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FRIDAY, JULY 30, 1999
U.S. House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.

    The committee met, pursuant to call, at 9:50 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.

    Present: Chairman Leach; Representatives McCollum, Roukema, Bereuter, Baker, Lazio, Bachus, Royce, Kelly, Weldon, Cook, Hill, Ryan, LaFalce, Vento, Kanjorski, and Sherman.

    Chairman LEACH. The hearing will come to order. On behalf of the committee, let me extend a warm welcome to Deputy Secretary Eizenstat and our distinguished panel of private witnesses.

    The committee meets today to receive testimony on H.R. 21, the Homeowners' Insurance Availability Act of 1999, introduced by the Housing Subcommittee Chairman Rick Lazio and the Committee Vice Chairman Bill McCollum and sponsored by twenty Members of the committee.

    We will be recessing today starting at 11:00 for an hour so Members can attend the memorial service for our former colleague, George Brown, in the Capitol. Because we have limited time, it is my hope we can keep opening remarks brief.
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    H.R. 21 addresses the threat of natural disasters to the availability of adequate and affordable homeowners' insurance. It is similar to legislation passed by the committee in the 105th Congress with bipartisan support.

    The committee will hear today from a broad spectrum of witnesses who have been asked to address philosophical, as well as practical, questions regarding the nature and role of the Federal Government on this issue. The committee has worked with the Administration in every step of the legislation's development, and I am especially looking forward to the comments from Deputy Secretary Eizenstat.

    It is my hope that legislation can be advanced which will represent real opportunity for families to protect their homes, while at the same time avoiding significant contingent liabilities by the Federal Government. In this regard, it is my intention to remain open-minded in the pursuit of a consensus which satisfies these priorities. Based on our hearing today, I hope to be in a position to consider bringing legislation to the floor early this fall.

    At this point, I would now like to ask John if he has any opening comments.

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

    First, I would like to welcome the new Deputy Secretary of the Treasury, Stu Eizenstat. This is his first appearance before our committee with that title. He has had a few titles in the past, and he has appeared before us under those auspices.
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    Mr. Eizenstat truly is one of the finest public servants that I have had the pleasure of working with from the day I first met him, and I believe that was sometime in 1976. Certainly, beginning January of 1997, we began having almost a day-to-day working relationship on a whole wide range of issues.

    I think you started out, Stu, as what, the Domestic Policy Advisor to the President? And I can't begin, you know, to remember all the positions. I don't have your bio in front of me. Whether it was Ambassador, where you were coming in from the State Department to Commerce Department. In any event, I know now that you are the Deputy Secretary of the Treasury Department and you have a portfolio, though as I understand it, that includes not only those responsibilities of the Treasury Department, but you carry over some other responsibilities because of the fine work you did in those areas.

    You have always proceeded in an objective, a bipartisan manner, and our committee is delighted at your new position. I think I can speak for all of us in saying we look forward to working with you very, very closely.

    Now, on the subject of the day, I am very pleased we are having today's hearing to address the issue of improving the availability of natural disaster insurance for homeowners in high-risk insurance markets. How our society responds to losses caused by catastrophic events is an extremely important and, compared to most issues, an extremely complex issue. Continuing changes in weather patterns and new developments in our reinsurance and capital markets clearly add to this complexity. I think it is important to define, before we do anything else, the nature and extent of the problem that is being addressed in this legislation.
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    Contrary to some allegations, we do not confront a situation where basic homeowners' insurance is unavailable in portions of the country. Nor have we seen any breakdown or incapacity in the market for catastrophe reinsurance. I think the April subcommittee hearing was very helpful in clarifying both of those points.

    We do confront a problem of pricing as opposed to capacity. In areas considered high risk for catastrophic events, the cost of both primary and reinsurance coverage for damage due to hurricanes and earthquakes is extremely high. Many primary insurers have simply chosen not to offer this coverage, or not to purchase reinsurance to help reduce the cost of such coverage for consumers, and this leaves many homeowners in the difficult position of going without specialized catastrophe coverage; and it puts greater pressure on Government at all levels to help pay the cost of major disasters that are not covered by private insurance.

    The question that Congress must address is whether there is significant public need for affordable disaster insurance coverage in high-risk markets and whether this need is great enough to warrant Federal involvement.

    If we agree that a Federal effort is needed, a second consideration is whether the reinsurance program proposed in H.R. 21 presents the best approach for addressing this problem.

    Given the increased incidence of major disaster events in the past decade, as well as escalating property and construction costs in high-risk areas, it is difficult for any single locality or State or any grouping of insurance companies to adequately cover all potential costs of a major catastrophic event. These events tend to strike regions rather than States.
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    The Federal Government, however, does have the capacity to adequately spread the cost of such events broadly enough to make catastrophe coverage available on a broad basis. The private marketplace has developed its capacity significantly and may, in time, develop adequate capacity, but there is a need to address the reality that catastrophic disasters can occur at any time, even today.

    H.R. 21, which I have co-authored, provides a vehicle to address these issues, and many of my initial concerns about this legislation were addressed in amendments adopted by the committee last year, and all of those changes have been incorporated in this year's legislation.

    We have come a long way in crafting a workable approach in H.R. 21, but our work may not be finished. Treasury has some very strong concerns with the way that Federal liability is limited and reinsurance payments are allocated under the bill. These are legitimate concerns and we must address them.

    Business and consumer groups have made compelling arguments for the need to assure that greater resources of the insurance industry are committed before any Federal reinsurance payments are made. Those concerns require careful consideration.

    I also believe that more attention must be given to encouraging effective loss mitigation activities in order to ensure that Federal involvement actually helps reduce the potential costs of major disasters rather than merely spreading the costs more broadly. FEMA has some strong views in this area, and we should have the opportunity to hear from them.
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    This past week, I asked that several additional witnesses be invited, and they were. Unfortunately, a number were unable to attend today's hearing on such short notice. The New York Superintendent of Insurance has released a detailed report assessing the current market for catastrophe reinsurance, and he has recommended against the creation of any State catastrophe fund.

    The capital markets also have introduced a number of promising alternatives for spreading catastrophe risks that should be included in either today's or a future discussion. Our committee will, if we are to proceed as we should, hear from these perspectives also.

    These are issues that I encourage all of today's witnesses to address, along with any additional recommendations or proposals that might help our committee improve this bill.

    I join the Chairman in welcoming Deputy Secretary Eizenstat and all of today's witnesses. I thank the Chair for his kind indulgence.

    Chairman LEACH. Thank you, John.

    Mr. Lazio.

    Mr. LAZIO. Thank you, Mr. Chairman. Let me thank you for putting together what promises to be an exceptionally balanced hearing, airing the views of all sides; that again reflects your philosophy.
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    And welcome, of course, to the Deputy Secretary, and I compliment him not only on his work with respect to natural disaster insurance, homeowners' insurance, but on a whole range of other issues and, most particularly, the Holocaust Asset Commission on which he has been a driving force.

    This committee and this Congress have been focused on the issue of liquidity among homeowners' insurance markets for alomst ten years, and over the last three years we have been acutely focused on the legislation before us today. Last year, we reported out legislation identical to our proposal with strong support from both sides of the aisle.

    In the simplest terms, our efforts today are about providing maximum opportunities for families across America to protect their homes. Many of us here take the ability to insure our homes for granted, but it is not so easy for working families in Missouri or North Carolina or Texas and many other States, not to mention California or Florida. For them, the forecasts of more frequent and more forceful storms over the next few decades only bring uncertainty and fear of the future.

    Today, Mr. Chairman, we are likely to hear about the zero sum game among businesses and industries, the reinsurance industry and the insurers, who gains and who loses, but in the end I think we need to focus on the people, the public, the families, the exposure that they face and the possible loss of their most important asset, their homes.

    It is about people like 87-year-old Mildred O'Shaughnessy whose home of 51 years was destroyed just last year when Hurricane Georges hit Louisiana. Mrs. O'Shaughnessy has been unable to find insurance to protect her home, so now she is forced to rely on her family and donations from the community for shelter and the necessities of life.
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    Some States have been able to rebuild in the aftermath of natural disasters from the early 1990's, but for the most part, that ability has been simply a matter of luck. For example, devastated by $16 billion in insured losses from Hurricane Andrew in 1992, the property insurance market in Florida virtually collapsed. Since then, Florida has been somewhat successful in encouraging the reexpansion of the private market, and today they can absorb about $11 billion in insured residential losses, but that success has only been possible for one reason, Mother Nature has spared Florida a major disaster during that time. It also pales in comparison to what a major hit in southern Florida might mean to that market.

    Other committees have already acted in this Congress to address issues associated with the rising costs of natural disasters. In March, the House passed two separate bills designed to address the issue of disaster mitigation, and our colleague, Mr. Terry and others on this committee were co-sponsors of one of those pieces of legislation.

    So clearly, the House has recognized the importance of mitigation efforts in preparing for natural disasters. And as is appropriate, it is an issue being dealt with by the committee of relative jurisdiction.

    Our proposal creates an environment where the private market is encouraged to re-engage in the business of homeowners' insurance across the country. In subcommittee hearings this Congress, we have heard testimony that a more stable and confident private insurance market in vulnerable areas of the country would benefit all Americans.

    Since 1983, taxpayers have spent more than $80 billion in Federal assistance effort disaster relief. It is true that population growth and coastal development play a part in rising costs of natural disasters, but it is also true that within the next ten years, according to the U.S. Census Bureau, almost 75 percent of our total population will live within 100 miles of a U.S. coastline. Regardless of anything we do here today, we cannot mandate where people and families live and we cannot forcefully relocate families living in cities like Miami, New Orleans, Seattle, Los Angeles, St. Louis, Memphis or New York.
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    Today we may hear that there is no longer a lack of available and affordable homeowners' insurance. The facts dispute that. We may also hear that there is an overabundance of reinsurance capacity. That also is contested by the facts.

    Tell that to Mrs. O'Shaughnessy. Tell that to the hundreds of thousands of families who are forced into insurance pools of last resort across the country, which in some areas have grown by more than 800 percent over the last six years. They simply would not be necessary if we had adequate reinsurance.

    Mr. Chairman, we could wait to take action until Congress is forced to act in the wake of some future earthquake or hurricane in the middle of a panic, or we could proceed deliberately and calmly without the environmental crisis that would accompany a major catastrophe.

    Mr. Chairman, one way is a responsible approach to public policymaking. The other is not.

    I want to thank you again for your even hand and for your balanced approach to this hearing.

    Chairman LEACH. Thank you.

    The Chair would like to stress we have an awkward long day based upon having a delayed markup, or a hearing from last Wednesday, because of the Brown funeral. I would like to ask Members to keep opening comments, if they can, as brief as possible.
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    Mr. Vento.

    Mr. VENTO. I will be brief, Mr. Chairman.

    I am pleased we are having this hearing. I supported this bill in the last session, but I am happy to have another look at it. I think that many of us are very uneasy with this step into an assumption of a responsibility by the national Government. As meteorological science improves and the insurance entities are better able to protect risks, they understand the inevitable problems with some sectors of the country in terms of homeowner losses and have withdrawn from the markets in these areas, and obviously there are questions about reinsurance availability and the affordable cost of this.

    I hope indeed that the mitigation efforts are not stopped. Certainly we are very reluctant to demand mitigation efforts, and trying to do zoning from the national level has been generally unacceptable to most jurisdictions.

    I think it is important that Under Secretary Eizenstat, whom I welcome, along with my friend John LaFalce and many others on the committee, see someone who has been in Washington almost as long as I have. It is good to see you here, Stuart.

    Mr. EIZENSTAT. Thank you.

    Mr. VENTO. But I think his testimony points out the necessity of not supplanting, but supplementing what is going on, to provide the necessary framework so that we can, in fact, establish a private sector initiative and to permit that to go forward in terms of doing the job that it has historically done.
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    Obviously, our work with disaster assistance and other matters is not going to go away on the basis of this endeavor, but it is good to try and provide, or to develop a private market, but hopefully to try and not outguess what the market will do. So I think we have to be very careful as we go down this road, and I commend the Members working on it and the witnesses that we have today.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. Vento.

    Mr. McCollum.

    Mr. MCCOLLUM. Thank you very much, Mr. Chairman. I certainly appreciate your holding the hearing today.

    As we all know, this is the second time that this legislation has been before the committee in the last Congress. The bill that Rick Lazio and I introduced this year was, indeed, what was passed by this committee and ultimately presented to the floor, though too late for consideration.

    The reason for it is, I think, very obvious, because we have in earthquake-prone States, and in States like mine in Florida, hurricane-prone States, tremendous problems with insurance availability and potentially with greater costs even than now for homeowners, because of the risks that are involved with the absence of a private marketplace with respect to reinsurance for insurance companies. And while there may be other factors involved, when you have the 1-in-100-year event, the really big hurricane, the really big earthquake, there frankly is no protection for insurers in terms of their potential losses if they issue this kind of insurance.
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    Consequently, if we don't do something, I don't think it is simply a question of even availability in some of the States for insurance in the future or higher premiums. It is going to be a question of a huge loss to the American taxpayers, because just like with Hurricane Mitch in Honduras and Guatemala and Nicaragua this last year, there will be a call for aid the likes of which we haven't seen here before for a disaster in our own country, and that will undoubtedly be done. We will wind up approving it.

    So I believe that while there may be some perfections that need to be done to this legislation, that today's hearing can give us some guidelines as to what those are; but ultimately we need to produce this legislation, and we need it badly, before we get to the point where the terribly difficult 1-in-100-year event does occur, and a Hurricane Andrew strikes downtown Miami instead of striking south of it, and then we all have a tremendous problem on our hands beyond what we can foresee right now.

    But I thank the Chairman for holding the hearing, look forward to working with him on crafting whatever product we ultimately produce, and I thank you very much for the time.

    Chairman LEACH. Well, thank you, Mr. McCollum.

    Does anyone else seek recognition?

    Mr. COOK. Mr. Chairman.

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    Chairman LEACH. Excuse me one minute. I think Mr. Sherman on this side, please.

    Mr. SHERMAN. Thank you.

    Chairman LEACH. Mr. Sherman.

    Mr. SHERMAN. Mr. Chairman, thank you for holding these hearings. Since I represent Northridge, I regard this as a matter of earthshaking significance.

    The current system has not completely broken down, but at least in southern California the cost of earthquake insurance is horrendous and then it comes with an enormous deductible that makes it almost worthless. And we are just one earthquake away from a breakdown in the insurance system, because if there was another earthquake in southern California in the aftermath and in the several years after that, you may not be able to get earthquake insurance; you may not be able to sell your home or even refinance it.

    The reinsurance markets have developed to some extent, but at least my State, I believe, is paying 10 times the actuarial value for the reinsurance it is buying on the private market. We do have a Federal interest in risk mitigation and one in encouraging people to purchase insurance, and by making disaster insurance affordable and providing reasonable coverage, we can meet that Federal interest.

    Thank you, Mr. Chairman.

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    Chairman LEACH. Well, thank you very much. For a unanimous consent request, I recognize the gentleman.

    Mr. BAKER. I just ask unanimous consent to submit my statement for the record.

    Chairman LEACH. Without objection.

    Mr. Bachus.

    Mr. BACHUS. Thank you. I would ask unanimous consent. I have got a rather lengthy statement which I won't make.

    I have one area of concern, and I hope to work with Mr. Lazio and others who are sponsoring the bill, and that is the balance between the private and the public sector. We don't want to crowd out the private sector. There are a lot of studies recently that show that reinsurance is plentiful, that it is cheap, that its availability is rising. And it may be that the trigger level in this legislation needs to be revised, and I will submit my concerns in a statement. Thank you.

    Mr. ROYCE. A brief statement, Mr. Chairman.

    Chairman LEACH. One second.

    Any other statements on the Democratic side?
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    Please, Mr. Royce.

    Mr. ROYCE. Thank you, Mr. Chairman.

    Mr. Chairman, this legislation is premised on the view that the supply of reinsurance in the private marketplace is not adequate to meet the demands of a catastrophic natural disaster, and before we decide to turn over to the Federal Government the role of providing reinsurance, I think we should consider that recent studies indicate that the capacity of the private marketplace to handle these losses is far greater than is contemplated by H.R. 21, which sets trigger levels at $2 billion.

    For example, the 1995 study by U.S. Re Corporation, which has been cited by this committee as an authoritative analysis of the total supply of reinsurance, has now been updated by a much more recent July 1999 study. That revised analysis suggests that for much of the country capacity has more than doubled from $7 billion to $14 billion per region since four or five years ago when that report was first produced. A similar conclusion was reached in a study by Renaissance Reinsurance.

    Take California, for example: The increased capacity is pegged at $11 billion. In addition, both reports suggest that additional capacity is available from other forms of reinsurance agreements and from the capital markets which have brought significant new capital to the table by securitizing natural disaster risk.

    Taken together, there is closer to $20 billion of reinsurance available per region, significantly greater capacity than the outdated figures upon which this legislation is based.
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    These numbers are significant because they illustrate the fact that the private marketplace for reinsurance has grown significantly in recent years and is much better prepared to handle catastrophic natural disasters. Indeed, as a third study conducted by the Wharton School and published just two weeks ago concluded that gaps in catastrophic risk financing are presently not sufficient to justify Federal Government intervention in private insurance markets in the form of catastrophic reinsurance, and that was just two weeks ago that that study came out.

    A massive new Federal disaster program, in my view, Mr. Chairman, would only hinder further innovation and growth in the private sector, potentially pushing out private reinsurance companies and leaving the taxpayer with much greater liability.

    I appreciate you allowing me to give my thoughts, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. Royce.

    Mrs. Kelly.

    Mrs. KELLY. Thank you, Mr. Chairman. I ask unanimous consent to insert my statement in the record.

    Chairman LEACH. Without objection.

    Mrs. KELLY. As a part of my statement, Mr. Chairman, I would like to also insert in the record the February 1, 1999, study, ''A Report to Governor Pataki and Members of the New York State Legislature by the Temporary Panel on Homeowners' Insurance Coverage.''
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    Chairman LEACH. Without objection.

    Mrs. KELLY. Thank you.

    Chairman LEACH. Mr. Cook.

    Mr. COOK. Yes, thank you, Mr. Chairman. I would like to ask unanimous consent to insert my statement into the record.

    I would just like to point out that the cost of natural disasters is approaching $1 billion a week in America, and I would like to reemphasize the strong support that H.R. 21 currently enjoys with over 97 co-sponsors and, additionally, several real estate groups like the National Association of Realtors, the National Association of Home Builders, whose members face this and other types of homeowners' insurance issues every day, support this bill strongly. In fact, I would like to ask unanimous consent that a statement in support of H.R. 21 on behalf of the National Association of Home Builders be submitted for the record.

    Chairman LEACH. Without objection.

    Mr. RYAN. Mr. Chairman.

    Chairman LEACH. Yes.

    Mr. RYAN. I would also ask unanimous consent to insert my statement in the record.
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    Chairman LEACH. Without objection.

    Mr. RYAN. I would also likes to lend my 2 cents worth with some of my colleagues, which is, we do have new data. We do have a new study which shows that there is approximately $20 billion of reinsurance sold per region.

    And I also have the same sorts of concerns that we may be overreaching here, we may be undermining the private insurance markets, we may be crowding out better alternatives; and it is something that we really have to police and watch very, very closely, that we do not overreach in this area.

    It may be a point of moving triggers, but there is a threshold to which we can crowd out these private market incentives, private new tools that are on the horizon, and I hope that this committee does not pass legislation which does so.

    Chairman LEACH. Thank you, Mr. Ryan.

    Mr. Hill.

    Mr. HILL. Thank you. Mr. Chairman, I want to thank you for holding this hearing and echo the comments of others in allowing us to fully flesh out the issues here.

    I have many concerns about the bill, but the most significant has to do with the triggers, and there are three triggers in the bill. One, they are described as the greater of either $2 billion, the capacity of the State cap mechanism, or a 1-in-100-year event.
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    These three criteria are—discussing them is much like discussing apples and oranges. $2 billion is an arbitrary set dollar amount. The significance of that trigger would change dramatically when the nature and geographic boundary of that event changed.

    Example, a $2 billion trigger in California is significantly different than a $2 billion trigger in Montana. Likewise, the loss being capacity of a State mechanism bears no relationship to anything except perhaps the willpower of the State taxpayers. Certainly a $10 billion capacity in California would be substantially different than a $10 billion trigger in Montana or Texas for that matter.

    The most confusing, I think, clearly the most misunderstood, is the 1-in-100-year event trigger. In 1982, Ten Mile Creek flooded the Helena Valley, my home. It was caused by 10 inches of rainfall falling on the Continental Divide 10 miles away, hence the name Ten Mile Creek. It was a 1-in-500-year event and it caused a couple of million dollars' worth of damage.

    Now, in the Helena Valley along Ten Mile Creek, this was a massive, catastrophic event, but on a national scale it would probably hardly cause a blip.

    A 1-in-100-year event that is based on a national or global scale event, that might occur in California, is of significantly different magnitude than a 1-in-100-year event that would occur in the same place when the scale is more narrow—say, the State of California.

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    Expressed another way, 1-in-100-year earthquake event in California would be a lesser magnitude earthquake than a 1-in-100-year event based on a U.S. scale and even lesser than a magnitude event on a world scale.

    Further, this criteria bears no relationship whatsoever to the economic impact. For that reason, we need to completely re-examine the matter of the triggers.

    We should be trying to protect simply the solvency of the insurance industry, not events, the purpose of which is to make insurance more available to consumers at a lower cost. Events of certain economic impact, not intensity, are what impose the economic risk. The trigger should be set at a level higher than the capacity industry, both the primary insurance and reinsurance industry, and it should be calculated by first establishing the capacity of primary insurance and then the reinsurance in capital market alternatives.

    My calculations would put these triggers at somewhere between $25 billion and $40 billion.

    Now, what we need to do here is to calculate what the appropriate capacities of individual insurers are for a probable maximum loss, so that whatever reinsurance contracts we have are really adjusted or suited to the needs of individual insurers, based upon their exposure.

    It is my hope that we will be able to understand these issues better from this hearing and perhaps approve this bill so that it can pass.

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    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you very much. Does anyone else seek recognition?

    If not, we would like to begin with the Deputy Secretary, and I would like to just take 15 more seconds to echo everything Mr. LaFalce indicated.

    We are pleased you are in your position, Stuart, and we look forward to your testimony.


    Mr. EIZENSTAT. Thank you, Mr. Chairman, and Representative LaFalce, Members of the committee. I appreciate the opportunity to discuss this important issue, and I want to begin by complimenting you, Mr. Chairman, Mr. LaFalce, Representatives Lazio, McCollum, and Barney Frank, for whom we pray a speedy recovery from the operation he will be having, and other Members of the committee for their bipartisan leadership in facilitating the deliberations on this important legislation.

    Your collective and individual skills, insight and perseverance, we believe, will lead to a good legislative outcome.

    The Administration's view with respect to this important issue can be summarized as follows: The characteristics of natural disasters make the financial risks associated with them especially difficult for both private insurers and reinsurers to handle. In the wake of a major disaster, prices tend to spike, leading to a contraction in the availability of homeowners' insurance and to a reduction in reinsurance.
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    Given the states of development of the private markets for this risk today, we are persuaded that there is a limited interim role for the Government to play with respect to the reinsurance of the most severe, most remotely probable of these events.

    The principles that we believe should be respected as we move forward are that the Government's role in this area must be designed so as to leave more than enough room for private market activity to flourish, and so the taxpayers are thoroughly and adequately compensated for all risks borne by the Government. We view the legislation before us as a constructive step forward in addressing these problems, but as Secretary Summers and the Department have noted, there remain concerns about some important aspects of the bill.

    Turning to our specific concerns with the legislation, we believe first that this committee should seriously consider whether the cap on annual pay-outs will adequately serve the objective you have in mind. I will be outlining in some detail an alternative approach that we have been exploring and that we believe may offer a more robust tool for fiscal control.

    The Administration, under the leadership of James Lee Witt, the Director of FEMA, has developed a comprehensive policy dealing with natural disasters, going beyond simply the response to them; but trying to help in working with local communities, making them less prone to natural disasters. We see the legislation before this committee as a potential complement to this policy.

    We also believe that the appropriations requirement currently in the legislation should be removed in order to bring this program into conformance with general practice of other Federal insurance programs and to promote maximum clarity that the Government will make good on its financial obligations.
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    Finally, with respect to the issue of triggers, which I will get into in more detail in a moment, we believe that the triggers should be set neither so high as to make the program irrelevant to State programs and private entities, nor so low as to crowd out private market activity.

    There are no easy answers to how this should be accomplished. On the whole, however, our instinct is toward the cautious end of the spectrum. So in balancing these competing considerations, we would put greater emphasis on avoiding crowding out.

    Three considerations argue for prudent interim participation of the Federal Government in this market. First, the Federal Government is uniquely capable of spreading risk across the population and over time.

    Second, the Federal Government would likely bear part of the costs associated with stabilizing collapsing insurance markets in a truly cataclysmic event regardless whether legislation of this type existed.

    And finally, the prudent participation at this stage of development may enhance the ability of private markets to deal with these risks.

    We are guided by a common set of common-sense principles that Secretary Summers has laid out. Federal involvement must be supported and not supplant private insurance markets. It should apply only to true catastrophes that the private market is not capable of handling and it should be strictly transitional, phasing out as private markets develop.
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    The Federal Government must share and not subsidize risk, and it must be at no net cost to the taxpayer.

    The legislation now before the committee is a generally positive step forward in this regard and creatively responds to the difficulty faced by both State funds and private entities in purchasing reinsurance against their large but low-probability risks. The bill has improved as it has moved through the legislative process, and we hope it will continue to do so, because we continue to have some concerns which are as follows:

    First, with respect to the cap, the proposed legislation would cap annual pay-outs at $25 billion. If claims in any one year exceeded that amount, each claimant would receive a prorated portion of the $25 billion.

    We obviously share your objective of developing a fiscally prudent piece of legislation. However, after careful study, we believe that the cap on annual insurance pay-outs may not be the best way to limit Federal liability.

    It would be difficult for the Federal Government to withhold pay-out on claims under this program on the argument that such a pay-out might later need to be prorated against claims from another event, and then if a second event were to occur within the same insurance year, it is entirely plausible that future Congresses and administrations would make full payment on all claims stemming from the second event, notwithstanding the requirement to prorate.

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    The only alternatives would be either to recall monies paid out pursuant to the first event or to impose the full burden of the annual cap on the victims of the second event. Neither is realistic.

    We would like to suggest a possible approach on the cap issue, which is demonstrated by this chart, copies of which we have handed out to all Members.

    It would involve limiting the amount of insurance to be sold rather than the amount of the pay-out to be made. Contracts sold under the legislation would cover 50 percent of any losses above the threshold level that triggers the Federal pay-out, up to an upper limit corresponding to the dollar amount that would be lost in the event of a more remote possibility.

    With your permission, if each of you would perhaps look at this chart, which is based on the concept of reinsurance offered, if in the State of Florida there were a 1-in-100-year loss, this is estimated to be $13 billion. For 1-in-500-year loss, the estimate is $26 billion in the State of Florida.

    Under our suggestion, the Federal liability would be capped at half the difference between $26 billion, the top 1-in-500-year event; and $13 billion, the 1-in-100-year event; or $6.5 billion.

    This loss would occur only if the industry actually purchased all the contracts that were offered.

    The aggregate maximum Federal pay-out then would be computed as the sum of the maximum obligations in each State and region. Our preliminary data—and please understand this is more back-of-the-envelope, ballpark estimates—indicates that if the upper limit were set at the dollar amount associated with a 1-in-500-year event, in each State and region, the maximum Federal liability in any given year would be on the order of $50 billion.
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    Under this approach, that maximum liability is easily dialed up or down by adjusting the probability associated with the upper limit.

    Under this approach, the Government would sell only a limited amount of insurance, but having sold it, it would make good on all of it. It also has the advantage, Mr. Chairman and Members of the committee—and you can see this by the white part of the bar next to the $6.5 billion—of leaving room for the private sector as well as the amount that the Federal Government would take, which is shown by the blackened area.

    Of course, the deductible amount would also be covered by the private sector.

    A second concern has to do with appropriated pay-outs. The proposed legislation would require that all pay-outs from the fund and borrowings by the fund be subject to congressional appropriations. In our opinion, this casts a potential shadow over the certainty of full pay-out and could therefore limit the number of bidders and possibly dampen their aggressiveness in bidding. The net result could be that the Federal Government would receive a less favorable price for its reinsurance. This concern could be addressed by striking out the requirements for appropriations of pay-outs and borrowings.

    The threshold trigger levels for a Federal pay-out, as I indicated, are an extremely important parameter of the proposed legislation. They have to be designed to strike an important balance between two very important considerations. On the one hand, the triggers should not be set so high that the program becomes irrelevant for either State programs or private participants; on the other, Federal involvement shouldn't crowd out private sector activity. This program should insure only losses of true catastrophes that the private market is incapable of handling.
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    In conclusion, Mr. Chairman, our suggestions derive from two core concerns: that relief for insured homeowners not come at the expense of taxpayers and that any Federal program share risk and support the private markets.

    The current proposed legislation provides a sound foundation for progress in this area, and we look forward to working with Members of this committee to resolve remaining issues.

    Thank you very much.

    Chairman LEACH. Well, thank you, Mr. Secretary.

    Let me just begin with the most basic query, and that is, obviously from a taxpayer's perspective any program in this area presents a potential contingent liability on the Government, which means the taxpayers.

    It is also obvious that lack of a program presents alternative Government expenditures.

    And so one of the great questions is: Is it prudent to go forth with a new approach under the assumption that: A, one wants to, under reasonable projections, have it pay for itself; but B, if there are unreasonable situations that develop, will the costs be less than the alternatives?

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    And I assume, based upon your testimony, which is presenting a little bit different alternative, that you accept the premise that the alternative approach is very expensive to the taxpayer and that moving people into an insurance setting is probably cheaper for the Government in the long run than otherwise. Is that a valid assumption?

    Mr. EIZENSTAT. Yes, sir. I think our feeling is that there are costs to the Federal Government associated with natural disasters in any event. That is one of the reasons that, under Mr. Witt's leadership, we are trying to develop proactive and preventive measures. We also believe that under the pricing that has been provided here, there should be no net cost to the taxpayer.

    Now, in something as uncertain as this, one can never be absolutely sure, but we think that it is likely that there would be no net cost and that, as you properly point out, there are costs to doing nothing.

    Chairman LEACH. Then the final premise that I would like you to address is that one of the extraordinary aspects of this country is that we have an insurance industry and then we have a reinsurance industry, both of which are quite vital. But it does appear that there is a circumstance of enormous national catastrophes that even the insurance and the reinsurance industries have a difficult time contemplating as both a reasonable business risk or cost-effective risk, and therefore, there is a role for Government to step in. Is that a valid assumption?

    Mr. EIZENSTAT. Yes, sir. We think that there is a market gap here. One of the reasons that we stress and that the legislation stresses, the interim nature of this with, for example, a ten-year sunset clause, is because we hope that that gap will, over time, be filled by the capital markets. There is already a securitization market which is developing, and the reinsurance market is growing. But there is a gap, and that gap, we believe, ought to be filled in the interim.
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    Chairman LEACH. I thank you.

    Let me just conclude by saying I appreciate the introduction of your chart as symbolic of an approach that you think the committee ought to seriously consider. I have a very open mind to that, and we will, in the wake of this hearing, look at this approach very seriously.

    Mr. EIZENSTAT. Thank you. It is really designed, Mr. Chairman, to try to make sure that there is a genuine cap, and our concern is simply that having the $25 billion cap with the notion that you would prorate additional disasters doesn't take into account the political realities that when that second disaster occurs, the pressures will be enormous to pay the full amount out. We think this provides a more certain cap at a somewhat higher level of assumption.

    Chairman LEACH. Thank you, Mr. Secretary.

    Mr. LaFalce.

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

    I share your open-mindedness on this question and look forward to dialoguing with not only the Administration, but everyone to better grapple with these issues.

    I am not sure that I fully appreciate the Administration's perspective, however. One of your concerns with the $25 billion cap is it may not effectively be a cap because it would not preclude future Congresses from acting to provide full repayment.
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    Is there any less likelihood that the alternative you have suggested to us would preclude a future Congress from politically deciding to provide fuller payment than is required under that alternative proposal?

    I don't quite see it.

    Mr. EIZENSTAT. Yes, sir. First, I want to thank you, again, for your very kind words.

    The difference is that the proposal in the bill is based on a pay-out concept. Ours is based on a sale concept, so that you can only offer for sale at the beginning of each year a certain amount of insurance, and that would establish immediately a ceiling and then the Government would pick half of that up. So it would be very difficult for a Congress to change that without literally amending the legislation in ways which we think would be much more difficult to do.

    Mr. LAFALCE. I really don't see that. You know, this is a political question rather than a technical, legal question, and if there is a political desire to exceed a cap of $25 billion, I don't know why there would be any less of a political desire to exceed a cap based upon premiums that have been purchased.

    You know, I mean, I can just see it right now. If there is a problem in Florida, they are going to say, ''The heck with it, we have got to get reimbursed.''

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    Mr. EIZENSTAT. But there wouldn't be—insurance simply wouldn't have been out there. You won't have the insurance out there for that political pressure to apply against because you have only issued a certain amount of insurance since our base is, again, on an offer-and-sale opportunity, not on a pay-out opportunity.

    Mr. LAFALCE. I understand that, but when we talk about coming to Congress for additional compensation, what insurance has or hasn't been out there oftentimes, in my judgment, would be irrelevant. You would look at the political pressure; you would look at the need. This is my perspective, and maybe I am wrong; but I will talk with you, you know, further on it.

    There has been a lot of talk about the desirability of mitigation, and I don't know that this has been a primary province of the Treasury Department. I think that there are some others, whether it is the National Science Foundation or FEMA, who have been most especially concerned about this. Does the Treasury, though, believe that the mitigation measures generally can help contain property losses from natural disasters and thus help reduce potential Federal reinsurance claims? And should support for or involvement in loss mitigation efforts be a requirement for Federal disaster reinsurance for both States' disaster programs and private insurance companies?

    Mr. EIZENSTAT. Before I respond directly to the mitigation, let me go back again to try to drive home why we think that although obviously there will be political pressures in both, it would be much more in the case of the cap that is in the bill. In the cap that is in the bill, people will have already paid premiums for the insurance that is out there, and they will expect a full pay-out. Under our proposal, there would be no insurance out there.
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    Now, obviously there will be some pressures for relief, but the fact that you don't have a paid-out amount, we think will reduce the amount of political pressure.

    Mr. LAFALCE. Well, right now, when there is political pressure, it is political pressure that has not been based upon insurance being out there. Correct?

    Mr. EIZENSTAT. Yes, but under the proposed legislation, you would have legislation out there and people would have already paid a premium for it and they are going to expect a full pay-out. That would not be the case again under ours.

    With respect to the mitigation issue, we think that the provision in the bill, which requires that in order to be eligible to participate, a State disaster insurance program must use at least 10 percent of its net investment income to mitigate losses is sound, with two additional items that we would like to suggest:

    First, that the language should require that any mitigation spending undertaken pursuant to the bill should be cost effective in its reduction of losses. In other words, it must take into account the financial interests of the State program in making the outlays.

    And second, that the mitigation spending financed by the provision in the bill should be integrated with FEMA's ongoing efforts in this area.

    We know that this has been a special concern of yours and Representative Maloney, and we appreciate the work that you both have done.
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    With respect to the broader point that you make, you are absolutely right, and this is what James Lee Witt has done in, really, I think, turning FEMA around from simply being—and I shouldn't say that this is unimportant, it is terribly important—dealing with post-disaster situations.

    From 1989 through 1998, FEMA spent $1.7 billion on mitigation activities through the hazard mitigation grant program. But what Mr. Witt and the Administration are trying to do is deal with predisaster mitigation. In our fiscal 2000 budget, for example, we have a $30 million request for predisaster mitigation under our project impact program, which has us working at the State and local level, and in particular with communities, to make those communities more disaster resistant.

    So we think that this is a very important issue. It is a way of reducing the future costs and that the FEMA work should be coordinated with this legislation.

    Chairman LEACH. Thank you.

    Mr. McCollum.

    Mr. MCCOLLUM. Thank you very much.

    Secretary Eizenstat, I certainly appreciate your being here today. I would like to emphasize that your testimony, on the whole, is very positive to going forward with legislation; and I think that your comments are on that line very, very much needed and appreciated because you recognize and have brought to our attention that the Administration recognizes the tremendous need to fill a void that is here at the moment so that consumers in the affected States ultimately have insurance products and have reasonable rates and that we don't have this void.
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    I wonder if you could elaborate in your own words, in a way, why and how consumers—that is, purchasers of homeowners' insurance—would benefit from the proposal that is before us and whatever form it comes out with, the details of the changes that you suggested, how and why would consumers benefit and why do we really need this legislation?

    Mr. EIZENSTAT. Congressman McCollum, first, again, I want to applaud your work and leadership in this area.

    I think in several ways. First, we would expect the additional Federal reinsurance to improve the availability of homeowners' insurance, in particular, to ameliorate market contractions following a disaster, where you get a real spike in prices and it takes many years for that to go down. In the interim, homeowners have less access to insurance.

    In addition, we believe that the kind of limited interim Federal reinsurance program that we envision and that is in this legislation could encourage a reduction in insurance costs in many areas that would be a real benefit for average Americans.

    Mr. MCCOLLUM. Well, I appreciate your summarizing that for us, because that is the bottom line. We may, and should, discuss, debate and come to some perfection of the final product; but in the end, we do have a great need for this at the moment, and hopefully it won't exist forever, but it is certainly there at the present time.

    With regard to the issue of the question of availability of insurance, if you are looking at it from that standpoint and we want to have insurers make more insurance available to be sure they are there, we need to have the program and the plan we put forward marketable; that is, that they will indeed buy the product, the reinsurance product. Do you believe that—with the new caps proposal that you have out, do you have reason to believe, from discussing with industry representatives, that the insurance industry as a whole would embrace this and find this to be, the product that we came out with, something that they want to purchase? Do you have any feel for that as opposed to the existing product?
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    The reason I ask that is because we know we have worked through the current language with them, and as a whole, the industry says we like it and we would buy the product. I am just wondering if your new cap proposal is something you had a chance to market through the industry?

    Mr. EIZENSTAT. This is, frankly, a new idea. It is one that we want to work with the reinsurance and insurance industry on. We think that it has many advantages. First, it very clearly, as the chart demonstrates, leaves a significant area above the deductible or the trigger for the private sector, because the Government is only picking up half the difference between a 1-in-100 and 1-in-500-year event.

    It has, we think, a reasonable deductible concept, very similar to that in the legislation. And it also would provide, as does the legislation, the ability to adjust the trigger so that, based on annual experience, if we feel that there is any crowding out occurring, that can be adjusted on an annual basis. And we appreciate very much that the legislation has given the Secretary of the Treasury the flexibility to do that; that is very important, and we think that that will give us a market test of whether or not we have set things at the correct level.

    Mr. MCCOLLUM. Well, I appreciate it, and my only comment and reason of asking this last question of you is that from my perspective, I am very flexible about how this product is crafted, the precise terms. I think we all need to be open minded about it, but I am most concerned that we craft a product that will be purchased.

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    If indeed the insurance industry were to find something here it wouldn't buy, this wouldn't work. And, therefore, I think as we go through the next few days and weeks working this legislation together, you and the committee, we need to make sure that if we make this change, or a change in this direction, that it indeed is something that insurers will purchase.

    Mr. EIZENSTAT. Well, we obviously share your same objective. If you have a product that doesn't sell, then you haven't accomplished anything.

    We think that ours does. And, again, the basic outlines of the legislation are ones that we feel comfortable with. The areas of concern, while they are significant, are ones we hope we can work with you on and work with the industry on.

    Mr. MCCOLLUM. I really appreciate it.

    Thank you, Mr. Chairman.

    Chairman LEACH. Well, thank you, Mr. McCollum.

    Mr. Vento.

    Mr. VENTO. Thanks, Mr. Chairman.

    I just wonder with all the mergers of the larger insurance companies and reinsurance, if there are some antitrust or other limitations that are preventing—because, you know, even other companies like Lloyds of London would run from some markets. So, you know, with the merger activity, it would be interesting to see why this isn't taking place.
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    One of the questions I had is, the current flood insurance programs that we now sponsor, will they be displaced or affected by this? Is this your view, Secretary Eizenstat, because they don't have a market for them today?

    Mr. EIZENSTAT. No. And I think that in response to your initial concerns, the difficulty in this area, Mr. Vento, is the difficulty of pricing a risk that is so uncertain and so catastrophic.

    It is not a typical risk. It is not even, you know, a 1-in-100-year flood type of risk, and I think it is that uncertainty which leads to the market gap.

    This would cover hurricane, earthquake and volcano, but not flood. So it would not displace the existing flood.

    Mr. VENTO. And straight-line winds, I might add, straight-line winds which we have been experiencing in Minnesota just lately. We lost a big swath through the Boundary Water Canoe Area, about 30 miles long and 15 miles wide, about 20 million trees.

    Very few people live there, but it could have happened a little further south, too. It would have been different.

    One of the questions that I have is the relationship between U.S. Treasury reinsurance and the relationship between FEMA and the Congress in terms of purchasing. This sort of reminds me of the crop insurance issue in which everybody—you know, just a few farmers purchased the crop insurance, but when we step in either through FEMA or through disaster assistance, everyone gets covered.
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    Mr. EIZENSTAT. Well, again, FEMA has largely been dealing—although again, under Mr. Witt's leadership, it is becoming much more preemptive—it has largely been dealing with the humanitarian concerns with disasters, relocating people, providing food and temporary shelter.

    But it doesn't deal and can't deal with the systemic problem of the spike in rates which catastrophic events lead to which, in turn, leads in the long term to pricing people out of insurance. That is not a FEMA responsibility.

    At the same time, we think it is important to work hand-in-glove with FEMA, particularly as it is trying to mitigate the likelihood of these disasters. But this is an entirely different situation which gets to imperfections in the insurance market, and that is, again, not a FEMA responsibility.

    Mr. VENTO. Let me talk about one of those imperfections in the market.

    The effect of the Treasury borrowing rate and what our costs would be compared to—you know, the issue here is that—what your desire to do would be to sort of atrophy as the private market developed for reinsurance, I take it?

    Mr. EIZENSTAT. Well, again, we want to complement the existing reinsurance market. There is a reinsurance market; it is a very important market. We want it to grow, and ultimately we want it to be able to take this responsibility over. We think that that can occur over a period of time.
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    Right now, there is a gap. The gap causes a serious problem for a tremendous number of American citizens. And as some Members have mentioned, the increase in the number of natural disasters that we have seen in this decade is really quite consequential. We can argue as to why that has occurred, but it certainly is factually the case. And so we want to give time for the capital markets to develop. We have every confidence that will occur, and therefore, the kind of sunset protection that is in the bill is important.

    And again, I want to stress, by giving the Secretary of the Treasury the flexibility to adjust the triggers, it gives us the capacity to make sure that if the reinsurance market is able, on a more rapid basis than one would anticipate, to fill these gaps, that there would be room to do so. The higher you place the deductible, the more the private sector can come in.

    Mr. VENTO. Well, I am, you know, concerned, I think, as most are that because of the low borrowing rates at Treasury and other factors, that it just absolutely will not be able to work.

    But in any case, the other questions I think that we have, the measurements over the certain amounts I expect you rely on, FEMA estimates and other factors, but another question—with time running out here—is the question of vigilance of States and private sector entities, including the insurance industry, to avoid most high risk. In other words, that is to say, today they play a vital role in terms of building codes and mitigation and other factors. By absorbing some of the risk, do we actually deter that?

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    Obviously, when you look at the Florida situation, you have shown us three-quarters of the loss inures to the private sector, so you would think that would be enough. But insofar as we are taking away some of the outer edge in terms of what that loss is, we are paying the last dollar on the most—well, not really the last dollar, but the last half in the example that you give for 1-in-500-year experience; there still is a significant amount of—will that affect, in fact, the motivation or vigilance of the State and private sector to mitigate possible damage?

    Mr. EIZENSTAT. Well, that is the moral hazard issue, and we think that in a situation like this, when you are dealing with truly catastrophic situations and only truly catastrophic situations, that it would not in any way dampen the enthusiasm of local communities to avoid, first of all, less catastrophic events, which are more likely to occur on a frequent basis, since this only again deals with the most catastrophic; and that for those terribly catastrophic events, that is an area where there is a market gap.

    And again, I would go back to what FEMA is trying to do. FEMA is working hand-in-glove with local communities to try to increase that capacity, and far from seeing—we would see no desire by local communities to reduce that. If this kind of legislation would pass, we think it would give a reassurance that those things against which, frankly, no community can protect itself, the absolutely totally catastrophic events, that this would not deter planning for things that were slightly less catastrophic.

    Mr. VENTO. Thank you, Mr. Chairman.

    Chairman LEACH. Thank you.
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    The Chair would like to make an announcement. We do have the memorial service for Representative Brown. It begins at 11:00. So I think we should recess for that service. I would also like to announce that on the floor immediately after the service is the motion to go to conference on H.R. 10. I don't think that will take very long, but I will be obligated to be there for that brief period of time, and other Members are welcome.

    Mr. McCollum will take the Chair, however, and will attempt to resume immediately after the memorial service.

    Mr. EIZENSTAT. Do you wish me to reappear?

    Chairman LEACH. I would be delighted if you could stay. Is that possible, Stuart?

    Mr. EIZENSTAT. What time would that be?

    Chairman LEACH. It would be a little before noon, I would think, we would reconvene.

    Mr. EIZENSTAT. I frankly will have to check if I can get with your staff. I will do the best I can.

    Chairman LEACH. We will consult with you about that.

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    Mr. LAZIO. I wonder if I could just indulge the committee in case Secretary Eizenstat has to go?

    Chairman LEACH. Surely.

    Mr. LAZIO. There is just one question I wanted to ask him, which I think is important in terms of framework, and I won't go on any further. I wonder if I could ask your indulgence just for 30 seconds?

    Chairman LEACH. Yes, of course.

    Mr. LAZIO. I just want to ask the Secretary this question.

    One of the potential alternatives to dealing with the liquidity issue in the homeowners' insurance marketplace, Mr. Secretary, is this idea or concept of a tax fix to try to incentivize the accumulation of reserves by insurance companies with the idea that that would incentivize them, in turn, to write more insurance.

    I am wondering if you are familiar with the concept and, if you are familiar with the concept, if the Administration has a position on that?

    Mr. EIZENSTAT. First of all, we would be happy to work with you, and we know that Mr. Hill has also had some interest in this area. We have some serious concerns at this stage. We think it would be difficult to design an approach along these lines that limited its benefits to incremental actions, and that would not simply reward reserving that would have taken place in any event.
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    In addition, we have some significant reservations as to whether an approach could be adequately administrable. We think that the tax benefits are not well targeted and would not materially reduce the risk of insurance and solvency from a major catastrophic event. So it is something we are certainly willing to work with you on, but we have some very serious problems.

    Mr. LAZIO. I thank you, and I thank the committee.

    Chairman LEACH. Thank you very much. I am glad that the colloquy was brought in.

    Mr. EIZENSTAT. I have a noon White House meeting, which I could try to have somebody else go to, Mr. Chairman.

    Chairman LEACH. We will work with you during this break.

    The hearing is in recess pending the memorial service.


    Mr. MCCOLLUM. [Presiding.] The hearing will come the order. When we went to recess a few minutes ago for the memorial services for the late Congressman Brown, we were in the midst of the opportunity for Members to ask questions of Deputy Secretary Eizenstat.
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    At this time, I will recognize the gentleman to my left, Mr. Bereuter of Nebraska, for five minutes.

    Mr. BEREUTER. Thank you, Mr. McCollum.

    Secretary Eizenstat, welcome. It is nice to see you in one more capacity serving our country, and I know you will do as superbly as you have done in all of your previous work.

    Mr. EIZENSTAT. Thank you.

    Mr. BEREUTER. I was certainly intrigued, as other Members have expressed themselves, concerning the idea of capping the amount of insurance to be sold rather than the amount of payments to be made, and we want to follow up on that.

    I also was intrigued by the information that Mr. Royce was citing, and by some of Mr. Hill's comments.

    I would just advise any Members and staff, hopefully that are here, that Mr. Blumenauer and I are well on our way to trying one more effort to reform the national flood insurance program, which Mr. Vento mentioned an hour or so ago.

    Mr. Kennedy and I have had two or three different efforts in the past—Representative Joseph Kennedy—and Mr. Blumenauer and I are working with Mr. Witt on that issue. So I want to inform and advise Members we may actually be able to introduce it next week.
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    Mr. Secretary, Section 7 of H.R. 21 relates to the auctions of contracts for reinsurance coverage, and the regional auctions whereby this legislation would divide the States into not less than six regions, but specifying separate regions for some or all parts of both California and Florida.

    Now, most of the area of this country is basically exempt from catastrophic occurrences—no volcanoes, little likelihood of earthquake, no hurricanes. This is a bit of a parochial question, but I am interested in how those regions would be formed, because the great majority of the country has no dangers from those types of cataclysmic events.

    For example, almost all the States in the interior of the United States would have no possibility for activities in those areas.

    Now, perhaps the most violent earthquake event in recorded history, took place in New Madrid, Missouri, but I am frankly not interested in having my State or the other States of the region lumped in with that part of Illinois and Missouri that are affected by the earthquake, because it would, I assume, have quite an impact upon premiums paid and on the kind of coverage that might be available and the costs thereof.

    What can you advise, if anything, about how we can assure that an isolated situation like New Madrid is not going to result in all of those States sharing in the difficulties, potential difficulties, at a recurrence of New Madrid, where there are certainly indications that there will eventually be another very large quake or series of quakes, of paying the costs associated with that very isolated part of the interior of the United States?
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    Mr. EIZENSTAT. First, if I may just mention your work on flood insurance reform, which we certainly appreciate and would encourage you to continue to work with Mr. Witt, this legislation should not affect that work.

    With respect to different regions, you are certainly quite right that different regions would be affected in very different ways in any auction system or in any regional system, because some are much more vulnerable than others to these kinds of catastrophic events.

    We would like to try to work with you and with the committee to see to it that States that do not suffer catastrophic events, or are most unlikely to do so, are not particularly disadvantaged in the way the regions are set up. This is, at the same time, also a State-by-State program. There is no requirement at all, it is not a mandatory program, that States have to pick up reinsurance; and presumably a State like Nebraska, that felt like it was less at risk, both its private insurers and its State program might decide that they don't wish to have this kind of protection.

    Mr. BEREUTER. I think that is quite likely, and I would just be concerned that, in fact, the whole interior of the country really does not have a significant problem in this respect. But how those regions are drawn is something I am not sure I am willing to leave up to the Executive Branch.

    Mr. EIZENSTAT. Well, that is why I said we will work with the Congress to try to develop that; and we certainly would welcome working with you to draw those in a fair way.
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    Mr. BEREUTER. Thank you very much.

    Thank you, Mr. Chairman.

    Mr. MCCOLLUM. Thank you, Mr. Bereuter.

    Mr. Lazio, do you wish to be recognized now? You would be next. Or if you wish to pass——

    Mr. LAZIO. I will pass.

    Mr. MCCOLLUM. I guess Mr. Weldon, you are next in order. Mr. Weldon, for five minutes.

    Mr. WELDON. Thank you, Mr. McCollum.

    I appreciate the work you are doing on this issue. As you know, it is a very important issue, not just to the State of Florida, but to many other areas of the country.

    I want to thank Mr. Eizenstat for coming and testifying. I apologize for missing your testimony. I assure you that I will be reviewing it.

    I would like to ask a question. I just got here. This may be a redundant question, but one of the concerns that has been raised to me, as I talk about this bill with other Members of the House, is the concern about the legislation encouraging more construction in areas that are at high risk. I want to get your opinion on that. Again, I apologize if somebody has already brought that issue up.
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    Mr. EIZENSTAT. No, it is a very good question, and I think that the best response is the following:

    First, that one of the reasons we think it is important that there be, in a sense, a marriage between this legislation and the work that FEMA is doing is for precisely this reason. Under Mr. Witt's really sterling leadership, we are working with—I say, we—FEMA is working with local communities to deal with this very issue, in advance of a catastrophe of overbuilding in high-risk areas. That is one of the key preemptive actions, so that FEMA is not simply responding in a post-crisis situation, but is also dealing in a pre-crisis situation.

    Second, we do not believe, given the nature of this bill which deals only with highly catastrophic situations, talking about things that are a 1-in-100 to 1-in-500-year cycle, are likely to discourage sound land use planning in high-risk areas. Those would be going on in any event. We are encouraging them; we think mitigation is terribly important, and the simple fact that you had this kind of reinsurance program, we don't think is going to lead people to start building in improper areas because they think that in some 1-in-100-year chance that Federal insurance may pick this up.

    There are sufficient incentives not to overbuild in those areas, we think, and that would be also reflected in pricing of traditional insurance.

    So I don't think that this aggravates an already difficult problem. We agree it is a difficult problem and FEMA is trying to deal with that.

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    Mr. WELDON. In a related vein, one of the reasons why I support this legislation is, every six months or so we are passing some sort of a disaster relief bill to bail out some section of the country, and if we were to get one of those 1-in-100-year or 1-in-500-year events it could even seriously strain the deep pockets of the Government of the United States to bail out, say, a major city that were severely devastated.

    Do you see this legislation as helping us prepare for that type of eventuality better? And if so, does that offset some of the concerns raised by, say, CBO scoring this thing the way they did? Then, as a corollary to that, the question I had was, what is the Administration's position on the scoring issue? Does that affect their willingness to move ahead on this issue?

    Mr. EIZENSTAT. Let me give a couple of responses.

    First of all, one has to consider the costs of the alternative of doing nothing, and there are very real costs. The costs of spikes in insurance rates, of less homeowners' insurance and of the potential cost of the Federal Government having to deal with the costs of stabilizing a collapsing insurance market in the event that there is a cataclysmic event, those are all very real costs and some of those can be mitigated by this.

    Second, with respect to the CBO conclusion, the CBO itself observed that the budgetary impact is highly uncertain, and we are committed to a process that will yield as informed an estimate of expected losses as possible. We believe that we can develop a pricing formula that is fully protective of the taxpayer and that is free from political pressure.

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    Our goal and our support of any legislation would be contingent on a no-net-cost analysis.

    Now, with respect to the issue of scoring, this is ultimately an issue for CBO and OMB to work out, but in terms of cost, we believe that there will be no net cost and that the pricing of these policies will take that into account and achieve that result.

    Mr. WELDON. Thank you very much.

    Mr. MCCOLLUM. Thank you, Mr. Weldon.

    Mr. Kanjorski, you are recognized for five minutes.

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

    I am getting a little bit schizophrenic here, Mr. Secretary. The proponents of this legislation, to a large degree, are the very people that are constantly telling me to get Government out of and off the back of average people, and that Government can't do anything right and Government shouldn't be involved with the private sector, can't operate; and we seem to be listening to some of your testimony, and some of their questions indicate that apparently there is a great need in the United States for Government to do other things that other people aren't doing or can't do; and that the private sector seems to be not omnipotent. And I am pleased to learn that because I tend to agree that there are roles for Government to function.

    But I am not sure this is one of the roles, the way this is structured. The thing that bothers me about this is that if there is such a need for the private sector to have a secondary market, and it runs to the benefit of some of the people of this Nation that do suffer or are located in catastrophic occurrence areas, I was just reading in a piece this other day that indicated that 42—no, I am sorry—38 States of the Union have surpluses now running to the amount of about $33 billion.
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    Since their budgets are all in balance and they have these tremendous surpluses, and I think one of those sheets states that one of those surpluses is the State of California, I think one is the State of Florida and I think one is the State of Texas. Now, that could be because they have such gigantic economies that they are running those surpluses and they have been so successful.

    Why aren't we looking at these three States that tend to suffer these catastrophic events more than other States in the Union as being much larger players and perhaps turn over to them and say, ''Look, go create a secondary market for your area. You have got the funds. You are in surplus.''

    Why should the taxpayers of the rest of the country be involved?

    Second, the thing that I really find disturbing about our private market supporters in the Congress is, they seem to lose their support when there is an immediate impact on their constituents and they want the Federal Government to rush in an to be the savior. But what about the theory that as we create an artificially subsidized secondary market we are impacting the long-term natural private market forces of where people relocate to, what type of structures they build and where population shift will occur over the United States?

    It seems to me that if California is earthquake-prone, 32 or 34 million people presently exposed are an awful lot, and we shouldn't probably encourage another 10 or 20 million people to move out there to be exposed, but we are going to certainly encourage them to move out there to be exposed if we are going to underwrite their risk and underwrite the State risk and we are going to subsidize the relocation of people from the heartland of America, or from more safe areas of America, to go to more risky areas. I think we have certainly seen that in Florida.
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    Some of the studies have indicated to me that if we start this type of a program, even though it is now for residences, that wouldn't solve the problem in Florida and in Hawaii in terms of commercial insurance. They are going to be back in the door the next day saying, ''We need commercial secondary markets so that we can sell our hotels, apartment buildings, and we can finance our commercial operations,'' and they are going to want a secondary market to accomplish that, too. And that totally destroys this whole concept in America that public policy and social policy should work closer in a free market system, that money is not going to flow into areas where it is more at risk and more expensive to make that investment, and that you will have a natural barometer or protector of unusual growth if the Government stays out of it.

    We are rushing right in and encouraging another 10 million people to move to Florida, and then we are coming along and we are putting $2 billion or $3 billion in to give them clean water so there will be enough water for those people down there to drink. We have to take care of the Everglades. I am not against it, but it is clearly—obviously these expenditures are occurring to match the unusual development desires of States like that, States like California.

    Now, I think this is not well thought out at this time. I think it is premature. I don't think it covers nearly enough. It is awfully nice that Florida is going to get covered for a hurricane that occurs with secondary insurance, but as that hurricane reduces to water and just travels up the East Coast and floods the East Coast cities of the United States, those people are going to get no benefits from this type of an insurance policy because they are going to be affected by the aftermath of a hurricane, which is flooding.
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    On the other hand, the people that are in the tornado zone, they are not going to get any help because the tornado isn't quite as large as a hurricane or an earthquake.

    It just seems to me, if our friends, the private sector supporters on the other side, really think that the private sector has failed—and I don't think they have. I agree with some of the studies that indicate there is more money in our system right now to develop a very strong secondary insurance market in this country. And it would work well, not only for residences, but for commercial development and everything else; but it would be guided off the private sector, that the prices and the ranges would occur at the risk, and it wouldn't falsely impact on social relocation in this country.

    When the Government gets involved, we are going to impact falsely on social relocation in the country. We are going to be competitive with the private market and probably reduce its maturity, the speed with which it matures. But finally, we are going to put the taxpayers at risk again and certainly make people that are determined to live in distressed areas of the country, economically distressed areas, help bail out and pay for our friends that are going to bathe in the sun on islands that they should not have homes on or in locations that shouldn't have been developed originally, and where there should be a risk, but we are going to support.

    I have some friends that are just going to North and South Carolina on the Banks and they are going to enjoy living in those million dollar homes that are out there that get wiped out every seven years that we pay for and subsidize so that that distressed residential portion of our population can live on sandbars that were never intended to be habitats for the human animal.
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    I am just wondering, is the Administration prepared to give a critique that really goes to the depths of this issue; or is the Administration going to allow our privateers on the other side to be hypocritical and inconsistent in their positions and call for Government help when they want it, and they will support their interests and their constituents in the short term? That is totally contrary to the free market system.

    Mr. WELDON. Would the gentleman yield?

    Mr. MCCOLLUM. The gentleman's time has expired, but Secretary Eizenstat may respond if he wishes.

    Mr. EIZENSTAT. I would hope there would be an alternative between those two extremes.

    I appreciate the concerns you have raised. They are all legitimate concerns, and let me try to deal with them. You raised a number of issues.

    First of all, in general, in a commercial area, the Federal Government ought to be involved only when the private market fails to satisfy a need; and here we believe that there is a gap and that gap is occasioned by the inherent difficulty of private insurers and reinsurers to be able to handle the characteristics of enormous natural disasters, not your day-in/day-out hurricane or problem that occurs, but truly catastrophic situations. It is in those instances where we think the Federal is useful.

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    Second, that role ought to be interim, it ought to be limited, and as I mentioned, I think, before you came in, Mr. Kanjorski, that by having the flexibility of adjusting the trigger or deductible—and we would also ask that we have a similar flexibility on the cap—you can on a year-to-year basis adapt the program so that if the private sector begins to fill that gap, which we believe it will—there is now a reinsurance industry and it is growing—then the Federal role would diminish over time.

    Second, you mentioned the issue of States, and you mentioned both surpluses and why should taxpayers elsewhere deal with three States. Well, we are, after all, the United States of America and what affects some States in a catastrophic way needs to affect us all.

    Mr. KANJORSKI. Under devolution, you still think we are the United States of America?

    Mr. EIZENSTAT. Yes, sir.

    I also would urge that what happens in catastrophic events in a couple of States—and you are quite right in saying that that is where the majority of problems are, does have an impact nationwide. It has an impact in terms of cost of insurance. It has an impact in terms of diminishing the amount of reinsurance that is available for less catastrophic events around the country, because you will have drawn down the pool of private insurance to such a degree.

    So this is not an isolated event for a couple of States. It will have a pervasive effect across the country.
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    In addition, although there are healthy surpluses in many States, due to both good fiscal management and, we think, to the remarkable economy that we have had over the last seven years of this Administration, those surpluses, particularly when taken on a State-by-State basis, would be dwarfed by the impact of catastrophic events. That is one of the reasons that FEMA has to come in, why there is pressure for Federal emergency assistance. But it would be dwarfed, and we think that——

    Mr. KANJORSKI. $33 billion is more than what your cap is on this.

    Mr. EIZENSTAT. Well, you have accumulated the surpluses in 38 States. I mean, the disaster would occur not in 38, but in one or two. So if you look at the surplus in any one particular State, it would be minuscule compared to the enormity of the costs of the catastrophes.

    Then last, on the issue of subsidizing movement, I would answer in a couple of ways. First, we believe that the robustness of the pricing process in the legislation—and that we would hope to have delegated as well—will create an absence of incentives to locate or relocate to high-risk areas. It is a legitimate concern, but pricing in all insurance markets should be set according to market principles and that certainly applies here.

    Second, in terms of homeowners, which is what this covers, I have to say that it passes me that a person is going to decide, or a family is going to decide, to move to Florida or to California or another high-risk area, North Carolina, simply because or even significantly because there may be a Federal reinsurance program, which I daresay most will have no idea about.
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    So I don't see it as a way of subsidizing movement to high-risk States but, again, the pricing process here is a very robust one and that can take care of a lot of the concern you legitimately have about building in high-risk areas.

    Mr. MCCOLLUM. Thank you very much.

    Your time has expired, Mr. Kanjorski.

    Mr. Hill, you are recognized for five minutes.

    Mr. HILL. Thank you, Mr. Chairman.

    And, Mr. Kanjorski, it is interesting, hearing you argue against Government intervention and hearing my Republican colleagues argue for Government intervention. I am going to advocate for my principle, which is, the markets ought to be allowed to work.

    First, let me compliment you, Mr. Secretary, on the ideas that you brought to the table here with regard to the trigger mechanism and setting the limit of insurance, changing the concept from putting limits on how many payments would be made to the amount of insurance that is sold, eliminating the concept that we would somehow prorate the payment of claims, which would be an absolutely unworkable proposition in the event there were multiple events. I think those are all good ideas, and I want to compliment you. I am not sure I am ready to embrace all elements of that, but I think that they are constructive.

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    I also believe we should eliminate State-by-State auctioning and go back to regional auctions and allow those States funds to compete with private markets if we are going to auction reinsurance.

    The problem that I am having with all of this is that the marketplace for insurance is this: There are primary insurance companies; they are the closest to the consumer. Then we have the reinsurance marketplace. And now we are proposing a third tier, which is a Government insurance mechanism.

    If we want to have more insurance available to consumers at lower prices, then we should strengthen the primary market's ability to deliver insurance to its customers. This is kind of trickle-down economics, if I might use a term that Mr. Kanjorski would probably more often use, and that is, if we make the reinsurance mechanism work better, somehow consumers are going to buy insurance cheaper. Maybe they will; maybe they won't. But if we make the primary insurance market mechanism work better, you know that you are going to have lower cost of insurance to consumers because that is how the marketplace is working today; which is why I have proposed an idea of allowing primary insurance companies to prefund their loss reserves, which will strengthen them economically and eliminate the instability associated with the impact of catastrophes on their books of business, on their balance sheets and on their income statements.

    I would just urge you again to look at that and to study the idea as we move forward.

    One of the concerns I have about this whole mechanism is that in the areas where we have catastrophic exposures, we have overexposed insurance companies. That is why we were in here arguing for reinsurance. We have companies that have too high concentrations of risk, and we have an absence of competition in the market because other people don't want to enter in.
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    If we sell reinsurance to those companies, what we are doing is simply giving them the ability to write more insurance in a market where they are already overexposed, making them even more dependent on this Government solution.

    Would you agree with that? Do you agree with that concern? Do you see that as being a potential perverse outcome of this whole thing?

    Mr. EIZENSTAT. Well, I understand the concern you are expressing, and we certainly feel that it is important to have a strong primary insurance system. I am not sure that I would necessarily share the concern that you express, because I think that the pricing mechanism that will be used will act as a disincentive to overextending one's self in terms of reinsurance; and in some respects the argument you are making would apply, as well, to the private reinsurance market. I mean, it is an argument against any reinsurance. And given the layers of liability that exist with respect to catastrophic—and again, please remember, as you know—I mean, you have been a leader in this and I know from my conversations that you are highly expert—that this is not the day-to-day reinsurance situation. We are dealing with highly unlikely events of a truly catastrophic nature.

    So I think the concerns you expressed will both be taken care of by the pricing mechanism and by the fact that this is a highly unusual situation, only dealing with circumstances that occur in probable circumstances.

    Mr. HILL. Mr. Secretary, let me just draw your attention to one example and there is one particular insurance company that is a strong advocate of this program who, before the creation of the Florida fund and the California fund, had nearly its entire surplus at risk under a probable maximum loss situation. And so they were very active in the creation of the California and the Florida pools, and as a consequence of that, shifted risk dramatically to those two. They laid off their exposure to those two cat funds.
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    As a consequence of that, were there lower premiums? No.

    Was there increased capacity in those markets? No.

    Was there any reduction in the exposure to FEMA in those markets as a consequence of that? The answer is no. But the shareholders more than doubled the value of their stock as a direct consequence of those two interactions by Government agencies.

    Is that what we are after? Is it after rewarding the shareholders, or is it after creating a more stable insurance market, lower costs and more available insurance for consumers?

    Mr. EIZENSTAT. It is certainly the latter. We want to improve the availability of homeowners' insurance. We want to encourage a reduction in insurance costs and we want to make sure that following a disaster, you don't have a tremendous contraction in the market for insurance. That, we have found by experience in Hurricane Hugo and others, does occur.

    So it is certainly the latter and not the former.

    Mr. MCCOLLUM. Thank you.

    Thank you, Mr. Hill.

    Mr. Lazio, you are recognized for five minutes.
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    Mr. LAZIO. Thank you very much, Mr. Chairman.

    Again, I want to thank you, Mr. Secretary. I know you have had some excellent questions here and you have handled them extraordinarily well, particularly because I didn't expect that you had the depth of knowledge that you have on the issue, and so I am very impressed.

    We have, as I said before, had numerous committee hearings on this subject, reported this almost identical bill out last year by a vote of 33-to-12. It was a bipartisan bill. Many of the issues that are being raised now have been raised in the past.

    I just want to briefly recount why it is so important for us to act. It is not about the profitability of the reinsurance industry. It is not about the profitability of the primary insurance industry. It is about families who have settled close to or near areas that are vulnerable to natural disaster; and as I said in my opening remarks, in a couple of short years, 75 percent of our population will be within 100 miles or less of a coastline.

    For somebody who loses their home in a natural disaster, who does not have the ability to insure or does not have the ability to sell their homes to somebody who can get insurance, for a lender who cannot secure their money, that would indicate a potential and likely, as a matter of fact, collapse of the real estate market, a plummeting of values, unbelievable unintended consequences as you have this devastation of value, reaching all the way to a tax base that is affected—particularly in my area, a property-tax-based area that is based on value—that you can have school districts, municipalities, terrible ripple effect through an entire community that would require, in my opinion, in the case of a very large natural disaster, extraordinary Federal intervention that affects every single taxpayer from every single State.
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    So I want to get away from this whole idea that it is only a few States that are affected by this. It is a national issue. It is a national issue because it affects the solvency of insurance companies at a rate throughout the entire Nation. It is a national issue because every taxpayer throughout every State in the country will have to absorb the costs of coming in and supporting a community that has been hit with a storm of the magnitude that we are talking about.

    So I wanted to just to mention that and maybe get your comment on that, and also on a couple of other things. I have noticed in your comments, and I appreciate them, that you have mentioned that we are in no way in this bill trying to prohibit the growth of the capital markets in terms of providing reinsurance capacity.

    As a matter of fact, I believe because of the ability for it to grow within the constraints of this bill, that we may be encouraging and do encourage the capital market reinsurance industry, and I am wondering if you can speak to that.

    Let me stop there and then I will go on to some other questions.

    Mr. EIZENSTAT. Thank you very much for your statement, and I ascribe to a great deal of it.

    I believe it is a national problem. As I mentioned in my response to Mr. Kanjorski's question, the impact of catastrophes is not limited to just those States in which it occurs.
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    It has an impact to the insurance market, on the solvency of insurance, on the availability of insurance, on the availability of reinsurance all over the country. We end up picking that cost up. If we are dealing with the solvency of insurance companies, that certainly would be a national issue and that will be a problem if we continue to have the kinds of catastrophes that we have had and we don't have some kind of a program in place.

    Second, with respect to the issue of capital markets, we obviously feel very, very strongly about encouraging the growth of capital markets and one of the things that we see as most positive is the growth of securitization that is occurring in this market, which indicates that there is the beginning of the development of a very healthy capital market.

    Nothing that we have proposed would in any way deter that. Quite the contrary. Indeed, in the cap that we talked about, our concept of the cap where you basically are having the Federal Government pick up 50 percent of the difference between the 1-in-100 and 1-in-500 year event, you are specifically leaving that other half for the private sector as well as the deductible.

    One of the positive aspects of this legislation is that by allowing the trigger to be adjusted on an annual basis, as the private market grows, so too can that deductible, and we can find private market taking over.

    We also have had conversations with market participants that suggest that the standardization of contracts would actually be helpful in encouraging market development. And developing the kind of infrastructure data that will be needed to make this program work, the kind of modeling will also be helpful to the private sector because the private sector also is improved to the extent that it has good data and good information available. And developing the modeling for pricing and so forth that will be necessary, that also will facilitate the growth of the private market.
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    Mr. MCCOLLUM. Secretary Eizenstat has indicated that he has to leave at 1:00. The only questioner remaining here is Mr. Royce, if he wishes to ask any questions.

    Mr. ROYCE. No questions.

    Mr. MCCOLLUM. Thank you for being here today and laying out the Administration position, and we look forward to working with you. Thank you again.

    At this time as Mr. Eizenstat departs, I would like to introduce panel two and ask them to take their seats. On this panel is Roger Joslin, State Farm Fire and Casualty Company; Ronald Hanna, Mississippi Insurance Department; Frank Nutter, Reinsurance Association of America; Don Beery, Eustis Insurance, Inc.; Mary Fran Myers, Natural Hazards Research and Applications Information Center, University of Colorado; Travis Plunkett, Consumer Federation of America; and Jack Weber, Home Insurance Federation of America.

    I want to welcome all of you to this panel today. We will begin with Mr. Joslin. We will submit your entire testimony to the record and you may summarize. Mr. Joslin, you are recognized.


    Mr. JOSLIN. Thank you. I am Chairman of the Board of State Farm Fire and Casualty Company, the largest writer of homeowners' insurance in the United States. More significantly, the State Farm Group is the largest writer of homeowners' insurance in catastrophe-prone areas.
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    We appreciate and applaud the bipartisan consideration and support of H.R. 21, from the Chairman, the Ranking Member, Representatives Lazio, McCollum, Bentsen and others. H.R. 21 embodies sound principles. First, the resources of the Federal Government should come into play only very rarely, yet the trigger should not be so high that the marketplace perceives the program as an illusion.

    Second, the price should properly reflect expected losses. Catastrophe-prone areas should not be subsidized. The Federal Government's contribution is the proper one because of its superior capacity to absorb the timing risk of mega-catastrophes. In analyzing the Federal Government's participation in this issue, we should not be confused by arcane insurance terminology. If the average expected annual loss is 1 percent of the nominal coverage, an 8 percent rate on-line is 8 times the annual average loss cost. I have trouble with my own staff getting them to convert rate on-line to a percentage of premium paid or to a multiple of the expected annual loss.

    Third, the backstop mechanism should have certainty and continuity so as not to evaporate during or following a major event. The possibility of proration of claims during an event is very unsettling. Eliminating that uncertainty enhances the desirability of the coverage. As we know, the percentage of the U.S. population moving into disaster-prone areas is large and growing. Climatologists forecast an increase in hurricane frequency and intensity. Hurricanes threaten major population areas. Events of this magnitude far exceed the claims-paying capacity of most private insurers serving these markets and all existing State funds.

    After Hurricanes Iniki and Andrew in 1992 and the Northridge Earthquake in 1994, homeowners' insurance markets and, as a consequence, real estate markets in Hawaii and major parts of Florida and California became dysfunctional. State-sponsored mechanisms to assume and pool the most severe of these risks helped reopen markets, but they are barely able to respond to events the size of Andrew and Northridge, let alone the very possible much larger catastrophes. They would for many years have almost no ability to cope with a second event.
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    Theoretically there is more than enough capacity, meaning capital, in the private markets to insure or reinsure the worst of natural disasters. This theory fails in practice. Primary insurers in the aggregate have substantial capital, but relatively little of it is devoted to homeowners' insurance in mega-catastrophe-prone areas. Many companies either do not write homeowners' insurance at all or avoid catastrophe-prone areas. A few years of profitability without a Northridge or an Andrew magnitude event certainly does not diminish the need for a Federal backstop for a 1-in-100-year event. Except for one event, Hurricane Andrew, Florida's property insurance had been very profitable. That one event, however, consumed more capital than State Farm Fire and Casualty had accumulated countrywide in more than 60 years. Private reinsurance is not the answer. Reinsurers have a relatively small capital base and they must reasonably balance their portfolio, reinsure commercial insurance, provide for quota share programs, and so forth. Excess-of-loss coverage is certainly not the sole product that is available from reinsurers.

    The capital markets have not solved the problem. Few financial resources have actually reached the catastrophe insurance market. Price and transaction costs have been high. And whether these securities would be available after a major event hasn't been tested. Actually, we call this a career ending decision. Who bought these dumb bonds in the first place?

    Some people erroneously describe insuring for catastrophic loss as accumulating over a period of years the amount of money necessary to pay the loss. Unfortunately, a 100-year or a 10,000-year event can occur in the first year. No private enterprise can earn a competitive rate of return in the business of insurance sitting on this quantity of stagnant capital. Moreover, the United States tax policy further aggravates the problem. In most years insurance of high magnitude, low incidence events generates tax liabilities on profits that do not exist. A tax-based solution seems politically unlikely. If anything, tax policy has become less favorable in recent years. In 1997, the loss carry-back provision was reduced from three to two years and the Administration actually proposed reduction of the carry-back to a single year.
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    We believe H.R. 21 is a step in the right direction. It provides consumer friendly pricing for reinsurance for State funds set up to insure or reinsure catastrophic risk. The provision establishing an auction of excess-of-loss contracts is a helpful innovation. H.R. 21 could be strengthened and we are pleased that the Treasury Department suggested ways to strengthen H.R. 21 to make the payment of losses more certain under the program and to better provide for the possibility of a second event.

    In conclusion, a 100-, 500-, 1,000-, 10,000-year event by definition occurs very rarely, yet it could occur tomorrow. Now is the time for Congress to act when the country is free from the trauma of a major catastrophic event.

    Thank you, Mr. Chairman. We are delighted to work with you in any way possible.

    Mr. MCCOLLUM. Thank you.

    Mr. Hanna, you are recognized for your statement.


    Mr. HANNA. Thank you, Mr. Chairman.

    I am the Deputy Insurance Commissioner for the State of Mississippi, and we appreciate the opportunity to come up and make our comments on H.R. 21.
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    As you know, Mississippi borders the Gulf of Mexico and has a long history with hurricanes, including Hurricane Camille, which killed 144 residents and caused $1.3 billion in property damage in 1969. A list of the ten hurricanes damaging our State and dating back to 1893 is attached to my written comments for your information.

    Along our three coastal counties, property owners have a limited selection of companies from which to purchase coverage for their homes. Six property insurance companies write 90 percent of the voluntary homeowners' policies on the Gulf Coast. Three companies write over 50 percent of the business in that area, that being State Farm, Allstate and Mississippi Farm Bureau. Their presence is vital to maintaining market stability. The State of Alabama has reported to our office that only five property companies are estimated to write 90 percent of the homes in that area.

    The Gulf Coast is a very volatile insurance market. Many companies are continually changing their underwriting strategies. This cycle creates a disruptive market and reflects the underlying issues of property companies unable to commit to a consistent pattern of controlled growth. The Mississippi Windstorm Underwriting Association, a market of last resort for residents unable to obtain traditional insurance coverage, has more than doubled in size since 1993. This is as a result of tremendous growth in the area and the limitations on access to commercial insurers.

    One of the most important factors in determining the availability and affordability of homeowners' insurance is the ability of the primary carrier to obtain reinsurance. Because State regulators do not approve reinsurance rates and most reinsurers are located outside the United States, I cannot provide you with firsthand reports about reinsurance markets or reinsurance capacity.
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    From the insurance executives I speak with, they report that the current market for reinsurance is ''soft.'' Mississippi Farm Bureau Mutual Insurance Company is the largest property insurance company domiciled in our State, and those officials report they can buy more reinsurance than they did several years ago at a lower overall cost. They have determined that this is due to the decrease in the number and severity of catastrophes around the world in the last several years.

    However, this has not always been the case. Several years ago when a series of natural disasters occurred both here and abroad, there was great concern about shrinking reinsurance markets and the escalating prices primary insurance companies had to pay for reinsurance coverage. There is no question that a series of future catastrophes could once again affect the availability and affordability of reinsurance.

    The Mississippi Insurance Department supports the efforts of Congress to enact a Federal reinsurance program. This plan should reduce the erratic pricing and availability of reinsurance which will likely result in a more stable primary homeowners' insurance market. As regulators, a stable market should be one of our most important priorities. Where there may be some technical issues with H.R. 21 that need to be resolved, the basis for the legislation is sound and we encourage the committee to move forward with enactment.

    We cannot afford to have another series of insurance insolvencies similar to those which occurred in Florida after Hurricane Andrew, which were mentioned this morning. The Florida Insurance Department reported to you in recent testimony that they placed eleven insurers in rehabilitation or liquidation as a result of the storm.
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    It is hard to imagine the number of insolvencies we will experience if there is a 1-in-100-year storm which hits a more densely populated area of the United States. Certainly such an event would do great damage to the market throughout the country. H.R. 21 can help to address this critical issue.

    Hurricanes, in most cases, are multi-State events. This means that it is likely that insurance markets in several States can be affected by a single storm. Even when the damage is confined to a single State, the effect of the insurance market can be regional as was the case with Andrew. It makes sense that there is a Federal program to deal with the problem comprehensively rather than leaving each State to handle the crisis alone.

    As the committee deliberates on H.R. 21, I would like to ask you to consider a particular issue concerning the sale of reinsurance contracts sold through the Federal auction. Under the current language contracts are sold on a regional basis. Companies which only write in Mississippi, for example, would be required to purchase contracts covering losses that might occur in neighboring Alabama or Louisiana even though they write no business in these areas. A fairer option would be to allow these companies to purchase coverage priced solely on the basis of their single State exposure. This approach would be fairer to all parties, but particularly to smaller domestic insurers which might otherwise not have sufficient incentive to participate in the program. It is also important that the trigger in the bill be kept at a reasonable level for the same purpose.

    In closing, I would like to commend the committee for addressing this matter, which is a real concern to the residents of the Mississippi Gulf Coast. We look forward to working with the committee in providing whatever technical assistance you may require for the success of this program. Thank you.
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    Mr. MCCOLLUM. Thank you very much, Mr. Hanna.

    Mr. Nutter, you are recognized.


    Mr. NUTTER. Mr. McCollum, thank you very much. We appreciate the leadership that you and Mr. Lazio have shown on this legislation. While it may seem counterintuitive to some on behalf of the reinsurance industry, we are here to endorse H.R. 21 as the foundation for a Federal role in financing catastrophe risk. We believe that the Federal Government must be involved as a necessary component of any solution to this problem. We have expressed to you privately, and again this year publicly, the need for reexamining the capacity in the insurance and reinsurance industry and setting the triggers associated with this legislation so that you neither infringe upon the private market nor expose the Federal Government to unreasonable risk.

    For those of us that are supportive of this legislation, the capacity is probably the most critical issue and I have supplied with my testimony information about the current state of the reinsurance market so that you have that information. That includes a report from U.S. Re which has been cited several times over the years as a source of information about the capacity. And they report that as of this time, July 1999, that there are $13 to $15 billion of excess-of-loss reinsurance being written in regions throughout the country, that you could add an additional 40 percent to that for other forms of reinsurance providing catastrophe protection per region, and in their view you could add another $1 billion of capital market capacity being written.
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    Two States, Louisiana and New York, have examined this question and both have concluded that there is an overcapacity in the reinsurance market. Some have raised a question of whether or not this legislation is just about the cost of reinsurance. We have also supplied the committee as part of the testimony the trends in reinsurance pricing which show that for the ninth consecutive semiannual period, catastrophe reinsurance pricing has dropped. Probably the best example of that is the California Earthquake Authority, which has gone to the market for both this year and next and found a 40 percent drop in reinsurance catastrophe pricing since the first year, 1997.

    In our view the marketplace has worked in its classic way. Yes, there were disruptions in the Florida market after Hurricane Andrew, but what that did was attract new capacity to that market. That additional capacity caused prices to decline over time as companies competed for this business and new products in the capital market arose.

    We have also pointed out that the primary market is very well positioned to deal with catastrophe exposure to a certain degree. Historically the primary market has borne between two-thirds and three-fourths of the catastrophe losses with the rest being passed on to the reinsurance market. We cite in the testimony the Wharton study which has been referred to by committee Members as a recent release looking at their approach or their analysis of the insurance industry's ability to pay for the big one. The essence of their conclusion is that the insurance industry has more than adequate capacity to pay at least 98.6 percent of a $20 billion loss and for a $100 billion loss, 92.8 percent. They do talk about gaps in catastrophe risk, but what they also say is that there are opportunities here for the capital markets to fill those gaps.

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    We believe that the capital markets indeed are potentially going to revolutionize the securitization of catastrophe risk and should be considered by the committee.

    I would also like to commend the States for what they have done in working with consumers and with the insurance industry in dealing with this problem. Many States have been aggressive about looking at options in coverage and options in deductibles and bringing prices in line with exposure which have revitalized catastrophe markets, and again the New York and Louisiana reports are probably excellent examples of that. Notwithstanding what I think is a very positive picture, there are fundamental problems dealing with the threat of a mega-catastrophe facing our country, one that exceeds the resources of the insurance and reinsurance industry and one that requires Federal involvement, and we encourage the committee to act on this legislation in that regard.

    I would like to make a point about something that will be brought up on this panel and that is this concern that by raising these triggers to something as high as a 1-in-250-year event, that that is an outrageous figure. The source of that suggestion actually is from A.M. Best, which is the premier rating organization for this industry. It rates companies that are commonly familiar with A-plus companies such as State Farm and Allstate. This is taken directly from A.M. Best guidance to companies about their reinsurance programs:

    ''We evaluate each company's reinsurance program to determine if it is appropriate and has good credit quality. To be considered adequate for catastrophe protection, a program needs to protect a company from impairment or insolvency, from large shop losses such as a 1-in-100-year windstorm or a 1-in-250-year earthquake.'' In addition, before this committee last year the California Earthquake Authority testified that, this is what Mr. Knowles said, ''I would say that the CEA is up and running and has dramatically reversed the problems of constricting the homeowner in earthquake markets in California and we can stand two 250-year probable maximum loss events.''
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    The point is that it is the credit community. It is the rating community that has encouraged consideration and in fact encouraged companies to provide protection against these very high level losses. The 1-in-250 or the 1-in-100 are just statistical probabilities. They do not reflect reality. As Mr. Joslin has said, these events could occur today, they could occur three times in the next ten years, and we have to be prepared for dealing with just exactly that.

    I would conclude, Mr. Chairman, with this comment. Low triggers encourage some insurers to push catastrophe risk into new State insurance programs, and that risk will be passed on to the Federal Government. Low triggers, like low deductibles in insurance policies, raise the cost to consumers in the States. Low triggers expose the Federal Government to higher cost of natural disasters. And low triggers create incentives for Government solutions and high triggers create incentives for private sector solutions. We too look forward to working with the committee to find the right approach.

    Mr. MCCOLLUM. Thank you very much, Mr. Nutter, for that testimony.

    Mr. Beery, you are recognized.


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    Mr. BEERY. Thank you, Mr. Chairman. I appreciate the opportunity to come to the committee and talk. My name is Don Beery. I am an insurance agent. I am a partner in Eustis Insurance in New Orleans, Louisiana. I also serve as the President of the Independent Insurance Agents of Louisiana. I have heard a lot of comments this morning and this afternoon about whether reinsurance is available, unavailable, cheap, expensive. All I can tell you is what the situation has become in Louisiana.

    A little historical perspective about what occurred, what the State has done to kind of try and fix the problem, how it affects our customers and our agencies and basically why we think H.R. 21 is an important bill.

    First of all, the first event that happened in Louisiana that had a great deal of effect on the insurance marketplace was Hurricane Betsy in 1965. Hurricane Betsy hit New Orleans with a Category 3 force, caused close to a billion dollars worth of damage and killed 74 people. As a result of that storm, insurance companies decided that nine coastal areas of Louisiana were not someplace where they wanted to put capital at risk, so they withdrew from those coastal areas.

    The map, as you can see over there, there is a blue line below which is the coastal area. As you can see in Louisiana, we don't have a lot of beach-front properties. We don't have a lot of white sand. What we have is swamp and we have very few people that live in that area. The States of Louisiana came up with a mandatory residual market, pool market called Louisiana Coastal Plan, to take care of homeowners' risk in that area, property risk. That plan successfully absorbed the exposures that were in that area and it became fully populated shortly after Hurricane Betsy and remains about the same level today.
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    The second triggering event was Hurricane Andrew. It hit your State a lot worse than it hit ours, but after it left Florida, it came to south central Louisiana, came up through the central part of the State and affected New Iberia, Lafayette, and even got to Baton Rouge.

    What happened after that was insurance companies decided to move that line a little bit further north. So we went from that Intracoastal Waterway line, the blue line, up to Interstate 10, and that line affects a lot more area in Louisiana and a lot more population.

    About the same time as the Coastal Plan was formed, Louisiana also formed another residual market pool called Fair Plan. That plan was initially set up to cover rural properties, class 10 properties, unprotected risk, and some urban properties that at that time were not being properly serviced.

    Well, what happened to the Fair Plan was all of a sudden they were asked to take on this additional risk of those unwanted homes that were left in the wake of Hurricane Andrew. My understanding was at that point the reason why companies pulled back was principally a reinsurance question. But what has happened is that pool, the Fair Plan, has grown by 800 percent since 1993. It still averages a thousand new policies a month. That is an awful lot of policies that are going out of the voluntary market.

    Again, I don't know whether reinsurance is available or not, but it seems to me if it was readily available and it was inexpensive, the regular markets, the voluntary markets would be in there. The frightening thing that comes down the road from this is that should another storm come in, those are pools. The insurance companies that write business voluntarily in the State are in there for the profits and for the losses. So if another storm comes in, there is going to be a tremendous assessment of those companies which could cause some insolvencies and other problems.
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    Another thing that I think that drives a part of this is this hurricane computer modeling. I question sometimes—in the past, these big catastrophic events have been the things that you dread and you wake up in the middle of the night and you worry about. I think these models bring it home like it is a real thing. And when insurance companies can see on their model what happens when a Category 5 storm comes up the mouth of the Mississippi River and how much they have at risk and how much they are going to lose, I think it makes it almost like a real event to them and causes some overreaction in terms of what they are willing to write and what they are willing to do in the areas.

    I think all of this brings to bear the need for this H.R. 21, for some form of Federal catastrophe reinsurance. I think that the current bill is good. It is fair. It allows for no discrimination among the different areas involved. I like some of the suggestions that were brought up by the Deputy Secretary of the Treasury this morning. I think that it has a lot of potential.

    I think that, in closing, I would like to reiterate the problems of Louisiana and other States are real, they are not made up. Over the last eighteen months you have heard from insurance agents from around this country as to what their personal war stories are. We have got a lot of them in our agency. We have some homeowners now that we are placing with Lloyd's of London, which to me in my 30 years in the business I never thought we would be insuring homeowners in Lloyd's of London.

    I think that the passing of H.R. 21 will restore some confidence in the insurance markets, force more business back to the private insurers and improve the quality of coverage for our customers. We urge you from Louisiana to do this and we have the support of not only the agents, our customers, but also the Insurance Department has recently sent a fax to the Louisiana delegation indicating that they are behind this bill also.
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    Mr. MCCOLLUM. Mr. Beery, I really thank you for bringing that up and I think you and Mr. Hanna have illustrated the problems in the coastal areas along the Mississippi and in Louisiana and that whole Gulf Coast area, and I appreciate your coming all of the way here to do that.

    Ms. Myers, you are recognized.


    Ms. MYERS. Thank you, Mr. McCollum. Thank you for the opportunity to speak with you today. My name is Mary Fran Myers. I am the Co-director of the Natural Hazards Research and Applications Information Center at the University of Colorado. We are a federally-funded organization, funded by a consortium of Federal agencies, including FEMA and the National Science Foundation, to serve as a national clearinghouse for research data on all natural disasters and programs to reduce damages from them.

    Our main mission for the past 24 years has been to bridge the gap between the hazards research community and the Nation's practitioners who deal with hazards on a daily basis.

    In May, we released the results of a federally-funded five-year, $750,000 study involving 132 of the Nation's hazards experts. It is called ''Disasters by Design,'' and the Federal funding came from the National Science Foundation, FEMA, the U.S. Geological Survey, the U.S. Environmental Protection Agency, and the U.S. Forest Service.
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    This team of experts took stock of all knowledge in the physical, natural and social sciences as well as the specialties of engineering regarding natural hazards to answer the question why, despite all of our knowledge about natural hazards, about the causes of, consequences from and remedies for disasters, our losses from extreme environmental events continue to rise at an ever-staggering rate. I am providing each of you with an executive summary of the book today, and I want to mention only a few highlights from the study itself. However, I ask that the entire executive summary be recorded as part of this official hearing.

    Losses from natural disasters are continuing to rise because our hazard reduction programs have been too narrowly focused on simple loss reduction. They fail to comprehend the complex and broad range of factors that contribute to disaster losses, specifically elements within the Earth's physical environment, among the Nation's ever-changing demographic composition and disposition, and within the growing density of our built environment. These factors interact with one another to affect not only disaster resiliency, but the other aspects of our sustainable society as well.

    The conclusion of our five-year study was that current loss reduction and mitigation programs are shortsighted and too reliant on technology. It is clear that these efforts, rather than reducing losses, are actually only postponing catastrophic losses to future generations, much as we postpone our national debt.

    Our study underscored that it is human beings and not nature who are the cause of disasters. Unless hazard loss reduction programs, be they proper land use planning, disaster relief programs, building codes or insurance programs, also take into consideration other basic aspects of sustainability such as economic vitality, environmental quality, and inter and intra-generational equity, they are doomed to fail.
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    Our study calls for a change in national culture regarding natural hazards in order to achieve a new way of dealing with extreme environmental events, and we call this changing culture sustainable hazard mitigation.

    In order to make that approach possible, several extraordinary actions are required, some of which are being initiated right now. The Deputy Secretary this morning referred to much of the work that FEMA is doing. For example, through its Project Impact Program, FEMA is providing leadership by facilitating consensus based networks in communities where citizens are determining which disaster losses are acceptable, which are not acceptable and how they are going to pay for those in the future.

    In other words, they are working on designing their future disasters. That is but one action—the building of consensus-based networks and communities—that our project is recommending. There are several others, but I want to mention two of them specifically.

    One is the need to measure progress and evaluate current mitigation programs. For example, as has been referred to this morning, the National Flood Insurance Program, arguably the Nation's largest mitigation program, has been in operation for 31 years in this country, yet its effectiveness has never been thoroughly appraised. We only know that floods continue to cause the most damage from any hazard in this Nation.

    Second, we are calling for a holistic Government framework to facilitate sustainable hazard mitigation. All policies and programs, especially at the Federal level, need to be integrated and consistent. To go ahead to establish a new national policy that affects hazard mitigation without considering its impacts on our complex society and the broad range of other mitigation strategies simply continues the Band-Aid approach to dealing with disaster problems that this country has traditionally pursued.
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    Our study determined, however, that disasters are not problems. Rather they are a symptom of broader and more basic problems. Losses from hazards result from shortsighted and narrow conceptions of the human relationship to the natural environment.

    Thank you for the opportunity to speak. I will be happy to answer any questions, but I also want to volunteer the resources of our center as you continue consideration of this bill.

    Mr. MCCOLLUM. Thank you very much, Ms. Myers. That is an impressive study and we thank you for your testimony.

    Mr. Plunkett, you are recognized.


    Mr. PLUNKETT. Good afternoon. My name is Travis Plunkett, and I am Legislative Director with the Consumer Federation of America. I will be offering comments today from Robert Hunter, who is our Director of Insurance. Unfortunately, he cannot be here today.

    Thank you for the opportunity to be here. We would like to start by saying that CFA sees the current reinsurance situation as an implication that no bill may be necessary at this time. The predicate for this bill may have actually been eliminated by normal market forces at work. In the July 12 National Underwriter, Mr. Peter Porrino, former Chief Operating Officer of Zurich Reinsurance and currently the National Director of Ernst & Young's insurance industry practice, said that capital markets and securitization have placed a permanent cap on the pricing of catastrophe reinsurance. He said that the reinsurance industry wouldn't again see the hard trends that followed 1992's Hurricane Andrew and 1994's Northridge Earthquake. In the same article a J.P. Morgan analyst is quoted as saying that the reinsurance industry is overcapitalized by about $75 billion at the same time USAA and other insurers have been protected by new securities market based reinsurance arguments.
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    It has been clear for some years now that this bill really only would affect State Farm and perhaps Allstate insurance companies in a significant way. These companies, through diversification, balance in their portfolios of risks insured, and in State Farm's case massive overcapitalization are no longer really in need of this bill either. So we would like to start by congratulating the Members of the committee for their patience over the years and for not overreacting to insurer pressure to enacting an unnecessary intrusion into this area being well handled by the private sector.

    However, that doesn't mean that there is not a need to consider the current system for insuring against disaster. Right now we have the time to do what is needed in the disaster insurance area, rationalize the system that is so inconsistent today. America has allowed its system for preparing and responding to natural disasters to grow in a haphazard way that inconsistently deals with natural disasters and which inadequately acts to save lives and property damage from natural hazards. Let me just give you a couple of examples of this inconsistency.

    Insurance takes care of smaller wind events such as tornadoes almost completely. Insurance also does a good job on large wind events, thus the relatively low need for disaster relief for damages from hurricanes compared with the large need for relief for the less insured hazard of earthquakes.

    The issue of State cross-subsidies is also important to consider. Our written testimony goes into this at length. Exhibit 4 of that testimony shows an estimate of the subsidy by State in dollars per household per year. The largest subsidies go to North Dakota and California. States paying the most are Connecticut, New Jersey, and Florida actually had a relatively low subsidy considering that Hurricane Andrew occurred during this period of study. This is because the people of Florida are paying their own way with insurance premiums for wind.
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    There are a number of questions we urge the committee to ask as you consider our crazy quilt disaster system, such as given the current overcapitalized insurance and reinsurance markets and the ready availability of catastrophe reinsurance, do we really need a Federal backup for any hazard? If so, should the program be limited to earthquakes only? What form should the program take? USAA has proposed an idea deserving of study, a program of tax deferred reserves to maintain catastrophe risk in the private sector while ensuring access to affordable insurance to consumers.

    Insurance company reports indicate that damage caused by Hurricane Andrew would have been a one-third to one-half less if building codes then on the books were enforced. Perhaps national verification of building code enforcement would be remarkably useful should there be such code verification.

    The issues of subsidies under H.R. 21 and how they might change from State to State should also be evaluated. Finally, we would add ours to the number of voices that we have heard this morning urging the committee to look hard at the Wharton School study and to ask them in to testify, because we believe that that study answers a number of the questions that we have posed. Ultimately if we can find the right balance of mitigation, tax deferral response, insurance risk securitization and enforcement, we can devise a plan to pay for the current natural disasters and plan for future ones in a way that demonstrates to the taxpayers in such States as Connecticut, New Jersey, New York, Massachusetts, Ohio, and so forth, the States that are currently footing the costs of disaster relief, that they will be freed from today's cycle of higher and higher tax support of unwise construction in high-risk areas of the country.

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    Thank you for this opportunity to testify.

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

    Mr. Weber, you are recognized.


    Mr. WEBER. Thank you, Mr. McCollum. It is not surprising that at the end of the day you and Mr. Lazio are both still here with us. You have been with us from the start in looking at this issue and we want to express our gratitude for your dedication to this effort in making sure that this legislation gets done and gets done right. A couple of points that I would like to make. Before I do, we have two documents in addition to my testimony that I would like to have included in the record.

    One is a document, ''The Case for a Federal Disaster Reinsurance Program,'' and the other is a response to some issues dealing with the capacity in the reinsurance market and such and I would like those included in the record.

    Mr. MCCOLLUM. Without objection, so ordered.

    Mr. WEBER. Thank you. I would like to talk about a couple of the issues that have been brought up today and try to set the record straight on a few of them, maybe clear up some misunderstandings. The first is having to do with the trigger. There has been much discussion about the triggers in this legislation.
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    As you know, there are three tests for the trigger in the legislation: One, that the event which occurs has to occur less than once every 100 years. The second trigger is that it must exceed the level that current State programs have for dealing with these events. In other words, the trigger must be above the capacity of State programs. The third number, which I think has been greatly mischaracterized, is the fact that the trigger should never be less than $2 billion.

    I think it is important to keep in mind that when you look at the States that have these catastrophe exposures, that most of the triggers in this bill are well beyond $2 billion. For instance, Florida's 1-in-100-year event trigger is a $21 billion residential insured loss, not $2 billion.

    In California the trigger is approximately $7.5 billion of residential loss, not $2 billion. The $2 billion figure was inserted in this legislation largely to deal with extremely small States that clearly do not have the population or the premium volume to deal with very large events and the most relevant place that that applies would be the State of Hawaii. They have a program that was instituted after Hurricane Iniki, buying reinsurance from the private market using bonding capacity. They still only have a $1.5 billion capacity. So that $2 billion figure does not apply in most areas of the country.

    Second, I would like to point out that a lot has been made about concerns about this legislation interfering with the private markets and particularly the private reinsurance markets. I would like to just point out some of the provisions that the committee inserted into this bill last year to deal with that very subject, many of which were put in by those that were concerned about this subject.
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    In Section 3 the bill restricts the authority of the Secretary of the Treasury to offer Federal reinsurance contracts which would in any way displace or compete with the private insurance and reinsurance markets.

    In Section 6 the bill limits the eligibility of State programs for Federal insurance to plans which do not supplant coverage that is otherwise available in the private market.

    In Section 7 the bill authorizes private rereinsurers to purchase Federal reinsurance contracts and further allows such contracts to be transferable, assignable and divisible. This means that a reinsurer can buy these contracts and actually use them to increase their own capacity in serving the private market.

    In Section 8 the bill authorizes the Treasury Secretary to reduce the levels of Federal reinsurance, as has already been mentioned today, to 50 percent, so that even when the triggers are met, the Federal program is only covering 50 cents on the dollar of eligible losses.

    I would also like to mention a point that was raised and touched on today, which has to do with the capacity of the private reinsurance market and the pricing of reinsurance. For instance, it has been alleged today that the prices for reinsurance in fact have been coming down. That is true. Reinsurance rates are lower this year than they were last year. However, that characterization of the reinsurance market and the pricing is also misleading because in this decade reinsurance rates are still up a net 60 percent. They were up 120 percent after Hurricane Andrew. They have since come down by about 35 percent, but the net increase over the last decade is up 60 percent.
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    Another point that has been made is that the reinsurance capacity in the private market is in the neighborhood of $20 billion per region. And we reject that categorically and let me tell you a couple of the reasons why. First, the figure $20 billion, even if it were true, applies to all types of reinsurance sold, not just reinsurance made available to the homeowners' insurance industry. Almost one-half is devoted to commercial lines which are not covered in this bill. So the $20 billion figure has to be cut in half simply to allow for the issue of commercial lines which are not covered.

    Second, much of the estimate for reinsurance capacity involves double, triple and quadruple counting of reinsurance capacity. Let me give you an example. One of our member companies purchases a layer of reinsurance for their hurricane exposure in the Northeast. It is in the range of about $400 million. It is for hurricane exposure in the Northeast, but because they are a national company, that reinsurance capacity is theoretically available anywhere that they do business. And when the so-called experts who are estimating the reinsurance capacity count up those numbers, they look at that company that has bought that $400 million of reinsurance for the Northeast and they also say ''Well, because that is in place in the Northeast and it is a national company, it is also in place in California, and it is also in place in New Madrid, and also it is in place in the Pacific Northwest, even though none of those places are ever going to have a hurricane.'' So in other words, the $500 million of the $400 million of reinsurance that is being purchased is being assigned to the West, the New Madrid area, the Gulf Coast, even though it is really not practicably being used there.

    Finally, the issue of the ability of the insurance industry to cover these losses. The surplus of the property and the casualty insurance industry has been estimated in the range of about $300 billion. That is all insurance companies, that is not the insurance companies that write homeowners' insurance business. In fact, approximately 80 percent of the homeowners' insurance business that is written in this country is written by ten insurance companies. Those ten insurance companies have a surplus, which is a small percentage of that $300 billion figure. But what is more, most of the surplus of the companies that do write that business have derived their surplus, not from homeowners, but from auto insurance. The typical company that is a member of the Home Insurance Federation, their premium volume is essentially divided as follows: 80 to 85 percent is auto insurance and 10 to 15 percent is homeowners' insurance.
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    It is incredible to us that anyone would argue that a company that is generating only 15 percent of their income and profit from homeowners' would put their entire company at risk from a homeowners' peril: That is why companies are pulling out of the market in those areas where they feel that that surplus is that extreme risk. There are some other points that maybe we can take up in questioning. I know my time is up.

    Mr. MCCOLLUM. Thank you very much, Mr. Weber. I will yield myself five minutes.

    There have been a number of questions that have been raised by the panel and I would like to clarify a few things on my limited time.

    Mr. Nutter, you suggested that A.M. Best had proposed, or perhaps the idea of the 1-in-250-year event came from them, and then you laid out their comment about 1-in-100-year event for a windstorm, and a 1-in-250-year event for earthquakes.

    I had previously had the impression that the suggestion being made to us by perhaps you and others to change our 1-in-100-year event to 1-in-250 was for both windstorm and earthquakes. This sounds like A.M. Best is suggesting perhaps that might be bifurcated. Is that what I am hearing you say today?

    Mr. NUTTER. What I cited is from the A.M. Best study that when they evaluate companies and look at their reinsurance programs, those are the standards they expect those companies to meet. You are correct that what I said is that Best looks at those separately. And I cited it primarily because there was some suggestion that a 1-in-250-year event was a ludicrous number. In fact, it is a pretty common number by the industry's premier rating organization for earthquakes and the 1-in-100 for hurricanes.
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    Mr. MCCOLLUM. Also in regard to Mr. Weber's last point, I believe in your testimony, Mr. Nutter, you cited that $13 to $15 billion in excess-of-loss capacity in the catastrophic reinsurance area per region per event. Mr. Weber was citing $20 billion. I don't know what the actual number really is, but I am curious to know what, of the figures that you gave us, the $13 to $15 billion, is focused on residential versus commercial? Is that all residential you are giving us or does that include commercial and residential?

    Mr. NUTTER. The catastrophe contracts are generally written to cover both risks. So what Mr. Weber raises is a red herring. He is citing the fact that what has happened in past events is that the losses have been both residential and commercial so the losses themselves, as you would expect, cover both residential and commercial. If a hurricane went through a totally residential area, a property catastrophe reinsurance contract would cover those losses whether they were residential or commercial.

    So it is not a matter that the contracts are written to distinguish between the two. The contracts are written to cover the losses associated with an insurance company. They may be all residential. They could be all commercial as well.

    Mr. MCCOLLUM. I think the point is well made on both counts, but I do think the key is as we write this, your industry has said and you said at the beginning of your testimony, we need a Federal reinsurance program. It is a question where it enters, at what point. I want to assure you that we do not want to crowd out any private reinsurance market which is why the relief provisions are in here. We want to work with you to make sure that we don't do that whatever way we do it, and yet we still have to have a product that markets.
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    Mr. Joslin, there has been some discussion here and I think perhaps that was brought up by Mr. Plunkett in his testimony from Mr. Hunter from the Consumer Federation about capital markets and that there is an indication that there is sufficient capital markets out there. Secretary Eizenstat said that there were some incipient capital markets coming along and he hoped that this would help this process down the road so that we don't have to have this program forever.

    I gather from his testimony that the optimistic view of the Consumer Federation on this point is not shared widely. How is the capital market situation as you see it today for this purpose?

    Mr. JOSLIN. I think anyone who has ever had a bright idea in this area has made a sales call on us. We have found that it tends to be problematic. They are coming with an idea, but not necessarily with investors behind them. There have been transactions that have taken place, real transactions. The cost tends to be higher than reinsurance. As much as we may kick at the reinsurance people, the costs tends to be higher, and they clearly have much higher transaction costs. So it is developing. They are finding some formats that may work, but it is just not an awful lot that is showing.

    Mr. MCCOLLUM. I don't know if it is more or not, but what I am aware of is only one deal in 1998 worth $2.5 billion to securitize catastrophe risk in the capital markets.

    Mr. JOSLIN. Excuse me, sir. There are a whole handful of smaller transactions. I am aware of two larger transactions in which the primary insurer actually felt that they were subsidizing the program just to try to jump-start the market.
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    Mr. MCCOLLUM. So it is beginning to develop, but we are not there yet. By no means is that something that we should consider to say don't do this bill; am I correct?

    Mr. JOSLIN. I think the answer is absolutely not. I view the availability of the excess-of-loss contract concept as something that can support the capital markets and support reinsurers in their programs as opposed to the other way around.

    Mr. MCCOLLUM. You are yielded five minutes, Mr. Lazio.

    Mr. LAZIO. Thank you very much. I want to thank the entire panel for their testimony. All of it was very good.

    Let me, Mr. Beery, because I know you are so familiar with Louisiana, and those diagrams which are very compelling. Louisiana has a Fair Plan, does it not?

    Mr. BEERY. Yes.

    Mr. LAZIO. Can you describe what that is?

    Mr. BEERY. The Fair Plan is a mandatory State pool. The original concept was that it would insure, be market of last resort for country properties, unprotected Class 10 fire district properties, and also for some urban intercity properties that couldn't find insurance. And then after Hurricane Andrew when companies started to pull out of the areas that we indicated on those maps, the Fair Plan was a mechanism that stepped in and provided coverage to those people who found themselves unwanted as homeowners.
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    Mr. LAZIO. Otherwise they would not be able to get insurance?

    Mr. BEERY. Right.

    Mr. LAZIO. What has happened in terms of enrollment in these Fair Plans in Louisiana?

    Mr. BEERY. The increase has been like 800 percent since they started to use it since Andrew, and 1,000 policies a month are the average increase for the last few years. It is overpopulated, and it is frightening.

    Mr. LAZIO. So these folks would not have any risk management at all but for this Fair Plan?

    Mr. BEERY. There would be an absence of it, that is correct.

    Mr. LAZIO. Mr. Joslin, I want to address this to you, because I think it is somewhat related. You are the Chairman of an exceptionally large insurance enterprise which has a long reputation, and yet State Farm Fire was technically insolvent after Hurricane Andrew and after the Northridge Earthquake. Is that true, and can you tell me how that is possible?

    Mr. JOSLIN. We hate the words, but the answer is it is true for Andrew, because we had a very large exposure down there. We had frankly underestimated the exposure of the probable maximum loss, or even an intermediate level loss, which is probably closer to what Andrew was. State Farm Fire and Casualty simply did not have sufficient capital. Fortunately, it was able to call on the resources of its larger parent, and we have now established an intra-group reinsurance plan to provide additional capital on a contractual and permanent basis, but it still is a situation whereby we simply cannot write all of the business that is available in South Florida.
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    Mr. LAZIO. Let me turn to Mr. Nutter. I want to thank you for your testimony and for your general support for H.R. 21. I know you have some reservations.

    I just want to ask you a bit about the fact, the contract aspect of this and do you think reinsurers would participate in these auctions of the contracts and is some of your concern or a good deal of your concern mitigated through the modification of H.R. 21 that would effectively create a co-payment structure for losses above the trigger level?

    Mr. NUTTER. The answer is yes to your question. I do think, and I know our companies believe that the excess-of-loss contracts would be attractive to reinsurers, that they would use them to add capacity to the market, that they would be a vehicle, as Mr. Weber says, to facilitate additional capacity to their client companies.

    And yes, the 50 percent co-pay that was proposed by Treasury is an attractive feature to limit the impact that this legislation and the proposal might have on the private markets.

    Mr. LAZIO. The part that is in the existing bill now as a result of last year, this co-pay provision, you find attractive?

    Mr. NUTTER. Yes.

    Mr. LAZIO. If I can, Mr. Chairman, I may not be able to be here for the whole hearing. It is my youngest daughter's sixth birthday today. I want to apologize to the last panel if I am not here. It is not a lack of interest or lack of respect, it is only trying to keep my priorities in order.
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    Mr. MCCOLLUM. Thank you very much, Mr. Lazio, and that explanation is good.

    Mr. Royce, you are recognized for five minutes.

    Mr. ROYCE. One of my observations, Mr. Chairman, if the tax code were changed to allow for the accumulation of reserves without tax penalty I think we might be able to devise a solution to this, and I understand the concerns that we wouldn't be able to get that through, but I think it is a point that the private market could provide a solution in theory if it were not for the fact that the tax code imposes this penalty on accumulation of reserves.

    Let me ask Mr. Nutter. In your testimony you mentioned two recent published studies that have found that there is $20 billion of catastrophic reinsurance capacity available per region per event, and you state that this number does not include the capacity provided by the primary insurance market. In your view, how much more in additional capacity would be added to that number by the primary insurance market?

    Mr. NUTTER. That is a good question, Mr. Royce. The studies were our requests to participants in the marketplace to look at actual contracts in place, and I do not think that, as Mr. Weber has suggested, that there is any double counting there at all. They certainly were looking at actual contracts covering certain regions.

    I probably don't have a specific answer to your question about the ability of the primary industry and what their capacity is, but I would say this. In Hurricane Andrew about one-third of the losses that were paid in the net event were paid by the reinsurers, meaning two-thirds of the losses were picked up by the primary industry.
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    In the Northridge earthquake, about one-quarter of the losses went to the reinsurance industry and three-quarters went to the primary industry. My guess is, those numbers, that range, would give you some sense of what the primary industry would expect to pay in an event that was large to exhaust the reinsurance capacity. So those are the only things that I would really have to go on.

    Mr. ROYCE. OK. Thank you. You are also advocating that the trigger levels in the bill be raised from the current level of $2 billion or 1-in-100-year event to the new level of $5 billion or a 1-in-250-year event.

    Now, in the other testimony, some have complained, even said they are flabbergasted that this threshold of 1-in-200-year event would be argued. They say that is unreasonable, one of the panelists anyway.

    Would you explain the 1-in-200-year event again to us, and is this something that a company can prepare for? Give us again your analysis on that, if you will.

    Mr. NUTTER. Sure. The comment that I made earlier was that the industry's premier rating organization does, in fact, expect companies to fund their catastrophe exposure with reinsurance for a 1-in-100-year hurricane or a 1-in-250-year earthquake, a very realistic number that, frankly, is available to the private market.

    The suggestion has been made that a 1-in-250-year is somehow an outrageous number. We looked at the top ten catastrophes that have occurred in this country over the last 100 years, adjusted the numbers to 1997 dollars to determine whether a program of this nature would trigger at a 1-in-250-year event, and found that four of those ten largest events would in fact have triggered a program, one might have, and five probably would not have, but probably would have been covered in the private market.
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    And I also cited the California Earthquake Authority that testified last year that said that they believed they were covered for 2-in-250-year events. So it is a realistic number, in our view, about what the capacity of the market is to provide this coverage and what the ratings organizations expect the industry to cover.

    Mr. ROYCE. And in closing, what would be the consequences of a $2 billion trigger again, in your view?

    Mr. NUTTER. Our concern is that low numbers, like 1-in-100 or $2 billion, provide incentives to States to create State funds and have insurers roll the risk into State government programs that then would roll into Federal programs.

    Mr. ROYCE. And that drives up costs, arguably? How does that drive up costs?

    Mr. NUTTER. It is just like a deductible in your insurance policy. If you ask for a low deductible on your insurance policy, your premium is higher; if you want a higher deductible, your premium is lower. It is the same thing with these triggers.

    Mr. ROYCE. So overall, for all intents and purposes, it just increases the costs on the society?

    Mr. NUTTER. Low triggers would increase the cost to the Federal Government in paying claims. It would increase the costs to those who purchase the contracts.
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    Mr. ROYCE. Thank you.

    Thank you, Mr. Chairman.

    Mr. MCCOLLUM. Thank you very much.

    Mr. Hill, I will recognize you. We are going to have to have a recess pretty quickly, though, because I want to make this vote and I know you do, too.

    Mr. HILL. OK.

    Mr. Weber, presuming that H.R. 21 passed and it passed in its current format, the clients that you represent, the HIFA people, have they given any indication to that they would write more insurance in the catastrophe-prone areas of the country?

    Mr. WEBER. Yes, as a matter of fact, they have.

    Mr. HILL. OK. Would they write more insurance in the areas that Mr. Beery has discussed, the areas that are now blue-lined in Louisiana, the coastal areas? Could we expect that—I think that group of insurers write 50 to 60 percent of the homeowners' insurance in the country. Could we expect that they would write 50 to 60 percent of the homeowners' insurance in that area?

    Mr. WEBER. Well, I believe that they are already writing a substantial part of the business. You know, I can't speak to specific market shares, but I think that the point is——
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    Mr. HILL. But they would write more insurance in those areas?

    Mr. WEBER. They would write a prudent amount of business, yes.

    Mr. HILL. So you would have no objection, if there is a requirement in the bill in order to participate in reinsurance, that they do write insurance in those areas?

    Mr. WEBER. I think that it would be a mistake to dictate to any company what their specific business practices or plan would be. I don't think we would do that with any other company.

    Mr. HILL. If there is a requirement to have a Government subsidy for insurance, wouldn't it be appropriate for them then to make some commitment to write insurance?

    Well, let me ask Mr. Joslin, if we pass H.R. 10, will State Farm write a larger proportion of insurance in Mississippi, the area Mr. Hanna has talked about; the North Carolina coastal area, the area that Mr. Beery is concerned about?

    Mr. JOSLIN. Let's start by backing up just a tad, where you said if the Federal Government subsidizes the writing of insurance, it would be reasonable for insurers to write more. This bill does not call for the subsidization of primary insurance.

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    Mr. HILL. Let's not debate that. Let's go to the specific question.

    Mr. JOSLIN. OK.

    Mr. HILL. Will you write more insurance in the areas that Mr. Beery has described or Mr. Hanna has described, that we had earlier testimony, in the North Carolina coastal area if H.R. 21 passed?

    Mr. JOSLIN. I think almost certainly we would write more insurance. I think what would be even more important, though, is that we would find that other insurers would come in and make for a more competitive market, which I think is good for the consumer.

    Mr. MCCOLLUM. Mr. Hill, I am going to interrupt because we have less than two minutes to go for a vote. I am going to need to recess.

    Do you want to try to come back for this panel?

    Mr. HILL. I would like to, yes.

    Mr. MCCOLLUM. If you want to finish this yourself and take the risk, it is up to you.

    Mr. HILL. No, I will go vote.
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    Mr. MCCOLLUM. All right. We will be in recess. If the panel can stay, fine, but you will be the last questioner. We will be in recess.


    Chairman LEACH. [Presiding.] The hearing will reconvene. Mr. Hill is recognized for a continuation of his questioning.

    Mr. HILL. Mr. Joslin, I certainly wasn't trying to pick on State Farm. My point simply is, I am having a hard time understanding how H.R. 21 is going to translate into more retail-level, primary insurance available.

    I think, Mr. Nutter, you made the point that two-thirds to three-fourths of catastrophic claims are paid by primary insurers, and if we want to increase the availability of insurance in catastrophic areas, then we need to increase the availability of primary insurance in catastrophic areas. I mean, that is what we are trying to do with our alternative plan by allowing companies to prefund their loss reserves.

    But let me just ask you a couple of questions, because there is a whole debate about whether there is subsidy involved. You are concerned that one of the things that is going to happen with these low triggers and perhaps too-low-priced insurance is it will crowd out private reinsurance; is that correct?

    Mr. NUTTER. Yes, that is correct.
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    Mr. HILL. There certainly is a tax advantage to all of these State pools. In fact, this Treasury plan, there will be no tax on the premiums that are paid to the Treasury because it will be a tax deductible expense; there will be no tax paid on the income stream, and all the State funds, I believe, are tax-exempt entities. So there is a tax advantage to all of these States funds and State pools in this Treasury plan, isn't there?

    Mr. NUTTER. Yes.

    Mr. HILL. And also there is a cost-to-capital advantage. I mean, certainly the U.S. Treasury can get capital cheaper than any one of the insurance companies that are out there. In fact, some people are suggesting there is no cost to capital here; but those would create competitive disadvantages to the reinsurance industry, or at least potentially could, wouldn't they?

    Mr. NUTTER. Absolutely, which is why we have argued for higher triggers to have this program operate only at levels that the private market is really not capable of providing coverage.

    Mr. HILL. If the Chairman would indulge me for one last question, the debate is over whether there is a $21 billion exposure in Florida or it is $14 billion, but I would just draw from the example—and correct me if I'm wrong.

    Let's say it is $21 billion, as Mr. Weber has suggested that it is, and that traditionally two-thirds is covered by primary insurance, which would be $14 billion; and let's say that the $14 billion, or the regional reinsurance, is only half applied to residential insurance, my addition of 14 plus 7 is 21, which would cover the likely loss. Is there anything wrong with that math?
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    Mr. NUTTER. No, I can't find anything wrong with your math.

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

    Thank you. I thank the panel.

    Chairman LEACH. There is nothing wrong with you, Rick.

    Mr. JOSLIN. Mr. Chairman.

    Chairman LEACH. Yes, Mr. Joslin.

    Mr. JOSLIN. Nothing the matter with the math, but we had better define the terms. I think we have thrown some numbers around that may not fit the exact terms, but that is for the committee to work on.

    Mr. WEBER. May I just make a point, too, since you have brought me up.

    Chairman LEACH. Of course.

    Mr. WEBER. You are absolutely right about the math. $21 billion is the point at which the Federal reinsurance would kick in, nothing below that. So the private market, as you suggest, would take up the rest of that slack and the trigger in Florida is $21 billion under the bill.
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    Mr. HILL. If I might interject, Mr. Chairman, my point is that the concern here with availability of insurance in Florida is the $14 billion in the primary market; and that is where we have the problem, and that is where we have the problem with redundant claims where we have multiple catastrophes occurring in a single year, which argues for the case that I make that we ought to find a way to strengthen the opportunity for primary insurance companies by providing a mechanism for them to prefund catastrophic claims.

    I thank you again, Mr. Chairman.

    Chairman LEACH. Well, I thank you, Mr. Hill. I know of no bill that has more pros and cons than this one, and no bill that is more appropriate for people of contrasting perspectives to present their views.

    Is there anyone on this panel that would like to conclude with any observation that you think has not been fully dealt with at this point?

    Mr. JOSLIN. The hour is late. We thank you very much for your indulgence on a Friday afternoon.

    Chairman LEACH. Thank you, and let me apologize to you and others at the awkwardness of moving a hearing, based upon the death of a Member, and then having intervening circumstances on Friday as well.

    So let me thank the panel, and we appreciate your testimony.
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    The next panel will be composed of Mr. Robert W. Pike, who is Executive Vice President for Administration of the Allstate Insurance Company of Northbrook, Illinois; Mr. Darryl D. Hansen, who is Chairman and President and CEO of GuideOne Insurance Group, West Des Moines, Iowa, on behalf of the National Association of Independent Insurers; Mr. Tom Miller, who is Director of Economic Policy Studies, Competitive Enterprise Institute; Ms. Barbara Connery, who is a member of the North Carolina Association of Realtors on behalf of the National Association of Realtors; and Mr. Scott A. Gilliam, who is Assistant Secretary, Director of Government Relations of the Cincinnati Insurance Companies.

    I might note that I have been notified that Mr. Pike has a connection that he would like to keep.

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

    Chairman LEACH. Thank you, Mr. Pike.

    By unanimous consent, all of your full statements will be placed in the record and you may proceed as you see fit.


    Mr. PIKE. Thank you, sir. I will refrain from reading my testimony. Certainly Mr. Joslin, Mr. Hanna and Mr. Weber more than covered the points, and far better than I could, in their testimony on the second panel.
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    I think, if I can be of any value to the committee, it would be to touch on the one issue that Mr. Nutter indicated that in his mind was the most important, and that was the existing capacity within the insurance industry to take care of these catastrophic losses. I would suggest that the issue of capacity is nothing more than the sum total of the capacity that exists within the primary market, companies like Allstate and State Farm, the capital that exists within the reinsurance market, and arguably the implicit capacity that might be contained in the California cat fund and the Florida hurricane fund.

    That capacity is an interesting issue, because as Frank Nutter very properly indicated, at this time that capacity seems to be sufficient. Allstate Insurance Company happens to be the largest purchaser of catastrophic reinsurance. Nobody buys more than we do, so I think we have a reasonably good handle on how much really exists. We cannot buy enough. We certainly cannot buy enough at prices that could ever be forwarded onto the backs of the bill-paying customer. But when we talk about capacity, we have to realize that it is a time and place that we are talking about. The reason we have capacity in the insurance industry now is quite simply the fact that the asset valuation of our industry has never been greater in the last five years. The S&P has gone up approximately 27 percent a year. The long bonds are around 7.8 percent. In addition to that, we have had five years of unprecedented and arguably atypical catastrophe experience. So we have actually had five years of the ''best of times,'' to take a page out of Dickens.

    What we have not had, of course, is the ''worst of times,'' and as soon as interest rates spike and the concurrent equities go down, as so often happens, or as soon as there is this unfortunate catastrophic event, then that insurance capacity that we speak of today which, whether it is imagined, illusionary or real, will clearly disappear.
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    I think it is important that we realize that insurers, by definition, insure for essentially low-severity, high-frequency events. We know how to deal with issues like that. That is what we insure against.

    We are not good, nor can we insure, against the very high-severity, low-frequency event. Hurricane Andrew is a classic example of that for the Allstate Insurance Company. In that case, we gave back in one day all the premiums we acquired, including investment income, from every line of business we wrote in the State of Florida for 60 years.

    The private sector isn't capable of absorbing or maintaining that kind of capacity, nor is the reinsurance industry capable of providing that kind of capacity at affordable prices.

    H.R. 21 is, very simply, as good a public policy as this committee, after years of deliberation, could surround itself around while still maintaining a viable and workable private marketplace for both primary insurers and reinsurers. We are not talking about taking care of the State Farms, the Allstates, the Farmers, or the Independent Agents every time an event happens. We truly are talking about the 1-in-100-year event, which is simply not a mechanism that can be handled alone by the private sector. But a joint cooperation, without subsidy, with the Federal Government supporting it, as Secretary Eizenstat has indicated, is a solution; and it is a solution, Mr. Chairman, that I commend you and your leadership for endorsing and supporting. Thank you.

    I do have to catch a plane, Mr. Chairman.
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    Chairman LEACH. Fair enough.

    Mr. PIKE. I do apologize.

    Chairman LEACH. Fair enough. Could I ask just one 30-second question?

    Mr. PIKE. Please.

    Chairman LEACH. Isn't there a second definition to capacity, that is—or an ingredient of capacity, that is, you line up all of the wherewithal that exists, but coupled with that has to be the willingness of a company to risk that wherewithal and that forms a very different definition of capacity?

    Mr. PIKE. Absolutely. Our equity, our surplus, doesn't just support the 6.5 million homeowners. It supports all of the automobiles which we insure, and we have to allocate that. So your comment and your point is exactly correct.

    Chairman LEACH. I am not sure you gathered exactly what I was getting at, that you may be a company with great capacity, but you also may be unwilling to take on the risk of a given line of insurance.

    Mr. PIKE. Exactly.

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    Chairman LEACH. That point means that all of that capacity that is out there doesn't necessarily allocate to this particular problem.

    Mr. PIKE. Oh, exactly.

    Chairman LEACH. That is the only point I wanted to draw.

    Mr. PIKE. You are exactly correct.

    Chairman LEACH. That is, of all the dollars that exist in the various insurance company net worths, which fortunately have risen, that does not necessarily mean it applies to the risk associated with the calamity, because most of these companies have not taken on that risk and have chosen not to.

    Mr. PIKE. That is certainly our experience in the marketplace today.

    Chairman LEACH. Thank you.

    Mr. PIKE. Thank you, sir. And I do apologize.

    Chairman LEACH. Thank you.

    Mr. Hansen, who is going to apply thoughtful Iowa logic to this dilemma.

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    Mr. HANSEN. Excellent.

    Good morning—or good afternoon, I should say. My name is Darryl Hansen, and I am Chairman, President and CEO of GuideOne Insurance of West Des Moines, Iowa. I am also a member of the Board of Governors of the National Association of Independent Insurers, known as the NAII. Mr. Chairman and Members of the committee, I would like to thank you for inviting me here to comment on H.R. 21.

    I wish to state up front that I support the reinsurance proposals contained in H.R. 21, both on behalf of GuideOne Insurance and the NAII.

    GuideOne Insurance is a medium-sized company that writes consumer business across the United States, including many areas affected by catastrophic losses. The NAII is comprised of over 600 member companies, many of whom are also small- to medium-sized and write business in the same areas.

    As a result, GuideOne and many NAII members are exposed to exactly the type of financial risks that H.R. 21 is intended to alleviate, and we are vitally interested in the outcome of the debate over H.R. 21 for reasons I will describe.

    I have submitted written testimony that presents several concepts and points in detail, but during this statement I wish to emphasize three points. First, H.R. 21 addresses only catastrophes that are of truly a significant magnitude and which could have a negative financial impact upon the economy and financial markets of the country as a whole.
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    The catastrophes contemplated by H.R. 21 would not be limited to one geographic area or only to the insurance industry. This is not a situation where people who live in Florida or California would receive subsidies, nor is it a bail-out of the insurance industry. The program contained in H.R. 21 is a high-level reinsurance safety net that will respond only to the worst-case scenarios and will preserve a national economy from serious interference. This bill does benefit the entire country.

    The second point I wish to make is that catastrophe reinsurance plays an important role in the operations of many, if not most, insurance companies. It is definitely a critical factor in small- to medium-sized companies, especially those that do business in geographic areas that are prone to catastrophes. Without adequate catastrophe reinsurance, these insurers simply could not operate in these geographic areas. In that event, homeowners' insurance is either unavailable or priced to reflect the full risk and thus virtually unaffordable. Therefore, to the extent that a highly competitive insurance industry depends upon a solvent and reliable reinsurance market, the H.R. 21 proposal will bolster the available resources to the insurance industry, albeit on a high-level safety net basis. This bill will benefit a competitive insurance marketplace.

    Third, the ultimate consumers, persons who own or wish to purchase homes, suffer a distinct disadvantage when homeowners' insurance becomes unavailable or unaffordable. Lenders will not lend money for mortgages and builders will not build new homes where insurance is not accessible. When small- to medium-sized insurers elect to avoid the serious risks presented by catastrophe-prone areas, homeowners' insurance becomes inaccessible or available only from a limited number of insurers. In either event, the usually vibrant, competitive insurance market ceases to exist. People are then faced with the choice of relocating their homes or being exposed every day to the total loss of their most important asset, their homes. By reinforcing the reinsurance market with respect to the most serious types of losses, availability and affordability will be enhanced. This bill will benefit consumers.
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    In summary, the H.R. 21 proposal will insulate the national economy to a great extent from a truly major catastrophic event, will enhance a competitive insurance environment and will benefit consumers. At the same time, H.R. 21 will act as a supplement and not a competitor to the existing private insurance and reinsurance markets.

    I urge you to vote in favor of H.R. 21.

    Thank you again for inviting me to appear today.

    Chairman LEACH. Thank you, Mr. Hansen.

    Mr. Miller.


    Mr. MILLER. Thank you, Mr. Chairman. I am Director of Economic Policy Studies at the Competitive Enterprise Institute. We thank you for the opportunity to discuss the Homeowners' Insurance Availability Act. For the last five years, our insurance reform project has urged market-based reform of insurance coverage for catastrophic risks.

    Although H.R. 21 represents an improvement over previous versions of Federal reinsurance proposals, it fails to present the best answers to the challenge of dealing with natural disaster risks. The bill still has the potential to undermine private insurance markets and crowd out the development of better alternatives. It remains likely to produce cross-subsidies from low-risk insurance policyholders to high-risk ones, distort incentives for loss control and loss mitigation, further subsidize development in catastrophe-prone areas, increase unnecessary Federal intervention in State regulation of insurance, and impose significant financial risk on taxpayers throughout the country.
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    Private insurance and financial markets can effectively manage catastrophic risk if supported by sound Government policies. Unfortunately, the pricing provisions of the Homeowners' Insurance Availability Act threaten to distort those private insurance markets. The full effects of those provisions remain uncertain, in part because the Secretary of the Treasury would retain a considerable amount of discretion in setting those prices and implementing the reinsurance program. It is highly doubtful that the Federal Government would perform better than the insurance industry in overcoming the problems of estimating catastrophic losses and properly pricing insurance contracts.

    Given likely political pressure by particular States and other interests to keep the reinsurance contract prices low so that insurance coverage would be affordable in high-risk areas, it remains much more likely that the Federal reinsurance contracts will be priced too low rather than too high. The coverage triggers under H.R. 21 remain relatively low compared to current private sector insurance capacity. The level they set for Federal coverage would impede the development of private market insurance coverage.

    Private industry has already handled much more costly events, and since Hurricane Andrew and the Northridge earthquake, industry capacity has grown significantly. Reinsurance availability has increased remarkably. Industry capacity and efficiency to handle catastrophic risks continues to improve.

    Although gaps in insurance coverage and capacity provide a necessary role for further development of innovative financial instruments and contracts to handle catastrophic losses, those shortfalls in private sector financing do not yet justify a new Federal reinsurance program. Instead of encouraging greater private financing and more market-based approaches, H.R. 21 would invite more intervention by Federal and State governments. The lure of potential Federal reinsurance subsidies would foster the growth of State reinsurance funds in residual market pools, as well as the creation of new ones.
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    A large degree of regulatory control on rates and the supply of coverage accompanies those mechanisms. Over time, they tend to crowd out viable private sector coverage, in part due to their favorable tax status. Price and supply controls also tend to produce cross-subsidies, which in turn inefficiently distort incentives for loss control and loss mitigation.

    If enacted into law, a Federal reinsurance program would be likely to live on indefinitely, as all but a few Federal programs do, despite the sunset dates provided in H.R. 21. The combination of regulatory discretion and political pressures in future years make adherence to actuarial principles in market-based pricing for Federal reinsurance unlikely, thereby increasing potential unfunded liabilities that can be transferred to Federal taxpayers.

    The current Federal reinsurance proposal does not address the underlying regulatory and tax policies that have limited the availability of insurance coverage that can be offered to consumers and underwritten by private insurers of catastrophic risks. As the Shadow Insurance Regulation Committee concluded last March, constraints on insurers' efforts to charge adequate rates decrease the voluntary supply of catastrophe insurance and hamper insurers' ability to purchase reinsurance and other financial instruments to diversify their catastrophe risk. Restrictions on rates and underwriting also discourage the entry of new insurers into the market that could enhance the availability of coverage.

    Current Federal tax rules make insurance against relatively rare, but very large catastrophe losses much more expensive because insurers are not allowed to establish tax-sheltered reserves for catastrophe losses. They can only deduct losses that have occurred. The combined effects of taxes on premiums and investment income produce very large premiums in relation to expected indemnity for small probability events. A well-designed system of tax-deferred reserves for catastrophe coverage would materially improve the availability and affordability of catastrophe insurance in the private sector. Encouraging growth of substantial prefunded insurer reserves would establish a necessary buffer against insurer insolvencies, keep natural disaster claims handling in efficient private markets and help maintain the link between risk-taking and personal responsibility to risk-based insurance pricing.
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    Freeing up the private market will, in the long run, prove to be more productive than creating yet another partly disguised Federal subsidy program. Thank you.

    Chairman LEACH. Well, thank you very much, Mr. Miller.

    Ms. Connery.


    Ms. CONNERY. Thank you, Mr. Chairman. I appreciate the opportunity today to present the views of the National Association of Realtors on H.R. 21, the Homeowners' Insurance Availability Act. I would like to thank you, Mr. Chairman, as well as Representatives Lazio and McCollum, for their leadership in building bipartisan support on this very important issue.

    I am a realtor from North Carolina and a Director of the North Carolina Association of Realtors. The deterioration in the availability and affordability of homeowners' insurance in disaster-prone areas is an issue of very real concern to NAR. Our members specialize primarily in the business of assisting sellers and buyers in residential sales transactions. It is this business focus that motivates NAR's interest in the resolution of this problem.

    Although I am testifying today on behalf of the real estate industry, I cannot emphasize enough that the ultimate victim of the homeowners' insurance crisis is the consumer who is frustrated in his or her attempt to realize the American dream of homeownership. When a young family is precluded from owning a home because homeowners' insurance is too difficult to obtain or too costly to afford, we all suffer the consequences.
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    Last year, NAR testified before this committee on the difficulties faced by current and prospective homeowners. One year later, the situation has unfortunately not improved. In a number of States throughout the country, including my home State of North Carolina, consumers are burdened by rate increases, as well as reductions in coverage and higher deductibles.

    Since homeowners' insurance is difficult to obtain in North Carolina, many homeowners obtain coverage from our State pool, the North Carolina Insurance Underwriting Association. Although such coverage is expensive and limited and was instituted to serve only as an insurer of last resort, it is often the only alternative in many of our communities.

    The inability to obtain affordable homeowners' insurance is a serious threat to the residential real estate market. Not only does it imperil the market for single-family detached homes, but for the condominium, co-op and rental markets as well. New home purchases, resale transactions and housing affordabilities are negatively impacted in several important ways. First, homeowners' insurance is a necessary component in securing a mortgage and buying or selling a home. If the potential homeowner is ultimately unable to obtain the required insurance either because it is unavailable or unaffordable, the sale will not be completed. As a result, many creditworthy potential homeowners are priced out of the market.

    A recent NAR survey reported that an estimated 2,450 transactions fell through because of difficulties in obtaining disaster insurance; 75 percent, an overwhelming majority of those respondents, cited unaffordability as the reason.

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    Second, homeowners' insurance is tied directly to the cost of owning a home. If the homeowner is unable to maintain insurance required by the mortgage lender, the mortgage is in default. If insurance coverage is optional, potential buyers may choose not to purchase a home because the insurance is too expensive, or in the very worst case, they may choose to go unprotected.

    Third, insurance costs impact rent levels. Insurance costs incurred by landlords are ultimately passed on to the tenants. Consequently, increased insurance costs result in higher rents and a further inability of many renters to enter the homebuyer market.

    NAR supports H.R. 21 for the following reasons:

    First and foremost, it protects against mega-catastrophes. State programs that have been created to address the problem are well-intentioned first steps. However, neither State disaster programs nor the private insurance industry has the capacity to cover the risks presented by mega-catastrophes far more damaging than either Andrew or the Northridge earthquake. The creation of a Federal disaster reinsurance program today will help to prevent future interruptions in the availability of homeowners' insurance.

    Second, it produces fiscal responsibility. By establishing a program which promotes insurance coverage for those at risk of property losses from a natural disaster, H.R. 21 will minimize future unforeseen disaster assistance expenditures. It is far more responsible for the Federal Government to act before disasters occur rather than after.

    A strong housing market is the linchpin of a healthy economy, generating jobs, wages, tax revenues and a demand for goods and services. In order to maintain a strong economic climate, we must safeguard the vitality of residential real estate.
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    We urge the committee to take action this year on this very important issue. Again, Mr. Chairman, thank you for the opportunity to present the views of the National Association of Realtors today.

    Chairman LEACH. Well, thank you, Ms. Connery. We appreciate it.

    Mr. Gilliam.


    Mr. GILLIAM. Thank you, Mr. Chairman and the remaining Member of the committee, last but not least. I couldn't resist.

    One more personal note. I have something in common with Congressman Lazio, who had to leave to go home to his six-year-old daughter's birthday party. My nine-year-old daughter is anxiously awaiting my arrival for the same purpose, so I will try and be brief.

    Mr. Chairman, I am Director of Government Relations for the Cincinnati Insurance Companies, headquartered in Cincinnati, Ohio. Our group of companies market property and casualty insurance in 29 States and are among the top 20 publicly traded property and casualty insurers, based on 1998 revenues of $2 billion. I am honored to be with you today to present the Cincinnati Insurance Companies' perspective on H.R. 21. We commend you for your leadership in holding this hearing to address the issues of natural disaster exposure and insurance.
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    You have my written testimony, which I will now briefly summarize. The catastrophe exposure we face from our own book of business has prompted us to engage in this important debate.

    Our hurricane exposure in Florida and Alabama alone is nearly $1.8 billion, representing over 10,000 homes. In the Midwest, our estimated exposure from a 6.8 Richter Scale earthquake in the New Madrid fault region is in excess of $13.4 billion, which would damage more than 118,000 homes.

    These are significant exposures for the Cincinnati Insurance Companies when considered in relation to the current level of assets for our property casualty group, $6 billion.

    Let me turn now to the legislation at hand, H.R. 21. We do not disagree that there may be a need for high-level Federal involvement in excess of private market capacity to insure that Americans are provided with appropriate insurance protection for losses arising from hurricanes, earthquakes and other natural disasters. However, we have several concerns with H.R. 21 as it is presently drafted.

    Our primary concern with H.R. 21 is its trigger for payment of losses, a trigger which is far below existing industry capacity. As currently drafted, the trigger for payment of losses is as low as $2 billion, despite the fact that the industry paid losses from Hurricane Andrew of $16 billion to $17 billion and from the Northridge earthquake of $12 billion.

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    Why should the Government step in at such low levels at a time when the industry continues to gain financial strength?

    Since 1992, the industry's policyholder surpluses increased from $162 billion to over $333 billion today.

    The fact of the matter is, the industry has handled all catastrophes to date regardless of their size, and it has handled them totally within the private sector. But with trigger levels as low as $2 billion, H.R. 21 shifts catastrophe risks from the private markets onto the Federal Government. This form of low-level risk transfer runs counter to conservative principles of less Government, less Federal spending and a balanced budget.

    These concerns were echoed by Treasury Secretary Larry Summers in January of this year in written remarks he delivered to a forum for property casualty insurers in New York, stating that a Federal reinsurance program like that proposed under H.R. 21 should impose no net cost on the taxpayer and the Federal Government cannot be the billpayer of last resort for such insurance.

    However, in the Congressional Budget Office cost estimate of H.R. 219, a Federal reinsurance bill introduced in the last Congress with features identical to H.R. 21, CBO concluded that it may not be possible to establish a price for the contracts that would have no present-value cost to the Federal Government. CBO expressed doubts that Federal reinsurance contracts could be priced so that contract revenues exceed payments and predicted the passage of the predecessor to H.R. 21 would likely result in a net increase in direct spending by the Government, thereby exposing taxpayers to a maximum of $25 billion annually in mandatory obligations to pay purchasers of insurance contracts. We do not believe that CBO's prediction has been taken seriously.
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    Another concern is the anti-competitive effect H.R. 21 may have on existing markets. Most insurers act responsibly, avoid large concentrations of risk, and purchase adequate reinsurance or otherwise develop adequate resources to absorb shock losses. Under H.R. 21, these responsible insurers would have to compete against irresponsible carriers who have overconcentrated their risk in cat-prone areas and put themselves in a position of having to rely upon State pools or other Government mechanisms to absorb shock losses.

    As one major insurer admitted in a notice to its Florida policyholders after Hurricane Andrew, ''In the past, despite well-intentioned efforts to determine what our policyholders should pay for insurance, we greatly underestimated the cost of covering hurricane damages. Over the years, our policy was of providing insurance to everyone who qualified and that we sold our product at too low a cost to too many people. We now know that it is not good business for anyone to insure every third or fourth home in an area where natural disasters strike.''

    With the low-level Federal backstop of Florida State pools under H.R. 21, such overexposed carriers will likely continue to rely on State pools to absorb shock losses and ignore the peril of risk concentration. Clearly this gives those companies an immediate and unfair market advantage and rewards irresponsible behavior.

    Moreover, H.R. 21 would give these carriers further incentive to write insurance in even higher concentrations in high-risk areas, further exposing the Federal Treasury.

    H.R. 21 is also flawed in that it does not provide coverage for commercial losses, despite the fact that both personal and commercial lines of insurance coverage are affected by catastrophic events. For example, our company's commercial hurricane exposures in Florida and Alabama are nearly as large as our personal lines exposure. Our personal lines exposure is $1.7 billion; commercial, $1.5 billion. We believe that there is simply no logical reason why commercial risks should be excluded under H.R. 21.
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    Let me try and quickly conclude this.

    While we have a number of concerns with H.R. 21 as presently drafted, we see little chance for the bill to gain industry-wide support unless the unreasonably low triggers are addressed. I have outlined a proposal for raising the trigger in my written testimony, and I will simply refer to it by reference, and let me just quickly conclude.

    We do not disagree——

    Chairman LEACH. Excuse me. What is your trigger?

    Mr. GILLIAM. OK. We would propose a trigger formula that was discussed last year in hearings before this committee by the Reinsurance Association. It would be a three-component trigger that was suggested along the lines of a conservative rule of thumb often used by insurers, which is the following:

    The first component would be an amount equal to 5 percent of industry surplus, an amount which insurers routinely retain for cat losses in the normal course of business. Under today's surplus of $333 billion, that would equate to $16.6 billion.

    Chairman LEACH. Excuse me. Before you say that, isn't it true that many of those insurance figures relate to lines of insurance that have nothing to do with this particular subject, I mean, automobile insurance? Or is that a fair correlation?

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    Mr. GILLIAM. Well, all—for example, my company, we write home, auto, business, life, all of our surpluses considered together. So it is the financial wherewithal of the entire company.

    The second component would be another 5 percent of surplus which equals the amount of exposure which insurers routinely transfer to reinsurers or to other risk-bearing mechanisms. That would be another $16.6 billion based on today's surplus levels.

    The third component would be an amount equal to another 2 percent of surplus to allow for the further development of capital market products. That would equate to $6.7 billion.

    Adding those all together, we would come up with a trigger of $39.9 billion.

    We feel this would be an appropriate trigger which would include residential and commercial coverage, and that it is important that this be considered; because by using surplus and percentages, rather than a static number, the trigger adjusts, based on the financial experience of the industry. This method of calculation and the accompanying dynamic trigger level would take into account private insurance capacity and would avoid a major dislocation of private market capacity in favor of Government intrusion into the marketplace.

    Concluding, we do not disagree that there may be a need for high-level Federal involvement in excess of private market capacity to ensure that Americans are provided with appropriate insurance protection for losses arising from hurricanes and earthquakes and other natural disasters, but if this committee and this Congress are serious about passing legislation to protect policyholders against the perils of natural catastrophes, the legislation ultimately adopted must not encourage Government subsidization of catastrophic risk or supplant the private market for insurance and reinsurance.
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    Unfortunately, H.R. 21, as presently drafted, does not satisfy these minimum criteria. Thank you.

    Chairman LEACH. Thank you, and I thank you all for very thoughtful testimony.

    Let me just begin quickly with Mr. Gilliam. It is almost as if you are critiquing on both sides of the equation. That is, you don't like the bill and then you want to double the bill because you want to include commercial. Do I have that right?

    I mean, no one else here has argued for commercial coverage. You are arguing for commercial coverage.

    Mr. GILLIAM. Well, we have a number of concerns with the bill, as I have outlined, but if it came to a situation where the trigger was raised sufficiently my company would be in a position of, I guess I would say, neutral. We wouldn't jump up and down, but we wouldn't go out and defeat the bill. But we think it is very important that commercial risks be included too, because they are just as vulnerable to catastrophes as residential risks.

    Chairman LEACH. Well, I just—let me point out, it is not inconsistent, but it is an anomaly that you are arguing to double the expanse of coverage at the same time you are arguing against the bill. It is awkward.

    Mr. GILLIAM. That is my legal training. We always say ''It is bad,'' and then we say, ''Here is how we can handle it.''
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    Chairman LEACH. Let me turn to Mr. Hansen, because I think this is very interesting. You are an Iowa company, and you are not the largest company. There are several that are quite a bit larger than you.

    Mr. HANSEN. This is correct.

    Chairman LEACH. Yet you have an interest in this bill. Can you explain how as an Iowa company that this is important to you?

    Mr. HANSEN. We may.

    Chairman LEACH. And the similarly situated companies, is what I mean.

    Mr. HANSEN. Exactly.

    Chairman LEACH. By an Iowa company, I mean a Missouri and South Dakota, and not a mega-company.

    Mr. HANSEN. And, frankly, I think we reflect what a lot of smaller or medium-sized companies are probably going through.

    Although we are domesticated in Iowa and have our headquarters there, we write homeowners' insurance in 27 States in the country; have about 25,000 to 30,000 homeowners that we do business with. These are not large residential beachfront properties, as was testified to earlier, but our average home value is about $77,000. These are typical rural or Middle America kinds of homes.
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    The issue on the table is, these customers are located in many of the areas that we are talking about, that might be subjected to these kinds of risks, whether it is earthquake risk or hurricane risk.

    A company our size or smaller doesn't have the resources available to it to avail itself of; I do not get called on by the capital markets offering me lots of alternatives to create securitized instruments, if you will, because my portfolio isn't that big. So I have got to work within my own capital base and my own ability to judge the risk that I can afford to take on, and if I take on a thousand homes in Florida at an average of $70,000 or $100,000 in value, that is the equivalent of half of my net worth if a major catastrophe hits. And I have got to make judgments about whether I can afford that. And in the end, I can't afford that.

    So I am one of those companies that then withdraws or has to price so aggressively on the premium that I am out of the market in the first place. Customers won't buy from me; they will go to other options, if they are available.

    So from our standpoint, I need stability of reinsurance markets. And this H.R. 21 bill, which has been debated for months and months, has gone through the compromise process, and so forth, has negotiated the various terms, the trigger mechanisms, with all the interested stakeholder groups; and it meets my personal criteria as CEO of GuideOne, as well as the NAII's criteria, of a worthy bill. I need this kind of protection, this kind of stability in the market, if you will, to allow me even the option to consider making homeowners' insurance available in these markets, and likewise, my associates who run smaller companies. Without it, we are basically out of the market.
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    Chairman LEACH. Thank you. That is very interesting.

    Let me turn to Mr. Miller for a second. One, you comment that this bill will increase the regulation of insurance at the Federal level, but it is a voluntary option for States and companies. I think it would be fairly true to say it increases the role of the Government to the extent that role implies a little bit of regulation, but there is a major voluntary component to this, isn't there?

    Mr. MILLER. That is correct, initially. I think our concerns are less with the bill as it is proposed today, but the bill as it would be enacted and implemented several years down the road.

    I think this committee has had long experience with other programs which started out promising to be restricted, not open-ended, and not have all of these additional liabilities. We have to understand the inherent political dynamic of injecting the Federal Government, with all of its good intentions, but also its massive wallet, through the taxpayers, in a manner where we may end up with a very different environment several years down the road. In the same way that Deputy Secretary Eizenstat was asking for increased flexibility in the pricing under this, we have got to imagine what the situation will be five or ten years down the road in a different environment, once we have set in motion what is supposed to be a restrained program, and I think we have got a long experience suggesting that.

    Chairman LEACH. I think you have a fair warning. In fact, auctioneers like to say that, ''fair warning.'' I think you could pound your gavel on that and it would be a fair statement.
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    You also point out that we do have capital markets that are developing, and that that is not insignificant, and I agree with that. On the other hand, there is a possibility that by this particular type of approach that we will be growing more capital markets on the private side, that is, that this Federal intervention will be of a nature that will spur capital markets.

    Now, would any of you like to comment on that? Do you think that is pie in the sky, or do you think that it is the other way around?

    Mr. MILLER. Just to follow up, I would tend to go in the other direction. There has been a tendency for some of the evolution of the capital instruments to be perhaps not stalled, but hovering over it is the entire specter of: Is there going to be a Federal program? What will be the terms of it? And particularly the alliance of some major insurers deciding that that is the better horse to back politically suggests that there is less enthusiasm or potential for a private capital market solution.

    I think that private capital is the long-term answer to this in terms of the capital markets, and we are going to see some rapid development.

    Chairman LEACH. Let me ask Mr. Hansen, would you agree with that?

    Mr. HANSEN. Not necessarily.

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    Chairman LEACH. Do you think that private participation would spur a greater private interest in larger markets that don't exist before? And I ask you this because it relates to the question I asked Mr. Pike, that it strikes me that there is a little bit of apples-and-oranges to statistics; that is, it is true that insurance companies have major pockets in many ways, but it is also true that many don't choose, like your company, to enter markets because you want stability and you want protection and therefore you are not going to apply the pockets that you have unless there is a certain kind of arrangement which you can have confidence in.

    So that relates back to if there is—I mean, in the first instance, it seems like a logical inconsistency that a Federal role can spur a private market, because a Federal role is preempting, but where there are markets that are unserved, isn't it the case that a Federal role could expand the private market in such a way that a prudential company might be more likely to participate than they would otherwise?

    Mr. HANSEN. I think there is a role. What CEOs worry about is managing risk all the time—financial risk, business risk, all sorts of risks like that—and to the extent that certain kinds of risks like we are talking about here in H.R. 21, are dealt with in ways that we can understand how they are being dealt with, that the bill outlines—for instance, in this way, there is now stability rather than instability in an element of risk we had before that was unstable—if the capital markets were, in fact, functioning and able to handle this risk, I think we would have seen many more instruments not only created and talked about, but actually executed in the public markets or capital markets than we have today. And by virtue of the fact that instruments are not showing up in the capital markets, that leads me to believe that, one, that is evidence that, in fact, the capital markets aren't prepared to take on this kind of risk—don't know how to take it on, can't find investors for this kind of risk.
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    So that would be just one indication, if you will, for me that if we can provide some high-level stability, as H.R. 21 provides, and take some of that risk away. And again it is not a risk that is being subsidized, in my opinion, as the testimony that was given before, it is not being subsidized by the Government; it is a self-funded risk, if you will. Premiums are going into this reinsurance instrument from the industry itself. So it is not ultimately going to be money out of the Treasury, but it provides the stability that would allow other capital market instruments to be created and work around this top-level instrument, if you will.

    I could draw the analogy of home mortgage lending. When the Government would support that program, we found a very vibrant secondary market began to be created that funded billions and billions and billions of dollars of home mortgage instruments, if you will, and it flourished through programs like the VA and FHA, and so forth.

    Chairman LEACH. Fair enough.

    If Mr. Hill would allow me the discretion of one more question?

    Mr. HILL. Of course.

    Chairman LEACH. There is a question that has been raised, principally by Mr. Gilliam, of what the trigger level should be, and one might argue $2 billion is too low. Mr. Gilliam has come up with a figure of $39 billion, which strikes me as two figures not quite in the same ball park; I mean, that these are two very different magnitudes of where one could be.
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    Would you have a recommendation, Mr. Hansen?

    Mr. HANSEN. The trigger issue here is probably going to be one of those political tradeoff kind of discussions. As Mr. Weber testified earlier, there are really three components to the trigger: $2 billion all the way up to the 1-in-100-year event kind of trigger and then in between whatever States funds might be available to handle the unique State situation.

    The compromise, if you will, that has been worked over and drafted as currently in this legislation, I think, is absolutely acceptable and appropriate; and in our opinion, both in the NAII and speaking for my company, works very well.

    To the extent that your committee and Congress will have to draw some compromises along the way, some of that might be open for discussion, but I think when we start getting up into things like 250-year events, $39 billion kinds of trigger calculations, the devil is in the details, and look at the details before quickly going to those higher amounts.

    Chairman LEACH. Well, I appreciate that.

    All I must say is that now and again the associations bring in people from my State, and I am always astonished what quality people they bring.

    Mr. Hill.

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    Mr. HILL. Mr. Chairman, it is a mystery why people would bring folks from Iowa to come and testify before your committee, I am sure.

    Mr. Hansen, do you buy reinsurance in the private marketplace?

    Mr. HANSEN. Yes, we do.

    Mr. HILL. Have you been unable to buy as much reinsurance as you would want to buy?

    Mr. HANSEN. We buy as much as we believe our risk requires. So we measure up our total risk in our portfolio and go out into the private markets and try and buy as much as possible to cover the risk we have on our book and something that allows me to sleep a little better on the weekends.

    Mr. HILL. I understand that, having bought reinsurance for an insurance company. But my question really is, have you been unable to buy reinsurance?

    Mr. HANSEN. No.

    Mr. HILL. OK.

    Mr. HANSEN. In the three years I have been CEO of this company, I have not had that experience.

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    Mr. HILL. So the marketplace, as it exists today, has been able to accommodate your need?

    Mr. HANSEN. Yes, accommodate my needs with our company's current risk profile.

    Mr. HILL. Have you sought to buy reinsurance in disaster-prone areas that you have had an interest in entering the market?

    Mr. HANSEN. Yes, we have, for—both on the commercial side and residential side. We have found it difficult and could not—we could not factor in the pricing, if you will, in a way that we thought would be competitive.

    Mr. HILL. So you couldn't recover the price of the reinsurance and offer the product?

    Mr. HANSEN. More difficult for certain kinds of coverage, yes.

    Mr. HILL. This issue with regard to triggers I find a most interesting issue, because in the debate we had today there are some people that believe that H.R. 21 has a $7 billion trigger for Florida; some believe it has a $14 billion trigger for Florida; and Mr. Weber testified that it has a $21 billion trigger for Florida. That tells me that the bill isn't particularly concise with respect to defining a trigger.

    Would you agree with that, Mr. Hansen? Which trigger do you believe is the correct trigger?
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    Mr. HANSEN. I don't know.

    Mr. HILL. Mr. Gilliam.

    Mr. GILLIAM. Well, I have another number. The latest figures from the Florida hurricane cat fund say a 1-in-100-year event in Florida is $19 billion.

    Mr. HILL. OK. Good. Now we have four.

    All that says to me is that we need to look at that. But what I do see is Mr. Weber saying it is $21 billion, believing that that is an appropriate number. You say $19 billion. Maybe, in fact, we can actually write a bill that would define it at a level—I would be more willing to support a bill that I thought was at a $20 billion level than a $7 billion level. That is one of the concerns that I have.

    The Chairman made a point, I think the most significant point of this whole debate.

    Ms. Connery, you are here saying you need more insurance so people can insure their homes, and I agree with that. The question is, what do we do to get insurance companies to allocate their capacity to risk? That is what the question here is about.

    There is $75 billion, maybe $100 billion, worth of surplus capacity in the insurance industry, and people aren't willing to put it to this purpose. And the reason for that, I think, is that the idea that I think Mr.—the gentleman, Mr. Pike, from Allstate said the insurance industry seems not to be able to price low-frequency, high-severity risks.
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    But I remember hearing this debate twenty years ago in liability insurance, too, where people said, ''Well, we can't write professional liability and we can't write product liability and we can't write general liability and we can't write environmental liability, because these are risks that occur rarely and they are very severe.'' But we worked around that by creating financing mechanisms incurred but not reporting loss reserves, which is, in essence, prefunding of claims.

    Mr. Gilliam, I would ask you to comment, and maybe you, Mr. Hansen. Since two-thirds to three-fourths of catastrophic losses are paid by primary insurance, isn't part of the solution creating a mechanism for the primary insurance companies to set aside reserves today to pay future claims on property claims as we allow them to do on liability claims?

    I would ask you—Mr. Gilliam first, and then Mr. Hansen and Mr. Miller and Ms. Connery—if you would each answer that.

    Mr. GILLIAM. My company would agree with that, and we would put it in what we call the mosaic of solutions. There are a number of things that need to be addressed to solve this problem: mitigation and the idea or concept that you put forth of allowing property and casualty insurance companies to put aside on a tax-deferred basis their own reserves to be held for future mega-catastrophes.

    Right now we are not allowed to put aside the portion of premium you pay for a cat risk right now and hold it for that future event. The tax laws and the accounting laws don't allow us to do that. We would favor a proposal that would allow us to do that.
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    But let me also add that—and, again, Mr. Chairman, you questioned me on, you know, bashing the bill and then saying, ''But if you do this, it is OK,'' and we all know that Washington is a town of compromise; but in some respects, we view the concept embodied in H.R. 21 as kind of a Band-Aid. And the proposal Mr. Hill is talking about, of allowing us to put aside reserves for the future as a cure, there is a short-term problem and there may be elements of H.R. 21 that could address that; but we think it is important that this cat reserve idea be looked at very closely and given good attention by Congress.

    Mr. HANSEN. H.R. 21 is on the table today and it has gone through an elaborate process of evaluation and negotiation to get where it is today. The notion of prefunding is a good notion. The notion of setting up a mechanism by which we can anticipate the future in some way has merit, in my opinion. It is another in an array of instruments, if you will, that a company can use to deal with the issue.

    Then again, I go back to the notion of, if it is taking this long for H.R. 21 to get to the table, if H.R. 21 were put to the side in order to now debate a prefunding concept—we are now into a one-year, two-year, three-year kind of debate process, and then nothing has moved forward—I would argue since H.R. 21 is as close as it is, let's move forward with that, but not then not address a prefunding concept that may come on the heels. It is part of how the private markets can respond to this issue in the longer term.

    Mr. MILLER. We believe that tax-deferred cat reserves are an essential first step before enacting an H.R. 21-type of approach, and we need to strengthen the capacity of the primary market first.
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    Our tax policies have made it much more difficult to do that in a proper way, and it is essential that we address that as soon as we can.

    Ms. CONNERY. I think that the Association of Realtors feels that, first and foremost, we need a solution that makes insurance both affordable and available to homeowners in catastrophe-prone areas. While prefunding certainly is something that we should look at, we are very concerned that this approach might not as effectively promote the availability and affordability of insurance, and I would certainly echo what Mr. Hansen just said.

    It has taken H.R. 21 a couple of years anyway to get as far as it has gone, and if we start from scratch, we are now probably a minimum of two or three years out before we come to this point again; and I am not sure, at the rate that companies are still pulling out of the coastal area of North Carolina right now—we have three companies out of 200 licensed in our State that will even talk to us about writing homeowners' policies, and these are limited policies; they are not full homeowners' policies—I don't know that we have got, in many areas of the country, three more years that we can wait without a real serious housing crisis occurring.

    Mr. HILL. Mr. Chairman, if you will indulge me for one last question.

    Chairman LEACH. Go ahead.

    Mr. HILL. One of my concerns is that H.R. 21 is a mechanism that will encourage the creating of more State funds and more State pools which are often perceived as short term solutions to the circumstance which you describe, Ms. Connery.
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    We have heard testimony from Mississippi, Louisiana and we have earlier testimony from your State. What usually happens with State funds is it drives out the private companies and the private marketplace which usually requires Government bailouts and it almost always avoids effective mitigation. Frankly, one of the effective mitigations may be that you don't build houses in all of the places that you do today.

    What I see H.R. 21 principally doing is an opportunity for a handful of insurance companies to transfer their risks to the U.S. Treasury, which is what has occurred in the Florida pool and the California Earthquake Authority. There has been a transfer of risk from the private sector to the public sector.

    I would ask you, Mr. Gilliam and Mr. Miller, if you agree with that assessment, and if so what can we do with H.R. 21, working within the context of H.R. 21, to make sure that it doesn't do what I have just described?

    Mr. GILLIAM. Congressman Hill, a thought that we have had, right now there are three State funds in the country, Florida, California and Hawaii has a facility. A thought that we have had, why don't we limit H.R. 21 to existing State funds, that way it will not encourage the creation of more State subsidies for insurance and allow other solutions to this problem to have time to bubble up and go through this same process.

    Mr. HILL. Mr. Miller.

    Mr. MILLER. Within the limits that you have set that is difficult as the bill is designed to help out the State funds.
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    I would note that we play by two different sets of rules with private insurers as opposed to the State funds. The State funds have the tax advantages that we have talked about that the private insurers need. They also get to cap their exposure. Whereas the private insurers are worried about going insolvent and bankrupt, the State funds will limit their risk. They will have much more restrictive coverage in some cases than private insurers have. So we don't necessarily have them competing on the same scale. That is part of the problem in getting more private insurance capacity into some of these areas, in addition to the rate effects that occur from the subsidization.

    Mr. HILL. It is an important point that you make, that the California fund and the Florida fund and the cap reserve created by this would all allow for prefunding of the losses and so it would be in essence saying we would advantage the private sector over the public sector. We can't do it for the private sector, but we can do it for the public sector. That is one of the objections that I have.

    Thank you, Mr. Chairman, and I thank the panel. It has been very enlightening.

    Chairman LEACH. Thank you. I appreciate the variety of the panel and the observations. I would only stress that I think Rick has a legislative approach that is extraordinarily credible, but it is not precisely a substitute. It could be a substitute, or it could be an add-on to a program like H.R. 21. But obviously from this committee's jurisdiction it doesn't fit. We don't control taxes. But beyond that, we have had the United States Treasury testify today that they would object to it, and so that means even if you had a couple of years, you have a probable veto. It also means that one aspect of the Treasury that is a little different than some Government departments, the Treasury is the Treasury of a nature that is kind of true of all administrations. That is that when you switch political parties, you don't suddenly have a different Treasury position. It takes a lot to move Treasury.
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    So as much as this might be a good alternative or a better alternative, I am not sure that it is a credible alternative at this time, and certainly for the next couple of years.

    Mr. HILL. Would the Chairman yield on that point?

    Chairman LEACH. Of course.

    Mr. HILL. I think the Deputy Secretary did leave open the door to a discussion; and ironically it could be that H.R. 10 will generate the revenue source that could be used to offset the tax offsets that would be necessary to fund deferred tax reserves, so it may be more feasible than we think.

    Chairman LEACH. We can be hopeful, but I am not sure that is exactly what I heard from the Deputy Secretary. In any regard, we can all go back and look precisely at what he said. That leaves us with H.R. 21.

    I will only say that we will take together all of the comments that have been made today and I will review the testimonies that I wasn't here to listen to. We will then talk to all of the Members of the committee and see if there is a consensus to move in, recognizing that an issue like this will never get unanimity, and we will see where we are come the end of the August break.

    In the meantime, I am going to ask staff to review with Treasury where they are, review ideas suggested today, and we will see if we can get a basis for a bill that might credibly be received by the full House.
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    I want to thank you all very much and indicate a particular appreciation of those of you who came from long distances. The hearing is adjourned.

    [Whereupon, at 3:25 p.m., the hearing was adjourned.]