[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

                                 ______

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       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.
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    \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.
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    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.
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    \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.

                                
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