are going to put a roof over your head and get you back on your feet.'' This was a very difficult, very responsible action by the legislature and such groups as Consumers Union and the insurance industry working together to craft something that ensured that there was a product there available for consumers.

    While that did a lot to address the concerns of solvency, it did nothing to open up the market. It capped the risk, as opposed to controlled the risk.

    The second part of the solution was, of course, the California Earthquake Authority, which is a privately funded, publicly managed agency to provide earthquake insurance for California consumers. We have about 70 percent of the market has joined the CEA. So, if you are a policyholder for Allstate, Farm, or State Farm, you go into the CEA.

    If you choose to buy earthquake insurance, Allstate, State Farm, and folks on some of the homeowner's products will sell the earthquake product, similar to what happens with the Federal Flood Program. You go to your State Farm agent, you buy the State Farm policy, they sell you their homeowners, their flood product.
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    Very briefly, the reason we are here today is we have done a lot in California to take care of our problem. For the first time in 3 years, we do have an open, competitive homeowners' market where the participating companies in the CEA are selling at or near pre-Northridge levels. But no one State can solve the catastrophe problems alone. And it is clearly an area where the Federal Government should be involved since the risk does currently fall to all taxpayers.

    The Congress has been very generous to the State of California, helping us recover from our earthquakes, whether it be Northridge or Loma Prieta. Just in terms of Northridge, FEMA grants and loans for residential properties totaled over $3 billion. But despite the turnaround in the California marketplace, we have a catastrophe program that has accomplished what we have done with dramatically reduced coverages, and in some cases premiums that are two to three times higher than they were in pre-Northridge.

    What is more, in the unlikely event that the California Earthquake Authority could not cover the claims from an earthquake, the policyholders will be paid on a pro rata basis, will not be paid in full. And instead of taking that risk, many policyholders will make the economic decision to not purchase the CEA policy, knowing, or at least hoping, the Federal Government will be there with resources after an earthquake.

    We have purchased $3.5 billion of private capacity in the California Earthquake Authority, more than anybody thought possible. And with that, we have a $10.5 billion pool which will cover 2 1/2 times Northridge, but won't cover every event or worst-case event in California. So, we have a major gap of what our worst-case scenario is and what we can fund. And there is just not enough private capital out there. I have tried to. We have gone to the altar with the capital markets. And we have done, I think, all we can do responsibly, and have asked our citizens to pay as much as we can ask them to pay.
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    But, on a long-term basis, the Federal Government being there to backstop the California Earthquake Authority, I think, is an appropriate role for the Federal Government to be in. Not replacing the private market, but backing up States that have taken care of their own problems.

    Chairman LAZIO. Thank you. I think what we will do is to hear from each of the panelists and then we will address our questions to the entire panel. Thank you very much also all of you for traveling and making your arrangements to be here today.

    Mr. Sumner.


    Mr. SUMNER. Thank you, Mr. Chairman. The context of my comments is that we would ask the Congress to look at the situation where, if the State of Florida, its citizens, and the private insurance market all act responsibly to address the potential for hurricane losses, is there still a role, when all is done, for the Federal Government to serve as a backstop? I believe the answer to that question is, yes.

    In the aftermath of Hurricane Andrew, a term that became very familiar in Florida was ''probable maximum loss''. The probable maximum loss for a hurricane has two elements. The first is the intensity of the hurricane and, as Dr. Gray has indicated, there are expectations there will be more and more intense hurricanes over the coming decades.
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    The second element of probable maximum loss, or PML, is the density of development. And, in the State of Florida as a high-growth area, that second element is also very daunting in that there are more and more areas that are highly developed with high value dwellings.

    The importance of this is, for example, 20 years ago, an area of Florida that might have been undeveloped woodland or coastal estuary lands is now developed property. And what was at one time simply a high intensity hurricane, now becomes a major natural disaster when landfall becomes a part of the hurricane path.

    And, really, what we are looking at in the State of Florida is not a uniform problem over the State. I think you have to look at the State of Florida and the potential for hurricane loss as a series of bands of geography, a certain number of miles wide, where you look at the potential for hurricane and the density of development. And you have to look at whether or not there are areas of Florida where that the density of development and the likelihood of hurricane in combination create a magnitude of loss which is beyond that which the private insurance market in the State of Florida can bear.

    Let me summarize a couple of things that we have done in Florida to be responsible and to address the hurricane risk. One of the issues that has come up with the private insurers is that if a private insurance company, under the Federal tax laws, seeks to accumulate, over time, catastrophe reserves through their premiums, if in any particular year catastrophe reserves are not paid out, it becomes income and is taxable. Therefore, if a private insurance company under the Federal tax law seeks to accumulate money over time to have on hand to pay hurricane damages, that money, in essence, becomes minimized in its value because of the tax consequences.
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    In order to try to create an alternative to taxable reserves for private insurers, Florida has created the Florida Hurricane Catastrophe Fund, which is a State fund, which collects premiums from private insurers on a tax-exempt basis and maintains those funds to be reimbursed to insurers on a reinsurance basis should there be hurricane losses of a certain threshold amount.

    Since 1993, that fund has already accumulated $1.4 billion in cash and has the ability to leverage that cash for another $5.5 billion of bonding for a total capacity of reimbursement of around $6.9 billion. If you look at the insured losses of Andrew of about $16 billion, you can see that just since 1993, Florida, through the creation of this fund, would be able to reimburse over 40 percent of the insured losses of Andrew in the event of that sort of loss. We are very proud of the capabilities of the Hurricane Catastrophe Fund.

    But, even with that fund available, there are areas of the State of Florida where the private insurance capacity is such that there simply is not adequate private insurance to cover all those who are in need of insurance, and the State of Florida has created two mechanisms which are what are called ''residual market mechanisms'' or ''mechanisms of last resort'' to provide coverage for Florida citizens to assure that everyone does have available coverage. And that is the Florida Residential Property and Casualty Joint Underwriting Association, called the JUA, and the Florida Wind Pool Association, which is a specific hurricane and wind facility for designated coastal areas.

    In the JUA, currently, there are about 600,000 policyholders. In the Wind Pool, there are about 320,000 policyholders. In other words, in the State of Florida, despite the creation of the Cat fund, and several years without major hurricane losses, we still have over 900,000 policies, who are being insured through a legislatively created State-sanctioned residual market mechanism.
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    Now, with regard to the JUA, as the market softens in certain areas, the JUA has been successful in depopulating. And we expect that the depopulation will go down about another 200,000 in the next few months. But, again, this depopulation is not evenly distributed. It is mainly depopulation in the areas where the PML is relatively lower.

    For example, in the Orlando area, you have less JUA demand and much easier, if a policy does go into JUA, to depopulate it, because even though you have relatively high density of development, you have a lower risk of hurricane, and, therefore, you have a lower PML and more insurance capacity.

    The persistent problem remains in the Dade, Broward, and Palm Beach areas where, going from downtown Miami, northward to downtown Fort Lauderdale, in a worst-case scenario, a Class 5 hurricane hitting in that 30– or 40–mile stretch, anywhere in there, the probable maximum loss is estimated to be about $53 billion.

    This sort of loss is simply more than the insurance industry capacity, the JUA, and the Wind Pool can absorb at any one time. It is this particular scenario, or the scenario of multiple hurricanes striking one after another, in essence, bankrupting the JUA and Wind Pool, which create the real need for Federal backstop.

    So, what we have is that there are going to be, in the State of Florida's view, persistent problems having adequate capacity, both in the private insurance and residual market basis, for the most heavily populated areas with the greatest risk of hurricane loss. It is those scenarios which we are most concerned about and which we think should be the focus of your consideration. Thank you.
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    Chairman LAZIO. Thank you very much.

    Dr. Klein, good morning.


    Dr. KLEIN. Thank you, Mr. Chairman, for the opportunity to testify on this issue. As an economist, I have studied insurance markets and public policy toward insurance for 18 years, including the very disturbing problems presented by the risk of natural disasters. The risk of severe earthquakes and hurricanes has created a serious crisis which insurance markets and public institutions are not managing effectively.

    Without a coordinated public and private strategy to address this problem, all Americans face an enormous potential financial liability. Under normal conditions, insurance can be an efficient mechanism by which individuals can pool their risk and protect themselves from a devastating financial loss. However, the risk presented by severe earthquakes and hurricanes is substantially different from the types of risks normally assumed and managed by private insurance markets.

    Mega-catastrophes are infrequent and unpredictable. But, when they do occur, they cause severe and geographically concentrated losses that overwhelm the financial resources of the communities they strike and the insurers that insure them. For several reasons, insurance markets have been unable to diversify this risk sufficiently to secure their financial viability and protect policyholders.
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    Additionally, many people and firms fail to purchase adequate insurance, particularly for earthquakes, which further undermines risk pooling and creates potentially devastating financial liabilities for them and the general public.

    For instance, less than half of the homeowners in earthquake-prone areas purchase earthquake insurance and their number is declining as insurance rates rise. Also, our failure to mitigate hazards will result in excessive and unnecessary human economic losses from natural disasters. Experts estimate that a severe hurricane or earthquake striking a major population center such as Miami or St. Louis would cause nominally insured financial losses from $50 to $120 billion. This does not include uninsured losses and damage to public infrastructure, which could easily double this amount in the case of earthquakes.

    Such an event would not only devastate a city, it would have severe rippling effects throughout the national economy and blow a large hole in the Federal budget. While the probability of a severe loss occurring in any given year is relatively low, say approximately 1 percent for a $70 billion loss, it is a significant possibility within the next 10 to 30 years. Such a disaster is inevitable. It is only a question of when and where it will occur.

    For non-catastrophic risk, insurers can protect against their potential bankruptcy by purchasing reinsurance. However, reinsurers do not have the financial resources to cover the losses from a mega-catastrophe. Catastrophe reinsurance is difficult and expensive to obtain. And primary insurers are retaining a much higher level of risk now than before recent disasters.

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    Financial markets have the capacity, but not the will, to cover these losses today. Cautious investors, because of their unfamiliarity with catastrophe risks and the high potential downside, are unwilling to assume this risk, except at very high rates of return which consumers cannot—or will not—pay. This situation may improve over time, but not soon.

    I think, as other testifiers have indicated, that Government policies and programs encourage people to incur excessive risk and discourage them from buying insurance. Overdevelopment of high risk areas is encouraged by public subsidies, as are catastrophe losses that people fail to mitigate and insure. We have made some strides toward encouraging better hazard mitigation, but strong political resistance and the lack of proper financial incentives cause mitigation efforts to fall far short of what they should be.

    The unfortunate fact is that Government spending, tax, and regulatory policies allow high-risk communities and property owners to externalize a substantial portion of their catastrophe losses to all Americans.

    This situation has imposed enormous pressure on property insurance markets in high-risk areas. Premiums have doubled and insurers have been compelled to reduce their policies in high-risk areas. Many homeowners have been forced to get insurance through subsidized State and residual market mechanisms as 30 percent of Florida homeowners have been compelled to do.

    However, these problems reflect only the tip of the iceberg. Economic and political pressures have caused State officials to restrict the necessary adjustment of insurance markets to catastrophe risk, which has created a false sense of security. Insurance rates are still woefully inadequate, and insurers have been prevented from adjusting their catastrophe exposure to safe levels. Insurers cannot adequately spread their risk and protect policyholders if they cannot charge adequate premiums and reduce their catastrophe exposure through reinsurance and geographic diversification.
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    The scary reality is that State funds and many private insurers will be bankrupted by a mega-catastrophe and will not have enough money to cover the claims they have promised to pay. This will force Federal and State governments, and ultimately taxpayers, to step in and cover the gap. Add the burden of uninsured losses that everyone will bear and you have a ticking financial time bomb.

    We cannot prevent earthquakes and hurricanes, but we can avoid this impending financial disaster. A coordinated private and public strategy led by the Federal Government can remedy this situation and efficiently and equitably manage the risk of natural disasters. To be successful, such a strategy will require a number of integrated elements that will maximize incentives for efficient catastrophe risk management.

    These elements should include; one, minimizing public subsidies of excessive catastrophe risk and uninsured losses; two, informing property owners on the benefits of mitigation and the need for insurance; three, establishing properly structured supplemental Federal and State catastrophe reinsurance mechanisms that can be eventually replaced by maturing financial markets; and, four, easing regulatory restrictions on primary insurance markets while maintaining proper solvency safeguards.

    These measures should be designed to promote proper financial incentives, fairly allocate the burden of catastrophe risk, encourage cost-effective mitigation, and ensure the long-term viability of private insurance markets.

    Insurance in high-risk areas will never be cheap. But enlightened policy can make it much less expensive and more secure than it otherwise would be.
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    This concludes my testimony. I would be happy to answer any questions that the subcommittee may have. And thank you for the opportunity to present my views on this critical issue.

    Chairman LAZIO. Thank you very much, Doctor.

    I want to thank you and the rest of the panel, for some excellent testimony.

    I have a few questions. Let me begin, if I may, with Mr. Butler, your experience with the CEA, the California Earthquake Authority. Did you purchase private reinsurance right now for the Authority?

    Mr. BUTLER. Yes. We purchased the equivalent of $3.5 billion of reinsurance, which is by far the largest placement ever done worldwide.

    Chairman LAZIO. Is that the limit of reinsurance that you think that the Authority could handle?

    Mr. BUTLER. From a pricing perspective, yes. Thirty percent of our premium is going to paying reinsurance premiums. To buy much more than that, even if it was available, would again raise the prices higher than they are already. As I said before, there has been a substantial increase in prices since Northridge.

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    Chairman LAZIO. So, the premiums for the reinsurance pool, obviously, affect your ability to cover more policies?

    Mr. BUTLER. Well, in an actuarially-sound basis, we would cover our general loss. We would build up funds. But the exposure, if everyone had it, there is just not enough insurance out there in the world to cover every California risk.

    Chairman LAZIO. Are you saying the CEA has got 70 percent of the market right now?

    Mr. BUTLER. Yes.

    Chairman LAZIO. So, the private insurers make up for 30 percent. Are they in the very same areas, or is there some polarization that occurs?

    Mr. BUTLER. It is a mixed bag. There are some insurance companies that are statewide and write statewide there. There are some niche players that only write in the Central Valley or only write in certain areas of the State or, as what happened with one insurance company, only wrote in a high seismic area. So, there is a mixed bag in California.

    Chairman LAZIO. Let me ask both Mr. Sumner and Mr. Butler, if I may, if you have deductibles through those policies; and, if so, is there discretion as to how big the deductibles are? If there is a Federal role, finally, in creating sort of a reinsurance backstop, what do you think the right deductible ought to be?

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    Mr. BUTLER. We in California have a very substantial deductible—15 percent of the policy limit. So, on a $100,000 home, we would cover everything in excess of $15,000 in damage.

    Chairman LAZIO. So, the consumer would pick up the first 15 percent?

    Mr. BUTLER. The consumer would pick up the first $15,000 and mostly going to the Federal Government for an SPA loan. In Florida I know it is much less.

    Mr. SUMNER. In Florida, we have a sliding scale. For homes under $100,000 you can offer 2 percent, but you also must offer $500. For homes between $100,000 and $250,000, you can offer 5 percent and you can mandate 2 percent. Over $500,000 in value, there is no limit on deductible, as you can offer any deductible which the market will bear.

    Chairman LAZIO. Let me say, Dr. Klein, now you talked about externalizing costs. It seems to me deductibles are one area in which, if you have a very low deductible available through a public-sponsored program, that that is one way of externalizing costs. Would you speak to that issue?

    Dr. KLEIN. Well, my concern is not about low deductibles. I mean, any type of loss that someone is able to bear within their own budget or income resources and doesn't exceed the equity they may have in their home, they are going to have an incentive to cover that and they can. The types of losses that I am talking about are the high losses, the catastrophic losses; and there are a number of ways that those losses, those costs get externalized.
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    For one, you can declare on your income taxes a deduction of any uninsured losses. Second, if the losses are so high, you might default on your mortgage. Now, most people are required to carry homeowners' insurance to have a mortgage, but not earthquake insurance. So, you have a liability there, and that falls to lenders and the people that back them up.

    You also have externalization through, obviously, Federal spending for disaster assistance for people that don't have insurance coverage and, also, through personal and commercial bankruptcies. If insurers become bankrupt, the losses that they cannot pay ultimately work their way through State insurance guarantee funds.

    Well, those guarantee funds and the assessments they impose on solvent insurers ultimately get passed back to taxpayers and consumers, given the way that tax policy works and State and Federal law work. So, ultimately, you have a mechanism by which uninsured losses, whether they are simply losses that people have not bought an insurance policy to cover or losses that can't be paid by a bankrupt insurer or by a bankrupt State insurance fund, that effectively pass those losses to taxpayers and consumers generally throughout the country, no matter where that loss occurs.

    Chairman LAZIO. Or through the tax code?

    Dr. KLEIN. Right.

    Chairman LAZIO. Let me also ask, finally, Mr. Sumner and Mr. Butler and, Dr. Klein, if you want to chime in on this, that is fine. If we were to have a Federal reinsurance program as a backstop to the State programs, do you believe that your State should pay actuarially correct premiums?
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    Let's start with you, Mr. Butler.

    Mr. BUTLER. Absolutely. I mean, the basis of the CEA—and we talked a little bit about the deductible—was everything has got to hold together financially; and we have to be intellectually honest about what exactly the coverage is going to cost; and that is how we can bring in private capital. The minute you get away from the CEA or the Federal Government, if the role or if the idea in the future is to securitize that risk to the capital markets, the rates have to be actuarially sound. You know the question is, for my State, do we add on additional premium needs to buy additional coverage?

    Mr. SUMNER. Well, I would agree that the rates should be actuarially sound; but I think there are a lot of underlying issues in regard to the way in which that should be implemented.

    Look particularly at Florida, where you have a high retiree population, where you have fixed-income budgets. I think that any sort of drastic increase in their insurance rates in any one period of time probably would have unintended consequences with regard to quality of life which we would want to certainly think about. But I think, over time, that the goal should be that the State program should be actuarially sound and then any backstop on the Federal basis likewise should be actuarially sound.

    Dr. KLEIN. My comment would be that you should definitely move toward actuarially sound rates and away from subsidies. Now it may take some transition, and if you gain some cost savings through mitigation you may be able to use some of those funds to help soften the impact. But, ultimately, the program is not going to be successful and it is not going to create the right incentives unless it is risk-based and people in this country wouldn't have an incentive to support a program that is not risk-based.
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    Chairman LAZIO. OK. Thank you very much.

    Other questions?

    Yes, Mr. Ney.

    Mr. NEY. Mr. Chairman.

    Any members of the panel who would like to answer this, but I know Florida's JUA had lost some money, and they had to go back in and I think raise probably over—what—20 percent back up in the premium into it? I think JUA had lost money, right?

    Mr. SUMNER. In the early periods of the JUA, the premiums were inadequate; and there was a deficit for a year or two. In the 1996 year, there was no deficit; and the JUA made a small profit.

    Very briefly on that issue, what the Florida Legislature has done with the JUA to make sure that it is not a competitor price-wise with the private marketplace is to require, for each county, that the JUA rate must be at the highest for all the rates of the top 20 insurers in each county. So, the JUA is actually at the top of the marketplace.

    Mr. NEY. Let me ask you this—and, again, anybody who would like to answer. Do you believe that everyone who does business in the State should, in fact, be part of a program? In other words, you can't pick and choose whether you are going to insure on the coast of Florida or not. If you do business in the State, do you think you ought to then be part of the risk?
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    Mr. BUTLER. Just in terms of California, for the California Earthquake Authority, we went in with a philosophy of it should be voluntary for both consumers and companies. As I said, we have a number of companies that are not in the CEA; and, put in perspective, we have, for the 15 companies in the CEA is representing 70 percent of the companies. There are another 85 companies that represent 30 percent of the market outside the CEA, and their reasons for not joining the CEA are very different.

    Mr. NEY. Let me ask you this: What is the incentive, then, for a company to go in versus a company not to go in?

    Mr. BUTLER. It really depends on the company and their particular situation. I reference the company that only writes the Central Valley and companies—Merced Mutual only writes in the County of Merced, which is not a seismically active area. It doesn't make sense for them to join the CEA with all the contingent liability that comes with it.

    Mr. NEY. What about the fact—or in any of these programs in Florida or California, has the legislature, in fact, mandated that the consumers, as part of their P.C. policies, have to, in fact, pay a premium for disaster? Is it a mandate or not?

    Mr. BUTLER. Not in California. That was tried after the Loma Prieta Earthquake and failed miserably. But, again, we have a very diverse State geographically where there are non-seismically active areas.

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    Mr. NEY. Was it successful creating an account that worked without actually mandating the consumer or citizen, in fact, had to pay? That probably failed miserably, too, didn't it?

    Mr. BUTLER. I am sorry. I missed your——

    Mr. NEY. You said it failed miserably when the citizens had to mandatorily pay. Did it fail when they didn't have to pay or is there——

    Mr. BUTLER. Well, it failed in both cases.

    Mr. NEY. I only raise that because I live in a county where 75 percent of my home county has an underground mine under it. Seventy five percent of the entire county. Obviously, when a house splits in half, it is extensive damage. It may not be an earthquake but, you know, the house was cut in half because of mines that were there, early-on.

    The Feds came in and said, ''Let's create a mine subsidence program''; gave the State of Ohio about $269,000 as a loan; became an insurer of type, you know, just a backdrop for the State. The State embarked on a venture on a voluntary basis, and it went down the tubes.

    We have the Feds' $269,000. We came back then and did something I don't like to do. We mandated that people in the affected areas had to, in fact, pay a $2 or $3 increase in their premiums. We brought people into it, even people as far up as Akron, Ohio, which made them squeal, obviously. But we found that the only way we could do it was at least take the regions that were affected by nature of underground mines, and also in parts of counties that weren't affected. It still would hurt the overall economy of the counties, the property values, and so forth. So, it has not been popular.
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    I normally don't like mandated benefits of any type or mandates; but I just think that, unless you have got everybody into the system potentially, let's say that is the way it has to be. But the Feds are going to be in it. You have to have some type of participation in danger-laden areas. Otherwise, it is not going to work. I don't know how else you do it.

    Do you want to comment on the fact of mandating?

    Mr. BUTLER. Yes. Well, we made some policy decisions in California when we were debating the creation of the CEA. Originally, like Florida, we had a provision where, if loss exceeded a certain level, we would do some bond indebtedness and retire that through a surcharge on all policyholders in California or all homeowners' policies in California. The legislators specifically rejected that. We do have a debt layer that is retired by all earthquake policyholders of the CEA but not all those in California.

    I know Florida does have a statewide——

    Mr. NEY. Do you think there should be a differential—or if anybody else wants to answer or you can, Mr. Butler—a type of reward for companies that at least will embark upon getting in there and sharing some of the risk, that should be rewarded in some fashion versus a company that won't go in or some type of differential—it doesn't maybe mean reward, but some type of break or enticement to come in?

    Otherwise, if you are going for—say here, you know, you come in, Bob. Rick goes in with his company. And I say, ''Fine, Rick, go ahead and go in,'' because I am sure not going to lose money going in there. I mean, if a company is going to come in and participate, should there not be some type of appropriate incentive?
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    Mr. SUMNER. If I might address that.

    First of all, in Florida, unlike in California, mortgage lenders require that there be wind and hurricane coverage on all mortgaged property, so we have a very high level of participation in hurricane coverage. Again, also in Florida, it is mandated under a new law that there be a hurricane premium in your homeowners' policy so you know exactly what you are paying for your catastrophe.

    Now, with regard to the issue of incentives, particularly with regard to depopulating the JUA, there have been both monetary bonuses of up to $100 per policy and incentives to insurers plus assessment relief from any of these residual markets to induce companies to either be created or to come into the State to take policies out of the JUA; and that has been very successful. Up to this point, we have had somewhere in the neighborhood of around 600,000 policies already taken out of the JUA using these incentives; and without those incentives, obviously, the JUA would be at a much higher number.

    Mr. NEY. So, it has been more successful with the incentives in Florida than the previous way prior to the incentives? Or has it?

    Mr. SUMNER. Well, I think it is a couple things.

    First of all, when JUA rates were taken to the top of the market where they were not competing with the private marketplace and then you incented private companies to allocate their capital to Florida, then I think we started to see the private marketplace coming in and picking policies out. But, again, I want to emphasize it is not on an even distribution basis. They would come in and take policies in the areas where there was less concentration of risk and lower hurricane risk; and those are the policies that, obviously, have come out first.
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    Mr. NEY. Thank you.

    Chairman LAZIO. I thank the gentleman.

    The gentleman from Florida, Mr. McCollum.

    Mr. MCCOLLUM. Thank you very much, Mr. Chairman.

    I want to thank the whole panel for coming and spending the time with us today; and I particularly want to welcome Mr. Sumner, being from my home State. I have got a couple of questions particularly to you, Mr. Sumner. Relative to the Catastrophe Fund, how big a storm would it take to wipe out the cash that we have got there and the bonding capacity? In other words, what size hurricane?

    Mr. SUMNER. Well, first of all, let's just take Hurricane Andrew, for example. That was $16 billion of insurance losses, and that was all borne by the private insurance market. With our current, let's say, $6.9 billion of Cat Fund reimbursements to the private market, that means that there would be less than $10 billion of a Hurricane Andrew storm that would have to be paid by the private marketplace.

    So, I think what you would then say is, to what extent would the private marketplace if—say, $7 billion of the losses were paid by the Cat Fund and therefore reimbursed—how much more capacity is out there? I think you would certainly be up somewhere into the $20 billion bracket before the insurers start having the same kind of solvency problems they did with Andrew.
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    Mr. MCCOLLUM. So, we are up to $20 billion now, as opposed to the $16 billion that Andrew was before. But if we had a $30 billion storm with a $50 billion one that, Dr. Gray, you talked about, that is way beyond the Catastrophe Fund that we have in our State to cope with.

    Mr. SUMNER. Well, there are a couple of important points to make. If you hit that $30 billion level, first of all, that means that you will have to issue bonds by the Catastrophe Fund to reimburse insurers and then there will have to be assessments to repay that bonding process. So, the Catastrophe Fund will be tapped out, in essence. Once you draw down on that money and bond, then the assessments really will have to be repaid over time.

    Likewise, if you have a catastrophe of that level, then both the JUA and the Wind Pool will likewise have to draw down on their lines of credit and, therefore, bonding, which means also they will then tap out their capacity to go to the financial market. So, once you have that kind of disaster, you have not only the rebuilding process but you have, over many years, then the assessment repayment process. Then we would have really no avenue to take care of the next storm.

    I think really what we are doing in Florida is we are dealing with one more storm. We are going for the next big storm. But once that occurs, then what is behind that is the real concern.

    Mr. MCCOLLUM. Who issues the bonds in these bonding situations? The State? Or are we talking about private bonders or who?
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    Mr. SUMNER. Both. Both the Cat Fund, the JUA and the Wind Pool all have the capacity to enter into a bonding arrangement. For example, the JUA has entered into an arrangement with J.P. Morgan as lead underwriter and has sold $500 million of pre-event bonds to have on hand. I believe that the Wind Pool is using Chase as a lead underwriter to issue pre-event bonds. So, it is done through the Wall Street marketplace.

    Mr. MCCOLLUM. I think it is really fascinating that you stated in your written testimony, for Mr. Lazio, in particular, what a hit on Long Island would mean for a Class 4 storm, but you did it for a number of different locations, Galveston, and so forth. We are talking about, you know, $30 billion, $40 billion, $50 billion; and I appreciate you very much putting that in the record.

    Let me also ask you a question about the tax issue, because you raised this. I don't think it was in your written testimony, but you raised it in oral testimony, with regard to the fact insurers today, under Federal law, if they reserve against a catastrophe, don't get any tax credit. In fact, they have to pay taxes on that reserve, Federal taxes, and that is what you made the point of.

    What about the Catastrophe Fund that Florida has? Is the money they are paying in premiums a business deduction for them? Can they take that as a business deduction, do you know?

    Mr. SUMNER. Once the money goes as a premium from the insurance company to the Cat Fund, that money is directly then passed through to the policyholder. So, the money does not come out of the surplus of the insurance company. It is essentially a pass-through where the Cat Fund premium is paid by the policyholder. Then, once the Cat Fund premium is in the account of the Cat Fund, then it accumulates as Cat Fund property until reimbursement occurs on a tax-exempt basis. But, no, the insurance companies do not pay them. They pay the Cat Fund premium, but they are only a——
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    Mr. MCCOLLUM. A conduit for it?

    Mr. SUMNER. Yes.

    Mr. MCCOLLUM. The reason I asked that question is some of the insurance companies who have come in to talk about this have talked about this as being some tax advantage, a way to help them, in a way, if each State had a Cat Fund like Florida did; and I never fully understood what they were talking about. I guess you are not helping me a whole lot here. It doesn't sound like there is a tax advantage here.

    Mr. SUMNER. Well, let me give you two examples.

    If the insurance company collects $100 from its policyholder to pay to the Cat Fund, $100 accumulates, tax exempt, in the Cat Fund to be later reimbursed to that insurance company. Therefore, for the money that they have received from their policyholder for catastrophes, all of that money then is entrusted for that purpose as long as it is needed in the Cat Fund and that is the vehicle to do that.

    On the other hand, if the insurance company simply takes $100 of premium, puts it in their own account and says, ''We will reserve this for some future catastrophe,'' if at the end of that tax year that $100 is not disbursed for catastrophic premium payments, then that $100 becomes income and is taxed; and they only have the net amount remaining to pay catastrophes in the next year.

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    So, that is where you have a great disincentive to reserve catastrophes in the insurance company account because of, in essence, it gets eaten away by taxes.

    Mr. MCCOLLUM. In other words, they have let it go into your fund, the pass-through business, and don't hold it. If they are not holding anything, then they are not incurring the liability they would if they held it in reserve?

    Mr. SUMNER. That is correct.

    Mr. MCCOLLUM. So, in essence, you are transferring a reserve in the State in this case and allowing them not to incur that tax liability that they——

    Mr. SUMNER. Yes, sir.

    Mr. MCCOLLUM.——Otherwise would incur annually? I am sorry. I didn't pick that up.

    Well, I see why they want the Cat Funds in the States, and that was really the question I have involved in it.

    Other than for that reason, do you think most States should have these Cat Funds? I know we have got the differences between Mr. Lazio's legislation and mine centrally located on the question of whether a State should be required to have a system like Florida's or California's in order to participate in a Federal scheme, and I gather that you do. But please explain why you think so, if that is the case.
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    Mr. SUMNER. I think we should on two levels.

    First of all, I believe it would be our position in Florida, at least from the State government's point of view, that we should not come to the Federal Government to seek assistance unless we are doing everything we can on a State basis. We believe that the citizens of the State of Florida through the Cat Fund, are taking the most responsible effort they possibly can on a tax basis to proceed to put money away for a catastrophe so it will be there.

    So, I think that in that sense, every State should have a Cat Fund so that they can come to the Federal Government with that kind of foundation upon which something has to be built.

    Mr. MCCOLLUM. Well, I thank you very much then.

    Again, my concern with it and the thing we have to resolve up here, I am sure you understand, is where the votes are. From a Florida perspective, we are happy with that proposition. But from the standpoint of whether we get North Carolina and Texas to go along, I am not sure; and that is what Mr. Lazio and I have to resolve.

    Thank you very much.

    Mr. SUMNER. Thank you.

    Chairman LAZIO. I thank the gentleman. I thank the panel.
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    I invite up the final panel, panel four. I welcome the panel and thank them for their travels in coming here.

    I am going to do the introduction, if I can and I again welcome the gentlemen.

    Jerry Thomas is currently Chairman of the Board of Quaker City Federal Savings and Loan Association in Whittier, California, where he has worked since 1961. Mr. Thomas has served as an officer or director of Savings and Loan Institute's Los Angeles chapter in the Whittier Affordable Housing Task Force. In addition, he is currently Base Chairman of the Western League of Savings Institutions.

    James Klagholz is a Co-owner and Secretary-Treasurer of Clayton N. Sterling Associates, Inc. in Seaside Park, New Jersey. He was named Chairman of the Governmental Affairs Committee of the Independent Insurance Agents of America in October of 1994; and prior to taking over his Government Affairs post Mr. Klagholz served as a member of the IIAA Executive Committee from September, 1991, to October of 1994.

    Finally, Steven Bupp founded Condominium Venture, Inc. in 1975 to professionally manage condominiums and homeowners' associations in the Maryland suburbs of Washington, DC. Today, his firm manages over 11,000 homes. He has been actively involved in the Community Associations Institute since 1977 and served on the board of trustees for the national organization between 1986 and 1992.

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    I want to welcome you all, gentlemen. Thank you. This is an attempt to get the private sector perspective. If we may, again the statements will all be included for the record; and I appreciate the effort that went into those. If you could just summarize them for the record, I would appreciate that.

    Chairman LAZIO. We will begin with Mr. Thomas.


    Mr. THOMAS. Thank you, Mr. Chairman. I will be happy to summarize it, and I appreciate the opportunity to appear here to discuss this very important issue.

    I give you the perspective of a real estate lender, a real estate lender involved with the Whittier Earthquake in 1987, Loma Prieta in 1989, and the Northridge Earthquake in 1994. From that, I think two conclusions as a real estate lender are most significant.

    The first is that the private sector, in reality, can't deal with an earthquake risk in California. The second, and closely related to that, is that California, though we are the richest State in the Nation and have an economy that is exceeded only by a handful of nations, we in California cannot adequately deal with the earthquake risk. I would point to just the virtual shutdown of the earthquake market post-Northridge as an example of the private sector's ability to deal with it.
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    Second, while we have heard here earlier from Greg Butler on the CEA, I think even Mr. Butler would acknowledge that the CEA today is underfunded.

    So, those two things, Mr. Chairman, are the two principal conclusions that, as a real estate lender, I come to you with.

    The system isn't working. Today, 3 1/2 years after the Northridge Earthquake, we, Quaker City Savings, have less earthquake coverage on our loan portfolio than we did prior to the Northridge Earthquake. So, something is amiss in all of that, and I think it goes directly to your legislation—Congressman McCollum's—legislation in attempting to address a national answer to this problem that is, in most cases, a local-type problem, but unresolved for all of the reasons that we have heard earlier here this morning on a local basis.

    I would leave you with several suggestions, again from a perspective of a real estate lender. I would argue that the insurance should be widely available and at reasonable rates, and I think this—and I am sorry Mr. Ney is not here, but I think this argues for mandatory coverage.

    I would submit that we have in the flood insurance a prototype for that type of coverage. If you live in a floodplain, you must obtain flood insurance. If you live in the proximity of an earthquake fault, you should obtain earthquake insurance. I think that is the only way that we are going to, over time, be able to adequately cover that risk on a broad basis.

    Second, I would argue that there must be a strong mitigation effort involved in all of this. What we found after, particularly, the Whittier and the Northridge Earthquakes were that approximately 20 percent of the housing stock did not meet even 1960 seismic standards. So, there must be some way to bring at least that part of our housing stock, a substantial part of the housing stock, a part of the housing stock that is basically central city and often occupied by the lower income elements of our community, up to current engineering standards. There must be some kind of assistance to provide for that.
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    Additionally and most importantly, we think that it must cover multifamily as well as single family.

    I take great issue with a comment that was put out in the Q and A portion of H.R. 219, sir, in that it alluded to commercial coverage as being more available than that of single family residences. That does not square with our experience at all.

    We had, prior to the Northridge Earthquake, approximately 21 percent of our portfolio covered that single family residence portion, but only 2 percent of the commercial. Since 1994, we have been virtually unable to obtain any kind of commercial coverage on multifamily dwellings yet in California. Los Angeles, San Francisco, over 50 percent of the residents of those communities live in rental housing, housing that is not adequately provided for in the legislation proposed.

    Further, I would submit that, following these three earthquakes, within 1 year's time, at least 90 percent of the single family residences had been repaired, had been brought back into housing stock of the community. Yet 3 1/2 years, in contrast, after the Northridge Earthquake, only between 50 and 60 percent of the multifamily housing stock has been brought back into the housing stock of the community.

    Just this past week my own institution made a loan commitment on a multifamily dwelling, 36 units in the San Fernando Valley. Earthquake damage, but as yet has never been repaired, hasn't been approached; and we hope—and it will be another year before this property is back.
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    So, it is a much longer process and I think speaks to the inadequacy of the coverage of that particular market.

    Two final thoughts: one based, Mr. Chairman, on experience; the other an observation and a bit of conjecture, if you will.

    The experience factor, if the cost of the damage and the repairs of the damage exceed the equity in the property, sooner or later the lender is going to get the keys to that property. Now that is fairly obvious. But we saw that in spades after the Northridge Earthquake, which came 3 years into the middle of a recession where the recession had already eroded a great deal of equity in these properties. There was a higher default rate after the Northridge Earthquake than there was with either the Whittier or the Loma Prieta, and it was because of the economic cycle in which it all occurred.

    So, I think in the vanguard of all of this attention—and I am surprised that we don't have Fannie Mae and Freddie Mac, we don't have FHA, VA here; and we ought to have the FDIC squarely in the front ranks of addressing this on some kind of national basis. Because I would submit that these quasi-public sector institutions are among those that would be most affected by an adequate redressing of the concern.

    An observation: Your Banking Committee in the last several weeks' time has been furiously addressing something that we call ''Financial Modernization,'' charters the type of ownership that says who can own what within financial institutions, investment powers, all of these things.
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    Conjecture, Mr. Chairman: I would submit that if we had a Kobe-size earthquake, a 7.4 with an epicenter in Los Angeles or in San Francisco, that the last thing on any Banking Committee Member's agenda, or in Congress in general and certainly any real estate lender, is going to be what our charter says or who our ownership is, our investment powers.

    It is my judgment, sir, that, long term, the debate and the outcome of this legislation is the most important work that this Banking Committee will undertake for some time.

    Thank you, sir.

    Chairman LAZIO. Thank you, Mr. Thomas.

    Chairman LAZIO. Mr. Bupp.


    Mr. BUPP. Good morning, Mr. Chairman.

    My name is Steve Bupp. I am here today as a national officer of the Community Associations Institute. CAI is the national voice for 32 million people who live in over 150,000 community associations of all sizes and architectural types throughout the United States. Community associations include condominium associations, homeowner associations, cooperatives and planned communities.
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    Today's topic is of considerable importance to community association residents, especially the nearly 13 million that own homes in Florida and California.

    The impact of insurance markets on community association homeowners is twofold. First, community association residents must deal with the direct cost of insurance coverage for property they individually own. Then they are impacted by insurance costs a second time because their assessment payments also fund association operations, including costs for insuring common property.

    Following both Hurricane Andrew in Florida and the Northridge Earthquake in California, carriers, agents, regulators and consumers all struggled to deal with the disasters and their aftermath. The fallout has been well publicized: Insurance companies went bankrupt, policies were canceled, the availability of new coverage vanished, premiums rose, deductibles increased and existing coverage shrank.

    Today, locating and affording adequate insurance coverage remains a significant challenge for some community associations.

    Allow me to describe the situation of one association in Pinellas County, Florida. The association, which has never suffered storm damage, maintains $20 million in total insured value. Following Andrew, the association's coverage was canceled. It is presently participating in the Florida Joint Underwriters Association program, because no carrier will insure it. The Association's current premiums are four times what they were prior to Andrew.

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    The stories of some homeowners are equally telling. One resident in a community association outside Miami experienced only minor damage from Andrew. Before the hurricane, she paid $800 a year, with a $500 all-peril deductible, for $90,000 worth of coverage. Today, she pays $2,080 a year with a higher deductible for the same coverage. Additional examples are included in the written testimony that was submitted for the record.

    By late 1994, following the devastation of the Northridge Earthquake, insurance carriers throughout California were similarly reacting to limit exposure. Even today, several carriers report they are not writing new homeowner policies.

    Community association homeowners were particularly hard hit. Premiums for many associations doubled. Carriers increased deductibles by 15 to 20 percent, reduced or capped earthquake coverage and even eliminated coverage for certain community association property.

    When renewing policies, carriers also regularly changed per-building deductibles to deductibles based on a percentage of the total insured value.

    For a community association, this can mean a tremendous difference in cost to those members in the association. For example, an association with 10 buildings insured for $1 million dollars each with a 10 percent per-building deductible would have a $100,000 deductible for each building damaged. A 10 percent deductible on the total insured value, however, means the association's deductible jumps to a million dollars, regardless of the extent of damage to individual buildings.

    While the insurance market seems to be improving in some areas, residents, managers and insurance representatives report that many carriers are still not offering earthquake insurance under master policies to cover the associations' common property.
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    The rising cost of policies is also significant. Prior to Northridge, earthquake premiums typically represented about half of the total insurance budget for a common interest development. Today, that number approaches 70 percent for many associations.

    While no homeowner likes to see insurance cost increase, a tighter market with higher prices is not an unexpected result when liabilities and losses are large as they have been in the 1990's. The availability, viability and affordability of homeowners' insurance in certain markets have become issues of great concern, however, because the marketplace appears to be abandoning the principle of a fair product for a fair price.

    It is problematic that availability is scarce or virtually nonexistent in some areas. It is highly unsettling that premiums and deductibles continue to increase while coverage shrinks. It is approaching a crisis, however, when costs in some areas go so high that homeowners and community associations are forced to evaluate whether they can pay for coverage and still keep their community association financially viable.

    While these problems merit and demand our attention today, we must simultaneously consider the likely impact of the next catastrophe. Most insurance experts agree, and we have heard today that another disaster like Hurricane Andrew or the Northridge Earthquake, would bankrupt its share of carriers while devastating not only the environment but the insurance markets as well.

    It is, therefore, appropriate to consider what all interested parties can do to provide for insurance markets that offer homeowners a fair product for a fair price while guarding against the extreme fallout that will inevitably accompany the losses of the next disaster.
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    In this vein, the Community Associations Institute, welcomes the opportunity to work with Congress as it further considers the issue of a State disaster reinsurance program.

    While the purpose of today's discussion is not to address any specific proposal or legislation, I do wish to close by reaffirming CAI's belief that any viable reinsurance program would need to focus on supplementing and cultivating, not substituting for, the private insurance market. It would also be vitally important that such a program include the 32 million condominium association, homeowner association, cooperative and planned community homeowners in the 150,000 associations across the country.

    Thank you.

    Chairman LAZIO. Thank you very much.

    Chairman LAZIO. Mr. Klagholz.


    Mr. KLAGHOLZ. Thank you, Mr. Chairman.

    My name is Jim Klagholz. I am an owner of Clayton N. Sterling Associates, an independent insurance agency, located in Seaside Park, New Jersey, a community midway between New York City and Atlantic City on the Jersey Shore. I have been serving the insurance needs of my community since 1969.
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    I was asked by the subcommittee to come here today to discuss the current state of insurance, the insurance marketplace in my part of the country and, in particular, whether or not there are problems. Mr. Chairman, I am here today to tell you that there are very big problems and that they are growing worse.

    Recent hurricane activity, not in New Jersey, but in such distant places as North Carolina, Florida and even Hawaii, have had a devastating impact upon my ability to serve the insurance needs of my customers. Even though the demand for insurance has never been higher, over the past 5 years the homeowners' insurance business in my agency has declined by more than 35 percent. This is not business that is being lost to my competitors. I believe that it is business that is no longer being written because residents have been unable to find homeowners' insurance coverage and have stopped looking for it.

    Over the past 5 years, in my community and for my insurance agency I have watched insurance company after insurance company withdraw from the market or refuse to license my agency to sell their products. Insurance companies have told me they will write no business within 5 miles of the coast which, Mr. Chairman, encompasses the entire community of Seaside Park and virtually every community on the Jersey Shore.

    A 5-mile limit affects working neighborhoods and working families; and I have been told by some insurance companies that, because of their reinsurance contracts, they are precluded from doing business with my agency because the agency is located in a hurricane prone zone.

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    Mr. Chairman, many of my colleagues in New Jersey are experiencing much the same thing. We have not been able to help, where we have been able to provide coverage, it is obviously with a hodgepodge of measures, which is not the way we have done business for decades.

    Today, there are few, if any, insurance companies that will write the coverage. About the only viable alternative is the New Jersey Fair Plan, which provides the most basic of policies. It attaches a deductible equal to 2 percent of the amount of insurance on the building and excludes such things as theft, damage by frozen pipes that burst and other non-standard perils. It also provides coverage only for the depreciated value for the building, not for the replacement value of its damage.

    To get the coverages that are now excluded, I have to go to an insurance company that isn't even based in this country, Lloyd's of London, which, if I am lucky, may be willing to provide the supplemental coverage for a substantial price. Even if I am successful with foreign companies, my job is not yet done. I still have to handle the liability exposures of my clients. For that, I go to a third insurance company before I can reproduce the same coverage that, for decades, has traditionally been provided by one policy, one transaction and one insurance premium.

    Last year, the New Jersey Department of Insurance attempted to solve the problem by creating something called the New Jersey Windstorm Market Assistance Program or C-MAP for short. Theoretically, this is a voluntary association of insurance companies who participate in a program to provide coverage in coastal areas. But I use the word ''participate'' very loosely. I have submitted more than 25 customers to that and have had no success. Other agents in New Jersey have submitted more than 500 customers and have had no success.
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    I attended an educational seminar to see what the New Jersey Windstorm MAP was all about and how I might go about it; and I found that some of the requirements—and they are typical—are that structures have to be located anywhere from 1,000 to 5,000 feet from the water, and they have to be elevated anywhere from 12 to 25 feet above sea level.

    Being from Long Island, I am sure you are familiar with the Jersey Shore. It is not like the coast of Portugal where you look over the cliff down to the sea below. We don't have any structures 12 feet above sea level, and we certainly don't have any 25 feet above sea level.

    The fact is that many of the insurance companies say they are willing to write coastal business, but they are not. Quite frankly, in many cases, they are looking to reduce the number of insureds that they have in this area.

    This is a crisis, Mr. Chairman. Independent Insurance Agents of America, an organization in which I am actively involved, recently polled agents in coastal areas across the country, and in particular in hurricane prone areas. The results are startling.

    As the charts to my right show, 96 percent of agents responding said that insurers are regularly refusing to renew at least some of their policies in coastal markets; 82 percent who responded said that regionally- and locally-based insurers were either unwilling or unable to fill the void left by the exodus of national carriers; 61 percent said prospects were extremely bleak for the entry of new business into coastal markets. Finally, as was alluded to by Mr. McCollum, 89 percent said the lack of affordable reinsurance was one of the principal reasons cited by companies for withdrawing from the market.
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    These numbers are disturbing. Insurance is the life blood of the real estate market. Without it, a significant part of the economy will be left exposed to an often unforgiving Mother Nature.

    If we allow private insurance markets to deteriorate in hurricane- and earthquake-prone areas, what is going to happen when the inevitable devastating event occurs? People will turn to Congress. And what will Congress say? ''No. I am sorry.'' Of course not. But wouldn't it be far better if the private insurance market was functioning properly to absorb this potential drain on tax revenue? Wouldn't it also be fairer for those who do not live in risk-prone areas not to have to pay for those who do?

    Mr. Chairman, we commend you not only for H.R. 219, but in many other issues where you exhibit leadership and where we have had the capability and the opportunity to work with you. We look forward to working with you in the future, and we appreciate your leadership on this issue. Thank you.

    Chairman LAZIO. Thank you, Mr. Klagholz.

    Chairman LAZIO. I also want to note, from a personal standpoint, how helpful the Association has been in providing information and input and has been very active, of course, in ensuring that we find any solution without having a particular stake on what it might look like, but they are very active in that.

    Mr. KLAGHOLZ. Thank you, sir.
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    Chairman LAZIO. Let me ask you, you have referenced this New Jersey tome of insurance survey—recently-completed survey.

    Mr. KLAGHOLZ. The survey was by the Independent Insurance Agents of America.

    Chairman LAZIO. It was a survey on underwriting restrictions in coastal areas?

    Mr. KLAGHOLZ. No. This was the insurers who were participating in New Jersey's Windstorm Market Assistance Plan, the extent to how they would participate and what requirements they would have before participation.

    Chairman LAZIO. Is it your sense that what we are looking at is a temporary aberration or that we are in the midst of a trend toward less and less liquidity in the insurance market, less and less availability, more sort of de facto red-lining in high disaster-prone areas?

    Mr. KLAGHOLZ. My experience has been that we are most definitely entering a trend. With each hurricane, no matter where it is located, insurance companies are taking a very serious look at their exposures in coastal areas and whether or not, in the long term, they want to continue in these areas.

    Chairman LAZIO. And you think that the cost of reinsurance premiums has something to do with the fact that you see some contraction?
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    Mr. KLAGHOLZ. Yes, sir. Insurance premiums—on a State-by-State basis—insurance premiums are regulated by each department of insurance. So, whether or not reinsurance premiums are regulated, they are capped to the extent that insurance companies can only afford so much of their premium dollar for reinsurance.

    Chairman LAZIO. Do you believe that if the Federal Government presented a program that would provide some type of backstop or enhancement to State reinsurance efforts, that it would provide for more liquidity in these high-risk areas?

    Mr. KLAGHOLZ. Yes, sir, I do believe so.

    Chairman LAZIO. Let me finally just ask you, just as a practitioner in the area and as a resident in a coastal area. I take it, when you look down the road 10 years from now and you see the continuing trend of contracted availability of insurance products for homeowners, whether it is wind coverage or some type of more catastrophic plan, what do you think the consequences are to the community? What if we don't even have a major storm, what are we looking at?

    Mr. KLAGHOLZ. There is a drastic reduction in the real estate market, the value of real estate in the area. As I said earlier, alluded to, insurance is the life blood of the real estate market. Without that, it really has a dramatic and devastating effect.

    Chairman LAZIO. The lenders will not assume the risk of the loan?
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    Mr. KLAGHOLZ. That is right.

    Chairman LAZIO. I wonder if I can turn to you, Mr. Thomas, and ask you, on that very same point, if you see the same thing happening on the other coast?

    Mr. THOMAS. Absolutely. The answer would be virtually the same, Mr. Chairman. The lender is always going to be adverse to making a loan.

    In many instances, this is what closes a real estate sale purchase-type transaction or a refinancing. If there is a substantial risk that hasn't been mitigated in some manner—be it earthquake, be it windstorm, whatever it is—that is of concern to the lender. You tend to get more conservative. It is just a fact of life. It is in this area that I think that, perhaps, the greatest risk here really falls on those either direct lenders, or insurers, that take on the highest risk-to-value kind of loans, and I would submit the FHA, VA are probably in that arena and certainly Fannie Mae and Freddie Mac as well.

    Chairman LAZIO. Again, looking in the crystal ball at a potential catastrophe in LA or San Francisco, what do you think the impact might be on the mortgage lending industry if that were to occur?

    Mr. THOMAS. Well, the insured portion of the Northridge Earthquake was some $12 billion. A $12 billion loss, I can't relate that as an individual to my own institution. I can tell you that, with the Northridge Earthquake, we suffered a $6 million loss. Our reserves at that point were $60 million. It wiped out 10 percent of our reserves.
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    These were losses incurred by a single institution in an area that wasn't even geographically adjacent to where most of our loans are, so it would be catastrophic, sir. I don't know how an individual could equate it beyond his own limited expense.

    Chairman LAZIO. Do you believe that the banking regulators would be well advised to take a closer look at the exposure to banks and thrifts from that portfolio?

    Mr. THOMAS. Absolutely. Absolutely. They ought to be—I think I mentioned in the testimony—in the vanguard. They ought to be more concerned about this than anyone else, sir.

    Chairman LAZIO. I would add also perhaps the Comptroller of the Currency.

    Mr. THOMAS. Absolutely.

    Chairman LAZIO. Just from a conceptual standpoint, are you supportive of an effort to provide a Federal backstop, a Federal reinsurance enhancement, for the States that have taken the initiative to set up those programs?

    Mr. THOMAS. We are, both as an individual institution and speaking for the Western League of Savings Institutions, we are in that capacity as well. We believe that this is the only way that we can establish a broad enough base so that a calamity on the Gulf Coast of Florida or California, and the particular risks that have been cited here, are going to be finding any kind of redress. That has to go beyond the local marketplace, the local economy, the local jurisdiction. The reinsurance phase of this is the surest way to get to it, we believe.
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    Chairman LAZIO. Finally, let me ask you, Mr. Bupp, many of these areas, they have to be some of the most beautiful areas of the country. They are also some of the riskiest areas of the country.

    There has been, over the last 20 years, a great expansion of condominiums. Sometimes it is a second home, sometimes they are for primary homes, sometimes working families on the way up, sometimes for people who are nearing retirement or at retirement who want less bother. But many of the communities that we are talking about are populated by people that don't have the financial capacity to absorb the significant risk of having a lot of their equity, their lifelong savings in some cases, wiped out. They happen to be in a condo.

    Explain to me, if you would, whether or not we need to—I would guess it is stating the obvious—these condominium associations also need to have coverage, and why that needs to be the case?

    Mr. BUPP. In community associations, the common properties and structures are insured by the association. We have found it to be extremely difficult to get that coverage. For instance, in California after the earthquakes, the condominium associations were excluded from some of the programs that were in place. So, they are out in the private market trying to find the coverage, and many of them cannot insure the structure.

    Yet, as you say, these associations—and we estimate 60,000 of these communities are split between Florida and California—contain people's homes. We are concerned those associations could fail if they can't find that coverage.
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    We are also concerned, like Jerry said, that residents would just turn the keys back in if they lost all their equity. They wouldn't know what to do. But, probably, more importantly, it would end up back here with you. There would be this disaster facing the Nation if all these communities were not able to get insurance and would fail.

    Chairman LAZIO. What is the individual risk if an association can't get the insurance coverage?

    Mr. BUPP. If you live in a condominium association, the whole community—as the association—buys the property insurance, the earthquake insurance, the flood insurance; and then that covers the entire structure of the buildings. The individual person also has to buy coverage for his or her own personal property. So, they go into the marketplace on their own to cover their furniture and their draperies and other improvements they have made to their homes. But if that property coverage is not in place, they cannot refinance. Really, the person in the home doesn't have as much responsibility for locating the insurance as single family homeowners, because the association is forced to go to the marketplace to purchase this coverage.

    The other thing is that any legislation that does come through the Congress, should cover all of these common interest communities. Sometimes people only focus on the condominium; and, in fact, planned communities, homeowner associations and cooperatives are also important to be included in the community association definition, not just the condominium, although that is the one that is most familiar to a lot of people.

    Chairman LAZIO. Thank you.
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    I want to say two things. First of all, in response to Mr. Thomas' comment regarding the extraordinary commercial liability that is out there, these bills really do not directly address that problem. So, people need to be aware of the fact that this is a plan of attack on a significant aspect of exposure, but not all of it, and that we need to be thinking creatively about ways in which we can potentially assist States in their efforts to manage risk for commercial properties that are hit with a catastrophe.

    Second of all, I want to comment that I think this has been an extraordinarily helpful hearing, although we would have liked to have seen more Members. I will just tell you, from an insurance perspective, we have hearings right across the hallway right now involving the insurance industry, which I should probably be at myself. But the record will be distributed, and this will be a subject of a great conversation.

    We happen to be having a series of field hearings, so this hearing has helped build the base that we will need in order to project this bill, and I fully expect that we will have a bill done this year, if I have anything to do with it.

    Thank you very much. This hearing is adjourned.

    [Whereupon, at 12:15 p.m., the hearing was adjourned.]