Homeowners' Defense Act: Affordable Insurance or 'Beach House Bailout'?

House under waterBanks aren't the only ones that depend on taxpayer bailouts. Every time disaster strikes the government picks up the tab. Losses after Katrina totaled $90 billion, with only $45 billion covered by insurance. The government ended up spending almost $10 billion on homeowners who were uninsured or under-insured.

Yet, property and flood insurance rates are rising dramatically, even as some insurers scale back their coverage. For homeowners, that can make it harder to afford their homes, and more difficult to sell them.

With that in mind, the House Committee on Financial Services held a hearing on March 10 to consider "The Homeowners' Defense Act," a bill that would allow states to pool risk to pay for natural calamities. These pools would be used to build up reserves in advance for major catastrophic events.

The idea is that with a larger, national pool, homeowner's insurance will be cheaper for everyone. But the bill is controversial, with critics calling it a "beach house bailout" and environmentalists saying it will encourage development in vulnerable coastal areas.
California and Florida, two of Mother Nature's favorite U.S. targets, disagree with the critics. One of the people testifying at the hearing was Glenn Pomeroy, CEO of the California Earthquake Authority (CEA), which was created by the state legislature in 1996 to provide basic insurance coverage in the wake of the devastating Northridge earthquake. After the 6.7 quake, many insurers restricted coverage or refused to insure properties in the quake-prone region. Today, the authority has 800,000 policies in force with $600 million in premium revenue and almost $10 billion in claim-paying capacity. The CEA now writes 70 percent of all residential earthquake polices sold in California -- yet only 12 percent of Californians carry that type of insurance.

People living in riskier earthquake areas, such as Los Angeles and San Francisco, pay about $1,000 to $1,770 a year or more for the insurance on a home worth $500,000, while residents in less risky areas like Sacramento pay $300 to $400 for a home of the same value, says Pomeroy. So if one chooses to live in a risky area, she pays more for the insurance.

Florida had to do something similar so that people living along its coastal areas could find insurance. Florida set up Citizens Property Insurance Corporation, a not-for-profit government-sponsored insurer to provide coverage to residents who can't find affordable coverage elsewhere and to build state-wide funds that can be used in the case of disaster. This statewide insurance became a lifeline for Florida residents after State Farm recently dropped 125,000 insured in the most vulnerable areas along the coasts of Florida. Some friends of mine who live within five miles of the coast tell me they can only get insurance from Citizens.

James DeWitt, former director of the Federal Emergency Management Agency (FEMA) and currently the national co-chairman of ProtectingAmerica.org, also testified in support of the bill. High-quality insurance needs to be more available and affordable to consumers, he said, adding: "The best way to accomplish this is to enable and encourage more states to create well-structured, actuarially sound catastrophe funds and to supplement the protection offered by the current state catastrophe programs in California and Florida."

But the Heritage Foundation calls it "a dangerous step toward a federal government subsidy of property insurance coverage for natural disasters. The bill would also make it easier for individual states to create unrealistic disaster insurance programs, with underpriced policies, by creating a federal loan fund to cover losses suffered by those programs. Congress should reject attempts to place the risk of property losses due to natural disasters on the federal government."

Justin Pidot of the Environmental Law & Poverty Institute at Georgetown University believes that "a major new federal intervention in the private insurance market would likely have several unintended negative consequences, including imposing a potentially large financial burden on U.S. taxpayers, unfairly forcing those who live and own businesses in less hazardous areas to subsidize those in more hazardous areas, creating an incentive for additional coastal development that would increase the nation's long-term vulnerability to hurricanes and harm valuable coastal ecosystems, and displacing private insurance companies and stifling the development of new and innovative techniques to spread the risks posed by coastal hazards."

The National Association of REALTORS (NAR) supported this legislation at the hearing provided it, "encourages personal responsibility, promotes mitigation measures, ensures insurance availability and strengthens critical infrastructure such as levees, dams and bridges," Charles McMillan, immediate past president of the NAR, said in his testimony. The NAR is concerned because insurance rates skyrocket after major disasters in an area, hurting property values and ultimately sales.

"The inability to obtain affordable insurance is a serious threat to the real estate market, impacting not only single family detached homes, but condominiums, co-operatives and rental units as well," McMillan said in his testimony. He added, "Insurance is a key component to financing the purchase of real estate. Without property casualty insurance, lenders will not lend; without insurance, borrowers could be in default of their mortgage terms."

Most people don't realize how critical insurance is to finalizing a real estate transaction:
  • If a buyer can't get or afford insurance the deal will not be completed.
  • Property owners must maintain insurance, no matter what it costs, or a mortgage is in default and a lender can foreclose.
  • Commercial property holders pass insurance costs on to their tenants, which can make rental housing unaffordable. Sometimes, depending on market conditions, they can't pass on these costs and landlords end up in foreclosure when the property is no longer financially feasible to operate.

The state-backed insurance pools that were designed by California and Florida could serve as a model for other states. The Homeowners Defense Act recognizes the success of these two programs, and seeks to create a national comprehensive natural disaster policy and encourage more states to create similar pools.

And it's not only California and Florida experiencing rising premiums, McMillan said. The NAR has heard from its members of similar concerns in New York, New Jersey, South Carolina, North Carolina and the Gulf Coast region. As we watch the massive recovery efforts in Haiti and Chile, we should be thinking about what more can be done in the U.S. to prepare us for the next natural disaster.

Lita Epstein has written more than 25 books including "The Complete Idiot's Guide to Personal Bankruptcy" and "The 250 Questions Everybody Should Ask Before Buying Foreclosures."
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