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OPINION

Hurricane Sandy, tsunami scare expose state catastrophe debts

October 30, 2012

Of all accounting frauds state leaders commit to push devastating costs onto future generations, the worst is deluding citizens about the security of so-called catastrophe insurance funds. Hurricane Sandy and a tsunami scare in Hawaii at the same time should be warning enough for governors to start paying the premiums.

Early estimates of $20 billion in Sandy damage and a big Whew! In Hawaii after a 7.7 magnitude earthquake in British Columbia triggered tsunami warnings underline the reality that we know catastrophes happen.

If Sandy turns out to have been another "Storm of the Century" -- our eighth since 1900 - $20 billion is chump change compared to the more than $3 trillion taxpayers in nine states owe on catastrophe insurance premiums. According to the Government Accountability Office, that is how far in the hole we were as of two years ago, equal to 150 Sandies.

The report: Natural Catastrophe Insurance Coverage Remains a Challenge for State Programs does not even include Hawaii. That state looted its catastrophe fund to "balance" the budget and doubled down by taking borrowed money to replenish it.

Taxpayer subsidized insurance in high risk areas seems like a good idea.

In addition to all the emergency preparedness and planning we do to mitigate disasters, we also practice the ancient common good of spreading cost of destruction. For most disasters, risk is spread fairly evenly, so everybody has a stake in chipping in a little ahead of time to help the unlucky few.

But for hurricanes, floods, earthquakes and tsunamis, insurance companies can figure out precisely who is at risk, and those at risk never could afford the insurance premiums required to cover their losses.

The National Flood Insurance Program seems to have worked fairly well, though expansion of it for five years this summer with no way to pay for the increased coverage could put it at risk.

According to Insurance Journal hours after Sandy peaked, private insurers estimate about $10 billion in claims from wind and other hazards, and NFIP will "bear the brunt" of flood damage.

The fatal flaw in state catastrophe insurance plans is that governors can't resist temptation to not pay premiums, diverting the money.

Nobody notices until a catastrophe happens. Then taxpayers -- most of whom do not live in high-risk areas -- are on the hook. These subsidized insurance programs and national flood insurance overwhelmingly subsidize risky lifestyles of the rich.

Worse, they encourage development in areas that should not be developed and reduce incentive for builders and homeowners to pay for mitigation efforts that would reduce the cost of damages.

This is questionable public policy in the first place, even if politicians implemented it prudently. But when fraudulently administered, it actually makes catastrophes worse.

When GAO "reviewed state natural catastrophe insurance programs," in it found almost $3 trillion in "combined total exposure" that taxpayers are - not might be - responsible for when - not if - catastrophes happen.

Florida taxpayers owe more than $2 trillion for both of its programs.

The study looked at Alabama, California, Florida, Louisiana, Mississippi, North Carolina, New Jersey, South Carolina and Texas. "We found that most of the state programs ... had grown since 2005. In particular, the insurance programs in Mississippi, Texas and Florida experienced the most growth in total exposure to loss ..., with increases of 495 percent, 147 percent and 146 percent, respectively. ...

"Six of the 10 programs charged rates that did not fully reflect the risk of loss, potentially discouraging private market involvement and mitigation efforts by property owners. However, charging rates that do not fully reflect the risk of loss can also potentially increase broad-based participation in state programs."

According to GAO, this "can put state finances at risk in the event of a major natural catastrophe," and shift costs "from states to the federal government." That means all American taxpayers.

As GAO reports about the states it studied, "Reliance on post-event funding, by concentrating risk within the state instead of the broader private market, can put state finances at risk in the event of a natural catastrophe."

 ‘Catastrophe bonds' are well-named

Now we're not only jumping into the abyss of "catastrophe bonds" as a way to deal with gross mismanagement of insuring high-risk areas by looting premiums. State pension funds are buying the catastrophe bonds.

According to an article earlier this year in Pensions & Investments government pension funds, which chase high-risk to get returns they must have to pay promised benefits, are sinking taxpayer money into catastrophe bonds.

Those "can pay investors handsomely when the weather is clear but can cause major losses when the winds blow hard.

"But because of the potential for losses - even a total loss - buying insurance-related securities, as they are called, can be controversial."

Consider the Pennsylvania Public School Employees Retirement System (PSERS). In June it bet $250 million on a fund that, according to the winning firm's presentation to the pension board had the "... biggest exposure ... to the Southeast and Northeast U.S. hurricane risk, followed by California earthquake risk."

As remnants of Sandy crushed Pennsylvania Tuesday, the big question to ask is how big the bill to taxpayers will be stuck for storm damages and any increase in pension debt from PSERS' investment in catastrophe bonds.

All over America, state and local officials are juggling fiscal time bombs as fast as they can, hoping to pocket as much taxpayer money as they can and flee the scene of their fiscal crimes before something triggers detonation.

Simultaneous "Acts of God" such as Sandy and an earthquake on the other side of the world warn that reality sometimes catches politicians who secretly put us deeper in debt betting any blowup will be on the next watch.

Now is the time for prudent leaders to begin the painful process of reducing taxpayer risk and paying down debt or the real catastrophe could be political.


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