A catastrophic battle: some major players in the insurance industry say it's time the federal government provides protection against 'mega-catastrophes.' But a plan in Congress to create a federal backstop to state catastrophe funds continues to face an uphill climb.

It's April in Washington, and the jogging paths that line the Potomac are strewn with white and pink petals, the last remaining notes of the symphony of color produced each spring by the city's famous cherry blossom trees.

By sheer coincidence, the blossoms appear a near-identical match to the complexion of the man who strides to center stage underneath the dome of the cavernous Washington Convention Center, the hot overhead lights magnifying his shock of white hair and ruddy skin tones. Taking his seat among his fellow titans of the insurance industry, he peers out at the assembled throng of more than 1,000 insurance agents from across the country.

His name is Edward Liddy, and he is a man on a mission.

Today's mission is to represent his company--Allstate Corp., the nation's largest publicly traded personal-lines insurance carrier--in a panel discussion convened before the Independent Insurance Agents & Brokers of America's annual convention. But the long-term goal, the one that has been bringing him back again and again to the nation's capital, is the mission that has consumed much of his time this past year: winning another ally in the fight to create a federal backstop to natural catastrophic risks.

Liddy recognizes the IIABA as crucial to bringing that goal to fruition. Among the largest insurance lobbies in Washington, many pieces of insurance-related legislation have been known to rise or fall based on the agents' support or opposition. But with the industry still divided on the issue of a federal backstop--among today's panel, an executive from Liberty Mutual, a fellow member with Allstate of the Property Casualty Insurers Association of America, expresses the company's skepticism of the plan--the agents have been leery to pick any one side just yet.

"This issue is very important to our members, who need to be sure that affordable insurance remains available" said Robert Rnsbuldt, the group's president. "Our position is, look, we will stand with you in this fight. But the industry has to come together first. If it's a national backstop, if it's the [tax-free] reserving issue. We'll be with you, but you have to decide what it is that you want."

An Industry Divided

Allstate's support for the concept of a federal reinsurance facility predates Hurricane Katrina. In 1999, the company was a major booster of a backstop bill sponsored by former Reps. Rick Lazio of New York and Bill McCollum of Florida. But when catastrophes as big as Katrina befall companies as big as Allstate, the risks are certainly magnified. The company suffered $3.68 billion in pretax losses from the storm, and took a quarterly net loss of $1.55 billion. In response, it has restructured its book of business nationwide, seeking rate increases, pulling out of areas it deems poor risks, withdrawing virtually all earthquake coverage, and vastly expanding its reinsurance coverage.

But Liddy is careful when discussing the issue to emphasize that he sees it as bigger than dollars and cents. To him, the issue is, like mom and apple pie, about core American values, and in particular, the American dream of home ownership. It's a dream he sees as threatened by larger storms, growing catastrophe exposures, unaffordable or unavailable reinsurance, all driving a trend toward pressures on homeowners insurers, and ultimately, homeowners themselves.

"We'd like to expand the coalition, because of course, it's not just an insurance issue," Liddy said. "It benefits anyone who benefits from a robust real estate market--real estate agencies, banks and mortgage lenders--so, it should be a broader coalition. You see what's happening in New Orleans and the Gulf Coast, where people had 80% mortgages and lost all of their equity. The homes are not worth anything. So where is the money going to come from?"

Whatever the answer to that question might be, it ought not be the federal government, argues William R. Berkley, founder, chairman and chief executive officer of the W.R. Berkley Corp., and one of a number of major insurers who have come out squarely against the backstop concept.

"When we rely on the government to provide protection in any kind of exposure that has predictability and modeling as an alternative, you do away with the economic rules that cause appropriate action by consumers," Berkley said. "The best example is that people have their houses destroyed by hurricanes, and they rebuild. People build in places they know are dangerous and not safe, but they can buy insurance at prices that are silly."

Berkley concedes that it is theoretically possible that some natural risks could be so potentially large that they would exceed the ability of the industry to pay claims, but insists that any sort of government program to backstop such risks ought be done on "an economically viable basis," something he says both state and federal programs have shown little ability to accomplish.

"Look at what's happening [now]. You have regulators rejecting rate increases. You have states effectively providing homeowners insurance in the [Fair Access to Insurance Requirements] plans and state-sponsored insurance companies," Berkley said. "What would end up happening is that the states would create these sponsored insurance companies and then have the right to tap the taxpayers of the country. The nature of the political process is to avoid a problem for as long as you can, and that usually means that you wait until you have a crisis."

The Battle for Capitol Hill

Carrying the ball in Congress for a federal backstop is a sophomore Republican from Florida named Ginny Brown-Waite. Generally regarded as soft-spoken and nonpartisan, her eyes nonetheless can blaze red when it comes to the issue of rapidly escalating homeowners rates faced by her constituents back home.

"Come to my district and talk to my neighbors and ask them if they think their insurance rates are being suppressed," she said. "They can barely keep up."

Brown-Waite is the primary sponsor of H.R. 4366, establishing an entity called the Consumer Hurricane, Earthquake, Loss Protection Fund to cover purchasers for eligible losses, as well as to cover operating costs and reinsurance program administrative expenses. The bill is the congresswoman's second attempt this session to address the natural disaster issue, having previously introduced, with little success, H.R. 846 Homeowners Insurance Protection Act.

But buoyed by concerns about Hurricane Katrina, the newer bill has been building some momentum. In June, it was the subject of hearings before a house subcommittee of the House Financial Services Committee. And in addition to earning support from insurers such as Allstate and State Farm, it also has backing from many members of the National Association of Insurance Commissioners, which has been working to craft its own plan.

"If we can offer catastrophic reinsurance at the national level without using taxpayer dollars, continuing to build up a good reserve there, I think it just makes sense," Brown-Waite said. "It will translate into lower premiums for the insured. And it's not just a Florida issue. It's an issue for any state that has recently experienced natural disasters."

She added that hurricanes are far from the only events of concern. In an article published this spring, researchers at the Scripps Institution of Oceanography suggested that movements along the San Andreas Fault suggest it could be near the end of its dormant cycle, and that Southern California should prepare for a massive earthquake at some point in the next decade.

And yet, while 35% of California homeowners had earthquake insurance when the Northridge quake hit in 1994, that number has fallen to just 14% to 15% today. The low take-up rate explains part of why a recent study by Risk Management Solutions found that a repeat of the 1906 San Francisco quake would cause $260 billion of property damage in today's dollars, of which only $50 billion to $60 billion would be insured, most of it for the massive fire that followed the quake.

A Question of Capacity

Brown-Waite's legislation builds greatly upon the catastrophe plan model enacted in Florida in 1993 in the wake of a major flight of insurance capacity from the state following Hurricane Andrew. Premiums paid by the state's homeowners insurers to the Florida Hurricane Catastrophe Fund are significantly lower than those for comparable private reinsurance, often one-quarter to one-third the price, which most attribute to the fact that it is nonprofit and does not face the same risk-load costs that private reinsurers do.

Whether this cheaper cost is a desirable outcome depends upon whom you ask. Proponents of the concept, such as economist Robert Litan of the Brookings Institution, point to the low-risk load as the greatest advantage of public catastrophe funds. Unlike private reinsurers, who must raise capital before an event transpires and face constant pressures to deploy that capital in the most profitable ways, governments do not face "timing risk." They can issue post-event bonds to cover any shortfalls, and unlike private reinsurers, do not need to fear new market competitors looking to draw business away from firms that face "legacy costs," Litan notes.

But reinsurers and many primary insurers note that, in practice, such bonds have been financed largely by way of assessments on other lines of business, such as premiums for automobile insurance and commercial insurance. The effect, argue groups such as the Reinsurance Association of America and the American Insurance Association, is to cross-subsidize homeowners' risks and force other policyholders to bear a portion of those risks.

"To subsidize the insurance costs for someone who has a $1 million house is a joke," notes Berkley, himself the owner of a home in Palm Beach. "If you want to subsidize the rates under, say, $300,000 or so, the aggregation of value in those prices is a lot smaller."

Moreover, argues the RAA, the U.S. primary insurance industry earned $45 billion in profit for 2005, despite the fact that the year's record 27 named storms caused $80 billion in insured losses. And since late fall, approximately $21 billion in new capital has entered the industry, with $7.5 billion invested in new start-up reinsurance companies.

Commission a Study

With consensus on the issue difficult to achieve, the legislative solution perhaps most likely to see enactment in the short term is a comprehensive study of the various proposals, an approach favored by IIABA, among others. In June, the NAIC adopted a resolution supporting a federal commission to study ways to manage the economy-wide risk of catastrophic natural disasters, and bills proposing exactly that have been moved in the Senate by Sen. Bill Nelson and in the House by Rep. Debbie Wasserman-Schultz, both Florida Democrats.

Liddy notes, however, that political calculus could change quickly should another Katrina-sized event occur this hurricane season.

"Obviously, you don't want to see it, but the thing that might end up being the driver is just if we see another storm year this year like the last couple," Liddy said. "We hope that doesn't happen, but ff it did, and the scientists are predicting it will, I think you'll see a lot more support for our bill."

Editor's Note: On Sept. 18, 2006, Edward Liddy announced he would be stepping down as chief executive officer of Allstate at the end of the year.

Key Points

* Allstate, State Farm, congressional representatives from Florida and New York, realtors and others in the building industry, and some state regulators lead the push for a federal backstop to major natural catastrophes.

* The strongest opposition to the concept has come from reinsurers and a number of primary insurers.

* Political momentum for the concept may be building, but only very slowly.

Homeowners Insurance Protection Act of 2005 ( H.R. 4366)

* Instructs the Treasury Department to establish the National Commission on Catastrophe Preparation and Protection, which would advise the treasury secretary on estimated loss costs associated with contracts for catastrophe reinsurance coverage.

* Prescribes criteria for eligibility of state and regional catastrophe programs to purchase reinsurance from the federal government, requiring that the coverage be provided against residential property losses to homes, condominiums, cooperatives and apartments.

* Sets a minimum level of retained losses of $25 billion and maximum federal liability of $200 billion.

* Establishes the Consumer Hurricane, Earthquake, Loss Protection Fund to pay for eligible losses, operating costs and administrative expenses.

Hypothetical Super Earthquakes

Insured Loss: $140 Billion+

Total Economic Loss: $500 Billion+

* A major rupture of California's Puente Hills fault, which was only discovered in 1999, is capable of producing a loss greater than a recurrence of the 1906 San Francisco earthquake.

* Most of the damage would not be insured

Insured Loss: $150 Billion+

Total Economic Loss: $300 Billion+

* A major earthquake in the central Mississippi Valley would affect a much larger area than the same magnitude earthquake in California.

* Older, more vulnerable building inventory would result in extensive injuries and fatalities as well as property damage.

Source: AIR Worldwide Corp.

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Super Catastrophes--Hypothetical
Northeast and Florida Hurricanes

                                                        Property Loss
Modeler   Landfall                       Strength          $ Billions

Northeast Hurricane

AIR       North of Atlantic City, N.J.   CAT 4                  > 110
EQECAT    New York, N.Y.                 Weak CAT 4         95 to 110
RMS       New York, N.Y.                 CAT 4                  146 *

Florida Hurricane

AIR       Miami                          CAT 5                  > 140
EQECAT    Miami to Palm Beach            Strong CAT 4       95 to 130
RMS       Miami                          Strong CAT 4           118 *

* Estimates are before introduction of new model.

Sources: A.M. Best 2006 Hurricane Study, AIR Worldwide Corp.,
Eqecat Inc., Risk Management Solutions Inc. (RMS).