    [Senate Hearing 106-1109]
    [From the U.S. Government Publishing Office]

                                                           S. Hrg. 106-1109

       S. 1361, THE NATURAL DISASTER PROTECTION AND INSURANCE ACT OF 1999

    =======================================================================

                                    HEARING

                                   before the

                             COMMITTEE ON COMMERCE,
                          SCIENCE, AND TRANSPORTATION
                              UNITED STATES SENATE

                           ONE HUNDRED SIXTH CONGRESS

                                 SECOND SESSION

                                   __________

                                 APRIL 13, 2000

                                   __________

        Printed for the use of the Committee on Commerce, Science, and
                                 Transportation

                                     ______

                         U.S. GOVERNMENT PRINTING OFFICE
                                WASHINGTON : 2003
    80-582 PDF

    For Sale by the Superintendent of Documents, U.S. Government Printing Office
    Internet: bookstore.gpr.gov  Phone: toll free (866) 512-1800; (202) 512-1800
    Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001

           SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION

                           ONE HUNDRED SIXTH CONGRESS

                                 SECOND SESSION

                         JOHN McCAIN, Arizona, Chairman
    TED STEVENS, Alaska                  ERNEST F. HOLLINGS, South Carolina
    CONRAD BURNS, Montana                DANIEL K. INOUYE, Hawaii
    SLADE GORTON, Washington             JOHN D. ROCKEFELLER IV, West
    TRENT LOTT, Mississippi                  Virginia
    KAY BAILEY HUTCHISON, Texas          JOHN F. KERRY, Massachusetts
    OLYMPIA J. SNOWE, Maine              JOHN B. BREAUX, Louisiana
    JOHN ASHCROFT, Missouri              RICHARD H. BRYAN, Nevada
    BILL FRIST, Tennessee                BYRON L. DORGAN, North Dakota
    SPENCER ABRAHAM, Michigan            RON WYDEN, Oregon
    SAM BROWNBACK, Kansas                MAX CLELAND, Georgia
                      Mark Buse, Republican Staff Director
                Martha P. Allbright, Republican General Counsel
                   Kevin D. Kayes, Democratic Staff Director
                      Moses Boyd, Democratic Chief Counsel

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on April 13, 2000...................................     1
    Prepared statement of Senator Hollings...........................     3
    Prepared statement of Senator Inouye.............................     4
        Letter with attachment from Amori R. Ogata to Senator Stevens     4
    Statement of Senator Stevens.....................................     1
        Prepared statement...........................................     2

                                   Witnesses

    Brown, Charles T., Vice President, Baker, Welman, Brown Insurance    62
        Prepared statement...........................................    65
    Eizenstat, Hon. Stuart E., Deputy Secretary, Department of the
      Treasury.......................................................     5
        Prepared statement...........................................    13
    Gilliam, Scott A., Director, Government Relations, The Cincinnati
      Insurance Companies............................................    71
        Prepared statement...........................................    74
    Hunter, J. Robert, Insurance Director, Consumer Federation of
      America,
      prepared statement.............................................    28
    Keating, David L., Senior Counselor, National Taxpayers Union....    18
        Prepared statement...........................................    20
    Nutter, Frank W., President, Reinsurance Association of America..    36
        Prepared statement...........................................    38
    Plunkett, Travis, Legislative Director, Consumer Federation of
      America........................................................    26
    Weber, Jack, President, Home Insurance Federation of America.....    49
        Prepared statement...........................................    53
        Notes from GAO Report........................................    58

                                    Appendix

    Alliance of American Insurers, prepared statement................    81
    America's Community Bankers, prepared statement..................    82
    Graham, Hon. Bob, U.S. Senator from Florida, letter dated April
      7, 2000, to Stuart E. Eizenstat................................    81
    Hageman, John, Texas State Executive Officer and President, Texas
      Farmers Insurance Companies, prepared statement................    84
    National Association of Realtors, prepared statement.............    88
    Nevins, Louis H., President, Western League of Savings
      Institutions...................................................    89
    Reinsurance Association of America, letter dated April 21, 2000,
      to Senator Ted Stevens.........................................    87

       S. 1361, THE NATURAL DISASTER PROTECTION AND INSURANCE ACT OF 1999

                                  ----------

                            THURSDAY, APRIL 13, 2000

                                           U.S. Senate,
            Committee on Commerce, Science, and Transportation,
                                                        Washington, DC.
        The Committee met, pursuant to notice, at 2:52 p.m., in
    room SR-253, Russell Senate Office Building, Senator Ted
    Stevens presiding.
        Staff members assigned to this hearing: Robert Taylor,
    Republican Counsel; and Moses Boyd, Democratic Chief Counsel.

                OPENING STATEMENT OF HON. TED STEVENS,
                        U.S. SENATOR FROM ALASKA

        Senator Stevens. I am pleased to be able to hold this
    hearing on one of the most overlooked and potentially
    devastating subjects, that I feel exist in this country, the
    issue of natural disaster insurance is not a new issue for this
    Committee of the Congress. Senator Inouye and I have tried to
    build a consensus to do something to protect homeowners from
    natural disasters for some time, starting with the 103rd
    Congress. There have been a total of 11 hearings, including
    today's.
        I am not going to read this long statement; I'll put it in
    the record, but let me just close by saying I am sure that
    everyone realizes that one of the most powerful earthquakes
    ever to hit this continent was the one that hit Anchorage on
    Good Friday in 1964.
        My family and I lived through that quake. It left a
    permanent impression on me and all of us in Alaska, and we
    believe that something must be done to encourage state and
    local governments to adopt litigation strategies, and provide
    them with the funds derived from private industry to develop
    those strategies in order to try and share the burden of the
    many, many disasters of that type.
        We introduced this bill to secure affordable protection
    from natural disasters for homeowners; a resource pool to cover
    the cost of major catastrophes, and a way for the government,
    commercial insurance and consumers to participate in providing
    a hedge for homeowners, to industry and government if such a
    natural disaster occurs.
        I appreciate the time that you have all allocated to come
    and help us make a record again this year. Again, I apologize
    for those three unexpected votes, but I look forward to your
    testimony. Stu, I know that you have been at this for a long
    time, too; so we welcome your comments.
        [The prepared statement of Senator Stevens follows:]

                    Prepared Statement of Hon. Ted Stevens,
                            U.S. Senator from Alaska
        I'm pleased to hold this hearing to address one of the most
    overlooked and potentially devastating subjects facing this country.
        The issue of natural disaster insurance is not a new issue to the
    Committee and Congress. It has been studied many times.
        Senator Inouye and I have tried to build consensus to do something
    to protect homeowners from natural disasters.
        Starting with the 103rd Congress, there have a been a total of
    eleven hearings, including today's.
        During recent hearings on a similar measure in the House, there was
    considerable support for a government reinsurance program to deal with
    natural disasters.
        Our witness, Deputy Secretary Mr. Eizenstat is aware that my staff
    is working with Treasury to address some of the Administration's
    concerns. They merit our attention and hopefully we will be able to
    accommodate some or all of them as best we can.
        We will continue to work with the reinsurers. I believe that a
    provision to give the Treasury Secretary authority to set minimum
    trigger levels between $2 million and $5 billion as adopted in the
    House is possible.
        In my judgment, the reinsurers should have the opportunity to match
    terms and conditions of reinsurance contracts sold to state programs.
    Having said that, we should review whether we should include some
    provision to accommodate smaller states and small programs such as the
    Hawaii Hurricane Relief Fund.
        Every year, an area of our nation is devastated by a natural
    disaster and before we can recover from it, there is another tragedy in
    another area. I believe we must confront this issue and do all we can
    to protect the American people.
        Over the past decade, hurricanes have caused billions in damage to
    property. In the past year, hurricanes Dennis and Floyd tormented the
    entire eastern seaboard of the United States.
        Hurricane Floyd could have struck the mainland packing winds of 155
    mile per hour. According to the Disaster Relief Organization ``Floyd
    could have been the most powerful hurricane to strike the United States
    mainland this century'' where Hurricane Andrew left 160,000 homeless
    and caused over $26 billion in damages, Floyd could have been much
    worse.
        Alaska has three times more quakes than California. Alaska had at
    least nine quakes of 7.4 magnitude or more on the Richter scale since
    1938.
        The 1964 Good Friday quake was one of the world's most powerful at
    a magnitude of 9.2. My family and I lived through that quake. The earth
    shook for seven minutes.
        Most quakes last under two minutes. For example, California's
    Northridge quake lasted about thirty seconds.
        The Alaska quake destroyed the economic base of entire communities.
    Whole fishing fleets, harbors, and canneries were lost. The shaking
    generated catastrophic tidal waves. The effects of the quake were felt
    as far away as San Diego and Hawaii.
        Experts predict that a quake this size in the lower 48 would kill
    thousands and cost up to $100 billion. This is not improbable,
    especially in California or in the new Madrid fault line.
        When natural disasters have occurred, the federal government has
    had to bear much of the cost.
        According to an article in the Washington Post,

            Recent federal research suggests that because of migration [to
            the coasts] and housing development trends, future storms and
            earthquakes have the potential to cause $20 billion or more per
            event in heavily urbanized areas . . . a powerful hurricane
            making a direct hit on the New Jersey-New York coastline could
            produce $52 billion in insured property claims. A New Madrid
            category earthquake near Memphis could cause $69.7 billion in
            claims.

        I introduced a bill in order to secure affordable protection from
    natural disasters for homeowners, a resource pool to cover the cost of
    major catastrophes, and a way for government, commercial insurance, and
    consumers to participate in providing a hedge for homeowners, the
    industry and government if a natural disaster occurs.
        S. 1361 establishes a program for state insurance pools, programs,
    private insurers and reinsurers to buy reinsurance for natural
    disasters from the federal government.
        These entities would pay reinsurance premiums that are allowed to
    grow into a reserve to cover future losses if needed. The reinsurance
    is sold on a regional basis with the premiums based on risk.
        This bill also encourages states and local governments to adopt
    mitigation strategies and provides them with funds derived from the
    private industry to develop them.
        The $200 million mitigation figure at page 78 of the bill, as
    introduced, contains one too many zeroes--$20 million would be used
    from premiums for natural hazard mitigation.

        [The prepared statements of Senator Hollings and Senator
    Inouye follow:]

                Prepared Statement of Hon. Ernest F. Hollings,
                        U.S. Senator from South Carolina
        The underlying purpose of the legislation which is the subject of
    today's hearing is to reduce federal disaster costs by encouraging
    hazard mitigation and creating a mechanism to ensure the availability
    of property insurance for persons living in areas prone to natural
    disasters. I must say this is a laudable goal, and one that I can
    appreciate as a resident of a coastal state.
        As I indicated at previous hearings on this issue, I can definitely
    appreciate the concerns about natural disasters. Over a decade ago,
    South Carolina was struck by one of the costliest storms of the
    century--Hurricane Hugo. Hugo caused approximately 29 deaths, and an
    estimated $6 billion in damages.
        With respect to federal policy, I agree that efforts should be made
    to reform the manner in which the federal government currently handles
    natural disasters. I have always taken the position, however, that one
    of the most effective ways to deal with this issue is through
    mitigation. A sound mitigation program will result in the building of
    safer structures, which will help to reduce structural damage, and in
    turn, disaster costs. Title II of the legislation seeks to address this
    issue. I certainly would like testimony from the witnesses that will
    appear today, and from other experts, on whether the provisions in the
    bill effectively address the issue.
        Of course, the most controversial part of the bill is Title III
    which provides for the creation of the insurance program. The
    legislation allows for the establishment of a special corporation--to
    be comprised of and managed by insurance companies, to provide
    reinsurance to companies and state insurance pools in natural disaster
    prone areas. The reinsurance is to be provided in the form of
    individual contracts. The contracts will be used to pay losses whenever
    total losses from a single event reaches a certain trigger--$2 billion
    is the operative number in the bill. The premiums on the contracts will
    be set by the corporation and are required to be actuarially sound. In
    situations where losses associated with an event exceed the assets of
    the corporation, the corporation is permitted to borrow funds from the
    federal treasury to cover losses. The Treasury Department is mandated
    to make these loans available. The agency is to determine the interest
    rates based on the rates of other government maturities. The
    corporation will have 20 years to repay each loan. The bill also
    includes provisions to encourage states to implement mitigation
    programs. States that failed to do so would be prohibited from
    receiving mitigation funds from the corporation that are provided for
    under the bill.
         A number of groups have raised concerns about the legislation.
    These include the National Taxpayers Union, the Competitive Enterprise
    Institute, consumer groups, and small insurance companies. They argue
    that the Committee should approach the issue pursuant to the following
    questions:

              1. Is there sufficient capacity in the insurance market to
            provide insurance companies reinsurance without federal
            involvement?

              2. Should the federal government be in the business of
            providing favorable loans to an industry that has more than a
            trillion dollars in assets and does the program have the
            potential of exposing federal taxpayers to massive liability?

              3. Should the federal government provide aid to an industry
            that is not subject to antitrust and regulatory federal laws?

        These are legitimate questions to be raised and issues which
    today's witnesses have been invited to address. I must say for the
    record, however, that I am particularly sensitive to the issue
    concerning the federal regulation of insurance companies. For years, I
    have been a supporter of the McCarran-Ferguson Act and state
    regulation. It appears, however, that many in the insurance industry
    want it both ways--preserve state regulation but support federal
    involvement when it's to the industry's benefit. That I cannot support.
    Nevertheless, I am open to trying to put together a good piece of
    legislation that will adequately address the important issues
    concerning this subject. I thank the witnesses for appearing and look
    forward to their testimony.
                                     ______

                 Prepared Statement of Hon. Daniel K. Inouye,
                            U.S. Senator from Hawaii
    Mr. Chairman and Members of the Committee:

        I deeply regret a scheduling conflict will not allow me to attend
    today's hearing. As many of you know, my interest in providing a
    federal program for hazard mitigation and insurance against the risk of
    catastrophic natural disasters stems from the hurricane disaster which
    struck the Island of Kauai in 1992. Both Senator Stevens and I have
    examined various disaster insurance measures for the last several
    Congresses. I wish to commend Senator Stevens for his continued efforts
    on this issue. I remain committed to working with Senator Stevens and
    the Chairman to see a bill favorably reported by the Commerce
    Committee.
        Although S. 1361 will not completely eliminate the federal burden
    of disaster relief or the availability problems of disaster insurance,
    I believe the measure is a needed first step on which to build future
    efforts to provide affordable disaster relief coverage. S. 1361 will
    help to reduce the cost of natural disasters to federal taxpayers by
    promoting private funding of mitigation efforts at the state level and
    by promoting greater availability of private homeowner's insurance in
    areas prone to natural disasters.
        There are several differences of opinion with respect to the $2
    billion threshold established under S. 1361. For example, the $2
    billion threshold is too high for smaller states such as Hawaii. As
    this measure moves through the legislative process, I hope we will
    examine possible alternatives for a lower threshold for smaller states
    either by region or by state population size. In this regard, I am
    pleased to share with you a copy of a letter from Mr. Amori R. Ogata,
    Executive Director of the Hawaii Hurricane Relief Fund.
        I wish to extend a warm welcome to the witnesses and look forward
    to reading your testimony.
                                     ______

                                               State of Hawaii,
                                          Hawaii Hurricane Relief Fund,
                                          Honolulu, HI, March 20, 2000.

    Hon. Ted Stevens,
    United States Senator,
    Washington, DC.

    Dear Senator Stevens:

        We were asked by Senator Daniel Inouye to provide comments on S.
    1361, titled ``Natural Disaster Protection and Insurance Act of 1999.''
    We appreciate the opportunity to comment.
        The Hawaii Hurricane Relief Fund (HHRF) is a State entity started
    in 1993 for the purpose of providing hurricane property insurance in
    Hawaii. This was necessary following a scarcity in property insurance
    following Hurricane Iniki in 1992. The HHRF was intended as a short
    term solution that would terminate when the insurance industry became
    strong enough to once again provide sufficient residential insurance
    including coverage for hurricanes. If the HHRF were to continue its
    operations, S. 1361 provides a framework for loss coverage above the
    level of coverage provided by the HHRF.
        S. 1361 provides State operated insurance or reinsurance programs
    with reinsurance contracts above minimum retention limits of $2
    billion.
        Although the HHRF supports any legislation benefiting State-
    operated catastrophe insurers or reinsurers, the minimum retention
    limits proposed in the Act would make Hawaii's or any other smaller
    State program's participation precarious. For only one of the past
    seven years was the HHRF able to afford $2 billion in retention. Today,
    with the number of policyholders rapidly declining, the HHRF is unable
    to achieve a $2 billion retention. Additionally, modeling may not
    dictate that $2 billion is needed for the most likely loss scenarios. A
    possible solution to ensure that all States may participate is to have
    minimum retention limits actuarially determined. An actuarial report
    indicating retention levels could be submitted with the request to
    purchase reinsurance.
        Another possible solution would be to make reinsurance from the
    Natural Disaster Insurance Corporation available to several distinct
    groups of States, with the entire group subject to a group retention. A
    geographical solution may not be appropriate since, for example, Hawaii
    would likely be linked to California, lumping together Hawaii's more
    limited hurricane risk with California's earthquake risk. An
    alternative might be to group States by actuarially determined risk
    levels pursuant to actuarial reports submitted by all States. This
    might allow for a lower retention for groups of States actuarially
    determined to have lower risks. Another alternative might be to group
    States so that each group contained roughly equal populations.
        Also, to require these reinsurance contracts to be repaid if drawn
    upon moves this Act more towards a line of credit as opposed to
    traditional reinsurance. Given the size of the draw and limited
    finances of a State fund, the potential for a State to be perpetually
    in debt seems very possible. The HHRF would prefer to have these
    contracts maintain the characteristics of traditional reinsurance (full
    risk transfer). Alternatively, since the ``Risk Load'' component of the
    cost of these contracts appears to provide for profit, once the
    reserves built within the program reach certain limits, the repayment
    requirement of drawn amounts could be terminated. Relative to the
    requirement to continue to purchase reinsurance contracts following a
    drawing, the HHRF is unsure whether the premiums paid for the
    reinsurance contracts would be used to pay down any loans borrowed. If
    not, the requirement to continue to purchase reinsurance contracts
    would decrease the available cash to pay on any loans outstanding.
        Finally, the HHRF is concerned that they would have been surcharged
    on the reinsurance contract should the payout on claims be prorated.
    Therefore, would there be any refund of premiums?
        Attached, please find additional technical comments.
            Very truly yours,
                                                Amori R. Ogata,
                                                    Executive Director.

                                                             Attachment
                         Technical Comments To S. 1361
        1. Section 4. Definitions. Number (22)(A): It's not clear whether
    the state insurance pool must provide coverage for all listed perils or
    whether it can provide for one or more listed perils. That is, the
    ``and'' should be an ``or.''
        2. Section 303. Program Authority. 303(c)(1): How can the
    reinsurance coverage avoid competing with the private insurance or
    reinsurance markets or capital markets? Perhaps this requirement should
    be deleted.
        3. Section 305. Covered Perils: (1)(D). The ``and'' should be an
    ``or,'' unless each reinsurance contract is to cover all listed perils.
        4. Section 306(a)(6)(B): Depending on the way the regulations are
    worded, items (ii), (iii) and (iv) could change the way existing State
    programs are functioning. For example, State operated insurance
    entities may not be charging the optimum rates, or providing the
    optimum coverage, suggested by an actuary.
        5. Section 306(b)(7): Are reinsurance premiums applied to loans or
    does the state entity have to repay loans and purchase reinsurance? We
    suggest a clarification on that point to the effect that premiums are
    applied against the loan amount.
        6. Section 306(b)(8) INFORMATION: Should there be a requirement
    that the Corporation hold confidential certain types of information
    that may be in the possession of the State program (e.g. relating to
    private insurers book of business)?
        7. Section 306(c) PRICE GOUGING PROTECTIONS: line 4: Can any laws
    or regulations be ``sufficient to prohibit price gouging''? Maybe it
    should read ``laws or regulations that prohibit price gouging'' or
    ``laws or regulations sufficient to deter price gouging.''
        8. Section 308(b)(3) ANNUAL ADJUSTMENT, last two lines: How can the
    reinsurance coverage avoid competing with the private insurance or
    reinsurance markets or capital markets? Perhaps this requirement should
    be deleted.

              STATEMENT OF THE HON. STUART E. EIZENSTAT,
              DEPUTY SECRETARY, DEPARTMENT OF THE TREASURY

        Secretary Eizenstat. Thank you, Mr. Chairman. It's always a
    privilege to be with you, and I want to compliment you, Senator
    Stevens, for your steady and consistent leadership on this
    issue. I mean that with all sincerity.
        We look forward to continuing to work with you toward our
    shared objective of achieving a legislative outcome
    commensurate with the grave seriousness of the problem.
        Disasters are of course a tremendously tragic occurrence;
    their costs can be astronomical not only in financial but in
    human terms as well. The administration has developed a
    comprehensive policy for dealing with natural disasters, under
    the leadership of James Lee Witt, the FEMA director; and we
    view well-functioning insurance markets as a compliment to that
    policy.
        We believe there is in fact a role for the Federal
    Government to play with respect to the provision of reinsurance
    for the risk associated with the most severe, least probable
    disasters. And we believe that role should respect two
    principles, Mr. Chairman; one, that we should leave more than
    enough room for private market activity to grow and flourish,
    and second, the taxpayer should be adequately compensated for
    any financial risks they are asked to bear.
        In line with those principles, we believe the Federal
    involvement should be strictly limited and on an interim basis,
    pending the more complete development of private market
    solutions.
        We see the legislation now before the Committee which
    you've championed as a generally positive step forward, and as
    a solid foundation on which to build. In our view, the proposed
    legislation constructively and creatively responds to the
    difficulty faced by both state funds and private entities, in
    purchasing reinsurance against their potential large but low
    probability losses on homeowner's insurance.
        The characteristics of natural disasters make the risk
    associated with them especially difficult for the private
    insurance market to handle. Natural disasters happen only
    infrequently, but when they do they can be exceedingly severe,
    as you reflected in your own experience in Alaska.
        Reflecting this difficulty, prices for disaster reinsurance
    for homeowner losses can be very high, measured relative to
    expected losses; and prices have in the past spiked and markets
    have shrunk following such disasters for a considerable period
    of time.
        Because of their tremendous capacity for absorbing loss, we
    view the capital markets in which disaster risk increasingly
    can be bought and sold like many other risks, as a crucial
    compliment to the traditional reinsurance industry. We very
    closely monitored the development of the private capital
    markets in this regard, and while progress has not come as fast
    as we had hoped, we still expect that insurance securitizations
    in capital markets will be a significant part of well-
    functioning markets for disaster risk in the long run.
        But we are persuaded at the same time that a problem still
    remains at least for the short period of time, until the
    private market can fully take over while the volume of these
    securitizations builds, and that a well-designed transitional
    Federal program could be constructed.
        Four considerations argue in favor of a prudent, interim
    participation by the Federal Government in the market for
    disaster risk management. First, it is better to undertake
    policy prior to a catastrophic event. Second, the Federal
    Government is uniquely capable of spreading risks across the
    population and over time. Third, the Federal Government would
    likely bear in any event costs associated with destabilizing
    distressed insurance markets if there were a true cataclysmic
    event, whether or not we have this legislation. And finally,
    prudent participation at this stage may enhance the ability of
    private markets to deal with these risks.
        It is essential that any Federal involvement be guided by a
    sense of, we think common sense principals. First, that Federal
    involvement must support and not supplant private insurance
    markets. It must be partial, applying only to two true
    catastrophes that the private market is not capable of
    handling, it must be transitional, phasing down as private
    markets develop.
        And second, Federal involvement must share and not
    subsidize risk. Federal involvement must create new capacity to
    absorb risk, but that involvement should be priced so as to
    compensate the taxpayer adequately for the financial risk
    involved. The pricing of this Federal involvement should be so
    robust that on a prospective probability rated basis, the
    program would impose no net cost to the taxpayer.
        We believe, Mr. Chairman, that there are several ways in
    which the legislation can be improved so it better addresses
    the market problem we see and fulfills our public stewardship
    responsibility. And permit me to briefly summarize.
        The first involves governance. S. 1361 would establish a
    new corporation, owned and operated by the purchasers of the
    disaster-related contracts sold under this program. That
    corporation would have special ties to the government,
    importantly including a limited ability to borrow from the U.S.
    Treasury.
        Our concern is that it would create an entity that is
    charged with fulfilling a public mission, making public
    judgments, and having access to public benefits, but that would
    be owned and controlled by private purchasers. There's a risk
    that the entity may not carry out its charge appropriately and
    could use public benefits for private gain.
        In our view, a preferable approach would be to lodge the
    authority squarely in the Federal Government. We believe this
    for several reasons, Mr. Chairman.
        First, it would provide a very strong set of controls over
    operations that have to be in place to assure the taxpayers are
    adequately protected in assuming risks.
        Second, a Federal entity is better suited, in our opinion,
    for making decisions of a truly public nature, such as are
    inherent in this program. To take just one example, pricing
    decisions have to reflect a balance of factors including
    fairness to taxpayers. And finally, a Federal entity could be
    focused narrowly upon the direct mission; it would be more
    easily sunsetted when there is no longer a need for Federal
    intervention.
        At the same time we would be pleased to continue to work
    with you and the Committee to develop alternatives that set the
    entity properly within the Federal Government.
        Next is the issue of caps. The proposed legislation would
    limit or ``cap'' payouts on the contracts sold by the
    corporation in the event the contractual obligations exceed the
    resources of the corporation. This cap would be implemented by
    limiting the corporation's borrowing from the Treasury to the
    amount it could repay within 20 years. If contractual
    obligations were to exceed the sum of all resources available
    to the corporation, then available resources would be prorated
    among entities holding the contracts and due a payment.
        We obviously share your objective of developing a fiscally
    prudent piece of legislation. We share your belief that a limit
    on the potential draw on the Treasury is an essential item of
    fiscal prudence. But we are concerned about the robustness of a
    cap that would, in some circumstances, require proration of
    payments across claimants. The reason is, that in those
    circumstances Mr. Chairman, we believe there would be enormous
    pressure for full payment to be made on all contracts, despite
    the fact that the fees or premiums on the contracts had been
    set on the assumption that only partial prorata payments would
    be made. As a result, we believe it plausible that taxpayers
    would be exposed to financial risk for which they haven't been
    fairly compensated.
        We believe that it's possible to design an approach to
    capping the Federal liability that would avoid such exposure.
    One possible approach would involve limiting the amount of
    insurance to be sold, not the amount of payoff to be made, and
    honoring the face amount of these contracts in all cases.
        Briefly, Mr. Chairman, a mechanism would work along these
    lines, and we've enclosed a chart which I have here, and we'll
    go through in a minute.
        Contracts sold under the legislation would cover 50 percent
    of losses above a deductible, up to an upper limit
    corresponding to the dollar amount that would be lost in the
    event of some more remote probability. For the sake of
    illustration, one could consider setting the upper limit at a
    dollar amount corresponding to a one in 500-year event.
        Under this approach, the maximum theoretical draw on the
    Treasury would be calculated as the sum of the maximum
    obligations in each state and region. The probability that this
    draw would actually be made would extremely small. There would
    be certainty about what we could pay; we would pay out exactly
    what we said we would pay.
        On this chart, Mr. Chairman, the Federal Government's
    liability again would be limited by capping the amount of
    insurance sold, rather than selling an unlimited amount and
    then capping payments.
        In this chart, the deductible amount is set at a loss
    associated with a one in one hundred year event. For example,
    on the far left, Florida; a one in one hundred year event for
    Florida would inflict--for illustrative purposes, and these are
    of course rough figures--residential property damage of about
    $13 billion.
        Again for purposes of illustration, the ceiling would be
    set at a loss associated with a one in 500-year event. The one
    in 500-year event for Florida would be shown and is shown at
    $26 billion. The coverage would be offered to Florida for half
    of that layer in between. Similarly, for California, next to
    Florida, the chart shows an one in 100-year event at $11
    billion and a one in 500-year event at $14 billion.
        The government's maximum exposure in each state is 50
    percent of the difference between the ceiling and the
    deductible. For example, in Florida, there is again a $13
    billion difference between the deductible level, which is
    around $13 billion, and the ceiling level, which is $26
    billion. The U.S. Government would then pick up 50 percent of
    that difference, leaving the other 50 percent to the private
    sector.
        That would therefore cap the U.S. Government liability at
    $6.5 billion if a $26 billion one in 500-year event occurred.
    Of course, if it was only a one in 300-year event, exposure
    would be less.
        For California, the maximum exposure would be $1.5 billion.
    The private market would remain exposed for the remaining 50
    percent. So again, the government's maximum exposure would be
    the sum of these amounts across states. A loss of this
    magnitude to be experience with all contracts offered to each
    state and region were actually purchased, and an event of
    sufficient size occurred in every one of them.
        The aggregate amount of government exposure could be set in
    your legislation. The ceiling amounts in each state and region
    would follow as an implication of the desired aggregate
    exposure and deductibles. Separately, Treasury would adjust the
    level deductible after the first year, taking into account
    developments in private market and other factors.
        This has the other advantage, Mr. Chairman, of leaving room
    for the private sector in two ways: First, in that first one in
    100-year event; that is the deductible amount, that is all
    private. So for example in the Florida example, that would be
    that first $13 billion. And then even on the amount above it,
    where the Federal role will come in, the Federal Government
    would only pick up 50 percent, the $6.5 billion, leaving an
    additional amount for the private sector to be able to come in.
        So under the approach we are proposing, the corporation
    would only sell a limited amount of coverage, but having sold
    it, would make good on all of it. We'd be happy to continue to
    work with you and the Committee to create a cap on Federal
    liability consistent with our mutual objectives of designing a
    fiscally prudent program.
        Another issue is a sunset. We believe that this program
    should be sunset after some fixed number of years, and we would
    work with you on how long that should be. To preserve adequate
    incentive for the further development of private market. The
    goal should be to ensure that the proposed program supports
    rather than supplants the growth of the private market and
    sunsetting would be a way of achieving that.
        Next is the continued purchase requirement in the
    legislation. The proposed legislation would require a state
    program participant to continue purchasing reinsurance in the
    even that the participant were to receive a payout from the
    corporation that caused the corporation to have to borrow or
    increase its borrowing from the Treasury. The participant must
    continue to purchase the reinsurance until the borrowed funds
    are repaid.
        We have some problems with that provision, Mr. Chairman.
    For one, we think it could further burden an already stressed
    public or private entity in the aftermath of a disastrous
    event, raising the possibility of a scenario in which the
    requirement would be waived. In this case, the corporation
    would have been adequately compensated for the financial
    service that it would have.
        An alternative approach, we think, is to provide for the
    option of offering multi-year as well as 1 year contracts, if
    market conditions indicate such contracts would be appropriate
    and desirable.
        So just to go back to one more minute on the cap, because I
    know this is a crucial issue, we are concerned with the fact
    that in the cap that is provided in the bill, that there would
    just be enormous pressure when you are talking about prorated,
    to go ahead and make complete payments. And so we think
    therefore the risks would be higher than under our cap.
        In conclusion, Mr. Chairman, all of our suggestions derive
    from two basic principles; that relief for insured homeowners
    not come at the expense of taxpayers, and that Federal
    intervention must share risk and support private markets. The
    current proposed legislation, your legislation, we believe
    provides a sound foundation for progress in this area. We look
    forward to working with you, Mr. Chairman and other members of
    the Committee, to resolve those concerns that we have, and we
    believe that that is something that is certainly possible.
        So thank you for the opportunity. We look forward to
    working with you and we respect greatly the effort that you
    have put into this over the years.
        Senator Stevens. Well, thank you very much, Mr. Secretary.
    I have some problems, I had a conversation yesterday with
    Senator Gramm, who is chairman of the Banking Committee,
    probably has some jurisdiction over this bill, too; and I
    pointed out to him the House bill.
        I am told that when you testified on the House bill
    concerning--H.R. 21--you said that the administration remains
    convinced that a well-designed reinsurance program could help
    provide the foundation for communities, individuals and the
    private markets on which they could depend, to a sound recovery
    and financial crisis.
        And it went on to say--that's sort of paraphrased in one
    place. In our view, the proposed legislation, H.R. 21,
    constructively and creatively responds to the difficulty faced
    by both state insurance funds and private entities in
    purchasing reinsurance against their large but low probability
    losses on homeowner's insurance.
        Now I do know that your staff and ours are working
    together, and hopefully we can come together.
        Are you saying you prefer the form of the House bill over
    the Senate bill? Is it a matter of substance, or form?
        Secretary Eizenstat. We think as a matter of substance that
    the House bill reflects our view on a variety of issues,
    including cap and repurchase and so forth, to a greater degree.
        Again, we believe that your bill does provide a sound
    basis, but we believe that the closer one can come to the
    administration's views, many of which were incorporated in H.R.
    21, the more enthusiastic we can be.
        Senator Stevens. Do you view it possible that we could work
    together and take the approach of the House bill and modify it
    to some extent by what we've developed over here, and have a
    bill that the administration could approve?
        Secretary Eizenstat. Well, it obviously would depend on
    precisely what changes were made, but we certainly would like
    to work with you, Mr. Chairman. We would like to see, and I
    want to make this very clear; we would like to see legislation.
    We think this is an area in which legislation is needed; we
    think there is a market imperfection here; we believe that
    additional Federal reinsurance would improve the availability
    of homeowner's insurance, it would ameliorate market
    contractions and long-lasting price spikes following a
    disaster, and that it could encourage a reduction in insurance
    costs in many areas, and actually encourage private
    reinsurance.
        So we think there is a need, and we would look forward to
    trying to work with you to produce legislation that we could
    accept.
        Senator Stevens. Our goal really is to try and deal with
    the homeowners problem, and as much as possible to take that
    out of the area where, in a normal--not 500-year, not 100-year,
    but a normal period of disasters, regional rather than national
    type, that the private sector could adequately deal with them.
        Our experience is that in the smaller disasters that are
    enormous for one state but isolated in that state, requires a
    national mobilization, takes time to bring people from
    Washington or wherever they might be in the region; whereas the
    private sector can move in very quickly and help ameliorate the
    loss, and bring about recovery much faster under conditions
    that are a lot more flexible in terms of the basic instructions
    to those who are adjusting the losses, and that the whole
    nation would be better off with that.
        We seem to be spending our time mostly on the extraordinary
    loss, which is the more than 300, up to 500-year projected
    possible loss. And that is what is holding us up. We are not
    really dealing with the $13 billion, we never get to that. We
    just assume that the industry will be capable of covering that
    without any basic assurance that if it goes in excess of that,
    that they wouldn't all be bankrupt. I would hope that we would
    find some way to get together. As I said, I think this is the
    11th hearing that I've chaired or participated in on this
    subject in the last terms of my existence here in the Senate
    and Senator Inouye and I are sort of getting a little weary
    about pursuing it, because we get right down to the point where
    it's possible to move, but then something else comes up every
    time.
        I think we ought to find some way to come to closure. I
    would urge you to do that. I think we can accommodate most of
    what you've just said in modification to this bill or the House
    bill and achieve our common goal with the House. But that never
    takes place.
        Secretary Eizenstat. Well, we have absolutely no
    inclination to delay or forestall action. We would like to work
    with you. We've put frankly a lot of time and effort into it
    ourselves. We tried to come up, for example, with what I think
    is a fairly creative cap.
        I want to stress to you that there is no magic to the one
    in 500 and the one in 100 levels; I understand for example that
    some in the reinsurance industry are saying, well they might
    like a different level so they have a greater opportunity to
    come into the market at the beginning. There is no magic level
    to it; what we want is a realistic program and one that
    protects taxpayers, and one that fills a market void--and there
    is a market void.
        So we are, as we did with the House, willing to work with
    you sincerely, with your staff--our staffs, as you mentioned,
    have already been working--and nothing would please me more
    than this would be your last hearing on this issue.
        Senator Stevens. We want to work with you. The problem is
    without some reinsurance capability, an assurance that the
    government will be there, there is no--these policies are not
    being marketed at a price that they can be afforded, and as a
    consequence, we see an ever-increasing exposure of the
    taxpayers, witness the Rapid City exposure, the California
    earthquake, the recent hurricanes along the East Coast. Those
    dwarf in settlements--the settlement that took place in Alaska
    after that monstrous earthquake. Every year they get higher,
    and every year it gets more difficult to pass legislation that
    might limit the recovery, particularly in terms of the times
    when there's a repeated disaster to the same home.
        I think we're going to have to find some way or ultimately
    the public is going to say it's a total Federal responsibility
    and not have any really private sector coverage on disasters of
    this type because of the fear that the next one might be the
    biggest one.
        Secretary Eizenstat. Well, the GAO recently expressed
    concern over the ability of insurers to withstand the greater
    than one in one hundred event, and of course no one can know
    for sure, but if history is a guide, if you look at two recent
    huge events, Hurricane Andrew in 1992 and the Northridge
    earthquake in 1994, following each of those events, smaller
    companies became insolvent, insurers and reinsurers withdrew
    from the market to reassess their exposures, and markets went
    through frankly a surprisingly long period of turmoil; prices
    spiked, private insurance availability shrank, state risk pools
    expanded.
        So there is a problem. We recognize that. We believe there
    is a Federal role; it should be limited and it should be
    sunset, but there is a role and we want to work with you to
    appropriately put that role in and protect taxpayers at the
    same time and not crowd out the private market. We think this
    cap mechanism does just that.
        Senator Stevens. Well, we look forward to our staff
    pursuing that avenue with you and your staff. We stand ready,
    those of us that have been involved here, to meet with you
    personally or anyone that you select, to see if we can bring
    this to a closure this year. If possible, we would like to see
    that happen.
        Secretary Eizenstat. That would be our goal as well.
        Senator Stevens. Again I apologize for keeping you waiting.
    It was just beyond my control.
        Secretary Eizenstat. Never a problem.
        Senator Stevens. Thank you.
        I will print your full statement in the record in case you
    didn't read it all, and my opening statement.
        Secretary Eizenstat. Thank you. I did not read it all, so
    that would be appreciated. And if the chart also could be put
    into the record, we'd appreciate it.
        Senator Stevens. It will be. It is a good chart. It's very
    self-explanatory, as a matter of fact.
        [The prepared statement of Secretary Eizenstat follows:]

       Prepared Statement of Hon. Stuart E. Eizenstat, Deputy Secretary,
                           Department of the Treasury
    I. Introduction
        Mr. Chairman, Senator Hollings, Members of the Committee. Thank you
    for providing me the opportunity to discuss with you the important
    issue of natural disaster insurance. Let me begin by complimenting you,
    Senator Stevens, for your steady and consistent leadership on this
    issue. We look forward to continuing to work with you toward our shared
    objective of achieving a legislative outcome commensurate with the
    seriousness of the problem.
        Disasters are of grave importance for all. Their cost can be
    astronomical, not only in financial terms but also in human terms. The
    Administration, under the leadership of James Lee Witt, the Director of
    FEMA, has developed a comprehensive policy for dealing with natural
    disasters, going beyond simply the response to them, to work with local
    communities to reduce their exposure to natural disasters. We view
    well-functioning insurance markets as a complement to that policy.
    While insurance cannot undo the costs of a natural disaster in human
    terms, it can provide the foundation for a sound recovery in financial
    terms.
        We believe there is a role for the Federal government to play with
    respect to the provision of reinsurance for the risk associated with
    the most severe, least probable disasters. We believe that role should
    respect two principles--that we should leave more than enough room for
    private market activity to grow and flourish, and that the taxpayers
    should be adequately compensated for any financial risks they are asked
    to bear. In line with those principles, we believe the Federal
    involvement should be strictly limited, and on an interim basis,
    pending the more complete development of private market solutions.
        In that regard, we see the legislation now before the Committee as
    a generally positive step forward. In our view, the proposed
    legislation constructively and creatively responds to the difficulty
    faced by both state funds and private entities in purchasing
    reinsurance against their potentially large, but low-probability losses
    on homeowners' insurance. Although we are concerned about some aspects
    of the bill, I understand that our respective staffs have begun a
    productive dialogue, and we look forward to working with Members on
    both sides of the aisle to explore means of resolving those concerns.
        An important portion of the bill addresses issues related to
    mitigation. We respect and appreciate your interest in this topic. As
    you know, the Administration strongly supports efforts to encourage
    mitigation, an indispensable form of ``preventive medicine'' to protect
    communities against the ravages of natural disasters, and is placing
    increased emphasis on pre-disaster mitigation efforts. However, this
    vital area is not a province of Treasury, so I must defer to FEMA on
    questions that reach solely to mitigation policy and provisions. My
    testimony will therefore focus on the reinsurance aspects of the bill,
    and will touch on mitigation provisions only insofar as they affect
    those reinsurance aspects. However, let me say that we view insurance
    markets and pre-disaster mitigation initiatives as natural complements,
    and I understand, Senator Stevens, that you have spoken with Director
    Witt several times on mitigation.
    II. Review of the Problem and Our Principles
        The characteristics of natural disasters make the risk associated
    with them especially difficult for insurers to handle: natural
    disasters happen only infrequently, but when they do occur, they can be
    exceedingly severe. Reflecting this difficulty, prices for disaster
    reinsurance for homeowner losses can be very high measured relative to
    expected losses, and prices have in the past spiked--and markets
    shrunk--for a considerable time following a disaster.
        Because of their tremendous capacity for absorbing losses, we view
    the capital markets, in which disaster risk increasingly can be bought
    and sold like many other risks, as a crucial complement to the
    traditional reinsurance industry. We have closely monitored the
    development of capital markets. While progress has not come as fast as
    we had hoped, we still expect that insurance securitizations in capital
    markets will be a significant part of well-functioning markets for
    disaster risk in the long run. But we are persuaded that a problem
    still remains at least for a time--while the volume of these
    securitizations builds--and that a well-designed transitional Federal
    program could be constructive.
        Four considerations argue in favor of a prudent, interim
    participation of the Federal government in the market for disaster risk
    management at this time. First, it is better to consider undertaking
    policy prior to a catastrophic event; surely, if we can do it, the time
    to fix the roof is when the sun is shining. Second, the Federal
    government is uniquely capable of spreading risk across the population
    and over time. The capacity of the Federal government to gather
    resources from a wide base for the purpose of meeting short-term
    contingencies dwarfs that of any single private-sector entity. Third,
    the Federal government would likely bear part of the cost associated
    with stabilizing distressed insurance markets in a truly cataclysmic
    event regardless of whether legislation of the type now before the
    Committee is enacted. Finally, prudent participation at this stage of
    development may enhance the ability of private markets to deal with
    these risks.
        It is essential that any Federal involvement be guided by a set of
    common-sense principles. Let me enumerate those principles.

       Federal involvement must support, not supplant, private
            insurance markets.
        --It must be partial, applying only to true catastrophes that the
                private market is not capable of handling.
        --It must be transitional, phasing down as private markets develop.

       Federal involvement must share, not subsidize, risk.
        --Federal involvement must create new capacity to absorb risk, but
                that involvement should be priced so as to compensate the
                taxpayer adequately for the financial risk involved. In
                particular, the pricing of this Federal involvement should
                be sufficiently robust to ensure that--on a prospective,
                probability-weighted basis--the program will impose no net
                cost on the taxpayer.
    III. The Bill Before the Committee
        Let me now turn to the specifics of the proposed legislation before
    you. In brief, S. 1361 would establish a new not-for-profit Corporation
    that would sell excess-of-loss reinsurance to qualifying state funds,
    and auction industry excess-of-loss contracts to interested State or
    private purchasers for losses above certain threshold ``deductible''
    amounts, incurred on residential policies. The Corporation would
    establish a Trust Account into which a portion of contract payments and
    associated investment earnings would be placed; and would disburse
    monies from that Trust as well as proceeds from its own borrowings, if
    any, to holders of its contracts in the event of a qualifying disaster.
    The Corporation would be able to borrow from private markets; in
    addition, it would be eligible to borrow from the Treasury in the event
    that its other resources proved insufficient to make promised payments.
    The bill would establish an Independent Board of Actuaries that would
    approve the initial operating plan, and help ensure that the pricing of
    the contracts sold by the Corporation offered sufficient protection for
    taxpayers.
        The bill would require that states develop and undertake mitigation
    plans approved by FEMA to reduce the hazards of covered disasters, with
    progress to be evaluated periodically by FEMA. It would also establish
    in Treasury a separate Mitigation Account, consisting of required
    annual payments by the Corporation and appropriated funds, to be
    distributed to participating state programs that have satisfied the
    mitigation plan requirement.
    IV. Suggested Improvements
        We believe there are several ways in which the legislation can be
    improved so that it better addresses the market problem as we see it
    and fulfills our public stewardship responsibility. Let me enumerate
    here the most important of these suggested improvements.
    Governance
        S. 1361 would establish a new Corporation, owned and operated by
    the purchasers of the disaster-related contracts sold under this
    program. This Corporation would have special ties to the government,
    including importantly a limited ability to borrow from the Treasury.
    Our concern with this aspect of the bill is that it would create an
    entity that is charged with fulfilling a public mission, making public
    judgments, and having access to public benefits, but that would be
    owned and controlled by purchasers. There is a risk that the entity may
    not carry out its charge appropriately, and could use its public
    benefits for its own private gain. In our view, a preferable approach
    would be to lodge the authority for this program squarely within the
    Federal government, for several reasons. First it would provide the
    very strong controls over operations that must be in place to assure
    that taxpayers are adequately protected in assuming risks such as
    these. Second, a Federal entity is better suited for making decisions
    of a truly public nature, such as are inherent in the operation of this
    program. To take just one example, pricing decisions must reflect
    considerations of fairness to taxpayers. Finally a Federal entity could
    be focused narrowly upon the direct mission, and would be more easily
    sunsetted when there was no longer a need for Federal intervention. The
    House bill, H.R. 21, embodies a concept along the lines we prefer. We
    have had productive discussions with your staff on this topic, and
    would be pleased to continue to work with the Committee to develop
    alternatives that set the entity within the Federal government.
    Cap
        The proposed legislation would limit or ``cap'' payouts on the
    contracts sold by the Corporation in the event that contractual
    obligations exceed the resources of the Corporation. This cap would be
    implemented by limiting the Corporation's borrowing from the Treasury
    to the amount the Corporation could repay within 20 years. If
    contractual obligations were to exceed the sum of all resources
    available to the Corporation, available resources would be prorated
    among entities holding the contracts and due a payment.
        We share your objective of developing a fiscally prudent piece of
    legislation. And we share your belief that a limit on the potential
    draw on the Treasury is an essential component of fiscal prudence. But
    we are concerned about the robustness of a cap that would, in some
    circumstances, require proration of payments across claimants. In those
    circumstances, we believe there would be enormous pressure for full
    payment to be made on all contracts despite the fact that the fees or
    premiums on the contracts had been set under the assumption that only
    partial payment might be made. As a result, we believe it plausible
    that taxpayers would be exposed financial risk for which they had not
    been fairly compensated.
        We believe that it is possible to design an approach to capping the
    Federal liability that would avoid such exposure. One possible approach
    would involve limiting the amount of insurance to be sold. Briefly, a
    mechanism along these lines could work as follows. Contracts sold under
    the legislation would cover 50 percent of any losses above the
    deductible, up to an upper limit corresponding to the dollar amount
    that would be lost in an event of some more remote probability. For the
    sake of illustration, one could consider setting the upper limit at the
    dollar amount corresponding to a one-in-500-year event. Under this
    approach, the maximum theoretical draw on the Treasury could be
    calculated as the sum of the maximum obligations in each state and
    region. The probability that this draw would actually be made would be
    extremely small. The attached chart illustrates our proposal.
        Thus, under the approach we are proposing, the Corporation would
    sell only a limited amount of coverage, but, having sold it, would make
    good on all of it. We have had constructive discussions with your staff
    on this point, and we would be happy to continue to work with the
    Committee to create a cap on Federal liability consistent with our
    mutual objective of designing a fiscally prudent program. The appendix
    explains our proposal in more detail.
    Sunset
        We believe that this program should be sunsetted after some fixed
    number of years. A sunset-type provision is important in order to
    preserve adequate incentive for the further development of the private
    market. As we have said earlier, we continue to believe that private
    markets will ultimately be able to supply coverage for even huge
    natural disasters, given sufficient opportunity for growth. The goal
    should be to ensure that the proposed program supports rather than
    supplants this growth of the private market. Again we would be happy to
    continue our work with your staff on this issue.
    Continued Purchase Requirement
        The proposed legislation would require a state program participant
    to continue purchasing reinsurance in the event that the participant
    were to receive a payout from the Corporation that caused the
    Corporation to borrow or to increase its borrowing from the Treasury.
    The participant must continue to purchase the reinsurance until the
    borrowed funds are repaid.
        This provision raises some difficult issues. For one, it could
    further burden an already stressed entity (public or private) in the
    aftermath of an event, raising the possibility of a scenario, not
    unlike the one that causes us concern over the annual cap, in which the
    requirement would be waived. In this case the Corporation would have
    been inadequately compensated for the financial service it would have,
    in fact, provided.
        While this provision may serve a useful role within the Corporation
    governance structure, it would not be needed were the program to be
    lodged within a Federal agency and were the cap on Federal liability to
    be revised as we have suggested. An alternative approach that might
    meet the intention of this provision would be to provide for the option
    of offering multiple-year, as well as one-year, contracts, if market
    conditions indicate that such contracts would be appropriate and
    desirable. We have had useful discussions with your staff on this issue
    also, and would be pleased to continue to work with your staff.
    V. Conclusion
        The Clinton Administration has long recognized the importance of
    improving the nation's ability to deal with natural disasters. While
    our list of concerns may seem long, it does not imply any lack of
    interest in working with you, and all of our suggestions derive from
    our two core principles: that relief for insured homeowners not come at
    the expense of taxpayers, and that any Federal intervention must share
    risk and support private markets. We believe that we all share a clear
    recognition of the importance of moving forward. The current proposed
    legislation provides a sound foundation for progress in this area, and
    we look forward to working with you, Mr. Chairman, the other Members of
    this Committee, its staff, representatives of industry and of affected
    communities, and with other stakeholders, to resolve these issues.
                                    appendix
    State Program Mitigation Requirement
        With regard to the requirement that state programs commit a
    specified percentage of their investment earnings toward mitigation, we
    would suggest a wording change, to require that the mitigation
    activities undertaken by states to fulfill this provision be cost-
    effective, and consistent with general FEMA guidelines.
    Tax Consequences of Buying Excess of Loss Contracts
        The statute refers to the auctioned excess of loss contracts as
    ``reinsurance coverage,'' and refers to the amounts paid by such
    contracts as ``premiums.'' We should note that, as a technical matter,
    if an insurance company purchases an excess of loss contract where the
    amount payable does not indemnify the insurance company specifically
    for its actual losses, then the excess of loss contract would not be
    considered ``reinsurance'' for Federal income tax purposes. This, for
    example, will mean that insurance companies could not deduct amounts
    paid for excess-of-loss contracts as reinsurance premiums. Instead,
    insurance companies would have to account for these purchases using
    Federal income tax rules that apply to purchases of similar financial
    instruments. To avoid any potential confusion on this issue, we would
    recommend that the statute be revised so that excess-of-loss contracts
    are not referred to as reinsurance coverage.
    Capping Payouts
        After careful study, we have concluded that capping payouts is an
    imperfect mechanism for limiting the potential draw on the Treasury. We
    believe that an effective mechanism for limiting the total Federal
    liability and ensuring fiscal prudence is an essential feature of
    fiscally prudent legislation, and we are confident that such a
    mechanism can be devised. This section of the appendix provides
    additional detail relative to the discussion in the body of the
    testimony.
        One approach we have been exploring would involve capping the
    amount of insurance to be sold by the Corporation. Under this approach,
    the total amount of insurance offered to each state and region would
    equal 50 percent of the difference between (a) a threshold trigger
    level (essentially, a ``deductible''), and (b) an upper limit loss. The
    bill sets the threshold trigger level at the greater of (a) the amount
    that would be lost in a 1-in-100-year event, or (b) $2 billion (or, for
    existing state programs, the claims paying capacity of the program).
    The bill also provides for certain transition trigger levels. The upper
    limit loss could be set similarly at the amount that would be lost in
    some less probable event, such as a 1-in-500-year event.

       For example, if the 1-in-100-year loss on insured
            residential property in Missouri were $4 billion, and the 1-in-
            500-year loss were $8 billion, then the total amount of
            coverage offered to Missouri would be half of the difference
            between $8 billion and $4 billion, or $2 billion.

        Coverage would be allocated between the state programs and the
    regional auctions in proportion to the share of the industry risk in
    each state that the state program (if any) covers.
        State with 100 percent state program: If a state elects to create a
    state program that, as a matter of policy, reinsures every insurance
    entity with exposure to residential property losses in the state for
    all its losses above the deductible, we propose to offer the full state
    allocation to the state program. Because the full amount of coverage
    for the state had been offered to the state program, nothing
    attributable to this state would be offered in a regional auction.
        No state program: If a state elects not to create a state program,
    we would attribute the full amount of that state's allocation to the
    applicable regional auction. If Missouri chose not to establish a state
    program, we would add $2 billion in total insurance to the auction of
    contracts for the region covering Missouri.
        The cap or aggregate maximum payout would then be defined as the
    sum of the maximum obligations in each state and region, and funds
    would be made available up to the amount of this payout. The
    probability of hitting this cap would be extraordinarily small; the cap
    would be hit only if every state and region bought its full allotment
    of contract protection, and huge events happened to every state and
    region in one year and caused the maximum payouts in each state and
    region to be made.
        An ancillary benefit of the approach sketched here is that it
    provides a natural method of allocating coverage across states and
    regions. The legislation as currently drafted does not address that
    issue.

        [The information referred to follows:]

        Senator Stevens. Our second panel includes Mr. David
    Keating, Senior Counsel, National Taxpayers Union; Mr. Frank
    Nutter, President of the Reinsurance Association of America;
    Mr. Jack Weber, President of the Home Insurance Federation of
    America; and Mr. Travis Plunkett, Legislative Director of the
    Consumer Federation of America.
        Gentlemen, you can proceed in any way you wish. You can
    proceed in the way I have just read off from the schedule; but
    if you have any other order you would like to proceed in, be my
    guest.
        Mr. Keating, you are first on this list. Is that all right
    with everybody?
        Mr. Keating. If it's fine with you, it's fine with us,
    Senator.
        Senator Stevens. Thank you very much.

       STATEMENT OF DAVID L. KEATING, SENIOR COUNSELOR, NATIONAL
                            TAXPAYERS UNION

        Mr. Keating. Thank you for inviting me to speak before the
    Committee today. We have appreciated the opportunity to work
    with you in previous years and with your staff to try to
    develop a consensus----
        Senator Stevens. Let me tell you--I have to interrupt you,
    Mr. Keating. An unexpected happening is we just voted the
    temporary adjournment resolution, and what is going on on the
    floor is the debate on the budget resolution that has just come
    over from the House, and that is going to go on the balance of
    the afternoon. But it is quite intense over there, so I don't
    expect to see any of my colleagues. Again, that's another thing
    I am sad about, but it's just the timing of this period right
    now.
        I do know you all realize we need the record in order to
    proceed. Thank you.
        Mr. Keating. You're welcome. Thank you.
        And I want to reiterate our interest in continuing to work
    with you and others on this Committee who would like to work on
    this issue.
        While we hope that a consensus can be reached, we must
    state our opposition to the bill as it has been introduced,
    because we believe it would unnecessarily increase the
    potential liabilities to the Federal Government, displace well-
    functioning private insurance markets that exist today, and
    perhaps equally important, stifle innovations that are greatly
    increasing insurance capacity.
        The way the proposed Natural Disaster Insurance Corporation
    is structured, and the management of this corporation, is
    unacceptable and very risky. There can be no doubt the
    legislation could be expensive. The bill itself says the
    Secretary of the Treasury shall provide direct loans in
    sufficient amounts to cover any shortfall.
        As we heard earlier from the Treasury Department, there is
    no effective limit on the total potential liability. There is
    no real limitation on the number or dollar amount of all the
    contracts that may be sold by the NDIC.
        We have also reviewed the House bill, H.R. 21, which is
    similar in many ways to S. 1361. CBO has said because of the
    frequency and severity of future catastrophic events that are
    exceedingly difficult to estimate, it's unlikely the Federal
    Government would be able to establish prices for disaster
    reinsurance that would fully cover the potential future costs
    of these financial obligations.
        We are also very concerned about the NDIC board and how it
    would operate as a whole. The NDIC board would be composed
    almost entirely of insurance industry representatives. Now,
    they would be subject to review by an allegedly independent
    National Disaster Insurance board of actuaries, but we don't
    think this board would be terribly independent.
        First of all, the private insurance industry
    representatives and member insurance companies of the NDIC are
    not liable--I'm quoting from the bill here--or in any way
    responsible for the obligations of the corporation.
        Well, that leaves a question of who is. If they make a
    mistake, if they price things too low, the corporate members
    don't pay; the taxpayers do. This is something that frightens
    us; this is something the Treasury Department just alluded to
    in its statement--the idea of conferring access to public
    benefits, meaning the Federal borrowing authority, to people
    who are entirely in the private sector and making decisions
    that would affect the private sector.
        We also think the NDIC board would face many political
    incentives to avoid charging the proper rates, one of which is
    that the industry greatly fears the whole spectre of Federal
    regulation. If actuarial soundness requires higher rates in
    politically sensitive areas, we think it's quite likely the
    board would avoid imposing such higher rates.
        Even more surprising to us, the NDIC would essentially be
    selling insurance as allowed under one part of this bill, to
    state governments, or entities controlled by state governments.
    Yet these very same state governments regulate the insurance
    industry today. We don't think it is likely that the NDIC will
    negotiate a fair rate of return for reinsurance under such a
    clear conflict of interest.
        As for the independent board of actuaries, there are a
    number of flaws we see with its potential independence. I'll
    just name a few of the seven that I identify in my statement.
    One is, the actuaries only have 90 days to review the business
    plan or rates, and we think this is much too short a period of
    time.
        The actuaries apparently can also be removed at the will of
    the Treasury Secretary or the President, which we think would
    also reduce their independence.
        The board of actuaries also has a very difficult burden of
    proof. We think the burden of proof is actually reversed.
    Here's the standard in the bill: The board may disapprove the
    prices or methodologies only if it presents compelling and
    substantial actuarial evidence on the record that the prices or
    methodologies are materially inconsistent with actuarial
    soundness. We think, if anything, the burden should be exactly
    opposite. The NDIC board should have to prove the compelling
    and substantial actuarial evidence to justify their prices and
    plans.
        Finally, if there are any new developments or new
    information, the actuaries apparently have no power to reopen
    and reject current rates or business practices.
        I think one of our key concerns with either this proposal
    or the House proposal is that the way things are structured for
    triggers on the contracts and payments. We think those triggers
    are much too low, and the NDIC would compete with the private
    sector. We believe that it would be better to set attachment
    points for Federal contracts at much higher levels, preferably
    $60 billion or more of losses, rather than the proposals in the
    House or Senate bills.
        Low attachment points for contracts threaten to crowd out
    existing private sector mechanisms, and what worries us even
    more is this will completely kill off financial innovations
    that have the potential to further expand capacity from the
    private sector.
        The bill addresses risk loads--now risk loads are charges
    that are meant to compensate for the riskiness of selling this
    type of insurance. The Congressional Budget Office notes that
    the risk load outlined in this bill and the House bill is about
    one-half to one-third the risk load seen in the private sector.
        There is also little incentive here to charge the proper
    risk load to compensate taxpayers. There's some language about
    having fair compensation for the risk being undertaken by the
    Federal Government, but we don't see any real incentive to
    ensure that the risks are appropriately offset by the proper
    pricing.
        We also think it's very important to limit the supply of
    contracts in any auction. Both House and Senate bills speak of
    auctions, but there's very little in the way of detail about
    how the auctions would run or how much would be supplied to the
    auction. As anyone who has followed auctions knows, you're not
    going to get a good, high price for something you sell if
    someone floods the market; and that's true whether it's on eBay
    or with the Treasury Department selling these types of
    contracts.
        We also see very severe management risks to having an
    industry-run federally created corporation with virtually
    unlimited Federal borrowing authority.
        I would also like to clarify that both the House and the
    Senate bills are not really selling reinsurance per se. What we
    have here is a contract that's actually a derivative
    instrument, not reinsurance. Now there's nothing wrong with a
    derivative in theory, but I think we should really know what
    we're talking about here. We have a contract that pays off, not
    based on the direct losses of any particular buyer of the
    contract, but pays off an amount based on losses in a certain
    area or region.
        So we have recommended for many years, and we're
    disappointed to see that the Treasury Department hasn't done
    much work in this area to date; and that is, before undertaking
    what we see as a risky and perhaps expensive experiment selling
    Federal reinsurance derivatives, that we should identify and
    reform laws and regulations that have the effect of making
    catastrophe insurance less available and more expensive.
        And your colleague, Senator Connie Mack, has identified one
    such area, and he's on the right Committee to try to do
    something about it, the Finance Committee. That is, the Federal
    tax laws have a huge implicit penalty on homeowners who attempt
    to purchase such insurance. His bill would fix that.
        We believe actually there is an emerging consensus around
    that approach and that legislation among both taxpayer and
    consumer groups that have not been terribly enamored with the
    idea of setting the Federal Government in the business of
    guaranteeing the nation's insurance companies.
        So again, Senator, thank you very much for your interest in
    this topic, and your continuing commitment to work with people
    of all views, and I think it's reflected in the panel that has
    been put together today. Again, thank you.
        [The prepared statement of Mr. Keating follows:]

           Prepared Statement of David L. Keating, Senior Counselor,
                            National Taxpayers Union
        On behalf of the 300,000-member National Taxpayers Union, thank you
    for the opportunity to present our views on the Natural Disaster
    Protection and Insurance Act of 1999.
        We have appreciated the opportunity to work with Senator Ted
    Stevens, his staff, and Committee staff in the past in an attempt to
    develop a consensus among a number of associations in this important
    area of public policy.
        While we hope that consensus can be reached, we must strongly state
    our opposition to S. 1361 because it would greatly and unnecessarily
    increase the potential liabilities of the government, displace well-
    functioning private insurance markets, and stifle innovations that are
    greatly increasing insurance capacity.
        The legislation proposes to establish a federally-chartered private
    corporation that would have enormous access to federal loans. The
    corporation, consisting of member insurance companies and called the
    Natural Disaster Insurance Corporation (NDIC), would sell derivative
    contracts that resemble reinsurance directly to eligible state programs
    or through an auction to private and state insurers and reinsurers.
        The NDIC would create many disincentives for the insurance industry
    to properly assume risks in a disciplined fashion at the right price.
    It would do little or nothing to encourage insurance companies to
    manage their disaster insurance risks well and it would likely reward
    companies that have been the least disciplined and the least
    professional in their accumulation of risks.
        Given its virtually unlimited access to federal borrowing, the
    structure and management of the proposed NDIC is unacceptable and
    extremely risky. S. 1361 would require the Treasury Department to
    guarantee payments on the multi-billion dollars-worth of contracts that
    could be sold by this corporation.
        The issue of an appropriate federal role in this area, if any, is
    highly complex and controversial. In our view, the Committee should
    legislate on this issue as carefully as it would if it were to create a
    new system of deposit insurance. There are very significant taxpayer,
    financial, public safety, consumer, insurance, and environmental risks
    involved, and all viewpoints should be heard. There are still a number
    of provisions in the legislation that are either unclear or pose a
    substantial risk of massive taxpayer losses.
    S. 1361 Would Create Enormous And Unlimited Unfunded Liabilities
        There can be no doubt that this legislation could prove to be
    enormously expensive. Section 7 would create a new Section 310 in the
    Earthquake Hazards Reduction Act of 1977 explicitly authorizing massive
    federal borrowing when it states:

              To the extent that the accumulated assets of the trust
            accounts described in subsection (a) or funds raised by issuing
            obligations in the private market pursuant to section
            301(e)(3)(C), are insufficient to pay claims and expenses
            resulting from the primary insurance coverages or the
            reinsurance coverage, the Secretary of the Treasury shall
            provide direct loans from the Private Loss Account described in
            section 402 in sufficient amounts to cover that shortfall in
            accordance with this subsection.

        The bill contains no effective limit on the total potential
    liability. There is no limitation on the number or the dollar amount of
    all the contracts that may be sold by the NDIC.
        S. 1361 provides that if ``claims under existing contracts for
    reinsurance coverage exceed the applicable maximum amount, each
    claimant shall receive a prorated portion of the amount available for
    payment of claims.'' Yet does anyone seriously believe that after a
    catastrophe Congress and the President would allow the federally-backed
    Natural Disaster Insurance Corporation to ration payments on claims and
    refuse to pass legislation making full payment on the contracts?
        The Congressional Budget Office agrees that such a program is
    likely to lead to losses. In its analysis of H.R. 21 (in many ways
    similar to S. 1361), CBO said ``because the frequency and severity of
    future catastrophic events are exceedingly difficult to estimate, it is
    unlikely that the federal government would be able to establish prices
    for disaster reinsurance that would fully cover the potential future
    costs of these financial obligations.''
    NDIC Has Overwhelming Incentives To Not Set Actuarially-Sound Rates
        S. 1361 requires that the NDIC board shall develop a plan of
    operation, including the ``guidelines, criteria, definitions,
    clarifications, and procedures necessary for the reinsurance
    coverage.'' The plan of operations and rates to be charged would be
    subject to review by an allegedly independent ``Natural Disaster
    Insurance Board of Actuaries.''
        Despite the bill's language to the contrary, the rates will not be
    fiscally sound for several reasons. The NDIC corporate members are
    specifically excluded from any liability for the NDIC's debts; the
    board and actuaries will be subject to strong political pressures to
    minimize rates; and, the NDIC rates would not accurately reflect
    reasonable risk capital charges.
    NDIC Members Are Not Liable For Its Debts, But Taxpayers Are
        Like the other versions of this legislation, this bill would have
    the practical effect of subsidizing insurance companies while putting
    taxpayers at substantial risk. Section 301 explicitly says that its
    insurance company members ``shall not be liable, or in any way
    responsible, for the obligations of the Corporation'' created by the
    bill.
        As noted earlier Section 310 makes it clear who is on the hook for
    perhaps tens or even hundreds billions of dollars: the American
    taxpayer, who is left without redress to those who took on the risk in
    the first place. This is moral hazard at its worst.
        Since the NDIC is intended to be a nonprofit corporation that only
    writes disaster insurance policies, this leaves less of a cushion for
    financially sound rates. Profit-making concerns, which now provide such
    insurance, can absorb reductions in their profits or capital because
    their rates reflect the actuarial risk to their capital. Most of these
    companies also have diversified risks since they insure many events
    other than natural disasters. Profit-making companies have much more
    incentive to develop advanced forecasting tools for proper rate-setting
    and analysis of risks.
    NDIC Board Likely To Become A Revolving Door, With Little
            Accountability
        The rates would largely be set by the NDIC board, which would be
    composed almost entirely of insurance industry representatives. Of the
    15-member board of directors, there would be nine insurance directors,
    and up to two insurance agents or brokers who can be elected to the
    board. Additionally, the other directors who might be elected will
    likely have close relationships with the insurance industry.
        Such a board would probably develop into a revolving door for
    property and casualty insurance interests to move in and out of the
    NDIC board, making decisions with respect to the disaster insurance
    market. There is a time lag between establishment of a policy and the
    moment when the NDIC reports the losses from that policy. That time lag
    would permit such revolving door directors to be out of the NDIC when
    fiscal losses occur, allowing them to escape accountability.
        Furthermore, the NDIC board would face many political incentives to
    avoid charging the proper rates. The property and casualty insurance
    industry greatly fears federal regulation, and if actuarial soundness
    requires higher rates in politically sensitive areas, it is entirely
    possible, and indeed likely, that the board will avoid imposing such
    rates. Of course the failure to set proper rates will not be felt until
    perhaps many years after those directors are no longer on the NDIC
    board.
    A Shocking Conflict Of Interest
        Even more surprisingly, the NDIC would essentially sell insurance
    to state governments. Yet these very same state governments regulate
    the insurance industry today. How can we expect the NDIC to negotiate a
    fair rate for reinsurance under such a clear conflict of interest?
    Board Of Actuaries Would Not Be Independent
        Proponents will claim that the ``independent'' board of actuaries
    must approve the NDIC's plan of operation and insurance rates. But this
    board would be a lap dog, not a watchdog.
        First, the legislation gives the actuaries only 90 days to review
    the plan of operation or rates. This is a ridiculously short period of
    time. If it is not disapproved within 90 days, the plan ``shall be
    deemed to have been approved and shall become final.'' Likewise if the
    board fails to disapprove within 90 days, the rate ``methodologies
    shall be deemed to have been approved.''
        Second, the actuaries themselves are likely to be subject to
    political control in several different ways. Most of the actuaries must
    rely on selling their services to current property and casualty
    insurance companies in the United States. Remember that the NDIC board
    of directors will represent some of the largest property and casualty
    insurers in the country. If an actuary tried to veto rates being
    proposed by the NDIC board, he might find it difficult to either find
    employment or to sell his services to NDIC member insurance
    corporations.
        Third, the terms of office make it easy for a President to appoint
    actuaries who will represent his wishes. The actuaries ``shall serve
    staggered terms for a maximum of 6 years as determined by the Secretary
    at the time of appointment.'' This wording is unclear, and may mean
    that the Treasury Secretary could appoint a member for a three-year
    term or a six-year term. In any event, the Secretary could clearly
    appoint a majority of the board within a President's term, which is
    hardly enough to protect independence. The President may feel intense
    political pressure to hold down rates in politically-important states
    such as California and Florida.
        Fourth, it appears that the commission members can be removed at
    the will of the Treasury Secretary or President, which would greatly
    reduce the already low chance of objective findings.
        Fifth, given that the pressures on the actuaries may well be
    intense, it is especially unfortunate that the board would apparently
    make its decisions by a simple majority vote. A unanimous vote would
    better ensure a more rigorous review.
        Sixth, the bill makes it very difficult for the actuaries to
    disapprove proposed rates. Here is the absurd standard: The board ``may
    disapprove the prices or methodologies . . . only if [it] presents
    compelling and substantial actuarial evidence on the record that the
    prices or methodologies are materially inconsistent with actuarial
    soundness.'' If anyone should have the burden of proving compelling and
    substantial actuarial evidence, it should be the NDIC board.
        Seventh, if new developments occur, the actuaries have no power to
    reopen and reject the current rates. Once the 90-day review period has
    been closed, that appears to be it. Certainly, the actuaries should
    have the power to reopen the rates or methodologies at any time and to
    declare them actuarially unsound. Yet the bill appears to prohibit such
    action by the actuaries.
    Reinsurance Contracts
        One portion of the proposal authorizes the NDIC to auction excess-
    of-loss-style reinsurance contracts. While such contracts can be
    designed and auctioned in a budget-neutral fashion, the legislation to
    authorize such contracts would likely lead to taxpayer losses,
    competition with the private sector, and distortions in the reinsurance
    markets.
        In a paper by Christopher M. Lewis--who is credited with developing
    the concept of these contracts--entitled ``The Role of Government
    Contracts in Discretionary Reinsurance Markets for Natural Disasters,''
    he explains how to design a fiscally sound program for federal excess-
    of-loss reinsurance. He writes that ``Only federal reinsurance
    proposals that provide coverage based on industry losses, offer
    capacity at levels above what is being provided in the private market,
    are capped and fully-funded, and are market neutral, are worthy of
    consideration.''
        Unfortunately, the bill as currently drafted does not meet these
    key tests. As already noted, the bill does not cap the amounts.
        Following are some of the other flaws we have been able to identify
    at this time:

    Crowding out the Private Sector. We fully agree with the comments made
    by many others that the triggers for payments on the contracts are much
    too low. The contracts could be structured to pay claims once losses
    exceed as little as $2 billion.
        Last year the Reinsurance Association of America (RAA), citing
    highly credible industry reports, indicates that there is
    ``approximately $20 billion of catastrophe reinsurance capacity
    available per region, per event.''
        That is just for reinsurance. As noted by RAA, ``the primary
    insurers have paid two-thirds to three-quarters of catastrophic claims,
    passing the remainder through to reinsurers.''
        According to industry estimates, the overall industry surplus now
    exceeds $330 billion. If just 20% of that surplus were available to pay
    for a catastrophe, that alone would equal $66 billion.
        There is even more capital available in the private sector. Thanks
    to recent financial innovations, increasing efforts have been made to
    securitize the financial risks of catastrophes. While still relatively
    small, the size of this market has dramatically grown in recent years.
    According to RAA, this securitization has ``grown from one transaction
    in 1994 totaling $85 million to eighteen transactions in 1998 totaling
    approximately $2.5 billion.'' My understanding is that the total of all
    such transactions completed to date now exceeds $5 billion.
        To stay out of the way of the private market, we believe any
    federal contracts should attach at points no less than $60 billion, and
    more likely $100 billion, under current conditions and should be
    increased based on the capacity of the sector.
        Low attachment points for the contracts threaten to crowd out
    existing private sector mechanisms and completely kill off financial
    innovations that have the potential to further expand capacity from
    private sector sources.
        Unless legislation is very carefully designed, it would seriously
    damage the private reinsurance markets and prevent financial innovators
    from entering this important sector.
        Current laws and regulations already pose high risks for the
    private markets and S. 1361 would exacerbate the current situation.
        Under current tax laws, state insurance pools have an enormous tax
    advantage over similar private sector funds in that all income to such
    pools is tax exempt (as are all earnings from capital in those pools.)
    This advantage alone has exerted substantial pressure for creation of
    state insurance pools. If low cost federally-backed reinsurance is made
    available, state pools will undoubtedly become more common, and those
    states with pools may well expand coverage limits.
        The end result will be a greater reliance on politically-run
    insurance programs and less opportunity for private insurers.

    Risk Loads. The legislation would set a price for state reinsurance
    contracts at the estimated annual losses, plus a risk load equal to
    those losses. A similar amount would be the basis of the minimum price
    for auctioned contracts.
        While such pricing sounds sufficient, one has to remember who would
    be responsible for estimating the likely losses--a politically
    influenced NDIC that has no responsibility to bear any financial risk
    from a too-low estimate. Equally important is the fact that such
    estimates are highly uncertain to say the least. After all, who really
    knows the chances of an earthquake striking in California or Missouri
    next year, or a strong hurricane passing directly over a major
    metropolitan area on the coast?
        The risk load is meant in part to compensate for, as CBO notes,
    ``the likelihood that available historical data do not fully capture
    current catastrophe risks.''
        The reality is that the price for sale of such contracts may well
    be less than the actual cost of the contracts, and is certain to be
    less than the price that would be offered by true private sector firms.
    CBO notes that ``risk loads observed in private transactions for
    disaster reinsurance against infrequent events, similar to those that
    would be covered under H.R. 21, are typically four to six times but
    sometimes exceed 10 times actuarially expected losses.''

    Cost of Capital. There is no provision requiring consideration of the
    cost-of-capital, except for some vague and unenforceable language
    requiring ``fair compensation for the risks'' being undertaken by the
    federal government. The NDIC should not compete with private reinsurers
    by charging less for the federal capital it has at risk. If it charges
    less, it will either drive out truly private firms or prevent them from
    entering the market.

    A Limited Supply of Contracts Is Essential. The Lewis paper notes that
    the program should be ``designed to enable the private sector to `crowd
    out' the federal government. . . . Once the market for these contracts
    is established, private companies can offer similar contracts in
    competition with the federal government.'' This is an essential
    component of this concept, but the draft legislation would make it
    virtually impossible for the private sector to accomplish the feat.
        In fact the legislation has no effective limitation on the supply
    of contracts, which would undercut the whole concept of an ``auction.''
        If the supply of contracts is not limited, the bids will be too low
    and a private sector market would not emerge at higher levels of
    capacity, defeating one of the key points of such a proposal.
        We strongly believe it would be a mistake for legislation to be
    completely silent on the auction process. While discretion is needed,
    guidance is essential.
        One cannot have a true auction with real bidding if the market is
    oversupplied. A rule must be devised that would be easily enforceable
    on the NDIC and would protect against political manipulation of the
    auctions.

    Taxpayer Standing. The bill appears to contain some provisions to
    protect the private sector and taxpayers. The reality is that these
    provisions are weak and unenforceable. Any such legislation creating
    enormous federal guarantees should allow taxpayers to have standing to
    sue to enforce any restrictions in the law protecting the private
    sector from NDIC competition or taxpayers from losses. There also may
    be enormous political pressure exerted in order to force the conclusion
    that a certain trigger has been reached, and that payouts should be
    made on the contracts. We believe in the principle of trust, but
    verify. Taxpayers should be given the standing in court to enforce the
    contracts if necessary in order to help ensure that they are honestly
    followed.

    Protection for the Private Sector. The tendency for government is to
    expand and crowd out the private sector. Since one goal of the excess-
    of-loss contracts is to expand the capacity of the private market, any
    such legislation should give the private sector a right to expand (and
    demand that the NDIC shrink) its sale of such contracts. For example,
    if a qualified reinsurer is willing and able to sell a contract, then
    we see no reason for the NDIC to sell a similar contract at a lower or
    even equal price.
    Political Risks of Reinsurance Contracts
        The comments expressed above outline our technical concerns with
    the bill's description of the contracts as defined by the
    ``Administration Policy Paper on Natural Disaster Insurance and Related
    Issues'' and the Lewis paper. A discussion of these contracts would be
    incomplete without a review of the inherent political risks.
        These political risks take two forms. First, and most important,
    are the political risks to prudent management of these contracts by the
    Congress, the President, and the Treasury Department and how payments
    are made. Second, and of legitimate concern to Members of Congress, is
    the public perception of the wisdom of offering these contracts should
    a disaster hit.

    Management Risks. The legislative description of the contracts leaves
    much discretion to an industry run federally-created corporation with
    virtually unlimited federal borrowing authority.
        While flexibility can be useful in designing a contract that would
    be accepted by the market, it can also be abused by a future Treasury
    Secretary who might be intent on granting back-door subsidies to the
    insurance market in a misguided attempt to increase capacity.
        A future Treasury Secretary might act politically to keep the
    reserve price down by putting pressure on the NDIC and the Board of
    Actuaries to lower their estimations of the costs of various risks.
        There may also be a great deal of pressure brought on the NDIC and
    Secretary to over-supply the market as early and for as long as
    possible. Please remember that the reserve price on auctioned contracts
    is at best an educated guess. We need a healthy, functioning auction
    market to incorporate more educated guesses--the guesses of those who
    wish to buy the contracts. If the auction market is flooded, that
    information will not be collected, nor will it be reflected in the bid
    prices for the contracts.
        After a major disaster, there may be great pressure on the NDIC to
    err on the side of making payments under the contracts. After all,
    those who hold the contracts can be expected to bring intense political
    pressure for billions of dollars in payments. Holders of the contracts
    might hire public relations and lobbying firms to state that payments
    on homeowners' claims could be made more quickly or completely if the
    NDIC were to make quick payments on the contracts.
        Clearly those who hold the contracts will have a court-enforceable
    right to force the NDIC to make the payments. But what would happen if
    the NDIC were to interpret the contracts and make payments that might
    not be clearly authorized? By contrast there is no legal recourse for
    taxpayers who will pay the bills--only a political recourse, which
    would likely come long after the improper payments were made.

    Public Perception of Risk. There is also political risk to Members of
    Congress from public perceptions of these contracts before or after a
    disaster. Consider the public's reaction if it appeared that these
    contracts were sold at too low a price or without a prudent auction
    process that would under supply the market, thereby ensuring healthy
    receipts to the NDIC. After a disaster that would result in taxpayer
    losses, the public reaction might be intense because there could be a
    perception of a huge subsidy to the insurance business, which both sold
    and became the owners of many, if not almost all, of the auctioned
    contracts. It is very important to get the technical details correct in
    order to minimize these political risks.
    Other Substantial Political Risks For Members Of Congress
        Members of Congress who vote for this should know that these
    contracts are actually a derivative instrument, not reinsurance. In
    fact, under current state regulatory rules, these contracts would not
    be treated as reinsurance--they would be treated as investments because
    the losses that trigger the payment of the contracts are not the direct
    losses of the insurer. This means that an insurer may or may not have
    incurred losses in proportion to the regional losses that cause
    contracts to be paid. There is nothing theoretically wrong with a
    properly-priced derivative. Yet the public perception of derivatives is
    that they are inherently risky and were responsible for the massive
    losses in California's Orange County.
        Even if the reserve price for the contracts is actuarially correct,
    which we doubt would happen, the federal government can still lose a
    lot of money very soon after passage of legislation. We could be
    unlucky. The first set of contracts could be sold in a year when a
    major disaster would cause the trigger to be reached and billions of
    dollars in payments to be made when receipts are merely in the
    millions. Such an event could immediately damage the fiscal reputation
    of the program.
        After a disaster, new information might become available that would
    show the reserve price was based on incorrect information. This is to
    be expected. With each subsequent disaster, new information is learned
    and incorporated into pricing decisions by the market. That's not to
    say that people won't try to use hindsight to criticize the NDIC's
    actions, especially if it appears that political pressure was
    successfully brought to bear on the NDIC and the Treasury Department to
    set a low reserve price.
    Fix Laws And Regulations First
        Before undertaking a risky and perhaps incredibly expensive
    experiment in selling federal reinsurance, Congress should first
    examine and reform laws and regulations that have the effect of making
    catastrophe insurance less available and more expensive.
        During our work over the last five years studying proposed
    legislation and public policy regarding natural disasters, we have
    found that a number of federal and state laws and regulations greatly
    hamper the ability of the private sector to provide insurance for
    catastrophes.
        Perhaps the most important impediment to affordable catastrophe
    insurance is the federal tax law, which contains a huge implicit
    penalty on homeowners who attempt to purchase such insurance. These
    same laws also prevent insurance companies to deduct an amount equal to
    the risk of catastrophic natural disasters; amounts that we consider
    legitimate business expenses. Here is why.
        When a taxpayer buys a homeowner's policy in a catastrophe-prone
    area, a large part of the premium represents the annual amount that
    needs to be saved over many years to cover the likely loss from a major
    catastrophe. Unlike normal fire or theft losses, which occur smoothly
    year to year and thus are deductible from income, losses from
    catastrophes are huge. An insurance company might go for many years or
    even decades before paying claims on a catastrophe.
        A prudent tax law would recognize that premiums that represent the
    best estimate of the risk from catastrophe losses should be deductible
    as a cost of doing business. That is not the case. Under our current
    tax system, virtually all premium income that represents the risk of
    loss flows into taxable income. Effectively our tax laws have created a
    sales tax on risk premiums for catastrophe losses! This misguided tax
    exacerbates the problems of availability and affordability of
    homeowner's insurance in catastrophe-prone areas.
        Of course, when the catastrophe comes, these claim payments can be
    deducted against an insurance company's income that year. Yet that does
    little good if the insurance company goes insolvent. For companies that
    remain solvent, loss carry-backs and carry-forwards are limited and the
    losses might never be fully recognized by the Tax Code. When it comes
    to catastrophes, we have created a tax policy that is not much
    different from the trick coin-toss choice: ``heads we win, tails you
    lose.''
        We believe a consensus is emerging around legislation to fix this
    problem in the tax laws and urge Senators who are interested in this
    issue to support S. 1914, sponsored by Senator Connie Mack.
    Conclusion
        S. 1361 is both politically and economically risky and should be
    subjected to more extensive examination and comment before being
    enacted into law. We strongly urge the Committee to remember that even
    the best-intentioned programs can have budget-busting consequences.
    While legislation may be needed to reduce the impact of natural
    disasters, Congress must move carefully in this highly complex area to
    ensure that it does not create a fiscal disaster or unwisely interfere
    with private markets. We would be pleased to work with you in order to
    protect against taxpayer losses and improve federal disaster policies.

        Senator Stevens. All right. If it's all right with you, I'd
    prefer to hear all of the statements and then see if we can ask
    key questions of each one of you.
        Mr. Nutter is next on our list, but Mr. Plunkett, you're
    sitting right there, why don't we just go down the table?

     STATEMENT OF TRAVIS PLUNKETT, LEGISLATIVE DIRECTOR, CONSUMER
                         FEDERATION OF AMERICA

        Mr. Plunkett. Thank you, Mr. Chairman. We also appreciate
    the invitation to offer our comments today, and we very much
    appreciate the diversity of comments that you are receiving.
        I am Travis Plunkett, I am the Legislative Director of the
    Consumer Federation of America, which is an association of 260
    state and national organizations focused on education and
    advocacy. Unfortunately, our Insurance Director, Bob Hunter, is
    unable to be here today; he's out of the country. So I am
    offering his comments.
        He is the former Texas State Insurance Commissioner. He
    also served as Federal Insurance Administrator under Presidents
    Ford and Carter, when he administered the National Flood
    Insurance Program.
        As we all know, the 1990's were a decade of very high
    levels of disasters. However, we want to note that even with
    payouts to disaster victims by insurance companies approaching
    $70 billion over that decade, the surplus of property casualty
    insurance business has skyrocketed from $134 billion at the
    start of the Nineties to about $330 billion today. This is a
    growth of almost two and a half times.
        The reinsurance industry is similarly rich. Further, new
    forms of private backup for primary insurance such as acts of
    God bonds and other forms of securitization have been developed
    in the last decade and are in the market now. All of this must
    be tapped, even stretched a bit before the taxpayer steps in to
    help.
        Although the insurance industry has not been adversely
    affected by disasters, even disasters at record levels over the
    last decade, consumers have. They have been subject to coverage
    cutbacks in the form of much higher deductibles, and other
    cutbacks in coverage. The amazing thing is that while
    reinsurance prices for catastrophes are now readily available
    at very cheap prices, often half of what was being charged a
    few years ago, consumer prices have not fallen.
        The proposals under consideration by this Committee today
    place too much emphasis on providing relief to the insurance
    industry rather than ensuring the availability of affordable
    insurance to consumers. I would note here that we also are not
    opposed to a Federal role if it meets the principles of sound
    public policy for handling disasters, and this bill just
    doesn't for several reasons. I'll touch on a few of them.
        First, S. 1361 does not assure the taxpayer of any
    reduction in the cost of disaster relief. While mitigation is
    encouraged and funds made available to the states, there aren't
    minimum requirements in the bill.
        I know from--this is Bob Hunter--having served at both the
    state and Federal levels, he knows that great pressure is
    brought to bear from developers on the states, and even moreso
    on local authorities to go easy on building codes. The Federal
    Government must bite the bullet on minimum standards, as in the
    Flood program, if mitigation is to be meaningful enough to cut
    costs.
        Second, the bill does not encourage that consumers in high
    risk areas get adequate insurance coverage. There are no
    provisions in the bill requiring that one more policy of
    insurance be written by state pools or the private insurers in
    exchange for the Federal backup.
        The Federal Government would be foolish to provide
    financial backup absent some guarantees of more coverage sales
    and the easing of the burdensome coverage restrictions now in
    use.
        Third, this bill clearly interferes with and impedes the
    development of the private insurance market; and on this we
    agree with David's comments. A trigger of $2 billion is really
    far too low in comparison to what just the primary market can
    deliver. USAA, the fine insurer from Texas, has securitized
    backup for at least $1.5 billion itself. The trigger should be
    tied to the industry's capacity and the capacity of new,
    innovative methods. A trigger below $50 billion, given today's
    market cap, is simply not needed.
        Fourth, the bill does not set standards for state pools
    that the taxpayer would be backing up. Pools could be set up
    that actually increased taxpayer exposure, such as the
    California earthquake authority, what they have done. We would
    also agree with the comments you've heard about the domination
    of the board of directors of the corporation by insurance
    companies. They simply have too much power, given the way that
    it's written.
        The 15-person board of directors of the corporation is
    dominated by the insurance industry; 9 of the 15 are from
    insurance companies and another is an insurance agent or
    broker. This industry organization will be empowered to provide
    the reinsurance and manage the trust. Members of the
    corporation will not be liable for corporation obligations, and
    members and directors shall not be liable for acts taken under
    these authorities.
        Worse, the board gets to certify that state plans comply
    with regulations it issues. The bill goes so far to say that
    the corporation may require the state pool to give all
    information it asks for as it determines. This means that
    insurance companies are essentially regulating the government.
        The bill includes requirements, finally, that the rates
    charged for reinsurance be very high, at least as high as the
    actuaries say it should be, and with at least a doubling of the
    price for the risk load.
        In closing, I would just like to say that we do oppose this
    bill as written. However, we would note that we do need, this
    country does need an integrated plan that lowers the risk of
    death and property damage across the country with a national
    mitigation strategy. We do need to develop mechanisms that
    would assure that people can get insurance.
        We can minimize both Federal involvement and taxpayer
    burden. We can also develop projections of how such a plan
    would work before Congress acts. So you, Mr. Chairman and
    others, know what you're getting into.
        We can assure that over time the cost of choosing to live
    in high risk areas will be borne by those who choose to live
    there more and more, eliminating the high taxpayer burden
    currently necessitated by the lack of a proper plan for the
    nation.
        So I would also say that we would look forward to working
    with you and your staff. Mr. Hunter would be available to
    anyone who would like to speak with him about how to construct
    a proper plan. Thank you.
        [The prepared statement of Mr. Hunter follows:]

          Prepared Statement of J. Robert Hunter, Insurance Director,
                         Consumer Federation of America
        Good morning. I am Bob Hunter, Director of Insurance for CFA. I
    served as Federal Insurance Administrator under Presidents Ford and
    Carter, during which time I administered the National Flood Insurance
    Program. I also served as Texas Insurance Commissioner in the early
    1990s during which time I developed a comprehensive disaster response
    plan for insurance and, unfortunately, got to test it in terrible
    flooding in the Houston area and devastating tornadoes near Dallas.
    Background
        The 1990s have been a decade of very high levels of disasters. Of
    the ten most costly insured disaster events all but one of them
    occurred in the past decade. However, even with payouts to disaster
    victims by insurance companies approaching $70 billion over the decade,
    the surplus of the property/casualty insurance business has skyrocketed
    from $134 billion at the start of the decade to about $330 billion
    today, a growth of almost two and one-half times.\1\
    ---------------------------------------------------------------------------
        \1\ Best's Aggregates and Averages, 1999 Edition, Pages 250-252.
    ---------------------------------------------------------------------------
        The industry leverage (as measured by the ratio of net premiums
    written to surplus) has dropped from just over 1.5 to 1 at the
    beginning of the decade to about 0.8 to 1 today. The standard for the
    industry that is considered ideal is 2 to 1. Thus the property/casualty
    has gone from strongly capitalized prior to the rash of catastrophes to
    significantly overcapitalized today.
        The insurance industry has not been adversely impacted by
    disasters, even disasters at record levels. The consumer, on the other
    hand, has been subject to coverage cutback in the form of gigantically
    higher deductibles and other cutbacks in coverage. The amazing thing is
    that, while reinsurance prices for catastrophes is now readily
    available at very cheap prices (often half of what was being charged a
    few years ago), consumer prices have not fallen at all.
        Consider the state that took the brunt of Hurricane Andrew's wrath.
    The rate of return on home insurance in Florida was 29.3% in 1998, the
    latest year of profit data available.\2\
    ---------------------------------------------------------------------------
        \2\ Report on Profitability by Line by State, NAIC, November 1999.
    ---------------------------------------------------------------------------
        Insurers have insulated themselves from catastrophes in several
    ways. The raising of deductibles \3\ shifts a significant part of the
    cost of disasters to consumers and to taxpayers. A clear example is the
    calculations of the California Earthquake Authority who estimated that
    the cost of future earthquakes in that state will be shifted so that
    63% of the cost will be borne by consumers (and taxpayers).
    ---------------------------------------------------------------------------
        \3\ 5% along coasts, even higher along earthquake faults.
    ---------------------------------------------------------------------------
    Toward a Rational National Public-Private Disaster Policy
        Before Congress acts to provide what is likely unnecessary
    assistance to the insurance industry for disasters, it must access the
    relationship between taxpayer-financed disaster relief and protection
    currently available from the private insurance market. Any program
    Congress enacts must ensure that the capacity of the private market is
    maximized and that claims against federal and state taxpayers from
    future disasters are reduced and, ultimately, eliminated through use of
    mitigation and private market mechanisms.
        The relationship between insurance and taxpayer-funded relief is an
    important one. Chart 1 shows that insurance payouts for catastrophes
    are large for wind type claims. 73.9% of insured cat payouts are for
    wind related events such as hurricane, tornado and other wind loss.
    Only 9.1% of the payout is for earthquake. Nothing is paid out by
    private insurers for flood since flood insurance is a federal program.
        Correspondingly, the chart at the bottom of Chart 1 shows that
    disaster relief payments are 35.4% for earthquake, 15.6% for flood and
    only 23.0% for hurricane.
        Not surprisingly, it works like this: the better the insurance
    coverage, the less the taxpayer burden.
        Charts 2 and 3 show the effect of private vs. tax-financed
    coverage. Chart 2 shows that people living in wind-prone areas pretty
    much pay their own way through high homeowner rates. Texas and Florida
    have among the highest homeowner rates in the country, for example.
        Unlike insurance rates, disaster relief is not paid for on a risk-
    related basis. Taxpayer subsidy from state to state is very real and
    varies depending upon the level of insurance coverage in the particular
    state. Outrageously, the better the state does at paying its own way
    through insurance, the more the state pays in subsidy to states that do
    not pay their own way.
        Chart 3 shows the household subsidy from state to state. California
    gets an average annual subsidy of $100 per family paid for by such
    states as Connecticut ($63), Nevada ($43), Michigan ($42),
    Massachusetts ($38), Texas ($23) and Arizona and Montana ($22 each).
        It is not fair for a state like Texas, where I well know
    homeowner's rates are remarkably high to cover catastrophes, to have to
    kick in a subsidy for states that do not insure their risks more
    completely.
        CFA's 1998 study, ``America's Disastrous Disaster System'' found
    that there is no real system in place in the United States to handle
    disasters from the insurance point of view. When a disaster strikes,
    there are times when there is almost complete insurance protection
    available from private sources. Other times there is partial coverage,
    sometimes from private sources, sometimes from government sources.
    Sometimes when a disaster strikes very little insurance protection is
    in force from any source.
        Mitigation and enforcement of codes is also spotty. Building codes
    for flood-prone buildings are set nationally, by FEMA. Wind and
    earthquake codes are set either at the state or the local level, with a
    wide disparity in code and in enforcement of code. You all know that,
    had the codes in Florida been enforced, Hurricane Andrew damage would
    have been 40 to 70% less.
        Our research shows that mitigation, enforcement and maximization of
    private insurance and reinsurance can sharply reduce the tax burden of
    natural disasters and, eventually, can largely eliminate them (except
    for immediate shelter and other emergency needs). Congress should
    develop and adopt a plan to accomplish this prior to enacting any
    legislation, which further exposes taxpayers to risk of payments in the
    event of disasters. We are very concerned about moving ahead with any
    bill that has not been prepared with the necessary analysis of mid- and
    long-term impacts on taxpayers of implementation.
    Principles to Guide National Disaster Policy
        The nation needs a new system, an integrated system, to deal with
    disasters. The proposal under consideration by this Committee today
    places too much emphasis on providing relief to the insurance industry
    rather than ensuring the availability of affordable insurance to
    consumers. Congress should not pass legislation bailing out insurance
    companies unless the bill meets the following principles to ensure it
    benefits consumers and taxpayers as well as the industry:
    1. Assuring Insurance Protection Occurs
       Any proposal must ensure that adequate insurance is
            available at adequate rates to all consumers, especially in
            high-risk areas. A transition plan may be needed to help
            current homeowners get through the ``sticker shock'' of changes
            in price for insurance in some areas.

       Low- and moderate-income homeowners should be protected from
            loss of insurance coverage.

       Deductibles, co-insurance and surcharges may all be ways to
            ensure that insurance is available but should not be used (as
            the California Earthquake Authority--CEA--does) to render
            coverage inadequate. Congress must also deal with the problem
            now extant where taxpayers pay the lower levels of costs of
            disasters under too-high private deductibles.

       Insurance rates on new construction must be based on risk;
            otherwise unwise construction is encouraged. The CEA cross-
            subsidizes rates for new construction in the highest risk areas
            of California. These subsidies will greatly increase cost and
            taxpayer burden over time.
    2. Strong Mitigation Measures to Reduce the Cost of Disasters
       Any proposal to back up the insurance industry must have as
            its focus mitigation of risk to reduce losses. To back up
            insurance in the highest risk areas of the nation without
            controlling new building in predictable ways is an invitation
            to build improperly.

       All stakeholders must be included in mitigation efforts--
            federal, state and local governments, businesses and consumers,
            developers, the insurance industry and other stakeholders.

       The proposal should encourage and at times require building
            away from the most dangerous locations (which locations are
            often visually appealing).

       The proposal must include measures to encourage and assist
            homeowners, especially low-income homeowners, to implement
            damage reduction measures.

       The program should encourage reduction in risk in existing
            homes.\4\
    ---------------------------------------------------------------------------
        \4\ As an example of an innovation to encourage retrofitting: If a
    program could be established that offered insurance rate discounts for
    retrofitting that would be sufficient to lower monthly cost by an
    amount sufficient to pay off a loan to pay for the retrofitting, that
    would surely encourage action by homeowners, even low income
    homeowners.
    ---------------------------------------------------------------------------
    Retention of Risk in the Private Market
       Any program must have a clear test to assure that as much
            risk as possible is served privately, taking into consideration
            the market's capacity and the type of risk involved.

       The property/casualty industry has over $325 billion in
            surplus today, 2 and \1/2\ times what it had in 1989 despite
            the worst decade of catastrophes in history. The industry is,
            as all observers recognize, overcapitalized. The reinsurance
            industry is similarly rich. Further, new forms of private back-
            up for primary insurance, such as Acts of God Bonds and other
            forms of securitization have been developed and are in the
            market. All of this must be tapped, even stretched a bit,
            before the taxpayer steps in to help.
    Appropriate State and Federal Oversight
       Federal oversight of the insurance industry is essential if
            the federal government provides financial back-up of the
            industry's writings. Are rates reasonable? Are consumers being
            underwritten in high risk areas?

       States must maintain proper protections such as rate review
            and approval, monitoring of availability of insurance, and so
            forth.
    Demonstrated Benefits to the Federal Government's Disaster Relief
            Expenditures
       Any back-up plan must be shown to reduce projected disaster
            relief payments by the federal government. The quid-pro-quo for
            the taxpayer must be proven reductions in payments for
            disasters over time. That analysis must be rigorous and
            available to the public. Congress must show that the short-term
            investment made by taxpayers in mitigation and insurance back-
            up liabilities actually will work to reduce long-term disaster
            relief costs. Otherwise, the taxpayer is being asked to buy a
            pig-in-a-poke. Congress should have a year-by-year projection
            with and without any bill so the public and Congress itself can
            measure whether the program is working as intended.
    The Natural Disaster Protection and Insurance Act Fails to Meet these
            Principles
        S. 1361 establishes a federally backed reinsurance program
    administered by the insurance industry itself, through the creation of
    the Natural Disaster Insurance Corporation. Reinsurance would be
    granted to qualifying State Pools and to private insurance companies.
    The reinsurance program would cover homeowners against the perils of
    hurricanes, earthquakes, volcanic eruptions, tsunamis, windstorms and
    wildfires. There is no dollar maximum for federal back-up, only a limit
    based on the unknown ``financial capacity of the Corporation to repay
    those loans not later than 20 years after receiving the loans.'' The
    Secretary of Treasury is authorized to borrow from the Treasury to make
    these loans.
        The state pool and the private insurers would have slightly
    different triggers, amounts that must be exceeded for reinsurance to
    kick in. State Pools must sustain the greater of $2 billion, the claim
    paying capacity of the Pool (as determined by the industry members of
    the Corporation) and the cost of the 100 year event (also determined by
    the insurer/members of the Corporation).
        Private insurers have cover triggered at $2 billion or the 100 year
    event cost (determined by the Corporation), whichever is greater.
        The bill is flawed in almost every particular:

       S. 1361 does not assure the taxpayer of any reduction in the
            cost of disaster relief. While mitigation is encouraged and
            funds made available to the states, there is no minimum
            requirement in the bill. I know from having served at both the
            state and federal levels that great pressure is brought to bear
            from developers on states (and even more on local authorities)
            to go easy on building codes. The federal government must bite
            the bullet on minimum standards as in the flood program if
            mitigation is to be meaningful enough to cut costs. Just
            throwing money and platitudes at the need has not worked in the
            past to bring down taxpayer costs from natural disasters. You
            can and must be specific as to what is required to cut costs.

       The bill does not ensure that consumers in high-risk areas
            get adequate insurance coverage. There are no provisions in the
            bill requiring that one more policy of insurance be written by
            State Pools or the private insurers in exchange for the federal
            back-up. The federal government would be foolish to provide
            financial back-up absent some guarantees of more coverage sales
            and easing of the burdensome coverage restrictions now in use.

       S. 1361 clearly interferes with and impedes the development
            of the private insurance market. A trigger of $2 billion is
            really obscenely low in comparison to what even just the
            primary market can deliver. USAA, the fine insurer from Texas,
            has a securitized back-up for at least $1.5 billion itself! The
            trigger should be tied to the industry's capacity and the
            capacity of new innovative methods. A trigger below $50 billion
            given today's market cap is simply not needed.

       The bill does not set standards for state pools that the
            taxpayer would be backing up. Pools could be set up that
            actually increase taxpayer exposure, such as the California CEA
            has done.

       The bill is a ``wish list'' of a few large insurance
            companies giving them too much power. The 15 person Board of
            Directors of the Corporation is dominated by the insurance
            industry. 9 of the 15 are from insurance companies and another
            is an insurance agent or broker. This industry organization
            will be empowered to provide the reinsurance and manage the
            Trust. Members of the Corporation will not be liable for
            Corporation obligations and members and Directors shall not be
            liable for acts taken under these authorities. Worse, the Board
            gets to certify that State Plans comply with regulations it
            issues. It goes so far to say that the Corporation may require
            the State Pool to give it all information it asks for, as it
            determines. How delicious for the insurance companies; they
            finally get to regulate the government!

       The bill includes requirements that the rates charged for
            reinsurance be very high (at least as high as the actuaries say
            it should be and with at least a doubling of the price for
            ``risk load'' \5\).
    ---------------------------------------------------------------------------
        \5\ This gouging is not justified in any way in the bill. As an
    actuary I say there is no such justification.

        There has been a history recently of insurers dumping good risks
    into State Pools, particularly in California and Florida. Now that they
    are flush with cash, with ample private reinsurance and other back-up
    available, many consumers still languish in these Pools. This bill
    could encourage more use of State Pools and give insurers more freedom
    to dump and avoid their responsibilities to serve all in the state in
    which they are licensed. This would arrest the fast developing
    securitization of catastrophic risk and cause imbalances in the working
    of the private market.
        The private market handled Hurricane Andrew. It handled the
    Northridge earthquake. Through these things the private insurance and
    reinsurance market prospered and new markets from other disciplines
    developed. The nation does not need S. 1361. We do not need to bail out
    insurers. We do need to develop national minimum mitigation strategies.
    We do need to do the analysis we have been asking to be done now for
    the 12 years this bill and its predecessors have died up on Capitol
    Hill.
    Good News on the Research Front
        Wharton School has gone a long way toward answering many of the
    questions that must be answered before you design a bill that really
    offers benefits to more than one or two jumbo insurance companies. The
    Wharton research is being done in its Managing Catastrophic Risks
    Program. You can see a list of 14 papers to review on their web site at
    www.fic.wharton.upenn/fic/wfic/riskinfo.
        The most important finding relative to need for federal back-up is
    this one:

       The industry has more than adequate capacity to pay for
            catastrophes of moderate size. E.g., based on both the national
            and Florida samples, the industry could pay at least 98.6
            percent of a $20 billion catastrophe. For a catastrophe of $100
            billion, the industry could pay at least 92.8 percent. . . .
            The results suggest that the gaps in catastrophic risk
            financing are presently not sufficient to justify Federal
            government intervention in private insurance markets in the
            form of Federally sponsored catastrophe reinsurance. However,
            even though the industry could adequately fund the ``Big One''
            doing so would disrupt the functioning of insurance markets and
            cause price increases for all types of property-liability
            insurance. Thus, it appears that there is still a gap in
            capacity that provides a role for privately and publicly traded
            catastrophic loss derivative contracts.\6\
    ---------------------------------------------------------------------------
        \6\ Can Insurers pay for the ``Big One''? Measuring the Capacity of
    the Insurance Industry Market to Respond to Catastrophic Losses,
    Wharton School, University of Pennsylvania, Cummins, Doherty and Lo,
    June 1999.

       Another remarkable Wharton finding is that securitizing the
            risk of catastrophes not only lowers the risk for the primary
            insurer, it lowers the portfolio risk for the investor as well
            since the catastrophe occurrences are not timed with market
    ---------------------------------------------------------------------------
            moves.

        I recommend that the Committee invite Wharton to testify if you
    have not already done so.
    Conclusion
        CFA strongly opposes S. 1361. The bill fails to meet the principles
    of sound public policy for handling disasters. It does not assure
    insurance for those who need it. It will interfere with existing and
    emerging private solutions to the financial back-up requirements of the
    primary insurance market. It will exacerbate the taxpayer burden
    because, absent sound mitigation requirements, the bill will encourage
    unwise construction. The trigger levels are way too low. There are
    inadequate incentives for insurance companies not to dump into State
    Pools and no incentives for insurers to take people out of such Pools.
    The insurance companies are delegated too much power, including
    regulatory rights over State Pools. Worst of all, there is no rigorous
    analysis establishing how the bill is intended to impact the disaster
    relief burden of taxpayers, no projection of long-term effects with and
    without the bill on subsidies so many states now pay for a few states
    that are inadequately protected from the cost of disasters.
        Mr. Chairman, you can do much better. You should do much better.
    You can adopt an integrated plan that lowers the risk of death and
    property damage throughout the nation through mitigation. You can
    develop mechanisms that would assure that people could get insurance.
    You can minimize both federal involvement and taxpayer burden. You can
    develop the projections of how the plan would work before you act so
    you know what you are doing. You can see that, in time, the cost of
    choosing to live in high risk areas will be borne by those who choose
    to live there, eliminating the high taxpayer burden currently
    necessitated by lack of a proper plan for the nation
        I would be happy to respond to any questions you may have for me at
    the appropriate time.
                                                                CHART 1

                                                                CHART 2
        The ten most expensive states in which to insure a home today are:

    ----------------------------------------------------------------------------------------------------------------
                                         Cost per                                                           Cost per
                 State \1\                $1,000                                       State                 $1,000
    ----------------------------------------------------------------------------------------------------------------
     1. Texas                              $7.55   ...................   6. Florida                           $4.98
     2. Mississippi                         6.60   ...................   7. Kansas                             4.94
     3. Louisiana                           6.34   ...................   8. Wyoming                            4.53
     4. Oklahoma                            6.23   ...................   9. South Carolina                     4.35
     5. Arkansas                            5.00   ...................  10. Alabama                            4.34
    ----------------------------------------------------------------------------------------------------------------
    \1\ The data from the national Association of Insurance Commissioners does not include California as of this
      survey. It will be included next year.

        The ten least expensive states in which to insure a home today are:

    ----------------------------------------------------------------------------------------------------------------
                                         Cost per                                                           Cost per
                 State \2\                $1,000                                       State                 $1,000
    ----------------------------------------------------------------------------------------------------------------
     1. Virginia                           $2.14   ...................   6. New Jersey                        $2.48
     2. Maryland                            2.21   ...................   7. Ohio                               2.55
     3. Delaware                            2.21   ...................   8. Oregon                             2.64
     4. Illinois                            2.39   ...................   9. Washington                         2.76
     5. Wisconsin                           2.46   ...................  10. Pennsylvania                       2.81
    ----------------------------------------------------------------------------------------------------------------
    \2\ The data from the national Association of Insurance Commissioners does not include California as of this
      survey. It will be included next year.

        The major reason for high prices is related to the degree of wind-
    related or hail-related natural disasters in the state.
        This has important implications for public policy in the high cost
    states. Mitigation of damage through better roofing and wind protective
    devices can save significant dollars in home insurance costs. Savings
    of at least 50% may be possible in some jurisdictions. In Texas, for
    example, just moving the homeowners rate half way toward the
    countrywide average cat load would cut the homeowners premiums by more
    than 25%.
                                                                CHART 3

    ----------------------------------------------------------------------------------------------------------------
                                               Disaster                                                     Disaster
                                                Relief                                                       Relief
                      State                    Subsidy                               State                  Subsidy
                                                 per                                                          per
                                              Household                                                    Household
    ----------------------------------------------------------------------------------------------------------------
    12 States Receive:                                                Other States Pay (continued):
      North Dakota                            $104.32                   Vermont                            -20.60
      California                               99.56                    Montana                            -21.76
      Hawaii                                   74.38                    Arizona                            -21.81
      South Dakota                             52.00                    Illinois                           -22.74
      South Carolina                           31.73                    Texas                              -23.41
      Iowa                                     25.69                    New Mexico                         -25.92
      Alaska                                   24.95                    Tennessee                          -27.40
      Florida                                  21.62                    Pennsylvania                       -27.42
      Louisiana                                20.19                    Wisconsin                          -28.91
      Missouri                                  4.57                    Indiana                            -30.32
      Nebraska                                  3.31                    Utah                               -30.48
      West Virginia                             0.10                    Rhode Island                       -31.22
                                                                        Ohio                               -32.62
    Other States Pay:                                                   Colorado                           -34.66
      Georgia                                  -0.09                    Virginia                           -35.57
      Mississippi                              -2.36                    Delaware                           -36.06
      Alabama                                  -5.75                    Wyoming                            -37.88
      North Carolina                           -8.07                    Massachusetts                      -38.11
      Kentucky                                -11.83                    New York                           -39.20
      Oregon                                  -12.22                    Michigan                           -41.60
      Idaho                                   -13.11                    Nevada                             -43.41
      Arkansas                                -13.86                    New Hampshire                      -43.65
      Washington                              -15.36                    Maryland                           -43.99
      Kansas                                  -15.40                    Dist. of Col.                      -49.73
      Maine                                   -16.75                    New Jersey                         -51.71
      Oklahoma                                -17.39                    Connecticut                        -62.61
      Minnesota                               -17.73
                                                                      Countrywide                           $0.00
    ----------------------------------------------------------------------------------------------------------------

        Senator Stevens. Thank you, Mr. Plunkett.
        Mr. Nutter.

               STATEMENT OF FRANK W. NUTTER, PRESIDENT,
                   REINSURANCE ASSOCIATION OF AMERICA

        Mr. Nutter. Mr. Chairman, thank you very much. The
    Reinsurance Association of America represents the United States
    property casualty reinsurance industry.
        As we have for some time we believe that there is an
    appropriate and necessary Federal component in any solution
    dealing with the financing of natural disaster risk. In our
    view, the states have done a lot to address this problem. They
    have provided insurers and consumers with coverage options,
    variable deductibles, and they have worked with insurers to
    find proper rates.
        We are encouraged by the development of the capital
    markets, which have been mentioned as increasing capacity to
    deal with this risk. And frankly we're encouraged by the
    increasing focus that FEMA and many private sector
    organizations are placing on mitigation. Yet there remains in
    this country an extraordinary exposure to hurricanes,
    earthquakes and volcanic eruptions threatening lives and
    people's property.
        We believe that S. 1361 is a sound foundation for a Federal
    role. We endorse the mitigation provisions of the bill, and we
    have offered to your staff certain technical amendments that
    were adopted by the House Banking Committee largely without
    controversy.
        I would like to focus my comments on two particular
    proposals which we view as constructive in improving the
    legislation.
        The first of these is the level at which the federally
    sponsored program assumes a financing role. Our philosophy is
    echoed very well in the Treasury testimony, that the Federal
    role should be a back-stop, it should be a safety net behind
    the industry. It should not compete with, replace, or provide
    disincentives for the private sector.
        Because the capacity of the insurance, reinsurance, and
    capital markets is robust, has been for a number of years and
    we believe will continue to be, we do believe that high
    thresholds for the Federal attachment point, or triggers, are
    necessary.
        We have recommended in our testimony that these minimum
    thresholds be a range of $5 billion or a 1 and 250-year event.
    Let me offer my perspective on each of those two numbers.
        First the $5 billion number: Three distinct reinsurance
    organizations in 1999 issued reports looking at the available
    reinsurance capacity and found essentially the same number.
    About $20 billion of property catastrophe reinsurance is in
    place, covering actual risk in the United States per region.
        Second, Louisiana and New York both issued reports stating
    that there was an overabundance of reinsurance in their
    markets. To this capacity in the reinsurance market, you need
    to add the capacity of the primary insurance market. Because
    the largest homeowner's insurers in the country buy very little
    reinsurance relative to their size, they offer capacity from
    their own balance sheets.
        A.M. Best, which is the principal rating organization for
    the industry, has stated publicly that the industry is over
    capitalized by $100 billion, even taking into consideration a
    1-in-100-year catastrophe.
        The Wharton School has issued a report stating that there
    is more than adequate capacity to deal with the risk in the
    United States. This capacity or surplus of the industry has
    risen even though the industry has paid $99 billion in
    catastrophe losses in the last 10 years.
        Even the $5 billion number that we have recommended would
    seem low in the context of these numbers that I have given in
    capacity, but we believe if treated properly in the legislation
    as a threshold, they should be acceptable to all parties.
        With regard to the 1-in-250-year threshold that we have
    suggested: that number may sound unreasonable to some people, a
    1-in-250-year event. But it's merely a measure, a probability
    measure of what catastrophe exposure is. In fact, it is the
    standard being used in the industry. Again, A.M. Best, the
    rating organization that is independent of the industry, uses a
    1-in-250-year event as a standard for insurers, for earthquake
    risk, wherever it is in the United States, and for Florida
    hurricane risk.
        Insurance companies must already demonstrate to this rating
    organization that they have the risk management tools in place
    for a 1-in-250-year event.
        So we encourage the Committee to increase the thresholds in
    the legislation to a $5 billion or 1-in-250-year event as a
    minimum trigger for the Federal role.
        The second suggestion that we make relative to the
    legislation is that the Committee adopt improvements to an
    amendment offered and adopted by the banking committee from
    Representative Baker. Our proposal is that the federally
    sponsored program provide reinsurance but require the program
    first to request proposals from the private market to provide
    all or part of the proposed cover.
        In this way, the Federal program will test the private
    market's capacity, it will test the pricing mechanism, and it
    will be protection against the intrusion of the Federal
    Government in the private markets.
        In conclusion, Mr. Chairman, we support your initiative. We
    caution against a program that discourages private sector
    development. We believe that low triggers encourage state
    government programs to be created, and that those state
    government programs will pass along the risk to the Federal
    program. Low triggers will increase the federally sponsored
    exposure or loss.
        Low triggers, like low deductibles in insurance, will lead
    to high consumer prices, and low triggers will encourage
    government approaches. Higher triggers, higher than those in
    this current bill, will in fact encourage and require private
    sector development and private sector approaches.
        We believe that S. 1361 is a very sound foundation for
    proceeding, and we look forward to working with the Committee,
    members, and staff.
        Thank you.
        Senator Stevens. Thank you, Mr. Nutter .
        Mr. Weber.
        [The prepared statement of Mr. Nutter follows:]

               Prepared Statement of Frank W. Nutter, President,
                       Reinsurance Association of America
        Chairman McCain, Senator Stevens and Members of the Commerce
    Committee, it is an honor to appear before you on behalf of the
    Reinsurance Association of America. We commend you, Senator Stevens, in
    particular, for your leadership in promoting legislation to address the
    issue of natural catastrophe exposure and insurance.
        The Reinsurance Association of America (RAA) represents U.S.
    domestic property casualty reinsurers.\1\ The creation of a federal
    reinsurance program is of great importance to our member companies.
    Over the years, the RAA has supported efforts to create a federal role
    to address the issue of natural disaster catastrophe exposure in the
    United States. In fact, over the years we have worked closely with
    Senator Stevens and his staff on legislation to address this issue. Our
    members firmly believe that federal involvement is a necessary
    component of any ultimate solution to this very important issue.
    ---------------------------------------------------------------------------
        \1\ Often described as ``insurance for insurance companies,''
    reinsurance is a sophisticated transaction by which one insurer
    indemnifies, for a premium, another insurer against all or part of a
    loss that it may sustain. The fundamental objective of insurance, to
    spread risk of loss, is thereby enhanced by the insurers ability to
    spread that risk through reinsurance.
        The key reasons a primary company purchases reinsurance are: (1) to
    limit liability on specific risk; (2) to stabilize loss experience; (3)
    to protect against large losses; and (4) to increase capacity so they
    can write more policies. The degree to which each insurer will utilize
    reinsurance for one or all of these purposes is determined by each
    insurer after assessing its own exposure to losses and its own capital
    resources.
    ---------------------------------------------------------------------------
        S. 1361 is a sound foundation for addressing a federal role in
    financing natural catastrophe losses. However, the RAA would like the
    Committee to address the level at which the government-sponsored
    program assumes the cost and risk of a natural disaster. We urge the
    Committee to fully consider the capacity of both the primary and
    reinsurance marketplaces to bear catastrophic risk. We propose that
    higher attachment levels (``triggers'') for the government role be
    incorporated to better reflect the private sector's risk bearing
    capacity. The RAA believes that such a change will help ensure that the
    private marketplace is not unnecessarily infringed upon and that the
    federal Treasury is not at risk by assuming too much of the cost of
    financing these disasters.
    RAA Principles of Natural Disaster Policy
        The reinsurance industry has maintained a consistent position on
    the need for a federal backstop when the costs of a natural disaster
    exceed the private market capacity. Such a federal role is crucial to
    protect the solvency of the insurance marketplace and maintain
    insurance markets for consumers.
        Providing catastrophe insurance and reinsurance coverage should
    otherwise be preserved for private sector carriers. State government
    catastrophe funds \2\ should only be employed as a last resort.
    ---------------------------------------------------------------------------
        \2\ A state run tax-exempt trust fund that provides reinsurance to
    insurance companies writing homeowners insurance in a particular state.
    ---------------------------------------------------------------------------
        That position is rooted in the following principles, which we urge
    the Committee to adopt as its own:

              (1) natural catastrophe exposures, hurricanes and
            earthquakes, are insurable risks in the private sector;

              (2) government's role should only be to address insurer
            solvency in the event of a mega-catastrophe, hereby fostering
            private sector coverage and preserving the claims paying
            ability of insurers;

              (3) the risk of natural catastrophes is best insured in a
            diversified marketplace which avoids concentration of risk in
            too few insurers or state programs;

              (4) the private sector's role, including insurance,
            reinsurance and capital markets, should be maximized and such
            financing mechanisms fully exhausted before any government
            capacity is provided, state or federal;

              (5) the government should encourage, and--where appropriate--
            fund pre-disaster hazard mitigation efforts; and

              (6) any federal proposal should not put taxpayers' dollars at
            risk when the private sector is more than capable of financing
            the costs of a natural disaster.

        These principles form the basis for the RAA's evaluation of all
    disaster-related legislation, whether they be federal or state
    proposals. They are founded solely in the belief that the private
    sector is the appropriate bearer of catastrophic risk, but are tempered
    by the recognition that a natural event could occur, one greater than
    any which has occurred to date, which exceeds the resources of the U.S.
    insurance and global reinsurance industries.
    Capacity to Finance Natural Disasters
        At the heart of the debate on S. 1361 is what is the capacity of
    the insurance industry to finance natural disasters. It is critical in
    evaluating capacity of the industry that the Committee keep in mind
    that insurance capacity for natural disaster exposures is provided by
    insurers, reinsurers and the capital markets. The bulk of catastrophic
    risk is retained by primary insurers which provide coverage directly to
    the public. Such coverage represents the typical homeowners contract
    where an insurance company agrees to indemnify their customer, upon
    receipt of a premium, for a loss or damage to property. The primary
    insurance industry is in the business to pay claims and finance losses
    associated with a natural disaster. Reinsurers provide protection for
    insurers in the face of large catastrophe losses but our segment of the
    industry, by premium volume or surplus, is roughly one-tenth the size
    of the primary industry.
        Although reinsurers assume the risk of a significant portion of
    most insurance companies' catastrophe losses, several of the largest
    national personal lines insurers, for example, purchase very little, if
    any, reinsurance, because their resources, as reflected in their
    capital and surplus, are large enough to retain risk and absorb shock
    losses.
        A smaller or regional insurer, however, may rely more on
    reinsurance to spread its risk of loss. No insurer should, or wants to,
    expose its entire capital base to a threat of a single natural
    catastrophe or an accumulation of catastrophes. In addition, insurers
    have a responsibility to stockholders or, in the case of mutual
    insurers, policyholders, to see that their capital provides an adequate
    return on equity and is not exposed to a risk of ruin from natural
    catastrophes.
        Thus, as this Committee deliberates this most important issue, it
    must not just look at the capacity of the reinsurance industry, but it
    must consider the capacity of the insurance industry as a whole to
    finance major catastrophes. In addition, the Committee must not ignore
    the ever growing capacity provided by the capital markets.
    Reinsurance Capacity Abounds and Prices Continue to Fall
        There is currently an abundance of catastrophe reinsurance
    available in the marketplace today. As the General Accounting Office
    reported in a February 8, 2000, correspondence to Members of the House,
    reinsurance is widely available and prices are low relative to historic
    levels. GAO's analysis is consistent with a Standard and Poors, Inc.
    1999 report that concludes there is currently an overabundance of
    reinsurance in the marketplace and the ``glut of capacity in the
    reinsurance marketplace will continue to hold back rate increases.
    Capital is very, very, strong in the reinsurance market.''
        In July 1999, a leading U.S. reinsurance broker, U.S. Re, wrote the
    Chairman of the House Banking Committee a letter that states that: (1)
    there is approximately $13-$15 billion of ``excess of loss''
    catastrophe reinsurance capacity in place per region, per event in the
    U.S.; (2) an additional 40 percent of capacity is in place from other
    forms of reinsurance being purchased (facultative, per risk of loss and
    proportional); and (3) that an additional $1 billion of capacity per
    region is also available from capital markets products (see Attachment
    A). These factors would result in approximately $20 billion of
    catastrophe reinsurance capacity available per region, per event. This
    number does not include the capacity provided by the primary industry
    to finance catastrophes.
        We believe the abundance of reinsurance in the marketplace as
    reported by many independent sources warrants the raising of the
    trigger levels in S. 1361.

       Consistent with the U.S. Re report, a July 1999, Renaissance
            Re report (see Attachment B) analyzing the reinsurance
            marketplace, concludes that: (1) there is approximately $14
            billion in capacity, per event, per region of excess of loss
            reinsurance purchased by the primary marketplace at this time;
            (2) reinsurers are offering additional capacity in the excess
            of loss market, but many insurance companies have decided to
            retain the risk on their own balance sheet, rather than
            purchase reinsurance; and (3) in addition to the $14 billion of
            excess of loss reinsurance available per region, there is
            additional reinsurance catastrophe protection currently being
            purchased from other forms of reinsurance agreements including,
            proportional, facultative and per risk excess of loss
            contracts. This additional protection adds approximately 40
            percent more reinsurance being purchased, resulting in
            approximately $20 billion of reinsurance sold per region. This
            number does not include the capacity of the primary industry to
            finance catastrophes. (Renaissance Re is one of the largest
            catastrophe writers in the world. It maintains an exhaustive
            database of all catastrophe offerings and is considered to have
            the most comprehensive database of catastrophe cover purchased
            in the U.S.).

       In February 1999, the Louisiana Property Insurance Task
            Force reported to the State Legislature that there is over
            capacity in the reinsurance market, without even counting
            capital markets capacity. The report concluded that in
            Louisiana alone, it is estimated that a market loss of over $13
            billion alone would be needed to exceed the catastrophe
            reinsurance limits purchased.

       In February 1999, the New York State Temporary Panel on
            Homeowners' Insurance Coverage reported to Governor Pataki and
            the State Legislature that there is a current overabundance of
            reinsurance capacity in the marketplace and that ``losses from
            a 250-year storm striking New York would be in a range of $6
            billion. This amount is easily within the industry's current
            capacity to absorb.''

       In August 1999, the Texas Insurance Commissioner wrote to
            Congress stating that the trigger levels of 1-in-100 or $2
            billion would result in an infringement on the private
            marketplace in Texas. The Commissioner suggested that a trigger
            level of 1-in-250 year event may be more appropriate.

       In the fall of 1999, the California Earthquake Authority
            reported that the claims-paying capacity of the CEA is $7.3
            billion. A 1-in-100 year event would result in $2.8 billion in
            losses. The CEA reported that it is expected to be able to
            easily pay losses resulting from a 1-in-100 year event, and to
            have approximately $4.5 billion left over to cover losses from
            subsequent earthquakes. CEA stated that it would take a single
            event on the order of 3 to 4 times the devastation of
            Northridge to deplete the CEA of its claims-paying capacity.
            (Last year before the House Banking Committee, the CEA
            Assistant Director testified the CEA could handle two 1-in-250
            year events.)

       In the same Congressional correspondence, when asked if
            there was current adequate private sector reinsurance available
            for the CEA to purchase, the CEA answered as follows: Yes, in a
            very short time frame (approximately three years) the market
            situation involving the catastrophe reinsurance product best
            suited to the CEA's needs has changed such that the CEA is
            currently purchasing its reinsurance at rates more than 40%
            less than it did three years ago. The CEA has such reinsurance
            contracts in place through the 2001 calendar year.

       Guy Carpenter, a reinsurance broker, reported in November of
            1999 that the reinsurance capacity has risen and insurance
            companies can now purchase traditional catastrophe excess
            coverage above $632.6 million per event, per insurer, as
            compared to $200 million in 1992.

       Evidence of this high level coverage came in January 1999
            when State Farm and Renaissance Re announced the formation of
            Top Line Re which will provide $3 billion in high level excess
            catastrophe coverage for non-U.S. business. The marketing plan,
            according to press reports, envisions that Top Line Re will
            make $500 million in high layer, catastrophe aggregate excess
            coverage available per insurer. Even though Top Line Re will
            not make the coverage available for U.S. insurers, its creation
            means competition is increasing in this sector.

        It has also been suggested by witnesses before a House Banking
    Subcommittee hearing on this issue that insurance agents are unable to
    sell homeowners insurance policies because ``unnamed insurance
    companies'' inform them that it is too expensive to buy reinsurance.
    The fact is, reinsurance prices are very low and have dropped for five
    years in a row. We urge the Committee to consider the following when
    addressing the catastrophe pricing issue:

       On June 1, 1999, Paragon Risk Management Services announced
            its Catastrophe Price Index (measure of domestic reinsurance
            catastrophe prices) and reported that reinsurance prices for
            renewals for January 1, 1999, had dropped for the ninth semi-
            annual period in a row. Paragon's report concludes that global
            catastrophe pricing remains under pressure as reinsurance
            capacity exceeds demands in all regions.

       Guy Carpenter Inc, a reinsurance broker, issued a 1999
            report noting that its reinsurance placements on behalf of
            clients continue to indicate a decline in the cost of
            reinsurance, noting that the cost of reinsurance is now close
            to Pre-Andrew levels. The report also notes that the prices for
            catastrophe reinsurance contracts have declined for five years
            in a row.

       The GAO reports that the California Earthquake Authority
            (CEA) has obtained billions of dollars of reinsurance coverage
            at substantially reduced rates, and that in 1999, CEA received
            offers for more reinsurance coverage than it required. How much
            money the CEA saves with the new rate: a $47 million savings, a
            23.4 percent reduction. For 2000/2001 the ``rate on line'' will
            decrease to 8.5 percent, reducing the CEA's premium cost by
            nearly 30 percent, thus reducing the CEA's reinsurance costs by
            approximately $39 million.
          The reinsurers also provided the CEA with a ``no claims bonus''
            for 1999 and 2000. If the CEA treaty is loss free, reinsurers
            will return 12.5 percent of premiums collected in the three
            years of 1997 through 1999. According to the then CEA Chief
            Executive Officer Greg Butler, ``the CEA was in a good position
            to negotiate, given the excellent loss experience (no claims),
            good operating performance, and excess capacity in the
            reinsurance markets. We asked a lot from the reinsurers, and a
            majority of them stepped up to the plate.''

        There are record amounts of reinsurance capacity available today.
    Ironically, this is due in part to the unprecedented insurer losses
    associated with Hurricanes Andrew ($15.5 billion) and Iniki ($1.6
    billion) which prompted an assessment of conventional insurance and
    reinsurance risk. Insurers and reinsurers reviewed their insured
    exposures and risk management programs and decided to revise their
    business plans for the coming years. Since 1994, reinsurers, investment
    bankers, and financial market traders developed additional contingent
    capital, reinsurance, and derivative risk management products and added
    new capacity through newly capitalized companies. This has led to the
    over capacity in the marketplace.
        It appears that the capacity will continue to grow in future years
    as well. In 1998 reinsurance broker Guy Carpenter made the following
    prognosis about the future of reinsurance during the Louisiana Coastal
    Task Force hearings: (1) there will be excess capacity, price
    reductions and continuity of market (the larger catastrophes are more
    easily absorbed by reinsurers without market concentration); (2)
    catastrophe reinsurance will continue to become more available and
    affordable; and (3) more sophisticated customized products will be
    developed and there will be lower transaction costs. The following
    contributing factors that cause this positive outlook on future market
    conditions were cited:

       Mergers and acquisitions, larger companies will assume
            larger amounts of risk;

       Strong investment returns;

       Entry of new players and new distribution channels
            including: (a) investment banks; (b) capital market investors;
            (c) alternative markets; and (d) strengthened Bermuda
            reinsurance capacity.
    Primary Marketplace Also Well Prepared to Finance Natural Disasters
        Historically primary insurers have paid \2/3\ to \3/4\ of
    catastrophe losses, passing the remainder through to the reinsurance
    industry. The primary industry is also well-positioned to finance
    natural disasters. As previously stated, it is very important for this
    Committee to consider the capacity of the primary insurers (not just
    reinsurers) in its consideration of the trigger levels in S. 1361.
    Although S. 1361 is a proposal to create a federal reinsurance program,
    the primary industry plays just as critical of a role in financing
    these natural disasters.

       According to A.M. Best, the nations' insurance rating
            agency, ``the industry remains overcapitalized by $100 billion,
            or 30%, relative to A.M. Best's minimum level for Secure-rated
            companies. This is true, even after accounting for a 100-year
            catastrophe.'' Best's Viewpoint, January, 10, 2000 page 6.

       RMS, a catastrophe modeling firm, reported in November 1999
            that the U.S. property and casualty insurance industry is
            overcapitalized by as much as $100 billion.

       According to the GAO, the insurance industry has sufficient
            capacity to pay most or all claims from a 1-in-100 year event
            loss, without taking into account reinsurance. GAO notes that
            the insurance industry surpluses of the insurers operating in
            the most catastrophe-prone states have grown by 140% over the
            last 9 years. GAO reports that the insurance industry surplus
            currently stands at $427 billion, even though over the last ten
            years the industry has incurred $99.5 billion in catastrophe
            losses.

       According to a July 14, 1999, study by the Wharton School at
            the University of Pennsylvania entitled ``Managing Catastrophe
            Risks,'' which analyzed the capacity of the U.S. property
            insurance industry's ability to finance major catastrophic
            losses, the insurance industry has more than adequate capacity
            to pay at least 98.6 percent of a $20 billion loss. For a
            catastrophe of $100 billion, the industry could pay at least
            92.8 percent. The report concludes that the gaps in
            catastrophic risk financing are presently not sufficient to
            justify Federal government intervention in private insurance
            markets in the form of catastrophe reinsurance.

       Not only have the primary market's capital and surplus
            rebounded since the disastrous effects of Hurricane Andrew and
            the Northridge Earthquake, most, if not all, insurers have
            taken steps to better assess their catastrophe exposure and put
            in place programs that mitigate the risk of financial
            impairment to their companies. These steps have included the
            establishment of subsidiaries devoted exclusively to high-risk
            markets, better management of the utilization of reinsurance,
            use of new capital markets products and special purposes
            vehicles, and catastrophe modeling to better evaluate and
            establish premium levels commensurate with risk.
    Capital Markets Continue to Provide Capacity
        The GAO reports that the potential for the capital markets to
    finance natural disasters is great. Over the last few years, the
    capital markets have developed and implemented products to securitize
    insured catastrophe risk and provide additional capacity to insurers
    (see Attachment C). The capital markets potential to provide capacity
    for natural disasters reaches into the trillions of dollars. Some of
    the nation's most prominent investment banking and securities
    organizations have actively securitized insurance catastrophe risk,
    including the Chicago Board of Trade, Goldman Sachs, Morgan Guaranty
    Trust, J.P. Morgan Securities, Credit Suisse First Boston, AON Re
    Services, Sedgwick Financial, and Merrill Lynch. The market for capital
    markets funding of catastrophe natural exposures has grown from one
    transaction in 1994 totaling $85 million to eighteen transactions in
    1998 totaling approximately $2.5 billion. While it is still in its
    infancy, a lot of resources are being directed by capital markets
    intermediaries to encourage development of the market and to complete a
    growing number of transactions. This development could revolutionize
    catastrophe insurance funding and greatly expand the capacity of the
    U.S. insurance market to deal with the financial risks attendant to
    mega catastrophes. The potential capacity from the capital markets
    should not be ignored or underestimated during the Committee's
    consideration of S. 1361. This is particularly important in light of
    the likely convergence of the financial services industries if
    financial modernization is enacted into law.
    State Solutions to the Catastrophe Exposure
        The RAA believes that the state insurance departments play an
    important role in the issue of homeowners insurance availability in
    disaster-prone areas. State insurance departments have been working
    with insurers to allow changes in policy coverages and premiums that
    bring premiums in line with the risk of catastrophes in their markets
    and give consumers options in line with their resources. Together, the
    overcapacity of the primary and reinsurance markets have done much to
    address consumer level concerns about the availability and
    affordability of catastrophe insurance and have provided additional
    security to insurers against the threat of financial impairment.
    Evidence of this is reflected in two recent state reports. In February
    1999, the New York State Panel on Homeowners's Insurance, chaired by
    the state superintendent of insurance, concluded that: the New York
    insurance market is resilient for the availability of homeowners'
    insurance in coastal communities, with few exceptions, has rebounded;
    and that the number of homeowners' insurance policies written by the
    New York Property Insurance Underwriting Association (a state-mandated
    market to ensure availability) has leveled off and the number of new
    policies is declining.
        In Louisiana, after the Property Insurance Task Force issued its
    study in 1999, the Insurance Commissioner issued a letter to Congress
    noting that ``. . . it is crucial that our homeowners are able to
    obtain affordable homeowners insurance to protect their property
    against a major catastrophe. In Louisiana, the private marketplace is
    doing just that, providing homeowners with affordable and adequate
    coverage to protect against such a catastrophe.''
        Recent developments in Florida also highlight the positive
    developments in the homeowners insurance markets. According to the
    state-run Joint Underwriting Association (JUA--insurer of last resort)
    in 1999 the number of policies dropped below the 200,000 mark. The
    policy count for the JUA peaked in the fall of 1996, when policies
    totaled nearly 937,000. The JUA issued a statement that ``the steady
    decline in the JUA policyholders is a sign that Florida's property
    insurance market continues to grow healthier after collapsing in the
    wake of Hurricane Andrew in August of 1992. According to a May 5, 1999,
    Sun-Sentinel report, ``reinsurance is playing a big role in breaking
    the logjam of policies stuck in the pools.''
        Hawaii has the Hawaiian Hurricane Relief Fund, created in 1993,
    which provides hurricane insurance directly, via a separate policy
    issued to the consumer. During the Fall of 1999, the Hawaiian Hurricane
    Relief Fund made plans to depopulate its fund and allow the private
    sector to issue some of these policies.
        Looking at the primary, reinsurance and capital markets, as well as
    state initiatives, the RAA believes that the private marketplace is
    more than equipped to handle losses above the levels provided for in S.
    1361.
    Mega-Catastrophe Still Threatens the Marketplace
        Notwithstanding these positive developments, a fundamental problem
    facing insurers and their policyholders remains: the threat of a mega-
    catastrophe that exceeds the resources of the insurance and reinsurance
    markets. An insured catastrophe that, for example, exceeds 20 percent
    of the aggregate surplus of the industry could have a significant
    negative impact on the solvency of some companies and their ability to
    provide coverage. Currently, according to GAO, industry surplus stands
    at $427 billion. Twenty percent of industry surplus would be a $84
    billion event. As previously cited, the Wharton School concluded that
    for a catastrophe of $100 billion, the industry could pay at least 92.8
    percent of the claims, however, a significant number of insolvencies
    would occur, disrupting the normal functioning of the insurance market,
    not only for property insurance but also for other coverages.
        The best approach to improve insurance affordability and
    availability and to prepare for the losses and devastating effects of a
    mega-catastrophe should include:

       Consumers who live in catastrophe-prone areas should pay a
            premium for insurance in direct relationship to that risk. A
            key component to ensure availability of insurance for these
            consumers is the experimentation with deductible programs.
            Earthquake programs have long been written with a percentage
            deductible of 2 percent, 5 percent, or 10 percent of policy
            limits. Wind policies have typically stayed with a flat
            deductible. Many insurers today believe that creation of new
            deductible programs will provide an incentive for consumers to
            take steps to mitigate against property loss. Many states have
            taken action to approve such deductible programs.

       Consumer information programs should be enhanced. A well-
            publicized effort to provide consumers with information on how
            to obtain property insurance is necessary. If a consumer
            chooses not to purchase affordable insurance, there is not a
            lot a federal reinsurance program can do for the consumer.

       States and communities working with the federal government
            should institute pre-disaster mitigation programs, including
            appropriate building codes and hazard reduction measures.
            Hurricane Andrew has emphasized the importance of enforcement
            since the Dade County, Florida, experience indicates that
            little or no enforcement existed for compliance with building
            codes. The result was billions of dollars in additional damage.

       At the federal level, a federal safety net providing
            protection for insurers above which they cannot absorb
            catastrophe losses should be put in place.

        With these measures, private sector competition and capacity will
    continue to flourish, damage to homes and lives will diminish and, in
    case of a mega-catastrophe, the financial infrastructure of the
    industry would remain intact, thereby averting wide dislocations
    throughout the economy. This combination of state regulatory action and
    federal legislation will solve this problem.
    Evaluation of Proposed Federal Approaches
        The RAA believes that S. 1361 is a sound foundation for addressing
    a federal role in financing natural catastrophes. The RAA supports the
    concept of a federal reinsurance backstop and the mitigation provisions
    in the legislation. The RAA's foremost concern in the legislation is
    the trigger at which the government sponsored program would provide
    reinsurance. In S. 1361, the program would provide reinsurance to state
    government-sponsored catastrophe funds once losses exceed $2 billion, a
    1-in-100 year event or the claims paying capacity of the state cat
    fund, whichever is greater. The trigger levels for the regional
    contracts to be auctioned are $2 billion or 1-in-100 year event,
    whichever is greater. The RAA believes that S. 1361 would interfere
    with the private marketplace and encourage the creation of more state
    government programs. We are seeking to incorporate higher trigger
    levels for the federal reinsurance program to better reflect the
    private sector's risk bearing capacity. As evidenced in the material
    above, the RAA believes these changes will help ensure that the private
    marketplace is not unnecessarily infringed upon and that the federal
    Treasury is not at risk by assuming too much of the cost of financing
    these disasters. We believe that low trigger levels tilt the field
    toward government solutions while higher trigger levels promote private
    solutions.
        The RAA urges the Committee to consider trigger levels that
    preserve the solvency of the insurance industry but do not supplant
    private market resources. The RAA has previously suggested trigger
    levels that are set based on losses to the insurance industry or
    insurance company surplus. Senator Stevens' bill in the 104th Congress,
    S. 1043, provided for the federal reinsurance program protection to
    trigger for insured losses which exceed 15 percent of industry surplus
    or losses by an insurer of 20 percent of its own surplus. If the
    industry was in a decline and surpluses were down, the trigger would be
    a lower number. If the industry continues to be robust, the triggers
    automatically rise. Therefore, the trigger level would adequately
    reflect the capacity of the insurance industry in good times and in
    bad.
        If the industry surplus trigger is not a viable one, the RAA
    proposes that at a minimum, the trigger levels in S. 1361, for both the
    state programs and the auctions of be raised to: the greater of $5
    billion, 1-in-250 year event or the claims paying capacity of the state
    cat fund. The House Banking Committee adopted part of our trigger
    language by incorporating a trigger that is in the range of $2 billion
    or $5 billion or in the range of a 1-in-100 year event or a 1-in-250
    year event, whichever is greater. The RAA urges the Senate to go
    further and simply adopt the $5 billion or 1-in-250 year event trigger.
    It is important to note that a 1-in-250 year event is a standard for
    the insurance industry. In order to get a favorable rating from the
    nations' insurance rating agency, A.M. Best, insurance companies must
    demonstrate that they have the risk management tools in place to handle
    a 1-in-250 year event for earthquakes and Florida hurricanes.
    Additionally, as already stated, the states of Florida, Texas,
    Louisiana and California have reported that the industry can handle
    these size of events in their respective states.
        The RAA also supports the concept of a private market amendment
    offered by Representative Baker that was adopted in the House Banking
    Committee. The Baker amendment provides that before the federal program
    sells the reinsurance to state catastrophe funds, the private sector
    must first be given the right to offer such reinsurance to the state
    program, in lieu of the federal government. The RAA believes that the
    concept of this amendment will further ensure that the private sector
    resources are fully utilized before implementing the federal program.
    We have drafted some technical amendments to the Baker amendment that
    we believe will improve the administration of this private market
    approach.
        The RAA is also seeking to incorporate amendments that are more
    technical in nature that we believe will help increase the
    effectiveness and fiscal soundness of the new federal reinsurance
    program.
        Finally, the RAA recognizes that S. 1361 is significantly different
    than H.R. 21 in that S. 1361 proposes to create a private insurance
    corporation to sell the reinsurance whereas the House bill provides
    that the Treasury Department sells the reinsurance. The RAA does not
    currently have a formal position as to which approach is preferable.
    The RAA understands that S. 1361 would require insurance companies who
    participate in the private insurance corporation to capitalize the
    corporation with start up loans for administrative costs. Additionally,
    participating insurance companies must repay the federal government
    within a reasonable period for any federal loans used to pay qualifying
    claims. The RAA believes that both S. 1361 and H.R. 21 potentially put
    taxpayer dollars at risk and thus would urge the Congress to adopt the
    approach that minimizes this risk and would result in the lowest cost
    to the U.S. Government.
    Additional Concerns about Low Triggers
       The RAA believes that the lower trigger levels will
            encourage the creation of state catastrophe funds. More states
            would then be taking on more liability for catastrophe
            exposures, and seeking to pass the states' liability on to the
            federal government. Any legislation should allow the private
            marketplace to assume most of the liability, before a state or
            federal program subjects their taxpayers to the risk of these
            exposures.

       The RAA believes that, together with more state funds, low
            triggers for federal reinsurance, and the requirement that the
            program underwrite each state fund based on risk covered and
            the prices charged to consumers, a federal oversight mechanism
            would eventually have to be created. This federal regulatory
            entity would have to make an evaluation of underlying rates
            charged to consumers (required by S. 1361 to be actuarially
            sound) and oversee solvency of state funds. Higher trigger
            levels would negate the necessity of federal insurance
            regulatory oversight.

       Lower trigger levels lead to higher consumer prices. The
            state catastrophe funds will purchase the federal reinsurance,
            but in order to fund the purchase of it, will have to pass the
            cost down to the primary companies in the case of Florida, who
            in turn will pass the cost onto the consumer. In Hawaii and
            California, the cost of federal reinsurance will have to be
            directly incorporated in the cost of coverage paid directly by
            consumers. Low triggers mean higher cost to purchasers and
            consumers.

    Closing Remarks
        The RAA principles on natural disaster legislation are rooted in
    the belief that capitalistic incentives, operating within a flexible
    regulatory environment, provide ample motivation for the private sector
    to offer homeowners insurance in disaster-prone areas. However, they
    also recognize that the inherent nature of the risk associated with
    that coverage creates a high-capacity void that only the federal
    government can fill.
        Those principles are further strengthened by a marketplace that has
    improved considerably over the last few years and is continuing to
    improve each passing day: insurance companies have surpluses that allow
    them to write more coverage; reinsurance capacity is abundant; the cost
    of reinsurance is at a five-year low; and new forms of reinsurance and
    capital markets are enhancing the catastrophe risk management market.
        Combine these dynamic developments with the guidance exhibited by
    Congressional leaders as yourselves, and I am optimistic that we are
    approaching a private/public partnership that will help ensure the
    availability of homeowners insurance to consumers in disaster-prone
    areas, while maximizing the resources of the private sector.
        I urge you to thoroughly evaluate both the capacity of the primary
    marketplace, the reinsurance marketplace and the capital markets. I
    believe doing so will result in your support for higher trigger levels
    which will minimize the risk assumed by the federal Treasury and
    maximize the resources of the private insurance industry.

                                                           Attachment A

                                           U.S. RE Corporation,
                                           New York, NY, July 28, 1999.

    Mr. Franklin W. Nutter,
    President, Reinsurance Association of America,
    Washington, DC.

    RE: Catastrophe Excess of Loss Reinsurance Availability in the U.S.A.

    Dear Frank:

        U.S. RE Corporation is pleased that it has been cited in the July
    23rd, 1999 memorandum from the Majority Staff to the Legislative
    Assistants' Committee on Banking and Financial Services. This
    memorandum discusses catastrophe exposures and we presume data
    contained therein will be discussed at the hearing of July 30th, 1999
    on H.R. 21, The Homeowners Insurance Availability Act of 1999.
        In the fourth paragraph of the Memorandum, it mentions that U.S. RE
    has publicly stated that the total supply of available reinsurance in
    any single region of the United States is approximately $7 billion. We
    wish to point out that this information is now substantially outdated,
    as it was based on an analysis our company performed in 1995/96. Since
    then, the capacity for catastrophe reinsurance protection has grown
    dramatically. In fact, based upon an analysis we have just completed,
    we estimate that the catastrophe reinsurance capacity for four of the
    key regions of the U.S.A. has now more than doubled, as follows:

    North East                                           $13.0-14.0 Billion
    Carolinas                                            $12.5-13.5 Billion
    South East                                           $13.0-14.0 Billion
    Gulf & Texas                                         $14.5-15.0 Billion

        We enclose copies of our exhibit which reflects this revised
    analysis for your convenience. We would also like to point out that
    based upon our estimate, the aforementioned amounts can be increased by
    as much as 40% when factoring the availability of the additional
    reinsurance capacity coming from proportional property treaty
    reinsurance, per risk excess of loss reinsurance and facultative
    reinsurance. Moreover, additional capacity is now available from the
    capital markets which began to emerge in 1994. This capacity has grown
    since 1994/95 to approximately $1 billion in any one zone.
    Consequently, the aggregate capacity is estimated to be more than $20
    billion of limit for any one zone. We also further believe that
    catastrophe capacity from the capital markets will grow more
    significantly now that investors in the security sector have begun to
    actively support securitization products tied to the assetization of
    catastrophic risk
        Considering that insurers themselves are generally prepared to
    retain a certain level of losses after deducting recoveries from
    reinsurance and other risk transfer devices, we believe that any
    legislation calling for a federal reinsurance mechanism should be
    formulated such that the federal program should not operate or trigger
    below an industry loss of between $25 to $30 billion. Furthermore, we
    believe that the trigger level established should be adjustable to meet
    future changes in capacity available from private sector mechanisms.
    With the foregoing in mind, U.S. RE Corporation urges the Committee and
    members of Congress to assure that H.R. 21 or any similar type of
    proposed legislation will not be formulated in such a way as to compete
    with private sector reinsurance capacity.
        We understand that the RAA's position is consistent with our
    philosophy and are prepared to assist it and the House Committee with
    any clarification or further information and remain at your disposal.
            Sincerely,
                                               Tal P. Piccione,
                         Chairman, President & Chief Executive Officer.

                                                           Attachment B

                                  Renaissance Reinsurance Ltd.,
                                 Hamilton HMGX, Bermuda, June 11, 1999.

    Frank Nutter,
    President, Reinsurance Association of America,
    Washington, DC.

    Re: Reinsurance Catastrophe Capacity

    Dear Frank,

        Thank you for inquiring about our views on the available
    catastrophe capacity by region in the United States. As you know,
    Renaissance Re is one of the largest catastrophe writers in the world.
    As part of this activity we maintain an exhaustive database of all
    catastrophe offerings we consider and pride ourselves in having the
    most comprehensive database of catastrophe cover actually purchased in
    the U.S.
        We run a variety of probabilistic models against this database of
    catastrophe contracts to determine and understand the dynamics of the
    risk in the market. Up until now we have maintained this information as
    proprietary to ourselves, but at your request, we are willing to
    release a certain amount of the information we have assembled. It must
    be understood that the information is our best attempt to model the
    reinsurance business and is subject to some degree of interpretation.
        Attached is an exhibit, which outlines the capacity available by
    major risk territory in the U.S.* To c1arify, this is the actual amount
    we calculate would be paid by the reinsurance market in very large
    events.
    ---------------------------------------------------------------------------
        * The information referred to has been retained in the Committee
    files.

                      Total Maximum Recoverable in an Event
                                   (millions)
    ------------------------------------------------------------------------
                                                                   Cat XOL
                              Region                              Purchased
    ------------------------------------------------------------------------
    Northeast                                                        14,000
    Southeast                                                        13,000
    California                                                       11,000
    New Madrid                                                       14,500
    ------------------------------------------------------------------------

        CAT XOL--Natural catastrophe excess of loss reinsurance provides a
    defined limit of coverage that indemnifies the company above a
    specified loss amount.
        As you can see, our data indicates there is about $14 billion in
    capacity per event by region currently purchased by the primary
    insurance market at this time. We also believe there is additional
    capacity available in the cat excess of loss market, but many insurance
    companies have decided to retain the risk on their own balance sheets.
    Also there is additional reinsurance protection that will be payable
    following a natural disaster from proportional, facultative and per
    risk excess of loss reinsurance agreements. More research needs to be
    done to ascertain the amount of additional reinsurance protection from
    these products, but we believe these products add about 40% more
    potential recovery.
        Thank you for your inquiry and hope you find this information
    helpful.
            Best regards,
                                              William I. Riker,
                                                     President and COO.

                                                           Attachment C

                       Securitizing Natural Disaster Risk
    Nationwide--Nationwide has the option to issue up to $400 million of
    9.222% surplus notes to fund new business opportunities or as
    reimbursement to catastrophic losses. Contract with Morgan Guaranty
    Trust Company. (1995)

    Arkwright--Arkwright has set up a trust to issue $100 million in trust
    notes to private investors. New proceeds of the notes will be used to
    buy government securities held by the trust. (1996)

    AIG Combined Risks/Benfield--Placed 5 catastrophe-linked bonds with an
    investment fund managed by Mercury Asset Management. Bonds will pay out
    if a catastrophe exceeding an agreed trigger occurs in: U.S., Japan,
    Australia, Caribbean, Europe or Japan. (1996)

    Hannover Re--Sold $100 million worth of catastrophe cover. The
    portfolio-linked swap is comprised of the following: Japanese
    earthquakes, U.S. natural catastrophes, Canadian natural catastrophes,
    North European storms, North European other catastrophes, Australia--
    all catastrophes and aviation excess of loss. (1996)

    St. Paul Re--$68.5 million deal through Goldman Sachs & Co. to increase
    capacity. St. Paul Re will cede reinsurance business from five classes
    under a 10 year reinsurance treaty. Investors participate in excess-of-
    loss underwriting by investing in bonds or preference shares. Enables
    St. Paul to increase capacity in 5 excess-of-loss classes: U.S./
    Caribbean property-casualty, European property-casualty, other
    property-casualty, retrocessional/Lloyd's short-tail and marine and
    aviation. (1997)

    Winterthur Swiss Insurance Group--Placed $282 million of catastrophe
    bonds in private capital market. The bonds cover Winterthur exposure to
    auto claims stemming from domestic summer hailstorms. Transaction
    managed by Credit-Suisse First Boston. (1997)

    Swiss Re--Placed $137 million in two-year bonds tied to reinsurance
    losses from a potential California earthquake. Swiss Re and Credit
    Suisse First Boston were the placement agents for the notes. (1997)

    Horace Mann Educators Corporation--Agreement allows Horace Mann to
    receive up to $100 million from Center Re, the transactions
    underwriter, in exchange for an equivalent value of its convertible
    preferred shared in the event of a mega-catastrophe. (1997)

    RLI Corporation--Aon Re Services developed a $50 million catastrophe
    equity put (CatEPut) for the RLI Corporation. The deal was underwritten
    by Centre Re. In the event of a catastrophe which exhausts RLI's
    traditional reinsurance coverage, the CatEPut program allows RLI to
    sell up to $50 million in preferred shares to Centre Re. (1997)

    USAA--Placed $477 million of hurricane bonds in the private placement
    market. The bonds will provide USAA with an excess-of-loss cover tied
    to a single hurricane producing losses of more than $1 billion during a
    one-year reinsurance period. The syndicate managers were Merrill Lynch
    & Co., Goldman Sachs & Co. and Lehman Bros. (1997)

    LaSalle Re--Aon Re, Inc. and Aon Securities Corporation developed a
    $100 million multi-year Catastrophe Equity Put (CatEPut) option program
    for LaSalle Re. The option program allows LaSalle to issue up to $100
    million in convertible preferred shares in the event of a major
    catastrophe or series of large catastrophes that result in substantial
    losses to LaSalle Re. (1997)

    Reliance National Insurance Company--Completed a $40 million
    securitization of non-catastrophe coverage for its property, aviation,
    marine drilling and satellite launch exposure. The placement ties bond
    payment trigger points to a catastrophe index established by Swiss Re.
    Sedwick Lane Financial structured the deal. (1997)

    Tokio Marine & Fire Insurance Co., Ltd--Tokio Marine has acquired
    earthquake risk coverage of $90 million purchased from capital markets
    investors through Parametric Re, Ltd. Parametric Re issued 10-year
    fixed income securities with principal reduction contingent on the
    occurrence and severity of earthquakes within an area centered on
    Tokyo. Goldman, Sachs & Co. and Swiss Re Capital Markets Corporation
    were co-leaders for the transaction. (1997)

    Centre Solutions--Issued $83.5 million in catastrophe bonds. The bonds
    provide retrocessional catastrophe cover for natural and man-made
    perils which Centre Solutions has underwritten. The bonds have an
    expected maturity date of December 31, 1998. The bonds were placed by
    Goldman Sachs. (1998)

    Mitsui Marine and Fire--Obtained $30 million in reinsurance cover
    backed by event-linked swap transactions. Payment is determined by the
    magnitude of earthquakes in and around the Tokyo area. The cover for
    risks is available for a three-year period which began April 1, 1998.
    Swiss Re Capital Markets served as the agent for the swap transaction.
    (1998)

    Reliance National Insurance Company--Purchased an option to issue
    multi-peril-linked insurance notes, providing a guaranteed reinsurance
    cost. The deal gives Reliance the right to issue notes over a three-
    year period to fund reinsurance coverage provided through SLF
    Reinsurance LTD. The notes are tied to five classes of risk: U.S.
    property, property outside of the U.S., aviation, marine drilling rigs
    and satellite launch failure. Sedwick Lane Financial structured the
    deal. (1998)

    USAA--Placed $450 million of hurricane bonds in the private market. The
    syndicate managers were Merrill Lynch & Co., Goldman Sachs & Co., and
    Lehman Bros. (1998)

    Yasuda Fire & Marine, Aon Capital Markets and Munich Reinsurance
    Company--Private placement of $80 million of catastrophe reinsurance
    notes that provide protection against Japanese typhoon-related losses.
    The notes may be triggered by either one large typhoon or two, smaller
    separate typhoons. (1998)

    F & G Re--F & G Re, in conjunction with Goldman Sachs and E.W. Blanche
    Capital Markets, completed a $54 million bond issuance that backs its
    property catastrophe excess-of-loss reinsurance contracts. The funding
    benefits Mosaic Re, an offshore firm that provides reinsurance on F & G
    Re's products. This is the first Cat bond deal to securitize multiple
    underlying reinsurance contracts sold to a variety of insurers. (1998)

    CNA--Issued $200 million of 6.6 percent notes due December 2008.
    Goldman Sachs is the lead manager, and Lehman Brothers the co-manager
    for the issue. The net proceeds will be used for general corporate
    purposes. (1998)

    Centre Re Solutions (Bermuda) Limited--Sponsors its second
    securitization of reinsurance coverage by purchasing retrocessional
    capacity against Florida hurricanes from capital market investors
    through special purpose vehicle. Trinity Re 1999, Ltd. has used $56.615
    mm of fixed income securities due 12/31/99. The loss of principal on
    the bond is triggered when Centre Re Solutions (Bermuda) Ltd. incurs
    losses as the direct result of a hurricane under an excess of loss
    reinsurance policy the company has written for a Florida residential
    property insurer. Goldman Sachs is lead manager, with Chase Securities,
    Lufkin & Jenrette Securities Corporation, and Zurich Capital Markets
    Securities, Inc. as co-managers. (1998)

    Allianz A.G. Holdings--Issued a $150 million catastrophe bond option to
    cover European catastrophe risks. The bond option gives Allianz the
    right to issue notes at a fixed rate any time over a three-year period
    to fund $150 million of reinsurance coverage through Gemini Re, a
    Cayman Islands special purpose reinsurer. The bond allows Allianz to
    hedge its future cost of reinsurance. If traditional reinsurance costs
    rise after windstorm losses, the company might find it more cost
    effective to exercise the option to issue notes. Goldman Sachs placed
    the notes. (1998)

    Hannover Re--Secured commitments for $50 million in options for risk
    securitization of catastrophe losses. The option was placed with North
    American institutional investors and was amended to a November 1996
    transaction. (1998)

    XL Mid Ocean Re--Placed a $200 million retrocessional property
    catastrophe cover. The transaction covers the upper layers of XL Mid
    Ocean Re's hurricane and earthquake exposure in the U.S. and its
    territories and possessions in the Caribbean. The deal provides
    retrocessional cover in the form of a swap in which claims recovery is
    triggered by catastrophe losses incurred by XL Mid Ocean Re. (1998)

    Horace Mann Educators Corporation--Agreement involving a $100 million
    transaction with Center Re. The transaction was managed by Aon Capital
    Markets. (1999)

    Constitution Re--Transferred its East and Gulf Coast hurricane risk to
    Arrow Re. The risk was spread through a series of securitization and
    risk-transfer transactions. The transaction involved a $10 million risk
    transfer. Goldman Sachs, Swiss Re New Markets and E.W. Blanch Capital
    Markets served as advisors. (1999)

    St. Paul--Completed a $45 million securitization transaction. The
    transaction provides additional capacity for a defined portfolio of
    U.S. property catastrophe excess-of-loss reinsurance contracts. Mosaic
    Re II issued the debt securities for the securitization. (1999)

    Kemper--Acquired $100 million of earthquake coverage. The capital
    markets transaction funds a fully collateralized reinsurance agreement
    providing $100 million of Midwest earthquake coverage to the Kemper
    Insurance Companies. The transaction was managed by Aon Capital
    Markets. (1999)

    Sorema--Issued a three-year $17 million deal to protect its European
    windstorm exposures and Japanese typhoon and earthquake risks. The
    bonds have an annually renegotiable interest rate and allow Sorema to
    adjust the size of the coverage and the premium to meet market
    conditions. Merrill Lynch and Aon Capital Markets arranged the
    transaction. (1999)

    Oriental Land Company--The owner of Tokyo Disneyland, Oriental Land
    Company, placed two catastrophe bonds totaling $200 million to protect
    against earthquake risk. In the first bond, Concentric Ltd. would pay
    Oriental Land $100 million upon the occurrence of an earthquake that
    meets certain trigger conditions. The second bond provides Oriental
    Land with a $100 million post earthquake financing facility. Goldman
    Sachs and Company was the placement agent for both transactions. (1999)

    USAA--Acquired $200 million in catastrophe reinsurance from Residential
    Reinsurance Limited. The proceeds of the sale of the bond were
    segregated into a trust to pay USAA's claims in excess of $1.0 billion
    arising from a category 3, 4, or 5 storm on the Saffir-Simpson index.
    The placement was co-managed by Goldman Sachs & Company, Lehman
    Brothers Holding and Merrill Lynch. (1999)

    Gerling Global Re--has secured $80 million of cover in a three-year
    deal to protect the company against U.S. hurricane losses of more than
    $200 million. The securitized retrocession is provided by a special
    purpose vehicle, Juno Re, based in the Cayman Islands. The deal was
    managed by Goldman Sachs. (1999)

    Marsh & McLennan--has completed a $50 million insurance-linked swap
    transaction covering losses in six states around the New Madrid fault
    line. (1999)

                  STATEMENT OF JACK WEBER, PRESIDENT,
                  HOME INSURANCE FEDERATION OF AMERICA

        Mr. Weber. Thank you, Senator Stevens.
        We'd like to thank you for the leadership that you have
    brought to this issue over the many years and we look forward
    to working with you on S. 1361.
        We think it is a very good bill and one that's worthy of
    the Committee's support.
        Natural disasters have received a tremendous amount of
    attention over the last few years. Two weeks ago, the Congress
    debated a supplemental appropriation bill containing funds to
    assist North Carolina regarding victims of Hurricane Floyd. And
    almost 1 year ago to the day, we are approaching the
    anniversary of Congress approving $1 billion of relief to the
    victims of Hurricane Mitch, which took place in Nicaragua and
    Honduras a little over 2 years ago.
        What makes the Hurricane Mitch aid so remarkable is that
    the money was appropriated even though the victims were not our
    citizens, never paid U.S. taxes, and will never repay the
    money.
        Americans are compassionate, and after a decade in which
    the Congress has appropriated more than $50 billion in disaster
    aid, there cannot be any doubt that whenever nature strikes,
    Congress will ride to the rescue.
        I think the question before this Committee and the one that
    has been raised by the introduction of this bill, is whether
    the current system is the best way of dealing with natural
    disasters. Is it best to ask all Americans to cover the cost of
    the next big event regardless of where they live, or is it more
    just to assure that a properly functioning private insurance
    system covers the bulk of the losses?
        Today, the private homeowners insurance marketplace is on
    shaky ground in the very places that it is most urgently
    needed. The availability, the quality, the affordability and
    the permanence of coverage is very much in doubt.
        Just a few examples: In North Carolina, a residual pool for
    homeowners who cannot obtain traditional insurance coverage
    covers an area of 18 counties which stretch as far as 100 miles
    from the Atlantic Coast.
        In Louisiana, a similar pool has grown by more than 800
    percent in the last 9 years. According to A.M. Best, the
    insurance rating agency which published its findings about a
    month ago, the Florida insurance market is ill-prepared for the
    next major storm and will suffer a great number of insurance
    company failures.
        In California, Washington State, and the New Madrid regions
    of Missouri and Tennessee, earthquake deductibles have been
    raised to as high as 20 percent, which means that the average
    homeowner will have to absorb $20,000, $30,000, or even $50,000
    in earthquake damage before making an insurance claim.
        As a result, the percentage of homeowners purchasing
    earthquake insurance has dropped precipitously to the lowest
    levels in a generation.
        Ask residents in any of the regions I have just
    highlighted, and they can tell you about the problems
    personally. But you will not find these people in a caravan
    ready to block the entrances to the Capitol. This is not that
    kind of a crisis. No one ever complains about the lack of
    insurance before they need the coverage. It's only after the
    disaster that the magnitude of the problem sets in. Then,
    homeowners will be wondering why their policy was inadequate,
    why their policy didn't cover the loss at all, or why their
    insurance company failed.
        They will ask quite rightly why the system failed, and they
    will demand relief and history shows that they will get it from
    this Congress or the next Congress just as they've gotten it
    from this Administration, and they will from any
    administration.
        S. 1361 is an alternative to the above-referenced scenario.
    The Stevens bill stands for the premise that it is more
    desirable to fix the problems in the homeowners insurance
    market now rather than after the next mega-catastrophe, and
    then rely more heavily on supplemental appropriations to fix
    the mess.
        We live in a time when the increasing frequency and
    severity of natural disasters is a near certainty. Just last
    year, the Southeast underwent the largest evacuation in history
    in advance of Hurricane Floyd. The storm lost most of its
    strength before making landfall, sparing billions of dollars in
    property and perhaps thousands of lives. However, it was not
    the reality of Floyd but would Floyd could have been that
    prompted USA Today to editorialize in its September 17th
    edition that the United States remains dangerously exposed.
        According to USA Today, should a ``big one'' arrive as a
    hurricane on the East Coast or a massive earthquake out West or
    in the Middle States, insurers are almost certain to find
    themselves unable to make good on all claims, leaving
    homeowners in the lurch and taxpayers on the hook.
        The only way to address such a debacle, according to USA
    Today, is with a national reinsurance program.
        We agree and we're not alone. As you've already heard
    today, the Deputy Secretary of the Treasury has spoken
    favorably about a national reinsurance program. In addition,
    the General Accounting Office, in a report issued last month,
    concluded that the U.S. property insurance market, and I'm
    quoting here, ``continues to be vulnerable to natural
    catastrophe losses despite efforts to contain potential losses
    since the 1990's.''
        Indeed, while the GAO found that the insurance industry's
    ability to pay the claims of events less than 100 years was
    likely, the ability to handle something greater than a 1-in-
    100-year event or a closely spaced series of smaller disasters
    could lead to a large number of insolvencies and reduce the
    availability of insurance in catastrophe-prone areas. Mr.
    Chairman, I'd like to, with your support, include the GAO
    report as part of the record at this time.
        Senator Stevens. I'm not sure we can include the whole
    report. We can include portions of it.
        Mr. Weber. Thank you. It is these events larger than 1-in-
    100 years that S. 1361 seeks to address, by providing a level
    of reinsurance protection which is neither available nor
    affordable in the private marketplace. Without it, insurers
    will continue to reduce their exposures in the areas where
    consumers need it most, which means inadequate coverage or no
    coverage for homeowners or coverage which is doubt in the wake
    of insurance insolvencies.
        Perhaps this is why during the debate in the House Banking
    Committee, Federal reinsurance legislation was supported by
    groups as diverse as the National Association of Realtors, the
    Western League of Savings Institutions, the National
    Association of Home Builders, Fannie Mae, Freddie Mac and the
    Independent Insurance Agents of America.
        Everyone loses if the homeowners insurance market fails,
    including consumers, lenders, stockholders, local and state
    governments and ultimately U.S. taxpayers.
        S. 1361 includes important provisions to make sure that
    private insurance markets and private capital are used to their
    fullest capacity. As I mentioned, the bill limits reinsurance
    coverage from the Natural Disaster Insurance Corporation to
    events that are greater than 1-in-100 years. As the term
    implies, these events are extremely infrequent. A 1-in-100 year
    event in Florida, for example, would cause insured losses in
    excess of $20 billion. Under the Stevens bill, none of these
    losses would be covered by the National Reinsurance Program.
    Only losses greater than $20 billion would be eligible for
    coverage and then at a reimbursement rate of only 50 percent,
    leaving plenty of room for private capital and reinsurance
    markets to provide their own capacity.
        It is clear that there is a scarcity of private reinsurance
    to cover worst case disasters. This ``capacity gap'' can best
    be described as an affordability problem. In simplest terms,
    the cost of capital, which governs the price of private
    reinsurance, is considerably higher than the premiums that can
    be collected from homeowners, based on the actuarial
    probability of loss. As a result, there is a limit to how much
    reinsurance primary insurers can realistically purchase.
        S. 1361 helps to close this reinsurance gap, which in turn
    should assure a steady and predictable supply of insurance
    coverage for the homeowner.
        While the precise threshold for this reinsurance would vary
    by region of the country based upon population and risk, the
    same 1-in-100-year principle would apply, thereby assuring that
    all regions and all states within a region were treated
    equitably.
        And I would like to reference a point that one of the--
    actually two of the witnesses on this panel raised, which was
    to raise the threshold of reinsurance to somewhere in the
    neighborhood of a 40 or 60 billion dollar event. To put in some
    perspective, the worst natural disaster in terms of insurance
    loss in U.S. history was Hurricane Andrew, which was a $10
    billion residential insured loss.
        If we were looking at six times that amount, I can assure
    you that the entire insurance market in Florida would be in
    total failure. But for places like Hawaii and Alaska, $60
    billion, I venture to say, is more than the entire town of
    Anchorage is probably worth. So that if we had that----
        Senator Stevens. Depends on who's bidding.
        Mr. Weber. That's true.
        (Laughter)
        Mr. Weber. If we had those kinds of thresholds, we would
    probably render this program completely meaningless to
    virtually every state in the country with perhaps the exception
    of Florida.
        Today, the fear of a mega-catastrophe and the inability of
    insurance companies to adequately reinsure their exposures, are
    forcing insurers to either withdraw from catastrophe-prone
    markets, reduce coverage, or place a moratorium on new writing.
        S. 1361 can reverse this trend and do so in a way that is
    fiscally responsible. It is highly likely that the program will
    never require any infusion of Federal resources since the
    probability of a claim is so small, but this high-level
    reinsurance eliminates the possibility of the super event that
    poses the risk, however slight, of a financial meltdown. Only
    government can provide this assurance.
        Private homeowners insurance paid for by the people who
    live in harm's way reduces the burden on taxpayers after a
    disaster and imposes costs on the homeowner which fairly
    reflect the risk of living in certain areas. It's in the public
    interest that the supply of this coverage is stable,
    predictable, and efficiently priced.
        S. 1361 will go a long way to assuring such stability and
    deserves your support. I would add that in reference to the
    comments made by the Deputy Treasury Secretary, that the groups
    that supported Federal reinsurance legislation, worked very
    hard with the proponents of H.R. 21 to come up with a plan that
    was acceptable to the administration and the other major
    players involved in the debate. As a result, the bill that was
    reported out of the House emerged from the Banking Committee
    with a very strong bipartisan majority, and I think we can do
    the same thing working with you in the Senate, Mr. Chairman.
        Thank you.
        [The prepared statement of Mr. Weber follows:]

                 Prepared Statement of Jack Weber, President,
                      Home Insurance Federation of America
        I would like to thank the Chairman and other members of the Senate
    Commerce Committee for this opportunity to appear before you to discuss
    S. 1361, the Natural Disaster Protection and Insurance Act.
        This is a good bill, Mr. Chairman, and one that is worthy of the
    Committee's support.
        Natural disasters have received a tremendous amount of attention
    from the Congress in the last few years. Two weeks ago, Congress
    debated a supplemental appropriation bill containing funds to assist
    the North Carolina victims of Hurricane Floyd. Exactly one year ago,
    Congress approved nearly $1 billion in aid to Nicaragua and Honduras to
    help in the clean-up of Hurricane Mitch. What makes the Mitch aid so
    remarkable is that the money was appropriated even though the victims
    were not our citizens, never paid U.S. taxes and will never repay the
    money.
        Americans are compassionate. After a decade in which the Congress
    has appropriated more than $50 billion in disaster aid, there cannot be
    any doubt that whenever nature strikes, Congress will ride to the
    rescue.
        The question before this Committee, however, which has been raised
    so eloquently by Senator Stevens and Senator Inouye, is whether this is
    the best way of dealing with natural disasters. Is it best to ask all
    Americans to cover the costs of the next big event, regardless of where
    they live? Or is it more just to assure that a properly functioning
    private insurance system covers the bulk of the losses?
        Today, the private homeowners insurance marketplace is on shaky
    ground in the very places it is most urgently needed. The availability,
    quality, affordability and permanence of coverage is in doubt. In North
    Carolina, for example, a residual pool for homeowners who cannot obtain
    traditional insurance covers an area of 18 counties which stretch as
    far as 100 miles inland from the coastline. In Louisiana, a similar
    pool has grown more than 800% in nine years. According to A.M. Best,
    the insurance rating agency which published its findings last month,
    the Florida insurance market is ill-prepared for the next major storm
    and will suffer a great number of insurance company failures. In
    California, Washington state and the New Madrid regions of Missouri and
    Tennessee, earthquake deductibles have been raised to as high as 20%,
    which means the average homeowner will have to absorb $20,000 . . .
    $30,000 . . . or even $50,000 in earthquake damage before making an
    insurance claim. As a result, the percentage of homeowners purchasing
    earthquake coverage has dropped precipitously to their lowest levels in
    a generation.
        Ask residents in any of the regions I have just highlighted and
    they can tell you about the problems. But you will not find these
    people in a caravan ready to block entrances to the U.S. Capitol. This
    is not that kind of crisis. No one ever complains about the lack of
    insurance before they need it. It is only after the disaster that the
    magnitude of the problem sets in. Then, homeowners will be wondering
    why their policy is inadequate, why their policy doesn't cover the loss
    at all, or why their insurance company failed. They will ask, quite
    rightly, why the system failed them. They will demand relief and
    history shows they will get it from this Congress or the next Congress,
    just as they will get it from this Administration or from any
    Administration.
        S. 1361 is an alternative to the above-referenced scenario. The
    Stevens bill, which is co-sponsored in this Committee by Senators
    Inouye, Breaux, Lott and Frist, stands for the premise that it is more
    desirable to fix the problems in the homeowners insurance market now,
    rather than after the next mega-catastrophe and then relying more
    heavily on supplemental appropriations to fix the mess.
        We live in a time when the increasing frequency and severity of
    natural disasters is a near certainty. Just last year, the Southeast
    underwent the largest evacuation in history in advance of Hurricane
    Floyd. The storm lost most of its strength before making landfall
    sparing billions of dollars in property and perhaps thousands of lives
    even while bringing enormous suffering to North Carolina, South
    Carolina, and southern Virginia.
        It was not Floyd, but what Floyd could have been, that prompted USA
    Today to editorialize in its September 17th edition that the United
    States remains dangerously exposed. According to USA Today, ``. . .
    should a `big one' arrive--as a hurricane on the East Coast or a
    massive earthquake out West or in the middle states . . . insurer[s]
    are almost certain to find themselves unable to make good on all
    claims, leaving homeowners in the lurch and taxpayers on the hook.''
        The only way to address such a debacle, according to USA Today, is
    with a national reinsurance program.
        We agree. And we are not alone.
        Both Treasury Secretary Lawrence Summers and Deputy Treasury
    Secretary Stuart Eizenstat have testified favorably before the House
    Banking Committee. According to Deputy Secretary Eizenstat ``the
    Administration remains convinced that a well-designed reinsurance
    program . . . could help provide the foundation for communities,
    individuals and the private insurance markets on which they depend to
    make a sound recovery in financial terms.''
        Moreover, the General Accounting Office, in a report issued last
    month, concluded that the U.S. property insurance market ``continues to
    be vulnerable to natural catastrophe losses, despite efforts to contain
    potential losses since the 1990s.'' Indeed, while the GAO found that
    the industry's ability to pay the claims of a 1-in-100 year disaster
    was likely, the ability to handle something greater than a 1-in-100
    year event or a closely spaced series of smaller disasters could lead
    to a large number of insolvencies and reduce the availability of
    insurance in catastrophe-prone areas.
        It is these events larger than 1-in-100 years that S. 1361 seeks to
    address, by providing a level of reinsurance protection which is
    neither available or affordable in the private marketplace. Without it,
    insurers will continue to reduce their exposures in the areas where
    consumers need it most which means inadequate coverage or no coverage
    for homeowners or coverage which is in doubt in the wake of insurer
    insolvencies.
        Perhaps this is why, during the debate in the House Banking
    Committee, federal reinsurance legislation was supported by groups as
    diverse as the National Association of Realtors, the Western League of
    Savings Institutions, the National Association of Homebuilders, Fannie
    Mae, Freddie Mac and the Independent Insurance Agents of America.
        Everyone loses if the homeowners insurance market fails including
    consumers, lenders, stockholders, local and state governments and
    ultimately U.S. taxpayers.
        S. 1361 includes important provisions to make certain that private
    insurance markets and private capital are used to their fullest
    capacity. As I mentioned, the bill limits reinsurance coverage from the
    Natural Disaster Insurance Corporation to events that are greater than
    a 1-in-100-year event. As the term implies, these events are extremely
    infrequent. A 1-in-100 year event in Florida, for example, would cause
    insured losses in excess of $20 billion. Under the Stevens bill, none
    of these losses would be covered by the national reinsurance program.
    Only losses greater than $20 billion would be eligible for coverage,
    and then at a reimbursement rate of only 50%, leaving plenty of room
    for private capital and reinsurance markets to provide their own
    capacity.
        It is clear that there is a scarcity of private reinsurance to
    cover worst-case disasters. This ``capacity gap'' can best be described
    as an affordability problem. In simplest terms, the cost of capital--
    which governs the price of private reinsurance--is considerably higher
    than the premiums that can be collected from homeowners based on the
    actuarial probability of loss. As a result, there is a limit to how
    much reinsurance primary insurers can realistically purchase.
        S. 1361 helps to close this reinsurance gap, which in turn should
    assure a steady and predictable supply of insurance coverage for the
    homeowner. While the precise threshold for this reinsurance would vary
    by region of the country based on population and risk, the same 1-in-
    100 year principle would apply, thereby assuring that all regions and
    all states within a region were treated equitably.
        Today, the fear of a mega-castastrophe and the inability of
    insurance companies to adequately reinsure their exposures are forcing
    insurers to either withdraw from catastrophe-prone markets, reduce
    coverage or place a moratorium on new underwriting. S. 1361 can reverse
    this trend and do so in a way that is fiscally responsible. It is
    highly likely that the program will never require any infusion of
    federal revenues, since the probability of a claim is so small. But
    this high-level reinsurance eliminates the possibility of the super-
    event that poses the risk, however slight, of a financial meltdown.
    Only government can provide this assurance.
        Private homeowners insurance, paid for by the people who live in
    harm's way, reduces the burden on taxpayers after a disaster and
    imposes costs on the homeowner which fairly reflect the risk of living
    in certain areas. It is in the public interest that the supply of this
    coverage is stable, predictable and efficiently priced. H.R. 21 will go
    a long way to assuring such stability and deserves your support. We
    look forward to working with members of the Commerce Committee as S.
    1361 proceeds to mark-up.
        Thank you.

        Senator Stevens. Thank you very much, gentlemen. It's an
    accident you arranged the table as you are, but you've got the
    Right and the Left at one table.
        My mind goes back to a bill we had here earlier today, and
    that was the Olympics sports bill. I remember hearing similar
    testimony from Olympic athletes and the AAU and the NCA, and no
    one thought we could ever get together. It took us about 5
    months, but we're in this room around those tables, and not
    listening to one another here but talking to one another at the
    table, and we finally reached a consensus, which is held solid
    now for almost 25 years.
        If we don't make it this year, I'm going to do that next
    year with this bill, and we're going to have meetings and
    meetings and meetings until we find some way to agree, because
    I think we are reaching the point now, where the limits on us
    and the budget process are such that we could probably not
    respond to even the 100-year occurrence within the constraints
    of the budget we're debating on the floor right now.
        I'm concerned to ask you, Mr. Keating, Mr. Plunkett, the
    GAO report indicates that if we have events in excess of the
    100 years, there will be severe harm to the insurance markets.
    There will be a disastrous effect as far as availability of
    insurance covering for consumers. How do we get around that?
    The people that you speak for are the ones that are going to be
    harmed if we don't find a solution to the differences between
    your groups and the industry groups.
        What do you think about GAO's conclusion? They really said
    that we do need--as I understand it--we do need to take some
    action to deal with future catastrophes. You seem to agree, but
    I don't see how we can get there from here and in comparing the
    comments that the four of you made, two on one side, two on the
    other, what do you two think? What do we need to bring you
    closer to Mr. Weber and Mr. Nutter?
        Mr. Keating. Well, first I guess I'll comment briefly on
    the GAO report. The GAO report I think was also notable for
    what it didn't include. It didn't look at the potential, and
    not only now but in the future, for securitization. We have to
    keep in mind our public capital markets are in the trillions of
    dollars. So what we're talking about here, even in terms of a
    worse case scenario, you know, 100, 150 billion dollars of
    losses to the insurance industry, when you compare that to the
    size of the capital markets in the trillions, obviously there's
    great potential there.
        If we just tap a small sliver of the capital markets to
    back this type of insurance, we're talking about a huge
    capacity that could be tapped into, and this is something, at
    least my reading of the GAO report, they didn't examine.
        I think the GAO report was also notable in that it
    definitely confirmed the numbers that Travis spoke of where the
    industry's surplus is much larger today despite record payouts
    during the 1990's. The surplus has actually increased.
        Now obviously a general industry surplus is not available
    to any individual company that may have written its business
    poorly, but clearly there's an enormous amount of capital in
    the industry itself. Whether it's this reinsurance or some sort
    of derivative, we believe that private money should be relied
    upon to the extent possible rather than bureaucratic decisions
    being made at the Treasury Department, especially when you
    consider that the real risks to the Federal Treasury here are
    likely to come from California and Florida.
        Now these two states are rapidly growing states, and that
    means politically they're growing in importance as well to any
    future administration. So we have to not only keep in mind
    whether a program is artfully designed from the beginning but
    whether there are sufficiently checks and balances on the
    political apparatus on a future administration that may seek to
    shovel subsidies to a state like California or Florida at the
    expense of the people around the country.
        A reform that I think holds great potential is the idea of
    fixing a problem in the tax laws that penalize both the
    homeowners that try to buy insurance coverage as well as the
    industries, the companies that try to offer insurance.
        The Federal tax laws treat putting aside money to paying
    for a mega-disaster as profit. This is ridiculous. If money is
    set aside to pay for that 1-in-100 or 1-in-250-year event,
    that's prudently putting aside the money so it's available, so
    when the big one does hit, the money's there.
        Senator Stevens. Ah, but what you don't see is if one hits
    in California all the small states are absolutely wiped out. It
    is a national system, Mr. Keating. That one earthquake in
    California, a 20-mile long earthquake costs 10 times as much as
    the total earthquake in Alaska and tidal wave in Oregon.
        I don't see how you look at those surpluses and say other
    than that they are prudent, yes, and I understand what you're
    saying about the tax bill. I wish we'd go along with that. But
    you, yourself, point to the surpluses as being a reason not to
    have reinsurance.
        Reinsurance for California is not going to do me any good
    if we have another earthquake in Alaska if they trigger first.
        I don't think you're helping us on a national system for
    your comments, frankly.
        Do you, gentlemen? Mr. Weber, do you have any comments? Mr.
    Nutter?
        Mr. Plunkett. Mr. Chairman, since you asked me to could I
    put in something you haven't heard it?
        Senator Stevens. Yes. Quickly, though, because I do have an
    appointment at 4:30, and I have two other people I want to
    hear.
        Mr. Plunkett. I'll ask Mr. Hunter to get to your staff our
    thoughts on the GAO report.
        I would encourage you to get the folks in from the Wharton
    School and ask them to talk to you about their series of 14
    papers on this issue.
        Senator Stevens. I've read the report, as a matter of fact,
    and I think a lot of that school, and I do know quite a few of
    them involved, and I understand what they're saying.
        But I think they, too, are sort of oriented on the concept
    of the national reinsurances is all we need, but really it
    doesn't deal with a state-by-state analysis of that problem.
        Mr. Nutter.
        Mr. Nutter. Mr. Stevens, if I could comment on what you
    said.
        Your state is a good example of the point that you make.
    Your state is served by some of the best capitalized insurance
    companies in the United States--State Farm, AllState, USAA are
    the principal homeowners insurers. Fine companies, fully
    capable of handling a significant major earthquake in your
    state.
        But if those companies are financially impaired as a result
    of a Los Angeles earthquake, or a Miami hurricane, but they
    will have problems serving a state such as your own. Standing
    alone they look like they're well within the resources to
    respond, yet this program is needed as a safety net behind
    those companies.
        I would also like to offer the comment that the insurance
    tax laws, already take into consideration catastrophe losses.
    Insurance companies are free to carry back 2 years and carry
    forward 15 years any catastrophe losses they have against their
    future profits or the past profits. That there is a tax
    provision which takes into consideration the smoothing of
    catastrophe experience that the companies have.
        Mr. Weber. Senator Stevens, you had asked me for my
    comments. I want to get them in real quick.
        The great irony of the GAO report is that it was the
    opponents of the legislation in the House of Representatives
    that were so eager and adamant to have the GAO study this
    problem. And the bottom line of the GAO report is that it
    corroborates the very point that the proponents of the
    legislation are trying to make, and that is that for events
    greater in 1-in-100, that we do have a problem that needs a
    role for the Federal Government.
        That's where S. 1361 kicks in. That's where the GAO says
    there's a problem. That's also where the House bill kicks in.
        As far as the capital markets are concerned, the GAO did
    take note of the capital markets, and what they said, and it's
    the absolute truth because we're dealing with the issue of
    capital markets everyday with the companies that I represent,
    is that the capital markets to date have not provided any large
    degree of new capacity.
        The capacity that has been provided has been more expensive
    than what's available in the private reinsurance markets, and
    actually in the last 2 years the amount of business that has
    been done in the capital markets regarding catastrophes has
    declined by over 40 percent.
        So we do not share the optimism of the taxpayer's union
    that the capital markets are the answer to everything.
        And finally on the issue of the changes to the tax code,
    the Home Insurance Federation, is comprised of some of the
    largest homeowners insurance companies in the nation, and at
    this point we do not oppose the tax proposal.
        But we would be remiss if we did not tell you that the
    changes that are being proposed with the tax code, would not
    make one bit of difference to our companies in terms of the
    amount of insurance that we write in risk-prone areas.
        S. 1361 would. And the reason is because the tax changes do
    not provide the kind of catastrophic protection against the
    worst case event that we need in order to feel comfortable
    writing that business.
        Senator Stevens. Thank you very much. We normally limit
    witnesses to 5 minute statements. I decided that you all ought
    to hear one another as we hear you and try to see if there
    isn't some way to bring you together.
        Now we represent consumers, Mr. Keating and Mr. Plunkett. I
    don't represent any of the insurance companies. I don't think
    there's an insurance company in Alaska or Hawaii, as a matter
    of fact, that writes this kind of insurance.
        But we suffer more of these disasters, our two states, than
    all the rest of the Nation put together. That's what motivates
    us and I've seen the change here since the Alaska earthquake
    and the Hawaii tidal wave. The amount of money we're putting up
    for things like the hurricanes on the East Coast, and the
    California disasters, as I said before, just pale our past
    recoveries from our disasters and just they're insignificant,
    really, compared to the payments we're paying now.
        You get paid for temporary housing. You get paid for
    recovery of rebuilding your home. Even if it's been built two
    or three times. You get paid to move it if it's in a newly
    defined zone of harm.
        That just continues now, and if you're really protecting
    the taxpayers, Mr. Keating, you'd find some way to limit that
    by taking out of the zone that the smaller disasters that
    happen throughout the country, and you do that by reinsuring to
    make sure that not one of these big ones, if it goes off,
    destroys the insurance that all the rest of us in the country
    carry.
        I don't see that we're coming together yet. I hope we get
    there, though. And I do thank you very much.
        I've got one more panel, and then I've got to go vote at
    4:30.
        Thank you very much. If you have any additional information
    we'd be pleased to receive it. We'll put all the statements you
    gave us in the record as so given and we will put parts of the
    GAO report in the record.
        Thank you all very much.
        [The information referred to follows:]

                             Notes from GAO Report
    p. 2--Results in Brief
    ``We did not assess the extent to which a major catastrophe could have
    long-term affects on insurers and consumers. Catastrophes can disrupt
    insurance markets and harm insurance companies and consumers even in
    cases where all claims are paid. Therefore, determining whether
    insurance companies have resources to pay all claims arising from a
    given natural catastrophe may ignore other important aspects of insurer
    capacity.''

    ``Although it appears that the insurance industry today as a whole may
    be able to pay for most or all claims arising from a 1-in-100 year
    catastrophe loss, the current level of insurer resources to pay
    catastrophe claims is unlikely to be stable over time. A catastrophe
    loss greater than a l-in-100 year loss or a closely spaced series of
    smaller disaster could temporarily deplete insurer resources, including
    the supply of reinsurance. Such disasters could lead to a larger number
    of insurer insolvencies than would result from a 1-in-100 year loss or
    reduce the availability of insurance in catastrophe-prone areas of the
    country. Other developments could also shrink insurer capacity. For
    example, after adjusting for taxes on realized capital gains on
    insurers stock and bond holdings, more than \3/4\ths of growth in the
    insurance industry's financial capital since 1995 was from capital
    gains. As a result, insurer resources could change with major changes
    in equities prices or interest rates.''
    p. 3
    ``Comparing the total available resources of the insurance industry to
    total potential catastrophe losses may, itself, not be the best way to
    measure capacity. A more thorough evaluation of the insurance
    industry's catastrophe capacity would also take account of the extent
    to which hypothetical disaster would erode the financial health of
    insurance companies and the degree to which individual insurers would
    react to those losses by restricting the supply of insurance after the
    event occurs. Historically, large natural catastrophe have disrupted
    insurance markets and harmed insurers and consumers. For example, in
    1992, Hurricane Andrew caused more insured losses than any other
    catastrophe in U.S. history. Even though more than $15 billion in
    claims were eventually paid and few insurers became insolvent,
    insurance companies then restricted the supply of certain types of
    insurance--notably homeowners insurance--in catastrophe-prone areas.''
    p. 4--Scope and Methodology
    ``We generally defined a major natural catastrophe as one that would
    generate a 1-in-100-year loss. However, the approach we used had
    important limitations. For example, it did not factor in any
    reinsurance that insurance companies might have held because we were
    not able to obtain such information. Omitting reinsurance might lead us
    to underestimate capacity. On the other hand, our analysis may have
    overestimated capacity because it included the surpluses of some firms
    that either were in the same corporate family or that do not sell
    property insurance.''
    p. 5
    ``Our comparison of insurers financial capital to catastrophe loss
    estimates suggests that they probably would be able to pay all or most
    claims arising from a single 1-in-100 year catastrophe loss that
    strikes one of the 10 states we studied. However, important limitations
    reduce the usefulness of the results.''
    p. 6
    ``In our view, growth in the entire insurance industry's surplus is a
    fairly crude measure of its natural catastrophe claims-paying capacity
    because the insurance industry as a whole does not pay catastrophe
    insurance claims. Instead, individual insurance companies pay claims on
    the basis of the damage that particular catastrophe inflicts on the
    properties they insure. For any given catastrophe, only a portion of
    the industry's surplus is available to pay disaster claims.''
    p. 7
    ``Recent estimates of reinsurance available to finance catastrophic
    losses indicate that reinsurance coverage has increased significantly
    since the mid-1990s. . . . The estimates were prepared for the
    Reinsurance Association of the America and submitted for the record by
    the Association at a hearing of the House Banking and Financial Service
    Committee in July 1999. We could not independently verify these
    estimate of reinsurance capacity because the data on which the
    estimates were based are not publicly reported and are proprietary in
    nature. Still, these estimates have certain limitations that must be
    understood so that their meanings are not misconstrued. First, regional
    figures should not be added together to obtain multiregional or
    national totals. This is because insurance companies tend to buy
    reinsurance to cover some share of their catastrophe exposure
    regardless of where the catastrophes occur. Therefore, a catastrophe in
    any one region would reduce the amount of reinsurance available to pay
    for additional catastrophes in that region or other regions.''

    ``Second, these estimates are for the value of the reinsurance
    purchased by insurers, not the surpluses of the reinsurance companies
    supplying the reinsurance; that is, not for the resources that back up
    the reinsurance contracts. An ISO official said that in a major
    catastrophe, some reinsurance companies might become insolvent before
    they fully honor their reinsurance commitments. Therefore, the actual
    amount of reinsurance that would be used to cover insurer losses in a
    major catastrophe could be less than the estimates provided by the two
    reinsurance companies.''

    ``A third financial resource--but by far the smallest--that insurance
    companies can use to transfer catastrophe risk is capital market
    products. These specialized products transfer some of insurers
    catastrophe risk to investors. Some sources with whom we talked told us
    that the potential for using capital market products may be great, but
    actual use of these products by the insurance and reinsurance
    industries has been very modest to date.''
    p. 9
    [Note that Modeled Losses cited in the GAO Report include both
    residential and commercial losses. H.R. 21 applies only to residential
    losses.]

    ``The results of our analysis suggest that some insurers claims from a
    single major catastrophe in a single state could be large relative to
    their surplus. As table 2 indicates, in four states (Florida.
    California, Texas and New York) more than 20 percent of insurance
    companies might have claims that exceed 20 percent of their surpluses,
    the level of surplus loss from a catastrophe that could trigger a
    rating review by the AM Best Co. To the extent that these losses were
    not replaced, for example, by reinsurance payments, some of these
    companies could face serious financial difficulty. Moreover, markets in
    these states could be disrupted if insurers reduced the number of
    policies they issued after the event, as happened in the aftermath of
    Hurricane Andrew in 1992 and other past major catastrophes.''
    p. 10-11
    ``The above analysis suggest that, in the 10 states we studied, most
    insurance companies should be able to handle a major catastrophe, but
    that some firms could incur significant financial harm in paying their
    claims. However, this analysis has important limitations.''

    ``Our analysis has other limitations as well. Two of these limitations
    may have led us to underestimate and two to overestimate insurance
    companies capacity to pay catastrophe claims.''

    . . . Our analysis only considered the impact that a single catastrophe
    that strikes a single state would have on insurer surpluses. In
    reality, insurance companies often must deal with catastrophes that
    cause damage in more than one state or that occur within a short span
    of time. To the extent this happens, our analysis overestimated
    capacity.

    . . . We [also] included some insurer surpluses that may not be
    available to pay catastrophe claims.
    p. 12
    [in reference to 1997 Wharton Study on Insurance Industry Capacity]

    ``The Wharton analysis also found that, even if the insurance industry
    as a whole could pay all or most claims arising from catastrophes of
    these magnitudes, a significant number of insolvencies would result. .
    . . The Wharton study concluded that these insolvencies would disrupt
    the normal functioning of the insurance market, not only for property
    insurance, but also for other types of insurance. . . . Moreover, the
    Wharton study's model may overstate insurance industry capacity for two
    reasons. First, as our analysis did, the study assumed that the total
    resources of all property and casualty insurer in the respective
    samples would be available to pay catastrophic loss claims, even though
    some of those companies do not write policies that likely would be
    triggered by a catastrophe such as firms that write only liability
    insurance.''
    p. 13
    ``Although it appears that insurance companies today may be able to pay
    for most or all claims arising from a 1-in-100 year catastrophe.
    insurers current capacity may not be stable over time. Insurance
    companies remain heavily exposed to catastrophe losses despite effort
    to reduce their potential losses. . . . The U.S. property and casualty
    insurance industry continues to be vulnerable to natural catastrophe
    losses, despite efforts to contain potential losses since the early
    1990s.''
    p. 14
    ``Insurance companies capacity to pay catastrophe claims can be
    affected by the occurrence of past catastrophes. In the event of a very
    large natural disaster or of multiple major disasters, insurer
    resources, including reinsurance, could be temporarily depleted. This
    occurred in the mid 1990s after Hurricane Andrew and the Northridge
    earthquake. . . . Moreover, historically, the P&C insurance business
    has been cyclical in nature . . . A major catastrophe or series of
    catastrophe could occur near the peak of a cycle, when both demand for
    insurance and insurance premiums were high by historical standards.
    According to an ISO official, in such a case, consumers could be harmed
    more than if the catastrophe were to occur during a period when
    insurance was readily available and prices were low.''
    p. 15-16 Conclusions
    ``Both the surplus of insurance companies and the amount of reinsurance
    they purchase have increased substantially during recent years.
    However, only a portion of these resources would be available to pay
    claims from any single catastrophe. Our analysis of insurance industry
    data suggested that the surpluses of insurance companies that operated
    in 1998 in each of the 10 states in our review exceed likely losses
    they would incur from a single 1-in-l00 year natural catastrophe.
    However, a simple comparison of the industry's total resources
    available to pay catastrophe claims with the estimated losses that
    could result from a large catastrophe ignore the importance of
    maintaining functioning insurance markets in the aftermath.''

    ``. . . The insurance industry's current capacity to pay disaster
    claims is not likely to be stable over time. A major catastrophe loss
    or a series of smaller disasters could temporarily deplete insurers
    resources.''

                       United States General Accounting Office,
                                   General Government Division,
                                      Washington, DC, February 8, 2000.

    B-284252

    Hon. Ed Royce,
    House of Representatives.

    Hon. Paul E. Kanjorski,
    House of Representatives.

    Hon. Rick Hill,
    House of Representatives.

    Subject: Insurers' Ability to Pay Catastrophe Claims

        The Homeowners' Insurance Availability Act of 1999 (H.R. 21) would
    establish a federal program to sell reinsurance \1\ (1) to state
    government programs and (2) at auction to cover some insured losses
    associated with certain natural disasters. The bill requires that the
    federal program not displace or compete with the private insurance or
    reinsurance markets, or compete in the capital markets. However,
    conflicting claims have been made concerning private insurers' capacity
    to handle such disasters.
    ---------------------------------------------------------------------------
        \1\ Reinsurance is insurance for insurance firms. Under a
    reinsurance contract, in return for a share of the premium it collects,
    an insurer is able to transfer a portion of its risk to a reinsurance
    entity, which, in turn, is obligated to reimburse the insurance company
    for an agreed-upon share of covered losses.
    ---------------------------------------------------------------------------
        You asked us to evaluate current industry capacity to pay natural
    catastrophe \2\ claims. To address this issue, we (1) compared
    available data on industry \3\ financial resources to estimates of
    potential insured losses that would result from natural catastrophes of
    various magnitudes, (2) considered two recent studies of capacity,\4\
    and (3) evaluated factors that may affect the stability of insurer
    capacity over time.
    ---------------------------------------------------------------------------
        \2\ The Insurance Services Office, Inc., a company that provides
    information on the insurance industry, defines a catastrophe as an
    event that causes at least $25 million in insured property losses and
    affects a significant number of property and casualty insurers and
    policyholders. Although some catastrophes are not nature-related (e.g.,
    riots), this report focuses on natural catastrophes.
        \3\ The U.S. insurance industry can be divided into (1) an
    accident, life, and health insurance industry and (2) a property and
    casualty (liability) insurance industry. This report deals with the
    property and casualty insurance industry only.
        \4\ The studies are (1) Can Insurers Pay for the Big One? Measuring
    the Capacity of the Insurance Market to Respond to Catastrophic Losses
    (Wharton School, University of Pennsylvania), July 14, 1999; and (2)
    P&C RAROC: A Catalyst for Improved Capital Management in the Property
    and Casualty Industry (Risk Management Solutions, Inc., and Oliver,
    Wyman, and Company). Fall 1999.

        Senator Stevens. We now turn to Mr. Charles Brown, Vice
    President of Baker Welman Brown Insurance of Kennett, Missouri;
    Mr. Scott Gilliam, Director Government Relations, The
    Cincinnati Insurance Companies.
        Gentlemen. Sorry to keep you. It should have been a very
    quick little hearing, but I decided to hear everybody.
        Mr. Brown, are you prepared to go first?
        Mr. Brown. Yes, sir.
        Senator Stevens. We'll put your statements in full in the
    record, as I indicated. But you tell us what you think we ought
    to all hear.

     STATEMENT OF CHARLES T. BROWN, VICE-PRESIDENT, BAKER, WELMAN,
                            BROWN INSURANCE

        Mr. Brown. Mr. Chairman, I want to thank you for the
    opportunity to address the Committee on the need for natural
    disaster legislation.
        My name is Charlie Brown and I'm Vice President of Baker,
    Welman, Brown Insurance in Kennett, Missouri.
        I am an independent insurance agent in this community and
    have the privilege of representing hundreds of homeowners with
    all different types and values of home. Currently, I also serve
    as the Chairman of Missouri Agents Earthquake Task Force and
    Chairman of the Independent Agents of America's Natural
    Disaster Task Force.
        I am here today to testify in support of S. 1361 on behalf
    of the hundreds of homeowners and all my clients, and the
    thousands of insurance agents across America that have and are
    experiencing problems with their homeowners' markets due to the
    threat of natural disasters.
        Unfortunately, my town is located in what has been
    predicted to be one of the worst affected ares of the New
    Madrid fault. Those who unfamiliar with the fault, it crosses
    five state lines and the Mississippi River in at least three
    places. Damage estimates for a major earthquake on the New
    Madrid fault run into the billions of dollars. A major event
    would devastate St. Louis and Memphis and impact thousands of
    homeowners in Arkansas, Illinois, Kentucky, Tennessee and
    Missouri.
        Senator Stevens. As a matter of fact, Mr. Brown, during the
    last earthquake in Missouri, the bells from the churches in
    Boston rang.
        Mr. Brown. That's right. That's what I've heard ever since
    I was a little boy.
        Ever since Hurricane Andrew and the North Ridge earthquake,
    we've seen our markets for earthquake coverage on homeowners
    policies dwindle at an alarming rate, even though we haven't
    experienced a major really since the 1800's.
        This change has been less dramatic than the market problems
    in Florida or California, but I want to stress the changes in
    our market are no less real for my clients.
        Let me further explain what has been happening in our
    Missouri marketplace.
        First, we see many companies simply withdraw from the
    earthquake-prone area of out state. For example, one national
    direct insurance company canceled of their agencies in
    Southeast Missouri. If all of the insurance companies in
    Missouri had done this, we would have seen an immediate crisis
    as we did see in California and Florida.
        My agency has been visited by a major national insurance
    company, and during that visit the company told us that they
    could no longer justify their earthquake exposure in Southeast
    Missouri. It would take at least a 1,400 percent increase in
    the rates to justify their exposure.
        The same company asked us to either take the earthquake
    coverage off our policies or to write it with a different
    company. Fortunately, we were able to find another company at
    that time to help us.
        Most insurance companies have taken a different approach to
    eliminating, reducing, or maintaining their amount of
    earthquake insurance they write in my area.
        Another insurance agency in Southeast Missouri was told by
    one of their companies they represented that they were being
    terminated because they had experienced too many losses. The
    owner of this agency didn't really believe this and so he
    checked into it himself and confronted the insurance company.
    The agent was then told he could keep his contract but he would
    have to non-renew all of his homeowners policies with the
    company. He was told that the real reason the company was
    canceling his agency and others in the area was to reduce the
    company's earthquake exposure.
        The most widely used tactic of insurance companies to exit
    our homeowners insurance market has simply been price. By just
    increasing the cost of the homeowners policy, they can easily
    see their business cancel. Rates have climbed 100, 200 percent
    in the last several years.
        The companies that increase their rates do not have to
    cancel any policies or withdraw from our area. Their price
    increases that form.
        Our Missouri Department of Insurance have been monitoring
    the cost of earthquake insurance for homeowners and the
    percentage of homeowners that have this covering. When they
    released their first data in 1996, he headline of their press
    release read ``Statewide earthquake insurance market relatively
    stable.''
        In 1997, the department issued a press release with the
    following headline: ``Earthquake insurance rates sharply up in
    the Bootheel. Coverage there falls off.''
        The last press release in 1998 read: ``Director Angoff
    orders examination of major increase in earthquake rate
    recommendations for Missouri businesses and homes.'' The press
    release went on to say that the residential rate hikes reached
    266 percent for some homeowners policies in Southeast Missouri
    and metropolitan St. Louis.
        The third manner in which insurance companies have handled
    their earthquake exposure in that area is by increasing
    deductibles and limiting coverage to just the home itself and
    providing no coverage for outbuildings, and none or only
    limited coverage for personal property.
        The standard earthquake deductible used to be 2 percent,
    now we see deductibles starting at 10 percent, going up to 25
    percent. One company our agency represents has stopped writing
    any new homeowners with earthquake and on their existing
    homeowners they have changed the coverage to just the home
    itself and a small amount on personal property.
        They did not increase their earthquake rates but by
    reducing their coverage they, in fact, took 100 percent rate
    increase.
        Some of the industry will tell you that companies
    increasing deductibles and limiting coverage is a partial
    solution to the problem with natural disasters. I just wonder
    where these homeowners are going to get the money for their
    personal property or to manage a 25 percent deductible. This is
    no solution for the average American but rather a prayer that
    somehow it will cost 25 percent less to rebuild their homes, or
    that when their home falls to the ground, that miraculously
    their furniture, clothes, and other items will remain useful.
        In January 1999, my agency contacted over 20 companies to
    see if we find a company willing to come to our area and write
    homeowners policies. Only one company would seriously talk to
    us. We heard many excuses from these insurance companies on why
    they would not appoint our agency, but a few were honest enough
    to tell us that their company was just not interested in
    writing any earthquake coverage.
        Missouri is by no means the only state that has been
    experiencing problems with their homeowners markets. Agents
    have testified on H.R. 21 from North Carolina, Louisiana,
    Massachusetts, Florida, New Jersey, and they all testified
    about the problems to that the homeowners face in obtaining
    adequate homeowners insurance.
        If time will permit, the same message could be told by
    scores of other insurance agents from California, Texas,
    Arkansas, Tennessee, Georgia, and South Carolina, just to name
    a few. The stories are all similar as is the need for a
    solution to the problem. The fact is that homeowners across our
    great nation are not able to protect their homes in the manner
    that most of us take for granted.
        In 1999, the Missouri Association of Insurance Agents, a
    group that represents independent agents in Missouri,
    introduced a bill on Missouri Senate to establish a fund
    similar to the Florida Hurricane Catastrophe Fund. All
    legislation was heard and unfortunately we did not have
    sufficient support to adopt the legislation at that time.
        We were concerned that, as you know, Senator, this debate
    has been going on a long time and we haven't seen the solution.
    After our General Assembly adjourned, our Earthquake Task Force
    met again and decided that while we believed it was a good idea
    to establish a state plan in Missouri, the problem of
    availability was going to have to worsen further. Getting a
    state plan established is no easy task.
        This brings me to one of the arguments against S. 1361. The
    bill encourages the proliferation of state plans to compete
    against the private market. If our effort in Missouri is any
    example of what it takes to implement a state plan, I cannot
    see how this argument against S. 1361 holds water. Because the
    threat that natural disasters pose to most states is that
    usually the entire state is not affected but usually certain
    areas.
        Convincing state legislature in this states to implement a
    state plan is extremely difficult if not impossible unless our
    markets continue to worsen. States like California, and Florida
    and Hawaii, where the entire states have been affected, have
    implemented those plans. I believe it will take similar
    situations in other states for more state plans to be
    developed.
        We don't really want to see the proliferation of state
    plans. We'd like to see a national solution as we believe it is
    a national problem.
        We think this bill should, in fact, help curtail the
    creation of additional state plans. The need for state plans
    only exist when the market fails, and we believe this bill can
    revitalize the markets in our states that are currently
    worsening; and, even more importantly, prevent what happened in
    Florida after Andrew when the market fell apart and not only
    affected insurance but affected all segments of the economy.
        The Independent Insurance Agents of America believes that
    the insurance marketplace has and will continue to have
    problems in dealing with mega-catastrophes like earthquakes and
    hurricanes.
        Insurers and reinsurers are well equipped to handle the
    normal types of losses that occur everyday from fires, theft
    and lots of other types of losses. But the losses that an
    earthquake or hurricane can present to many regions of America
    are beyond our industry's capability to manage without
    assistance.
        Some people have tried to paint this bill and the bill in
    the House as a bailout for the rich, for big beach houses, or
    for those that were foolish enough to build in areas where they
    shouldn't. Nothing could be farther from the truth. Most of my
    clients in Missouri live in modest homes ranging from $50,000
    to $150,000. These homes are not mansions but they are most
    value asset that most Americans possess.
        I also want to address another misconception about natural
    disaster legislation. Opponents will tell you that there is
    sufficient reinsurance to handle the problem, but I can tell
    you that will all the sufficient reinsurance being in the
    market after Andrew and North Ridge, we have continued to see
    our marketplace deteriorate.
        I really question the availability of sufficient
    reinsurance now and fear that the inevitability of a mega-
    catastrophe will once again strict reinsurance to levels that
    will send thousands of homeowners scrambling for a policy to
    protect their home.
        I also want to address the benefit of this legislation to
    the taxpayers in both disaster and non-disaster prone states.
        Senator Stevens. Mr. Brown, I hate to do this. I'm going to
    have to ask you to wind it up if you can. I have to get to a
    vote here.
        Mr. Brown. I really can't see the logic because we spend so
    much money in disaster relief. It makes more sense to me that
    we allow homeowners in those states that had the exposure to
    prepay for this by buying their homeowners insurance. That's
    what this bill will help us accomplish.
        [The prepared statement of Mr. Brown follows:]

            Prepared Statement of Charles T. Brown, Vice-President,
                         Baker, Welman, Brown Insurance
        Mr. Chairman, thank you for the opportunity to address the
    Committee on the need for natural disaster legislation. My name is
    Charlie Brown and I am Vice President of Baker Welman Brown Insurance
    in Kennett, Missouri. Kennett is a small town of approximately 11,000
    people located in the extreme Southeast or ``Bootheel'' of Missouri. I
    am an independent insurance agent in this community and have the
    privilege of serving hundreds of homeowners with all different types
    and values of homes. Currently, I serve as the chairman of the Missouri
    Agents Earthquake Task Force and chairman of the Independent Insurance
    Agents of America's (IIAA) Natural Disaster Task Force. I am here today
    to testify in support of S. 1361 on behalf of the Independent Insurance
    Agents of America and the thousands of insurance agents and homeowners
    across America that have and continue to experience problems with their
    homeowners markets due to the threat of natural disasters.
        Unfortunately, my town is located in what has been predicted to be
    one of the worst affected areas of the New Madrid fault. For those who
    are unfamiliar with the fault, it crosses five state lines and the
    Mississippi River in at least three places. Damage estimates for a
    major earthquake on the New Madrid fault run into the billions of
    dollars. A major event would devastate St. Louis and Memphis and impact
    thousands of homeowners in Arkansas, Illinois, Kentucky, Tennessee and
    Missouri. Still, my insurance agency, since its beginning in 1939, has
    never seen enough damage to a home from a minor tremor to pay an
    earthquake claim. However, the ripples and tremors from the potential
    for enormous damage in the New Madrid fault area, coupled with the
    financial impact of Hurricane Andrew and the Northridge Earthquake on
    insurance companies, have been felt by my clients and all homeowners in
    Eastern Missouri and other states that share this fault zone.
        As you are well aware, after Hurricane Andrew and the Northridge
    Earthquake, all insurance companies, reinsurance companies, and their
    rating agencies began taking another look at the potential for loss
    that major natural disasters could have on an insurance company's
    ability to pay claims. Even though these specific disasters did not
    happen in my area, attention has been focused on the potential for any
    natural disasters. Most potential hurricanes from Florida to
    Massachusetts and earthquakes in California pale in comparison to the
    potential insured property damage estimates from a mega New Madrid
    earthquake.
        As a result, we have seen our markets for earthquake coverage on
    homeowners policies dwindle at an alarming rate. This change has been
    less dramatic than the market problems experienced in Florida or
    California, but I want to stress that the changes in our market are no
    less real to my clients. We have seen insurance companies cancel their
    homeowners policies, invoke moratoriums on writing new homeowners
    policies with earthquake coverage, change earthquake coverage to
    exclude all contents of a home, and increase premiums on either the
    earthquake coverage or the entire homeowners premium forcing many
    homeowners to reduce or cancel their insurance.
        Let me further explain what has been happening in our Missouri
    homeowners marketplace. First, we have seen many companies simply
    withdraw from the earthquake prone areas of our state. For example, one
    national company canceled all of their agencies south of Cape
    Girardeau, Missouri. If all the insurance companies in Missouri had
    done this we would have seen an immediate crisis like California and
    Florida experienced. Instead our problem has not drawn headlines,
    partly because it has mainly affected Southeast Missouri and, only
    recently, has it begun to spread to the St. Louis area.
        My insurance agency was visited by a major national insurance
    company we represented. The regional vice president from Chicago came
    to see us and three other Southeast Missouri agencies that represented
    this company. He told each agency that the company had examined their
    earthquake exposure in Southeast Missouri and there was just no way to
    charge enough premium for that exposure. It would take a 1400% increase
    in the rates to justify the exposure. He asked us to either take the
    earthquake coverage off of our homeowners policies and write that
    coverage separately or to move the policies to another company. I was
    even more astonished when he offered to pay us to move the business! My
    agency did decide to move our client's policies. We did so not for the
    money but, because this same company official had told us that they
    would be limiting coverage and raising their earthquake rates to a
    level that would not be affordable for most homeowners.
        Most insurance companies have taken a different approach to
    eliminating, reducing, or maintaining their amount of earthquake
    insurance that they underwrite in Missouri. We have seen several
    different approaches used: 1) Blaming some other factor for leaving the
    market, 2) limiting coverage and/or increasing deductibles, and 3)
    increasing either earthquake rates or rates on their basic homeowners
    policy until consumers can no longer afford the coverage.
        An insurance agency in Sikeston was told by a company they
    represented that their contract with that company was being terminated
    because the agency had too many losses. The owner of this agency did
    not believe his agency had a loss problem with this company and, after
    reviewing the loss results himself, spoke with company representatives.
    The agent was told he could keep his contract but that he would have to
    non-renew all his homeowners policies with that company. He was told
    that the real reason the company was canceling his agency and others in
    the area was to reduce the company's earthquake exposure. This agency
    decided that he could not non-renew his client's policies and,
    fortunately, was able to find another market to take the business.
        The most widely used tactic of insurance companies to exit our
    homeowners insurance market has simply been price. By just increasing
    the base cost of your homeowners policy, increasing their earthquake
    rates on your homeowners policy, or increasing both rates, a company
    can easily see their business canceled. An outside observer might think
    that the homeowner, knowing of the potential for an earthquake in our
    area, would not like his homeowners premium increased, but would still
    keep the policy because of the need for coverage. What if your
    homeowners insurance cost $500 last year and you received a bill for
    the renewal with a premium of $1100? Naturally, you would look for
    other coverage which is exactly what many of my clients have been doing
    and will continue to do. The companies that increased their rates did
    not have to cancel any policies or withdraw from our area. The price
    increase accomplished this de facto.
        I will share another example of how my agency faced this price
    increase tactic. We represented a small regional insurance company that
    was purchased by a large national carrier. The company had agencies in
    almost every town in Eastern Missouri. The national carrier decided to
    absorb the smaller company. Previously, this national carrier had only
    a handful of agents in our area (mainly because they did not write
    earthquake insurance on their homeowners policies in the area.) With
    the absorption of the small company business, no homeowners policies
    were canceled by the company. However, they raised their homeowner's
    premiums on all renewals over 100%. The result was that almost all of
    our clients canceled their homeowners insurance with this company.
    Again, a price increase rid that company of its potential problem.
        Our Missouri Department of Insurance has been monitoring the cost
    of earthquake insurance for homeowners and the percentage of homeowners
    that have this coverage. When they released their first set of data on
    December 11, 1996, the headline of their press release read ``Stateside
    earthquake insurance market relatively stable.'' This was based on data
    from 1993-1995. On August 4, 1997 after they analyzed their data from
    1996, the Department issued a press release with the following
    headline: ``Earthquake insurance rates up sharply in Bootheel; coverage
    there falls off.'' The last press release concerning earthquake rates
    from the department was on February 2, 1998 where the headline read:
    ``Angoff orders exam of major increase in earthquake rate
    recommendations for Missouri businesses, homes,'' This press release
    went on to say that the residential rate hikes . . . reach 266 percent
    for some homeowners policies in southeast Missouri and metropolitan St.
    Louis, including part of the urban core, north St. Louis County and
    eastern St. Charles County.
        I agree with the department's last assessment on August 4, 1997
    that rates are up sharply and more and more homeowners are deciding not
    to buy coverage. The MDI data does not take into account the many
    companies that have increased not only their earthquake rates but may
    have increased both their basic homeowners policies and earthquake
    rates to exit the market totally. Unfortunately the MDI's data does not
    include the number of homeowners that have had to change companies for
    this reason. Also, not included in the last data are the number of
    companies that have exited our market like the company in my agency
    that asked us to move the business or the company that terminated
    agents for high losses (when in fact the true reason was to reduce
    their earthquake exposure.)
        The third manner in which insurance companies have handled their
    earthquake exposure in our area is by increasing deductibles and/or
    limiting coverage to just the home itself, providing no coverage for
    outbuildings and little if any coverage for personal property. The
    standard earthquake deductible used to be 2%. Now we see deductibles
    starting at 10%, going up to 25%. One company our agency represents has
    stopped writing any new homeowners policies with earthquake coverage
    and, on their existing homeowners, has changed the coverage to the home
    itself and $10,000 on personal property. They did not increase their
    earthquake rates because by reducing what was covered, they took a 100%
    rate increase. Once again, this type of action by a company has never
    been reflected in any MDI data.
        Many in the insurance industry will claim that companies increasing
    deductibles and limiting coverage is a partial solution to their
    problem with natural disasters like earthquake. I just wonder where
    these homeowners are going to obtain the money for their personal
    property or to manage a 25% deductible. This is no solution for the
    average Missourian, but rather a prayer that somehow it will cost 25%
    less to rebuild their home or that when their home falls to the ground
    that miraculously their furniture, clothes, and other items will remain
    intact.
        The final manner in which companies are dealing with the potential
    mega catastrophe presented by the New Madrid fault is by simply not
    appointing any agents in earthquake prone areas.
        When our agency first witnessed company's restricting coverage and
    knowing that we faced the possibility of our companies pulling out of
    our market or increasing rates to unaffordable levels, my agency
    contacted over 20 companies to see if we could find a company willing
    to come into our area to write homeowners policies. Only one company
    would seriously talk with us. We offered to give all of these companies
    over $500,000 of profitable business and write all lines of insurance
    for their company. We heard many excuses from these insurance companies
    on why they would not appoint our agency. At least a few were honest
    enough to tell us that their company was just not interested in writing
    any earthquake coverage. This same search for companies has been
    repeated by almost every independent agency in Southeast Missouri with
    similar results.
        Still, we do have markets available in Eastern Missouri. But how
    long can the few remaining companies keep writing more business as
    other companies use tactics I described earlier to eliminate their
    homeowners policies?
        The Missouri Department of Insurance in analyzing their premium
    date also noted in their last earthquake study that coverage was
    falling off in our area. Why are fewer homeowners purchasing earthquake
    coverage? The answer is price. Several years ago the earthquake premium
    on an a $80,000 home in my agency was $70. Now the average premium for
    a home can cost $300, in addition to regular homeowners premium. Before
    the problems began in our marketplace, I was proud to say that
    approximately 90% of my homeowners clients had earthquake coverage on
    their homes. Now this percentage has declined to roughly 70%. I fear
    that this number will continue to fall. If nothing is done to
    strengthen our homeowners marketplace, I can see the day when the only
    homeowners that carry earthquake coverage will be those that are
    required to do so by their lenders, and even so these homeowners will
    probably only carry a small percentage of what they really need. All
    one has to do is to look at flood insurance to see how this can and
    will happen if something is not done.
        Missouri is by no means the only state that has, and still is,
    experiencing problems with our homeowners insurance markets. A fellow
    independent insurance agent from Louisiana, Don Beery, who currently
    serves as the President of the Independent Insurance Agents of
    Louisiana testified last year before the House Committee on Banking and
    Financial Services. To explain the problem that homeowners face in
    Louisiana, the following is a quote from his testimony:

              After Hurricane Andrew ``we began having trouble placing and
            renewing homeowners business. . . . Eventually, the Louisiana
            Insurance Department authorized that the business which
            insurance companies refused to write could be placed into an
            insurance pool . . . know as the Louisiana Fair Plan. . . . The
            number of applications soared almost immediately. Between 1993
            and 1997, the Fair Plan grew by more than 750%. The growth
            continues today, nearly a decade after Andrew, at a rate of
            more than 1,000 policies every month.

              The Estis Agency (Mr. Beery's agency) lives with the
            insurance availability problem every day even though
            homeowner's insurance rates are considered adequate and are the
            second highest in the United States. Most of the companies we
            represent have placed severe restrictions on the number of new
            policies that we can place with them. Many insurers will only
            allow us to write one or two policies a month. Some will only
            allow us to write three or four new policies a year! Several
            insurers will not write any policies for homes valued at more
            than $100,000. Other will not write any policies on homes worth
            less than $400,000. Many of our customers are caught in
            between. It is not unusual, for example, that the only source
            of insurance coverage we can find for a $125,000 home is Lloyds
            of London. We do not feel that a homeowner with a $125,000
            mortgage belongs with Lloyds. Nevertheless, we have no
            alternative but to place them there.''

        Another independent insurance agent, W. Cloyce Anders, who serves
    on the executive committee of the Independent Insurance Agents of
    America, also testified last year before the Housing and Community
    Opportunity Subcommittee of the House Banking and Financial Services
    Committee. Mr. Anders related the problems that North Carolina
    homeowners are facing. The following is quote from his testimony:

              ``We have a facility in North Carolina for homeowners who are
            unable to obtain traditional homeowners insurance coverage
            called the North Carolina Insurance Underwriting Association. .
            . . In the last two years, the NCIU has grown 34%, the fastest
            rate in history. This is on top of double-digit increases
            nearly every year as far back as 1989. Demand is so great that
            the association can no longer keep up with the demand for
            applications. As a result, they now delay opening the office
            phone lines for two and a half hours every morning in order to
            process the previous days' business.''

              Mr. Anders also stated that ``It (the lack of homeowners
            markets) is also not a condition that is limited to beach
            communities and the affluent. In North Carolina, many insurance
            companies will not write hurricane coverage and many others
            will not write property coverage of any kind for any home which
            is located east of Interstate 95. In many places I-95 is as
            much as 150 miles from the Atlantic Ocean. The NCIU accepts
            applications from residents in 18 counties. The vast bulk of
            the applications come from middle class families that live up
            to an hour's drive from the coast.''

        We are all aware of the problems faced by Florida homeowners
    because of the threat of future hurricanes. Mr. Alex Soto, an
    independent insurance agent and State National Director from Florida on
    the Independent Insurance Agents of America board, stated the problem
    succinctly in his testimony before the Housing and Community
    Opportunity Subcommittee of the House Banking and Financial Services
    Committee. The following is an excerpt from his testimony:

              ``I am an independent agent and as such, represent numerous
            insurance companies. In fact, we work with more insurance
            companies than most of my peers. . . . Of all the companies . .
            . not one is openly writing homeowner's insurance policies in
            any of the communities I represent. Not a single company. . . .
            but it gets worse. Most companies are not only refusing new
            business; they are still actively non-renewing as many
            customers as possible, in order to reduce their exposure in
            Florida. This is not a trend which is reversing.''

        Mr. Chairman, other insurance agents from New Jersey and
    Massachusetts have also testified on the problems that homeowners in
    their states face in obtaining adequate homeowners insurance and if
    time would permit the same message could be told by scores of other
    insurance agents from California, Texas, Arkansas, Tennessee, Georgia,
    and South Carolina, just to name a few. The stories are all similar, as
    is the need for a solution to this problem. The fact is that homeowners
    across our great nation are not able to protect their homes in the
    manner that most of us take for granted.
        I had the privilege to testify less than a year ago before the
    United States House of Representatives Committee on Banking & Financial
    Services as they were considering passage of the Homeowner's Insurance
    Availability Act (H.R. 21). In my testimony before that Committee, I
    was asked if I expected Missouri to enact a catastrophic fund. At that
    time I stated that my goal was for the introduction of legislation in
    the next session of the Missouri General Assembly.
        In 1999 the Missouri Association of Insurance Agents had a bill
    introduced in the Missouri State Senate to establish a fund similar to
    the Florida Hurricane Catastrophe Fund. The main reason for our support
    of this legislation was that we were unsure that any federal natural
    disaster legislation would be passed. This legislation had a hearing in
    the Missouri Senate insurance committee, however because the problem of
    availability at this time is mainly in the Southeast part of Missouri,
    it was difficult to convince senators to adopt our plan and the bill
    was not voted on by the Committee.
        After the Missouri General Assembly adjourned from that session,
    our agent's earthquake task force met again and decided that while we
    believe that our legislation was a good idea, the problem of
    availability of homeowners insurance would have to worsen further
    before we could see a bill passed. We were also encouraged by action in
    the U.S. House of Representatives Banking & Financial Services
    committee on H.R. 21 and thought our best course of action for our
    clients was to support federal legislation at this time. Since most of
    the major direct and independent agency companies writing homeowners
    insurance supported federal natural disaster legislation, we believe
    that this legislation will in turn help our clients.
        This brings me to one of the arguments made against S. 1361; that
    this bill will encourage the proliferation of state plans that compete
    against the private market. If our effort in Missouri is any example of
    what it takes to implement a state plan, I cannot see how this argument
    against S. 1361 holds water. Because the threat that natural disasters
    pose to most states is usually not a state-wide concern, convincing a
    state legislature in most states to start a state plan will be
    extremely difficult--if not impossible--unless our markets continue to
    worsen. States like California, (where a large portion of the state is
    effected) and Hawaii and Florida (where virtually the entire state is
    at risk from a natural disaster) have already acted in forming state
    plans because their markets could not wait for a national solution.
    These states insurance markets were in a state of collapse. I believe
    that it will take a similar situation in other states for more state
    plans to be developed or expanded to handle our natural disaster
    exposure.
        S. 1361 should in fact help curtail the creation of additional
    state plans as it offers a true national solution to this problem. The
    need for state plans only exists when the market fails and S. 1361 will
    revitalize the markets in our states that are currently worsening and,
    even more importantly, prevent what happened in Florida after Hurricane
    Andrew when the availability of homeowners insurance threatened every
    facet of the state's economy. Insurance companies and state departments
    of insurance do not lightly tread into state plans. If Congress fails
    to enact meaningful natural disaster legislation and we experience a 1-
    in-100 year mega catastrophe in any area of the U.S., cries from the
    citizenry will demand that states take action on their own and create
    more state specific plans.
        The Independent Insurance Agents of America believe that the
    insurance market place has and will continue to have a problem in
    dealing with mega catastrophes. Insurers and reinsurers are well
    equipped to handle the normal types of losses that occur everyday from
    fires, theft and many other types of losses. But the losses that worst
    case 1-in-100 year can present to many regions of America are beyond
    our industry's capability to manage without assistance.
        I am not here to testify on behalf of insurance companies. The
    insurance companies that support S. 1361 can tell you why they believe
    this legislation is necessary. This bill is not about helping insurance
    companies. I come here today to represent average Americans that just
    want to protect their most valuable asset, their homes. These taxpayers
    are not looking for a hand out from Uncle Sam. They want the ability to
    purchase homeowners insurance so that they will not have to come
    begging to Congress for help after a mega catastrophes in the form of
    ad hoc disaster assistance.
        This is not just a Florida or California problem. While California
    and Florida have received the most press about the problems that
    earthquakes and hurricanes present, the disaster prone states are much
    larger. When studying a map of the catastrophe prone states we are
    looking at the entire east and west coast, states on the gulf of Mexico
    and the states surrounding the New Madrid fault in the center of the
    U.S. As the Carolinas witnessed last hurricane season, many states can
    suffer from natural disasters. The problem posed by mega catastrophes
    is truly national in scope and not limited to those few homeowners
    living in Miami Beach or on the San Andres fault.
        Some insurance companies and taxpayer groups have tried to paint
    this as a bailout for the rich that have been foolish to build
    expensive homes on the beach or on a earthquake fault line. Nothing
    could be farther from the truth. Most of my clients in Missouri live in
    modest homes ranging from $50,000 to $150,000. These homes are not
    mansions, but they are the most valuable asset they possess. Also, the
    exact path of hurricanes and fault lines for earthquakes can and do
    change. In recent hurricanes, homes far from the coast or beach have
    been damaged. How can one say that a homeowner in South Carolina living
    50 miles from the coast has been foolish to purchase a home in that
    area. Unfortunately many of the fastest growing areas in America face a
    threat from these mega catastrophes. I could go on to site numerous
    examples but the fact is that natural disaster legislation will help
    all facets of our society.
        I also want to address another misconception that opponents of
    natural disaster legislation have been promoting. These opponents claim
    there is sufficient reinsurance to handle this problem and those
    insurance companies supporting this legislation are just not practicing
    prudent risk management. Again, I will let the insurance company
    representatives tell their story. I want to relate to you how this
    ``sufficient'' reinsurance has failed to help the situation of many
    homeowners.
        I previously related to you how many insurance companies withdrew
    or found other ways to eliminate homeowners clients in my area. After a
    couple of years without the enormous natural disasters like Hurricane
    Andrew and the Northridge Earthquake and without a major earthquake
    along the New Madrid fault, we still have companies that will not sell
    homeowners insurance is my area. With all this ``sufficient''
    reinsurance there are still many insurance companies that will not
    write homeowners insurance in Southeast Missouri. Other companies still
    have a moratorium on writing new homeowners. And we have many other
    companies that have continued to take the approach of avoiding writing
    homeowners insurance by making sure their premiums are too high to
    consider. I really question the availability of ``sufficient''
    reinsurance now and fear that the inevitability of a mega catastrophe
    will restrict reinsurance to levels that will send thousands of
    homeowners scrambling for a policy to protect their home.
        I also want to address the benefit of this legislation to the
    taxpayers in both disaster prone and non disaster prone states. When I
    testified before the House Banking Committee on a similar bill to S.
    1361, I was shocked to hear testimony from some of the groups
    representing ``the average American.'' Many of these groups say that S.
    1361 is not good for the taxpayers. I find the logic on this debate
    hard to comprehend. They suggest that S. 1361 will cost the taxpayers
    millions of dollars. I tell you that history has shown that if
    taxpayers cannot purchase homeowners insurance it will cost the federal
    treasury many more millions, if not billions, in disaster relief after
    the fact. S. 1361 will give homeowners the opportunity to purchase
    insurance so they will not have to come begging to Congress for
    disaster aid. We have an opportunity with this bill to empower
    individual American homeowners in disaster prone states to exercise
    their responsibility to protect their property. What could be a more
    basic responsibility? I hope you can see my position that assuring the
    availability of homeowners insurance to taxpayers will help save the
    federal government millions of dollars in disaster aid, all of which
    comes out of the pockets of taxpayers.
        Some would also argue that while this bill will help disaster prone
    states, why should a Senator from a non-disaster prone state support
    it? The reason is that when a disaster strikes any area of America, it
    is never just the taxpayers in that area that pay for the disaster aid.
    All American taxpayers contribute their tax dollars in disaster relief.
    Therefore any money that we can eventually save in future disaster
    relief will reduce the tax burden of taxpayers all across America. The
    best way for Congress to shift the burden of paying for disaster relief
    to those that receive it is by making sure that those Americans in
    disaster prone states have the ability to purchase homeowners insurance
    and thereby pre-pay for the assistance they will receive from their
    homeowners insurance companies.
        Homeowners across America are being forced to abdicate their
    individual financial responsibility to provide insurance protection for
    their homes because of a lack of markets and a severe increase in the
    cost of coverage. What will be our country's future disaster relief
    costs if this trend continues unabated? Will we continue to make
    homeowners in disaster prone areas rely on what relief they can get
    from their state and the federal government when mega a hurricane or
    earthquake strikes?
        I find the abdication of individual responsibility to be one of the
    greatest threats that our nation faces and that is why I want to see
    this legislation enacted. There will always be a need for a level of
    disaster aid and the assistance of FEMA, but we have an opportunity to
    allow individuals to help shoulder burden of the costs of worse case
    natural disasters by strengthening their homeowners markets. I am
    reminded of the old saying, ``If you give a man a fish you feed him for
    a day. If you teach him how to fish you feed him for a lifetime.'' S.
    1361 is that lesson in fishing that will help our homeowners insurance
    markets revitalize and survive the mega disaster.

        Senator Stevens. I do thank you for coming.
        Mr. Gilliam, I'm sorry to do this but I'm going to have to
    leave here in about 11 minutes.

    STATEMENT OF SCOTT A. GILLIAM, DIRECTOR, GOVERNMENT RELATIONS,
                   THE CINCINNATI INSURANCE COMPANIES

        Mr. Gilliam. Thank you, Senator Stevens.
        Again, my name is Scott Gilliam. I'm Director of Government
    Relations for the Cincinnati Insurance Companies. We are a
    group of property and casualty insurance companies
    headquartered in Fairfield, Ohio, just north of Cincinnati. We
    currently market property and casualty insurance in 30 states,
    and our premium volume is around $2 billion per year.
        I am honored to be with you today to present the Cincinnati
    Insurance Companies' perspective on S. 1361. We commend you for
    holding this hearing and for you leadership over the last
    several years in raising awareness of the issues associated
    with natural catastrophe exposure and insurance.
        We also particularly commend you for the balanced panels
    that you've had today. You're hearing all viewpoints, and I
    picked up during your own comments that you're looking for an
    opportunity for us all to work together and try and solve this.
    And while we do have some serious concerns, I would like to
    help in that process.
        Let me now briefly summarize my written testimony.
        We do not disagree that there may be a need for a 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 S. 1361 as presently drafted.
        Our primary concern with the bill 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 insured losses of $15.5 billion for Hurricane
    Andrew in 1992 and $12.5 billion for the Northridge earthquake
    in 1994.
        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 surplus has
    increased from $162 billion to over $330 billion today. Simply
    put, with a private market which is twice as prepared today to
    cover the back-to-back natural disasters it handled on its own
    in the early 1990's at a cost of $28 billion, the Federal
    Government should not be stepping in to pay for events with
    damages as low as $2 billion.
        This is reinforced by the sentiments of Treasury Secretary
    Summers who told a New York forum for property-casualty
    insurers in January 1999, that a Federal reinsurance program
    like that proposed under S. 1361 should be limited to those
    risks that private markets currently have difficulty handling.
        With the primary markets industry surplus at $333 billion,
    the private markets do not have any problems handling losses at
    the $2 billion level or as great as $5 billion, $10 billion, or
    even more.
        In addition, as 1999 data from the Reinsurance Association
    of America reflects, there is approximately $20 billion of
    catastrophe reinsurance capacity available per region, per
    event in the U.S. and prices for catastrophe reinsurance have
    declined for 5 years in a row.
        Equally distressing is the fact that we believe S. 1361
    will expose taxpayers to new, unfunded Federal liability.
        In its February 2000 Cost Estimate for H.R. 21, the House
    counterpart to S. 1361, the Congressional Budget Office
    concluded it is unlikely that the Federal Government would be
    able to establish prices for disaster reinsurance that would
    fully cover the potential future costs of these financial
    obligations.
        This situation could be even worse under the Senate version
    of the bill, since it gives the program's governing body, the
    Natural Disaster Insurance Corporation, unlimited authority to
    borrow Federal funds to pay claims if the premiums collected
    are insufficient to pay those claims. This has the potential of
    creating a crisis similar to what we saw in the savings and
    loan industry not too many years ago.
        Another major concern is the anti-competitive effect the
    Senate bill may have on existing markets. Most insurers act
    responsibly. They avoid large concentrations of risk and
    purchase adequate reinsurance or other otherwise develop
    adequate resources to absorb shock losses.
        Under S. 1361, these responsible insurers would have to
    compete against irresponsible carriers who have over-
    concentrated their risk in catastrophe-prone areas and put
    themselves in a position of having to rely upon state insurance
    programs or other government mechanisms to absorb shock losses.
        As one major insurer admitted in the letter it sent to its
    Florida policyholders after Hurricane Andrew, and I quote, ``In
    the past, despite well-intentioned efforts to determine what
    our policy holders should pay for insurance, we greatly
    underestimated the cost of covering hurricane damages. Over the
    years, our policy providing insurance to everyone who qualified
    meant 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 back-stop afforded to
    state insurance programs under S. 1361, such overexposed
    carriers will likely continue to rely on state programs to
    absorb shock losses and ignore the peril of risk concentration.
        Clearly this gives those companies an unfair market
    advantage and rewards irresponsible behavior. S. 1361 would
    give these carriers further reason to write insurance at even
    greater concentrations in high-risk areas further exposing the
    Federal Treasury.
        Now I would like to address the issue of the trigger and
    give you some thoughts on what you think the trigger should be.
        The underlying goal of S. 1361 is very sound. To create a
    Federal reinsurance mechanism to buttress the solvency of the
    insurance industry in the rare event of a mega-catastrophe that
    seeks current or projected claims paying ability. With this
    goal in mind, it should not be difficult to determine
    appropriate trigger for Federal involvement.
        As a starting point, we believe it makes sense to look at
    the magnitude of past catastrophe losses handled by the
    insurance industry. As already mentioned, the industry handled
    back-to-back cat losses of $15.5 billion and $12.5 billion in
    the early 1990's.
        With the industry's current policyholders surplus at an
    all-time high of $333 billion, which is more than twice what it
    was at the time the industry paid combined losses of $28
    billion for Andrew and Northridge, we believe the industry is
    more than equipped to handle a $35 billion catastrophe without
    Federal involvement.
        For those who view the selection of a static trigger as
    problematic, another approach which has been given
    consideration, is a percentage trigger based on industry
    surplus or individual insurer's surplus.
        For example, Senator, under your bill in the 104th
    Congress, S. 1043, payments under the Federal Reinsurance
    Program would have been triggered when insured losses exceeded
    15 percent of industry surplus, which under today's numbers
    would be $49 billion, or 20 percent of an individual insurer's
    surplus in certain cases.
        By using surplus rather than a static number, the trigger
    will adjust 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 of the marketplace.
        We offer these comments on trigger levels as a starting
    point for determining an appropriate level under this bill.
        To try and wrap this up quickly, I would echo the
    sentiments of Mr. Keating in regard to Senator Mack's bill, S.
    1914, the Policyholders Protection Act. We are one of the only
    industrialized countries in the world that does not allow their
    insurers to put aside reserves to hold for future mega-
    catastrophes, and we think that could go a long way in insuring
    the solvency of the industry when the mega-catastrophe comes,
    which inevitably it will.
        That's the basis of my remarks today. Just a couple of
    quick points I would make in regard to some of the other
    testimony----
        [The prepared statement of Mr. Gilliam follows:]

    Prepared Statement of Scott A. Gilliam, Director, Government Relations,

                       the Cincinnati Insurance Companies
    Introduction
        Chairman McCain, Senator Hollings, Senator Stevens, members of the
    Committee, my name is Scott Gilliam. I am Director of Government
    Relations for The Cincinnati Insurance Companies, headquartered in
    Fairfield, Ohio, just north of Cincinnati.
        Our group of companies market property and casualty insurance in 30
    states through an elite corps of fewer than 1,000 local independent
    insurance agencies. That group of companies has nearly one million
    policies in force insuring businesses and families. Our parent company,
    Cincinnati Financial, is among the top 20 publicly traded property and
    casualty insurers based on 1999 consolidated revenues of $2.1 billion.
        I am honored to be with you today to present The Cincinnati
    Insurance Companies' perspective on S. 1361. We commend Chairman McCain
    and Senator Hollings for holding this hearing and Senator Stevens for
    his leadership over the last several years in raising awareness of the
    issues associated with natural catastrophe exposure and insurance.
        The frequency and severity of natural disasters have created
    serious issues that the insurance industry and government need to
    address. In recent years there have been a number of attempts at the
    federal level to deal with the problems associated with insurance
    protection for losses arising from hurricanes, earthquakes and other
    natural disasters.
        The catastrophe exposure we face from our own book of business has
    prompted us to engage in this important debate. For example, our
    hurricane exposure in Florida and Alabama alone is nearly $1.8 billion,
    representing over 10,000 homes. In the New Madrid earthquake region in
    the Midwest, our total insured values are $89.5 billion, based on the
    amount of earthquake coverage currently in force for homes and
    businesses. These are significant exposures for The Cincinnati
    Insurance Companies when considered in relation to the current level of
    assets for our property/casualty group ($5.9 billion).
        We have been further motivated by several basic concerns which have
    presented themselves over the years as various legislative proposals,
    the most recent being
    S. 1361, have been presented to deal with the problems associated with
    insurance protection for losses arising from hurricanes, earthquakes
    and other natural disasters. These include:

       the need to preserve state regulation of insurance
            (McCarran-Ferguson Act);

       finding a solution that will enhance private markets and not
            compete against them;

       the need to oppose legislation that is detrimental to any
            segment of our industry or would unfairly favor one insurer
            over another.
    The S. 1361 Proposal
        Let me know turn to the legislation at hand, S. 1361, which would
    create a new federal agency, the ``Natural Disaster Insurance
    Corporation'' (NDIC), through which federal reinsurance contracts would
    be offered for purchase by state insurance programs and for auction to
    state insurance programs and private insurers to cover residential
    losses in the event of a natural disaster. The federal reinsurance
    contracts would provide natural disaster peril coverage on an excess-
    of-loss basis with a trigger as low as $2 billion. Pricing of the
    contracts would be established by the NDIC, in consultation with a new
    federal commission, the ``Independent Natural Disaster Board of
    Actuaries.'' The NDIC would be authorized to make unlimited annual
    payments under the contracts and to engage in borrowing through the
    Secretary of the Treasury as necessary to pay claims and expenses under
    the contracts.
        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, earthquakes and other natural disasters.
    However, we believe that the following principles must be embodied in
    any legislation which endeavors to provide a federal safety net for
    catastrophe insurance:

              1. The risk of natural catastrophes is best insured in a
            diversified marketplace which avoids concentration of risk in
            too few insurers or state programs.

              2. The private sector's role, including insurance,
            reinsurance and capital markets, should be maximized and such
            financing mechanisms fully exhausted before any government
            capacity is provided, state or federal.

              3. Government's role should be to address insurer solvency in
            the event of a mega-catastrophe and should not come at the
            expense of taxpayers.

              4. Any federal proposal should include personal and
            commercial lines of insurance since both forms of coverage are
            affected by catastrophic events.

        Unfortunately, S. 1361, in its current form, falls short in a
    number of these areas.
    Low Trigger And New Unfunded Federal Liability
        Our primary concern with S. 1361 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 insured losses of
    $15.5 billion from Hurricane Andrew in 1992 and $12.5 from the
    Northridge Earthquake in 1994. 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 surplus has increased
    from $162 billion to over $333 billion today. Fact of the matter is,
    the industry has handled all catastrophes to date regardless of their
    size and has handled them totally within the private sector.
        Simply put, with a private market which is twice as prepared today
    to cover the back-to-back natural disasters it handled on its own in
    the early 1990s at a cost of $28 billion, the federal government should
    not be stepping in to pay for events with damages as low as $2 billion.
    This is reinforced by the sentiments of Treasury Secretary Larry
    Summers, who told a New York forum for property-casualty insurers in
    January, 1999 that a federal reinsurance program like that proposed
    under S. 1361 should be limited to those ``risks that private markets
    currently have difficulty handling.''
        Equally distressing is the fact that S. 1361 will expose taxpayers
    to new unfunded federal liability. In its February 9, 2000 ``Cost
    Estimate'' for H.R. 21, the House counterpart to S. 1361, the
    Congressional Budget Office concluded ``it is unlikely that the federal
    government would be able to establish prices for disaster reinsurance
    that would fully cover the potential future costs of these financial
    obligations,'' as a result of which ``federal payments for disaster
    insurance claims would exceed the premiums collected'' under H.R. 21.
    This situation will be even worse under
    S. 1361, since the Senate bill gives the program's governing body, the
    Natural Disaster Insurance Corporation, unlimited authority to borrow
    federal funds to pay claims if the premiums collected are insufficient
    to pay claims. This has the potential of creating a crisis similar to
    what we saw in the savings and loan industry not too many years ago.
        Similar concerns were voiced by Secretary Summers in his remarks to
    the same property-casualty forum mentioned above, Mr. Summers telling
    the group that a federal reinsurance program like that proposed under
    S. 1361 ``should impose no net cost on the taxpayer'' since ``the
    federal government cannot be the bill-payer of last resort'' for such
    insurance. However, that is exactly what will happen if S. 1361 is
    enacted in its current form.
    Government Competition With The Private Market
        We are also very concerned that S. 1361 will supplant the private
    market and stifle private sector development of new and innovative
    approaches to the problem of protecting Americans against catastrophic
    risk. Despite what others may have said today, reinsurance is available
    and affordable through the private sector for those who properly manage
    their risk. As 1999 data from the Reinsurance Association of America
    reflects, there is approximately $20 billion of catastrophe reinsurance
    capacity available per region, per event in the U.S., and prices for
    catastrophe reinsurance have declined for five years in row.
        The federal reinsurance program proposed under S. 1361 overlooks
    these important facts and invites the federal government to compete
    with and displace private markets for reinsurance. S. 1361 is a classic
    ``government-knows-best'' approach to public policy issues. By offering
    subsidized federal reinsurance to state insurance programs, S. 1361
    displaces the private insurers and reinsurers already assuming risks in
    those markets. The likely result is markets that are dictated by
    government officials with no room for private sector ingenuity.
        As the private reinsurance market continues to improve, we are also
    witnessing the introduction of innovative capital market approaches
    which are expanding the industry's risk-bearing capabilities for
    catastrophe exposures. An evolving form of securitizing risk through
    capital market instruments is providing significant new capacity to the
    insurance industry. In 1998, there were eighteen such transactions
    totaling $2.5 billion and similar approaches for securitizing
    catastrophe risk are in various stages of development. It is these
    types of approaches to catastrophic risk protection which Treasury
    Secretary Summers views as the most promising. As Secretary Summers
    told the property-casualty forum in New York:

            ``Ultimately, we believe that the most efficient means for
            underwriting these risks may involve the capital market as an
            important complement to the traditional reinsurance industry.''

        Unfortunately, S. 1361 may stifle further development of such
    innovative free market approaches to catastrophe securitization since
    it encourages the shifting of catastrophe risk out of the private
    sector and displaces private market capacity in favor of federal
    capacity. The bill's stifling effect on private market development and
    innovation is exacerbated by the fact that S. 1361 does not contain a
    sunset provision, unlike its House counterpart, S. 1361, which provides
    for a sunset of the federal reinsurance program after 10 years.
    Proliferation Of State Insurance Programs And Anti-Competitive Effects
        S. 1361 will also encourage the development and proliferation of
    underfunded and overexposed state insurance programs by making low-cost
    federal reinsurance available to these programs at very low trigger
    levels. Providing subsidized federal reinsurance to state programs will
    supplant private risk capacity and foster the existence of these pools
    of last resort which are often underfunded and overexposed (they
    contain each state's most undesirable risks and suppress risk-based
    rates for insurance). If the federal government steps in and offers to
    indemnify state programs at the low levels contemplated in S. 1361,
    there is little incentive for insurance commissioners and state
    legislators to consider common sense alternatives to underfunded and
    overexposed state insurance programs, e.g., market driven solutions
    premised upon two of the most essential principles of insurance:
    spreading of risk and risk-based pricing.
        Another concern is the anti-competitive effect S. 1361 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 S. 1361, these
    responsible insurers would have to compete against irresponsible
    carriers who have over concentrated their risk in catastrophe-prone
    areas and put themselves in a position of having to rely upon state
    insurance programs 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 costs of covering hurricane damages. Over
            the years, our policy of providing insurance to everyone who
            qualified meant we sold our product at too low a cost to too
            many people. We know now 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 afforded to state insurance
    programs under S. 1361, such overexposed carriers will likely continue
    to rely on state programs 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, S. 1361 would give these carriers further incentive to write
    insurance in even higher concentrations in high risk areas, further
    exposing the federal treasury.
    Commercial Risks
        S. 1361 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 (personal lines exposure: $1.7 billion;
    commercial lines exposure: $1.5 billion). There is simply no logical
    reason why commercial risks should be excluded from S. 1361.
    State Regulation
        S. 1361 will further endanger state regulation of the business of
    insurance. Since 1945, the insurance industry in the United States has
    been regulated by the States under authority of the McCarran-Ferguson
    Act. State regulation of insurance has and continues to work well. S.
    1361 would strike at the heart of McCarran-Ferguson and open the door
    for the federal government to enter into the business of insurance
    regulation.
        If S. 1361 becomes law, it would not be long before the federal
    government took an active role in the insurance industry. As soon as
    significant federal dollars are spent to bail out the over-exposed
    insurers who seek S. 1361 as a solution to their balance sheet
    problems, an argument would be made for more federal control over these
    insurers, and ultimately over all insurers. The bill's provision for
    the creation of two new federal bureaucracies: the ``Natural Disaster
    Insurance Corporation'' and the ``Independent Natural Disaster Board of
    Actuaries,'' would provide further impetus for full scale federal
    intrusion into regulation of the business of insurance.
        McCarran-Ferguson has worked well and we need to do all we can to
    preserve it. The passage of S. 1361 would imperil McCarran-Ferguson.
    Determining An Appropriate Trigger Level--Two Approaches For
            Consideration
        While we have a number of concerns with S. 1361 as presently
    drafted, we see little chance for the bill to gain industry-wide
    support unless the unreasonably low triggers are addressed. The current
    triggers fall far below the actual claims paid by industry for our
    Nation's largest insured losses: Hurricane Andrew at $15.5 billion and
    the Northridge Earthquake at $12.5 billion. The $2 billion trigger
    significantly underestimates private insurance capacity and would
    likely lead to a major dislocation of private market capacity in favor
    of federal capacity.
        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, earthquakes and other natural disasters. The
    pivotal question remains: what is an appropriate trigger level for
    federal involvement?
        The underlying goal of S. 1361 is sound--that is, to create a
    federal reinsurance mechanism to buttress the solvency of the insurance
    industry in the rare event of a mega-catastrophe that exceeds current
    or projected claims-paying ability. With this goal in mind it should
    not be difficult to determine an appropriate trigger for federal
    involvement.
        As a starting point for determining an appropriate trigger level,
    we believe it makes sense to look at the magnitude of past catastrophe
    losses handled by the insurance industry. As already mentioned, the
    industry handled back-to-back catastrophe losses of $15.5 billion
    (Hurricane Andrew) and $12.5 billion (Northridge Earthquake) in the
    early 1990s. With the industry's current policyholder surplus at an
    all-time high of $330 billion plus, which is more than twice what is
    was at the time the industry paid combined losses of $28 billion for
    Andrew and Northridge, we believe the industry is more than equipped to
    handle a $35 billion catastrophe without federal involvement.
        For those who view the selection of a static trigger as
    problematic, another approach which has been given consideration is a
    percentage trigger based on industry surplus or individual insurer
    surplus. For example, under Senator Stevens' bill in the 104th
    Congress, S. 1043, payments under the federal reinsurance program were
    triggered when insured losses exceeded 15 percent of industry surplus
    ($49 billion in today's dollars) or 20 percent of an individual
    insurer's surplus. By using surplus 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.
        We offer these comments as a starting point for determining an
    appropriate trigger level under S. 1361.
    S. 1914--The Private Sector Alternative to S. 1361
        As a property and casualty insurer, we are concerned that some
    high-level catastrophes may be beyond the financial ability of our
    industry. However, there is a viable alternative to the perils of S.
    1361. Under S. 1914, the ``Policyholder Disaster Protection Act of
    1999,'' property-casualty insurers would be permitted to set aside
    catastrophe reserves on a tax-deferred basis to better prepare for mega
    catastrophes, a bill introduced in the Senate last November by Senators
    Connie Mack and Kay Bailey Hutchison.
        The intent of the S. 1914 is to motivate insurers, through the
    correction of a flaw in federal tax law, to establish reserves for
    future catastrophes on a voluntary basis and to hold the funds backing
    those reserves in a segregated account until they are released to pay
    for catastrophic losses. But the current U.S. tax/accounting system is
    flawed in that it only allows insurers to look backwards--insurers can
    set aside consumer premiums in reserves to pay for past disasters but
    not for future, predicted events. As a result, consumers' insurance
    payments are taxed up front as profits, discouraging insurers from
    providing insurance in high-risk areas and reducing capacity to deal
    with catastrophes.
        The United States is one of the few countries in the industrialized
    world which does not allow insurers to prepare for future disasters by
    setting up pre-event catastrophe reserves. S. 1914 corrects this flaw
    by allowing and encouraging insurers to set aside part of the premiums
    they receive in special tax-deferred catastrophe reserves under strict
    regulation and oversight and dedicate them solely to pay for future
    major disasters. This will empower and encourage more insurers to serve
    markets in disaster-prone areas and encourage the insurers now serving
    those markets to remain. Policyholders will benefit from the resulting
    increase in competition in a number of ways, including the likely
    introduction of better insurance products and policy features and more
    competitive pricing.
        S. 1914 will also reduce the possibility that a significant portion
    of the private insurance system would fail in the wake of a major
    natural disaster and that governmental entities would be required to
    step in to provide relief at taxpayer expense.
        We strongly support S. 1914, as do the National Association of
    Professional Insurance Agents (PIA) and the Council of Insurance Agents
    and Brokers (CIAB), and believe it is a viable alternative to the
    federal reinsurance program proposed under S. 1361.
    Conclusion
        Regardless of which legislative proposal is ultimately adopted to
    deal with the problems associated with insurance protection for losses
    arising from hurricanes, earthquakes and other natural disasters, it is
    incumbent that we keep these basic principles and concerns at the
    forefront of the debate:

       The risk of natural catastrophes is best insured in a
            diversified marketplace which avoids concentration of risk in
            too few insurers or state programs.

       The private sector's role, including insurance, reinsurance
            and capital markets, should be maximized and such financing
            mechanisms fully exhausted before any government capacity is
            provided, state or federal.

       Government's role should be to address insurer solvency in
            the event of a mega-catastrophe and should not come at the
            expense of taxpayers.

       Any federal proposal should include personal and commercial
            lines of insurance since both forms of coverage are affected by
            catastrophic events.

       The need to preserve state regulation of insurance
            (McCarran-Ferguson Act).

        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, earthquakes and other natural disasters. But
    if this Committee and this Congress is serious about passing
    legislation to protect policyholders against the perils of natural
    catastrophes, the legislation ultimately adopted must not encourage
    government subsidization of catastrophe risk or supplant the private
    market for insurance and reinsurance.
        Unfortunately, S. 1361, as presently drafted, does not satisfy
    these minimum criteria.
        Thank you for your consideration of this important issue. I would
    be happy to answer any questions.
                               additional remarks
        Introduction. At the conclusion of the presentation of my initial
    remarks, Senator Stevens adjourned the hearing due to the necessity of
    his attendance at another appointment. This prevented me from making
    comments on several points made by other witnesses earlier in the
    hearing. I was subsequently told by Committee staff that I could
    provide those comments in written form and they would be included in
    the record. Those comments follow.
        Private Homeowner Insurance Market Not On ``Shaky Ground.'' One
    witness commented during his testimony that S. 1361 is needed because
    the private homeowner insurance market is on ``shaky ground.'' (Jack
    Weber, President, Home Insurance Federation of America). Simply put,
    nothing could be further from the truth.
        In catastrophe-prone Florida, for example, major insurers are
    writing new homeowners coverage in most of Florida's 67 counties.
    (Testimony of Susanne Murphy, Deputy Insurance Commissioner, Florida
    Department of Insurance, before the U.S. House of Representatives
    Banking and Financial Services Subcommittee on Housing & Community
    Opportunity, July 12, 1999 [in Tampa, Florida]).
        GAO Report Not Supportive of S. 1361. The proponents of S. 1361
    suggest the GAO report supports their contention that the private
    insurance markets are not prepared to cover catastrophe losses expected
    to occur as a result of certain 1-in-100 year events, from which they
    conclude that a federal reinsurance program like that set forth in S.
    1361 is therefore necessary. However, those who point to the GAO report
    as support for S. 1361 have overlooked several key limitations in the
    GAO report as well as several conclusions made in the report.
        The GAO report acknowledges many limitations to its research.
    Elements not considered in the report, either at all or in depth,
    include:

       Multiple disasters

       Multi-state disasters

       Varying capacities of individual insurers to respond to
            disasters

       Reinsurance

       Capital markets

       State insurance funds

       Long-term effects on insurers and consumers

       The effects of fluctuations in our overall economy

        The proponents of S. 1361 have also overlooked several of the most
    critical conclusions reached by the GAO in its report:

       The insurance industry has sufficient capacity to pay most
            or all claims from a major catastrophe loss using its own
            resources, without taking into account reinsurance.

       Most of the insurers in the top ten disaster-prone states
            would be able to easily pay off all of their claims after a
            major catastrophe, without even taking into account
            reinsurance.

       The surpluses of all U.S. insurance companies ($427 billion)
            are at an all-time high and have grown more than 140 percent
            over the last ten years.

       The surpluses of insurers operating in the most catastrophe-
            prone states--such as Florida, California, and Texas--have
            grown by more than 140 percent.

       Insurers currently have large surpluses despite suffering
            huge catastrophic losses over the years.

       GAO certifies independent studies that find that the
            insurance industry has sufficient capital to support its risk.

       Reinsurance is widely available and prices are low relative
            to historical levels.

       GAO acknowledges studies that report $20 billion of
            catastrophe reinsurance is currently in force in each of four
            U.S. regions, which is twice as much catastrophe reinsurance as
            was available in 1994.

       Reinsurance is cheap and plentiful for purchasers, including
            the California Earthquake Authority (CEA).

       The potential for the capital markets to finance natural
            disasters is great.

        Since the report concludes that there is adequate capacity in the
    primary insurance marketplace to finance losses from a major natural
    disaster, we believe there is a need for further research into the need
    for a federal reinsurance program before the Senate decides to act or
    pass legislation like that embodied in S. 1361.

        Senator Stevens. I'm sorry to tell you I'm going to have to
    go. I appreciate it. I'll put your full statement in the
    record. I am due over there now.
        I thank you all very much for coming to the hearing. I do
    hope we can get staff working with some of you people and your
    representatives as well as the other witnesses to see if we can
    work out something with the administration this year.
        Thank you very much.
        [Whereupon, at 4:26 p.m., the hearing concluded.]
                                A P P E N D I X

                              Bob Graham, United States Senate,
                                         Washington, DC, April 7, 2000.
    Hon. Stuart E. Eizenstat,
    Deputy Secretary of the Treasury,
    United States Department of the Treasury,
    Washington, DC.

    Dear Secretary Eizenstat:

        As you prepare for your appearance before the Senate Committee on
    Commerce, Science, and Transportation on April 13, 2000, regarding the
    Natural Disaster Protection & Insurance Act (S. 1361), I would ask that
    you voice your support of this legislation, in consideration of the
    issues discussed below.
        Increasing the availability and affordability of property and
    casualty insurance is very important to me and the over 15 million
    residents of the State of Florida. In the last two (2) sessions of
    Congress, numerous proposals to address this critical need have been
    forwarded by members of the House and Senate. Since the inception of
    these legislative proposals, Congress, the Administration, the
    insurance and re-insurance industries, consumer groups and other
    interested parties have worked diligently to come to an agreement on an
    acceptable mechanism to increase the availability and affordability of
    insurance in high-risk areas.
        Given the fact that 112 members of the House of Representatives
    have co-sponsored the Homeowners Insurance Availability Act of 2000
    (H.R. 21) and that Title III of S. 1361 contains provisions
    substantially similar to H.R. 21, I believe that we are rapidly
    approaching a compromise that will be accepted by both the House and
    the Senate. Secretary Summers' efforts in crafting this legislation
    were critical to the progress we have made thus far, and I would ask
    that you continue to work positively with Congress to pass legislation
    that will address the need for catastrophic disaster insurance.
        The Treasury Department's long-standing decision to focus primarily
    on the insurance side of the natural disaster equation is a good one.
    Although I remain committed to the mitigation of losses from natural
    disasters--and have introduced separate legislation on this subject (S.
    1691, the Disaster Mitigation Act of 1999)--combining insurance and
    comprehensive disaster mitigation into a single bill may confuse the
    issues and put both concepts in jeopardy. However, the insurance
    reforms contained in S. 1361 deserve careful consideration by the
    Treasury Department, and your support of the bill's approach will move
    us even closer to an acceptable compromise.
        Once again, I believe that it is vitally important that you and the
    Administration remain engaged and supportive in the process if this
    complex legislation is to be enacted and its benefits made available to
    the million of our citizens who are vulnerable to the effects and
    economic reverberation of a catastrophic event.
        I look forward to continuing to work with you on this important
    initiative.
        With kind regards.
            Sincerely,
                                                    Bob Graham,
                                                 United States Senator.
                                     ______

            Prepared Statement of the Alliance of American Insurers
        The Alliance of American Insurers is a national property and
    casualty insurance trade association representing more than 300
    companies. Alliance membership is diverse, representing large multi-
    line insurers doing business in all states as well as small regional
    and single state insurance companies. We offer the following comments
    on S. 1361, a bill to amend the Earthquake Hazards Reduction Act of
    1977.
        For more than two decades the Alliance has participated in
    discussions regarding a federal response to property losses from
    natural catastrophes. While we have supported congressional action for
    flood insurance and commend Senator Stevens for his effort in
    developing this legislation, we do not believe S. 1361 is either
    appropriate or necessary.
        We believe the current capacity of the reinsurance industry, both
    domestic and offshore, is sufficient to meet the needs of our domestic
    property and casualty industry. Access to the capital markets via
    ``securitization,'' as well as the development and use of other
    sophisticated risk transfer mechanisms, is functioning well to
    supplement traditional reinsurance. The successful placement of
    catastrophe bonds has expanded the industry's capacity to provide
    coverage. The legislation's encouragement of state programs and the
    creation of a federal reinsurance program strikes at the core of our
    belief that the private insurance market offers better, and more
    creative, responses to questions about the industry's ability to
    respond to natural disasters.
        Creation of a Natural Disaster Insurance Corporation, as required
    by this act, would establish a private reinsurer that would have the
    ability to raise funds through the auspices of the Department of the
    Treasury. While the stated purpose in S. 1361 is not to compete or
    supplant private markets, this is exactly what the bill would do.
        The bill allows state funds to collect reinsurance funds for loss
    occurrences not less that the greater of $2 billion or the ``claims-
    paying capacity of the eligible State program.'' The Alliance believes
    S. 1361 would thereby encourage the creation of more state catastrophe
    programs in order to take advantage of federal reinsurance.
        While S. 1361 does contain extensive provisions for mitigation, the
    Alliance is concerned that they do not adequately address the issue of
    overbuilding in catastrophe-prone regions of the country. The bill
    calls for a study of this issue by states, but does not require any
    action to limit the concentration of risk. Land use and zoning controls
    are needed, not increased exposures.
        For example, modest coastal cottages along the eastern seaboard are
    being replaced with luxury homes and high rise condominiums. Following
    the construction of these properties, the owners of these properties
    expect the same continued access to inexpensive insurance coverage as
    though they were located in a far less hazardous area.
        S. 1361 does nothing to address this continued expectation that
    people can build what and where they want with no consequences for this
    action. The bill does provide for the establishment of building code
    requirements and enforcement of those standards by states. However, we
    think that the funding incentive for these programs, 10% of investment
    income from the Corporation funds, is inadequate.
        The Alliance believes that the creation of a federal reinsurance
    program and the likely growth of state pools will place a continued
    burden on the U.S. taxpayer and private insurance policyholder to
    subsidize property insurance rates for people who choose to locate in
    catastrophe-prone areas.
        Under the Stafford Act, we continue to pay federal disaster relief
    to public entities that do not undertake mitigation activities to
    improve the survivability of their properties and often do not purchase
    insurance or set aside funds in a self-insurance program. This
    continued federal largesse acts as an incentive not to mitigate and not
    to insure. S. 1361 does contain provisions for a study of retrofitting
    of these properties. However, the level of mitigation funding makes it
    unlikely that improvement will occur.
        The Alliance opposes S. 1361 because it would continue to
    perpetuate the cycle of insurance rate subsidization of residents in
    hazard-prone areas and the continued overbuilding in these same areas
    of the country. While we can support pursuing a national mitigation
    policy, in our opinion, the imposition of a federal reinsurance program
    would not be an equitable trade-off. The market place has responded to
    the perceived insurance capacity problems as they relate to natural
    disasters. Market solutions are almost always preferable when
    responding to a perceived problem. We believe this is clearly the case
    in this instance.
                                     ______

               Prepared Statement of America's Community Bankers
        America's Community Bankers (ACB) represents the nation's community
    banks of all charter types and sizes. ACB members pursue progressive,
    entrepreneurial and service-oriented strategies in providing financial
    services to benefit their customers and communities. Establishing a
    federal approach to help maintain insurance coverage in areas subject
    to major natural disasters is a priority issue for ACB, and we
    appreciate this opportunity to provide a statement on this significant
    issue.
        Mr. Chairman, S. 1361 is an excellent step toward developing an
    effective legislative remedy to the natural disaster insurance dilemma.
    ACB believes that it provides a good foundation on which to build a
    natural disaster insurance program that provides support for the
    private sector insurance industry without imposing an undue cost to
    taxpayers. The legislation helps to ensure that regional economic
    infrastructures are maintained and that financing availability for
    housing is not diminished.
        ACB commends Senator Stevens for introducing this thoughtful
    legislation. ACB is committed to working with the Committee, the
    Administration, and the insurance industry in crafting an effective
    legislative solution. To make such a program effective, however, broad
    coverage is desirable. No type of improved property--whether
    residential, multi-family or commercial (mortgaged or unmortgaged)--is
    insulated from the effects of natural disasters, and none should be
    excluded from the natural disaster insurance program. However, we
    believe that adequate insurance coverage for residential property must
    have the highest priority.
    Impact of Natural Disasters
        The magnitude of the natural disasters that have plagued the United
    States recently has been staggering. For example, 119 natural disasters
    were declared from 1990 to 1994. From 1979 to 1993, the federal
    government provided assistance and loans of over $130 billion in
    connection with natural disasters. Prior to 1989, no natural disaster
    in the United States had caused more than $1 billion in insured losses.
    However, the losses associated with Hurricane Hugo, which followed
    shortly thereafter, totaled $4 billion.
        The peak losses in the early 1990s increased precipitously in
    comparison with the earlier periods. In August, 1992, Hurricane Andrew
    inflicted $15.5 billion in insured losses. It is estimated by many that
    Hurricane Andrew inflicted another $15.5 billion in uninsured losses.
    In addition, the Northridge earthquake in southern California generated
    claims totaling $12.5 billion.
        These natural disasters caused enormous suffering and massive
    property destruction, and a number of insurance companies sustained
    massive losses. In order to reduce risk exposure, certain national
    insurance companies withdrew totally, or severely restricted the
    availability of natural disaster insurance after these major disasters.
    Natural disaster insurance coverage in disaster-prone areas became
    significantly more expensive and contained larger deductibles. Under
    certain circumstances, these deductibles reached 15 percent of the
    value of the insured property. Without the creation of special state-
    sponsored, joint underwriting pools, even this scaled-backed coverage
    may not have been available.
        The absence of adequate natural disaster insurance in disaster-
    prone areas represents an enormous risk factor for lenders extending
    credit in those areas. ACB members provide financing for one-to-four
    family and multi-family residential mortgages, and community and
    business development lending. Without adequate insurance coverage,
    these community banks could suffer severe losses and funds for disaster
    recovery and credit for new development in disaster-prone areas would
    be severely restricted.
        Because our member institutions in the disaster-prone areas are
    subject to substantial risk, ACB is committed to the development of a
    prudent and effective natural disaster insurance program. Accordingly,
    ACB is working with state organizations and member institutions to
    obtain as much information as possible with respect to the financial
    risks related to natural disasters, and is exploring feasible solutions
    to the natural disaster insurance problem.
    State Initiatives
        After the devastation caused by these recent natural disasters,
    several state legislatures attempted to provide some degree of
    protection from natural disasters for their citizens. California,
    Florida, and Hawaii adopted disaster insurance programs that
    established a reinsurance fund for losses in excess of a specified
    amount per disaster. Unfortunately, these programs provide relatively
    limited protection. None of these programs have the capacity or
    resources to provide adequate protection against catastrophic losses
    resulting from major natural disasters.
        The primary criticism of state natural disaster programs is that
    they lack adequate funding and they are limited geographically. For
    example, the state of California's program is arguably the most
    comprehensive. Nevertheless, it has been widely criticized as too
    limited in scope and is substantially undercapitalized.
    Disaster Insurance on the Federal Level
        ACB believes it is imperative that Congress develops a realistic
    and comprehensive federal solution to the natural disaster insurance
    problem. S. 1361 addresses a number of issues inherent in the operation
    of a federal disaster insurance program. It is clear that major natural
    disasters can substantially overwhelm the capacity of private and
    state-sponsored insurance and reinsurance programs within the
    individual states. Thus, the natural disaster insurance problem
    suggests a federal-level solution.
        It should be emphasized that secured housing lenders are faced with
    a particularly acute problem since they underwrite loans in reliance on
    the physical collateral. Lack of adequate disaster insurance will
    reduce the availability of new loans and refinancings, and harm
    collateral on all outstanding mortgage loans. In the event of a major
    natural disaster, many community lenders would sustain severe losses on
    under-insured and uninsured loans.
        Unless they have insurance that covers natural disasters, borrowers
    generally do not have the financial resources to meet financial
    obligations if their properties suffer severe damage. This is
    especially true for residences financed with high loan-to-value loans.
    Therefore, lending institutions would incur losses on many properties
    impaired by natural disasters.
        The details of how a program is constructed are important and
    deserve close attention. For example, force-placing of insurance should
    be seriously considered. The use of tax incentives to encourage
    insurance industry involvement is worth exploring. Certainly,
    legislation should address support of state natural disaster programs,
    as well as the need to pool risks across a larger population.
    Logically, Congress should examine the merits of coordinating the
    existing federal flood insurance scheme with the new program, rather
    than establishing unrelated policies for flood and non-flood disasters.
    Mandatory Mitigation
        ACB is aware that an array of issues must be extensively
    scrutinized prior to promulgating an equitable program that would
    resolve the issue of natural disaster insurance availability. ACB
    believes that a committed and realistic loss mitigation program is an
    essential component of any federal disaster insurance effort. Under a
    mitigation structure, businesses and homeowners would be required to
    take adequate steps to reasonably fortify existing structures and new
    construction to mitigate the impact of natural disasters in high-risk
    areas. Although Section 6 of
    S. 1361 contains language relating to the development of state
    mitigation plans, ACB believes that the mitigation language should be
    more specific and provide more focused guidance in developing
    mitigation standards.
    Conclusion
        ACB supports a federal disaster insurance program such as the one
    proposed in S. 1361. We believe that the program must address the
    concerns of community banks and the borrowers they serve, and we
    believe this can be done in a manner that does not impose an undue
    burden on taxpayers or the federal budget. A natural disaster insurance
    program must also be structured so that it spreads the natural disaster
    insurance risk over a diverse geographic area. We believe that S. 1361
    addresses these natural disaster insurance problems and warrants the
    support of this Committee and the Congress.
                                     ______

     Prepared Statement of John Hageman, Texas State Executive Officer and
                  President, Texas Farmers Insurance Companies
        I would like to thank Chairman and the other members of the
    Committee for the opportunity to discuss S. 1361, the Natural Disaster
    Protection and Insurance Act.
        My name is John Hageman, and I am the chief officer of the Farmers
    Insurance Group in the state of Texas. I am also the current Chairman
    of the Texas Windstorm Insurance Association, which is a wind insurance
    pool for homeowners who cannot currently find coverage in the private
    market. By market share, Farmers Insurance is the third-largest
    homeowners insurance company in the United States, and the second
    largest homeowners insurance company in Texas.
        Permit me to offer some observations from the perspective on an
    insurance executive who must make underwriting decisions everyday.
        My company's most recent experience with major natural catastrophes
    was the Northridge Earthquake, which struck Southern California in 1994
    and in 45 seconds generated $20 billion in claims. In that event, which
    was considered modest by seismic standards, Farmers paid claims to
    23,651 of our customers in the San Fernando Valley and parts of Santa
    Monica, in the amount of $1,227,510,846.
        To put this loss in perspective, consider that Farmers sold
    earthquake insurance for more than 23 years in California and other
    states. Our loss from Northridge exceeded the total premium collected
    over those 23 years by a factor of nearly 400%. In other words, one
    event wiped out 23 years of reserves and assured that even if we had
    continued to sell earthquake insurance in the years ahead and paid no
    claims, it would take more than an additional 60 years to break even.
        Perhaps the most remarkable aspect of the Northridge quake was that
    the event even occurred. There were no known faults in the area where
    the quake occurred. Farmers, and other insurers in the area had no
    reason to believe that the risks in this area were particularly severe.
    Moreover, as bad as the Northridge quake was in terms of insured
    losses, we know that a major rupture of the San Andreas fault in the
    Los Angeles basin would cause losses many magnitudes greater than those
    experienced in 1994.
        Farmers cannot afford a repeat of the Northridge earthquake, which
    is why we have elected to reduce our exposure to earthquake losses . .
    . and why we are doing the same thing in hurricane-prone regions.
    Absent a means to protect against worst-case catastrophic losses, we
    risk financial losses so great as to threaten our on-going business. We
    cannot and will not assume such a risk.
        Permit me now to describe to you the circumstances in the Texas
    homeowners insurance market. Most people do not realize that Texas, on
    average, has the highest homeowners insurance rates in the Nation. The
    high rates can be attributed to the high frequency of tornadoes and
    hail which cause havoc every Spring in particular. Just two weeks ago,
    I inspected the damage from the costliest tornado in U.S. history,
    which struck downtown Ft. Worth on March 28. We estimate that the total
    insured loss from this one tornado will be more than $600 million.
        However, as bad as tornadoes and hailstorms are in Texas, the truly
    grave danger is a major hurricane in the Gulf of Mexico. Two years ago,
    a hurricane with windspeeds in excess of 170 miles per hour--some of
    the highest winds ever recorded in a hurricane--struck a relatively
    unpopulated stretch of the state between Corpus Christi and
    Brownsville. There was very little damage to people or property from
    Hurricane Bret because there were few homes within 100 miles of where
    the storm made landfall. In fact, we have a joke in Texas that in
    Kenedy County, cattle outnumber people 100-to-1.
        The situation would have been very different had Hurricane Bret
    struck Galveston--or even worse--moved up the Houston ship channel.
    Modelers tell us that it is not outside the realm of possibility that a
    Class 4 hurricane with windspeeds in excess of 150 miles per hour could
    strike this area, easily doing damage in excess of $25 or $30 billion.
        This would, by far, be the most expensive natural disaster to
    strike the United States, ever. It would surely kill many residents,
    since it is unlikely Houston or Galveston could be properly evacuated
    in time. A storm that struck Galveston Bay in 1910, for example, killed
    almost 20,000 people. Today, of course, early warning systems would
    allow us to better prepare. However, while we can do something about
    shepherding people to safety, we cannot do the same with property.
        Three insurance companies--Farmers, Allstate and State Farm--insure
    six out of every 10 homes in the state of Texas. Therefore, we are
    critically aware of the potential problem that could result from a
    major hurricane that might strike the Texas coast. That is why all
    three companies have tried to limit their exposure in coastal areas.
        The problem is that while Farmers, Allstate and State Farm have
    tried to limit their exposure to a worst-case hurricane, so too have
    other insurance companies in the state of Texas. The net result is that
    there are not enough insurance companies willing to insure all the
    homes which are exposed along the Texas Coast.
        In order to accommodate the tremendous need for insurance coverage
    in these areas, the Texas Insurance Department has authorized the
    creation of the Texas Windstorm Underwriting Association, an
    organization I chair. It is the job of the Windstorm Association to
    provide wind (hurricane) and hail coverage to homeowners who cannot
    otherwise obtain insurance coverage in the private market.
        Over the last decade, the Texas Windstorm Association has grown
    enormously. According to its most recent statistics, the Association's
    property exposure exceeds $12 billion dollars, against a cash reserve
    of only $239 million. You do not need to be a mathematician to conclude
    that $239 million pales in comparison to $12 billion. I should also
    emphasize that the $12 billion refers only to the Windstorm
    Association's exposure. Individual insurance companies shoulder even
    greater exposures.
        It is a certainty that in the aftermath of a major hurricane, the
    Texas insurance market will be on its knees. There is no question but
    that the Windstorm Association will be forced to impose assessments on
    every property insurance company doing business in the state in order
    to pay claims. Moreover, there is a very real possibility that many
    domestic insurers in the State, as a result of their own underwriting,
    as well as their exposure to the state guarantee fund and the windstorm
    association, could become insolvent. This could have the perverse
    effect of causing still more insurers to fail, resulting in even
    further hardship.
        Let me provide an illustration of the problem faced by homeowners
    insurance companies such as Farmers.
        There are many different kinds of insurance available including
    life insurance, health insurance, auto insurance, et cetera. Each of
    those products must deal with everyday events (such as auto accidents)
    where there are large numbers of occurrences over a period of time.
    This makes their costs, and the predictions of their costs, manageable
    and generally foreseeable. Insurers are therefore able to charge a rate
    that accurately reflects risk.
        This degree of certainty does not apply to the homeowners insurance
    market. Our actuaries must deal with the possibility of enormous losses
    at any point in the future, regardless of anything we do. For example,
    Memphis is just as likely to slide into the river tomorrow as it is 500
    years from now. As more and more people move to coastal and earthquake
    zones, exposures to home insurers grow exponentially.
        And as there are more exposures to be covered at greater cost, the
    ability for us to predict the actual risk posed in those areas becomes
    more and more difficult. Natural disasters, unlike everyday the
    occurrences in auto and life insurance, are unusual events. We must
    deal with unknown earthquake faults and unknown hurricane landfalls.
        While we are glad that to this point there have been few of these
    events, we must find a way to better plan for them. A single 45-second
    occurrence in homeowners insurance in the billions of dollars, as
    opposed to a single 45-second occurrence in auto insurance, which is in
    the thousands of dollars. So statistically speaking it is virtually
    impossible to have faith that the premium you are charging reflects the
    risk. Remember as well that we have less control over our rates, and
    you can see the difficult situation in which we are placed.
        So what do we do currently to guard ourselves and our policyholders
    against this risk? We purchase a product known as reinsurance, sold by
    the good companies of Mr. Nutter's fine organization.
        Reinsurance serves a vital role in the nation's insurance system.
    For a price, we are able to cede portions of our risk to the reinsurer.
    Reinsurance, as it is more of a financial tool than ``insurance'' in
    the traditional sense, must see a return that is comparable to the cost
    of capital in other parts of the financial markets. In other words,
    they can price their products to more accurately reflect the risk.
        Additionally, note that primary insurers such as Farmers are mostly
    rate regulated, as opposed to reinsurers, whose products are generally
    not rate regulated. As a result, their unregulated rates must be built
    in to our rates that are paid by homeowners in towns like Baytown,
    Texas.
        As a result we are forced to find a product which will allow us to
    cede the greatest amount of our risk load for the cheapest possible
    price. It is a difficult balancing act to keep on one hand enough
    reserves to pay day-to-day claims and handle administrative costs,
    while on the other hand pay out enough in reinsurance premiums to cover
    an ever-expanding risk load.
        Reinsurers are not willing to put money at risk that they could
    otherwise invest in other financial products. So in many cases, they
    are charging us 6, 8, or 10 times the actuarial risk of what we are
    ceding.
        For example, Farmers is one of the major participants in the
    California Earthquake Authority, an entity created in the aftermath of
    the Northridge Earthquake to provide earthquake coverage to California
    residents. The CEA is the largest purchaser of private reinsurance in
    the world. In fact, the CEA's coverage is five times larger than any
    other reinsurance contract sold worldwide. Despite this impressive
    designation, the CEA can only afford to purchase $2.4 billion in
    private reinsurance protection. Considering the potential losses in
    California are in the $80 billion and above range, this price is not
    reflective of what is needed.
        What does that mean? That means that we are unable to cede enough
    of our risk, which means we have to slow down new policy writings or
    raise prices. That has a tremendous impact on homeowners in risk-prone
    areas and on the admirable insurance agents in this country who are
    trying to make a living selling insurance products.
    Why S. 1361 is Solution
        The goal we all share is to protect the current availability and
    affordability of homeowners insurance as well as protect the homeowners
    insurance market's solvency going forward.
        S. 1361 addresses both goals. By providing affordable reinsurance
    to insurance companies and state, those insurers will be able to
    lighten their risk load. The result of this will be and expansion in
    the insurance offerings made by those companies, and will allow greater
    competition in those markets where there is currently very little or
    none. S. 1361 will punch a hole in the dam that currently holds back
    availability and competition in high-risk areas in the country.
        S. 1361 addresses the important national implication of insurer
    solvency by allowing these insurers to purchase high-level protection
    against the worst case scenarios.
        It is important to reiterate that these companies will be paying a
    premium for these reinsurance coverages, and that premium will be set
    at a regional auction. The government will not be giving away
    reinsurance.
        A storm of the magnitude we are addressing here could indeed wipe
    out the surpluses of major insurance carriers in the United States.
    Then the problem is more than a local one in Texas. Then we have a
    national insurance crisis.
        By passing S. 1361 in the Senate and H.R. 21 in the House, the
    Congress can signal that it recognizes this serious problem at a time
    when few people are concerned about it. No one likes to think about a
    catastrophe unless of course one occurs.
        The fact of the matter is that the ``big one'' is potentially
    bigger than any of us today can realize. Congress must ask itself
    whether it is worth putting the national insurance markets at risk, not
    to mention the tax dollars of hardworking Americans via an emergency
    appropriation. The option is to pass S. 1361 and provide protection to
    the nation's homeowners and allow the private marketplace to absorb
    more of what would otherwise have to fall under an emergency
    appropriation.
        Thank you very much.
                                     ______

                            Reinsurance Association of America,
                                        Washington, DC, April 21, 2000.
    Senator Stevens,
    Washington, DC.

    Dear Senator Stevens:

        I am writing to supplement the record for the April 13, 2000
    hearing on S. 1361 ``The Natural Disaster Protection and Insurance Act
    of 1999'' as it relates to statements made regarding the GAO's February
    8, 2000 study on ``Insurers Ability to Pay Catastrophe Claims.''
        Numerous witnesses quoted a finding by the GAO that ``a catastrophe
    loss greater than a 1-in-100 year loss or a closely spaced series of
    small could temporarily deplete insurer resources.''
        GAO states that the results of our analysis suggests that insurers
    likely could pay most or all claims from a single 1-in-100 year event
    loss that strikes a single state, without even including reinsurance.
    GAO estimates that the primary industry could pay the following l-in-
    l00 year event expected losses in the respective state, without
    including reinsurance.

    ------------------------------------------------------------------------
                                                     1-in-100 year expected
                         State                                loss
    ------------------------------------------------------------------------
    Florida                                                   $42.8 Billion
    California                                                $20.3 Billion
    Texas                                                     $11.6 Billion
    New York                                                   $9.8 Billion
    Louisiana                                                  $6.8 Billion
    Massachusetts                                              $4.8 Billion
    North Carolina                                             $3.4 Billion
    South Carolina                                             $3.0 Billion
    New Jersey                                                 $2.8 Billion
    Mississippi                                                $2.6 Billion
    ------------------------------------------------------------------------

        It is important to note that the GAO report did not include the use
    of reinsurance by insurance companies. GAO specifically points out that
    the report contains substantial limitations, one of which is the
    absence of reinsurance from its analysis. GAO states ``that it could
    not estimate the degree to which reinsurance companies would cover the
    losses that the insurance companies would incur in a 1-in-100 year
    loss. All recoveries would increase insurers' capacity to pay claims.''
    Thus, GAO's statement that a catastrophe loss greater than a 1-in-100
    year loss or a closely spaced series of small could temporarily deplete
    insurer resources does not include reinsurance. Reinsurance would add
    approximately $20 billion of additional capacity beyond that provided
    by the primary marketplace and the reinsurance industry usually pays
    25-35% of the catastrophe losses.
        As you are aware, reinsurance is a major risk management tool used
    by insurance companies to: (1) limit liability on specific risks; (2)
    to stabilize loss experience; (3) to protect against catastrophes; and
    (4) to increase capacity. Through the careful use of reinsurance, the
    disruptive effects that catastrophes have on an insurer's loss
    experience can be reduced dramatically. The RAA believes the absence of
    reinsurance from the GAO's analysis is significant and warrants your
    attention.
        Thank you again for the opportunity to testify at the April 13
    hearing. The RAA looks forward to working with you and your staff on
    this most important issue.
            Sincerely,
                                            Franklin W. Nutter,
                                                             President.
                                     ______

      Prepared Statement of the National Association of Realtors
        Thank you for the opportunity to submit this statement for the
    record which presents the views of the National Association of
    Realtors (NAR) on S. 1361, the Natural Disaster Protection
    and Insurance Act. NAR appreciates the effort of Senator Stevens in
    building bi-partisan support on this very important issue.
        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.
        We 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.
        Last year, NAR testified before the House Banking 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, consumers are burdened by rate increases
    as well as by reductions in coverage such as higher deductibles.
        Several states provide state insurance pools through which
    homeowners can obtain coverage. Although such coverage may be expensive
    and limited, it is often the only alternative.
        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 the
    condominium, co-op and rental markets are affected as well. New home
    purchases, resale transactions and housing affordability are negatively
    impacted in the following ways:

       Homeowners insurance is a necessary component in securing a
            mortgage and buying or selling a home. If a potential homebuyer
            is ultimately unable to obtain the required insurance, because
            the insurance is either unavailable or unaffordable, the sale
            will not be completed. As a result, creditworthy potential
            homebuyers are priced out of the market. In a recent NAR
            survey, respondents reported that an estimated 2,450
            transactions fell through because of difficulties in obtaining
            disaster insurance. Seventy-five percent of respondents cited
            unaffordability as the reason.

       Homeowners' insurance is tied directly to the cost of owning
            a home. If a homeowner is unable to maintain insurance required
            by a mortgage lender, the mortgage is in default. If disaster
            insurance coverage is optional, potential buyers may choose not
            to purchase a home simply because the insurance they consider
            essential is too expensive. Others may choose to go
            unprotected.

       Insurance costs impact rent levels. Insurance costs incurred
            by landlords are ultimately passed on to tenants. Consequently,
            increased insurance costs result in higher rents.

        NAR supports S. 1361 for the following reasons:

       It protects against mega-catastrophes. State programs that
            have been created to address the problem are well-intentioned
            first steps, and homeowners' insurance is currently available
            in these states. However, neither state disaster programs nor
            the private insurance industry have the capacity to cover the
            risk presented by mega-catastrophes far more damaging than
            Hurricane 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.

       It promotes fiscal responsibility. By establishing a program
            which promotes insurance coverage for those at risk of property
            losses from a natural disaster, S. 1361 will minimize future
            unforeseen disaster assistance expenditures. It is far more
            responsible for the federal government to act before disasters
            occur rather than afterward.

        A strong housing market is a 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.
        But more importantly, we must safeguard the cornerstone of the
    American Dream. NAR supports a federal response to the disaster
    insurance crisis which helps to make the dream of homeownership a
    reality for more and more Americans. We urge the Committee to take
    action this year on this very important issue.
                                     ______

      Prepared Statement of Louis H. Nevins, President, Western League of
                              Savings Institutions
        The Western League of Savings Institutions, which represents the
    thrift industry of California, would like to submit this statement in
    strong support of S. 1361, ``The Natural Disaster Protection and
    Insurance Act of 1999,'' into the hearing record of the Committee's
    proceedings on April 13, 2000. Our members hold and service hundreds of
    millions of dollars in residential mortgage loans covering both single-
    and multi-family dwellings on the west coast. We underwrite and assume
    credit risk on the mortgages we hold (and in many cases on mortgages we
    make and sell). This is our business. But we are exposed to major
    disaster losses for which we and our mortgagor customers are largely
    uninsured. Potentially, the losses form a devastating earthquake could
    be well in excess of our capital. This is the reason we are such avid
    supporters of S. 1361 and its House counterpart, H.R. 21.
        We are particularly appreciative for the leadership which Senator
    Ted Stevens continues to provide on this legislation. The
    Administration, too, has played a very constructive and positive role.
    The House Banking Committee has given this issue careful scrutiny over
    the past two years and approved its version of the bill in 1998 and
    again in 1999, both times with substantial bipartisan majorities. A
    great deal of progress has been made, narrowing differences and
    accommodating legitimate concerns. There is now optimism that the House
    will soon act to approve H.R. 21, and, like the Administration, we
    sincerely hope this legislation can be enacted this year. Earthquakes
    and hurricanes are not political events and the development of a
    national policy should not be politicized.
        Critics of natural disaster legislation contend that we should not
    be adding still another federal program to the statute books--that the
    private sector, possibly with new tax incentives, or the securities
    market can handle the problem. But the private sector cannot, and does
    not, provide unlimited protection against the kind of calamity that
    Californians dread and those exposed to hurricanes on the east coast
    fear most. There is more capacity, more reserves, today than the
    industry has had in the past. But it is the big event, the one that
    causes tens of billions of dollars in damages, for which we are
    unprepared.
        When terrible things happen, our government always responds with
    disaster aid. Our citizens are generous. But those who live in areas
    which are susceptible to disasters of epic proportions should be
    encouraged to make their own financial preparations. The problem right
    now is that adequate protection is not available--at virtually any
    price. Our national policy ought to encourage mitigation and it ought
    to encourage citizens living in risk prone areas to become less reliant
    on the generosity of their fellow citizens and more dependent on
    themselves. This is exactly what
    S. 1361 does. Ultimately, we would hope that disaster insurance can be
    made available to a wide variety of property owners. For the moment, we
    understand the priority is on residential housing, but it should be
    underscored that multifamily coverage is as much in need as single-
    family coverage and there should be no distinctions.
        In California today, less than one person in five, eligible to
    purchase earthquake insurance, carries it because deductibles are so
    high and the cost is so great. In many cases, the deductibles, which
    are as high as the first 15% of loss, exceed total initial equity in a
    home. According to the California Earthquake Authority (CEA), only
    about 1.3 million of a total of 7.9 million properties are insured. In
    short, most Californians today are completely uninsured against
    earthquake risk. The reason that the cost of primary insurance is so
    high may be attributed to the high cost of reinsurance. The CEA is the
    largest purchaser of reinsurance in the world and it is a fact that
    over two thirds of premiums that are collected from the Californians
    who do carry earthquake coverage go to purchasing reinsurance. Some 83%
    of our citizens have apparently concluded that what is available in the
    way of insurance coverage is simply not worth the cost.
        We need to do better, and we cannot envision a solution if the
    federal government is not the ultimate reinsurer. Tax-free accumulation
    of reserves would be of some assistance but, tax incentives generally
    are inefficient. We believe that a risk acceptance mechanism is the
    preferable approach.
        We are not experts on the exact level at which the federal
    government should be involved. The Committee has already heard
    testimony on this subject. Whether the bar should be set at a 100-year
    event or a 250-year event is not our area of expertise. And given the
    amount of competition our industry is exposed to from government
    programs, we are very sensitive to arguments in the insurance industry
    that they do not want to be crowded out by the government itself. S.
    1361 is neither a bailout to the insurance industry nor a replacement
    for it. Natural disasters, particularly massive earthquakes and
    hurricane devastation can cause total destruction of huge areas. There
    is no way that the insurance industry today can price this risk at
    levels where adequate coverage can be made available at affordable
    rates. Given the level at which the bar is likely to be set, we may not
    even make significant strides in affordability, but at least coverage
    will become more available.
        For the financial services sector, the risk of loss from natural
    disasters probably exceeds the potential of loss from economic
    calamities. Financial institutions cannot prudently require homeowners
    to carry natural disaster insurance. But homeowners insurance is
    virtually mandatory throughout the industry. The fact is that despite
    the requirement that borrowers carry homeowners insurance, our industry
    could more prudently insure itself against fire and theft than it can
    for natural disasters. The potential for natural disaster loss is
    concentrated in our most populated areas--eastern and western seaboard
    cities. Our hope is that Congress will enact a natural disaster policy,
    one that is anchored by federal reinsurance of catastrophic losses
    before the next event occurs--and it will--we just do not know when or
    where.
        In conclusion, we support S. 1361 because:

       The bill reflects public policy that is rooted in the
            principle that those who live in high risk areas should be
            encouraged, and some day even required to, provide their own
            protection;

       Only the federal government can provide the solution that is
            needed;

       It makes more disaster insurance available. There is a
            relationship between the level of Federal involvement and
            affordability, but the priority should be on availability, at
            least for the time being; and

       Mitigation is a part of the program.

        We urge the Commerce Committee to move this legislation this year.