Auto Insurance Wars

If you have noticed the clever Progressive and GEICO television ads for vehicle insurance, then you may find this post of interest.

Judging by recent advertising activity, those two startups have triggered strong reactions from two long-lived giants in the sector, All State and State Farm.

GEICO is a subsidiary of Berkshire Hathaway, while State Farm is still a mutual insurance company, with no outstanding equity. Policyholders are, essentially, owners.

GEICO has made 'The Gekko' famous from years of ads. Playing on the similar sounding names, the firm has commissioned a very memorable series of ads featuring the talking gekko. While separate, complete financials are obviously not available, recent advertising by State Farm and All State suggest GEICO has made inroads into their market share.

The same appears to be true for Progressive, whose ads feature the bubbly saleswoman with an attitude. She wields the 'pricing gun,' and emphasizes Progressive's do-it-yourself assembly of policy features and great service.

Now, All State is airing commercials observing that if you chose your own policy features, you might not be covered by commonly-occurring car damage such as falling tree limbs.

State Farm, on the other hand, is pushing its special discounts and market share, citing the relatively small customer bases for both GEICO and Progressive.

The five year price chart above for All State and Progressive does show the latter outperforming the former, but both trailing the index.

Still, just on the basis of competitive reactions alone, it's a good bet that Progressive and GEICO are making serious dents in the pricing structures and market shares of fellow vehicle P&C firms All State and State Farm.

Another Mistake: Bailing Out Life Insurers

I read with horror earlier this week that the federal government has decided to bail out at least three large life insurers- Hartford, Lincoln and Genworth. All three had quickly acquired small S&Ls or banks last fall, in order to get their snouts into the federal TARP trough.

Reading the Wall Street Journal piece announcing this development, I was sickened to learn,

"The news will come as a relief to a number of iconic American companies that have suffered big losses made worse by generous promises to buyers of some investment products. Shares of life insurers have fallen more than 40% this year. Their troubles led to a string of rating-agency downgrades that, in a vicious cycle, made it more difficult for some insurers to raise funds.

Life insurers had for a time seemed to be somewhat immune from the credit crisis, since they tend to invest in relatively safe assets in order to match their liabilities. These companies got into trouble for two main reasons, both tied to the weak financial markets.

First, many of the roughly two dozen insurers that dominate the variable-annuity business made aggressive promises on these popular retirement-income products, guaranteeing minimum returns, no matter what happened to the stock market. With the market's decline, the issuers are on the hook for big payouts, though most of the payments won't come due for 10 or more years. Second, the insurers also have lost money on the investments in bonds and real estate that back their policies.

Many life insurers also hold large portfolios of residential mortgage and commercial real-estate assets. While most of the assets are highly rated, further downgrades of those assets could put considerable pressure on insurers, forcing them to take additional write-downs."

So, basically, life insurers, as they seem to do once every few decades, sold products which promised returns they cannot deliver. And consumers were stupid enough to buy these.

Further, the insurance executives then invested premiums in assets of questionable value, which have now plummeted.

Such incompetence ordinarily leads to bankruptcy, sale of assets to a competitor, and the exit of the worst-managed firms.

Now, our government is rewarding these morons by bailing them out. Better-managed firms will be burdened by having to compete with insurers with access to cheap government capital.

And consumers won't learn to be more judicious in their purchase of investment products.

This bailout is troubling all the way around. Just a disastrous development.

The article further declared, as if to justify this government intervention,

"The life-insurance industry is an important piece of the U.S. financial system."

That's really rich. Does anyone think our financial system would have unimportant pieces just sitting around, operating for no good purpose? I don't think any existing financial players aren't "an important piece of the U.S. financial system," do you?

Frankly, I'm disappointed in the lack of critical reporting in the Journal on this rather important story. Why do I have to rely on my own memory to remind me that life insurers go through this cycle every 10-20 years?

Shoddy reporting of a mistaken financial rescue.

For a more uplifting story, consider the Pulte-Centex merger in the home building sector. That's an example of what should happen to struggling firms. I'll write about that tomorrow.

Rebuilding New Orleans- Again

Nearly three years ago, I wrote these two posts, here and here, regarding the aftermath of hurricanes Katrina and Rita on the US Gulf Coast. Holman Jenkins of the Wall Street Journal shared my sentiments in his editorial on the same subject of how, or whether, to rebuild New Orleans. I wrote in the first post,

"If they want the final say in rebuilding their city, then let them earn it. Ask for help borrowing capital that they will repay with a revitalized port, energy-related commercial zone and tourism areas that are safe and survivable. Rather than issuing demands that the rest of us, through the conduit of the federal government, simply hand over more than $100B to those government entities to spend as they wish. It takes a lot of gall to request/demand $100B to rebuild a city that wasn't safe in the first place, while seeming to stiff-arming the very people from whom they want the money when questioned as to how and why the reconstruction is to take place.

After all we have heard regarding the importance of the area to agricultural transport, energy production and distribution, and other general shipping needs, I don’t understand why the local and state governments can’t borrow against their infrastructure-based revenues to rebuild. I’d prefer to see the funds coming from increased prices paid for goods passing through that region to pay for the new and improved facilities, funded by bonds, than to simply hand over $100B to local and state governmental authorities.

Nobody questions the need and value or rebuilding damaged commercial infrastructure to standards which can better withstand a major hurricane, so long as that cost is economically rational. Either private or public revenue-backed bonds would seem to be feasible. If they can't attract capital, based upon the expected costs and revenues of improved and repaired facilities, then it begs the question of rebuilding commercial facilities there in the first place. What seems to be more in doubt is what kind of residential reconstruction is reasonable. Holman Jenkins wrote an excellent editorial about this in the Wall Street Journal two weeks ago."

And, as I wrote in the second linked post, the mistakes are not confined to the public sector,

"What is it about the Carolinas, Florida and the Gulf Coast? Living in a hurricane belt, you would think that the business owners and residents of the region would have shown more foresight regarding the potential damage from these storms when they build their facilities, homes and cities.

Take oil refineries, for example. I saw an interview with Lee Raymond of ExxonMobil on CNBC this week. He opined how until the past few weeks, he had never known how many experts on oil refineries there were in the US. That’s a pretty funny remark, until you let it sink in a bit.You don’t have to be an expert at building or operating an oil refinery to realize that concentrating so much evidently unprotected, vulnerable capacity in a hurricane zone seems like inept business planning. The oil industry executives bemoan over-zealous environmental regulations, but the net effect of their decisions on refining capacity and locations over the years is to be unable to keep pace with the growth of their customers’ demands for refined petroleum products."

Yesterday's excellent reprise of his three-years-ago editorial by Mr. Jenkins asked the question,

"Does the federal government have to be responsible for everything?"

He noted the difficulty homeowners had getting coverage in New Orleans after Katrina. Jenkins observed that local government officials viewed that as a 'problem,' whereas, in truth, it is the 'solution.'

Jenkins went on to write,

"No Louisiana politician will publicly write off the large submarine sections of the city and its suburbs. Yet the state in December disbanded the Louisiana Insurance Rating Commission, kicking over its portfolio of suppressed rate increases to the state department of insurance....No doubt local voters and politicians would decry it as a crime if New Orleans were forced to become a smaller, higher city because of such "greedy" behavior by insurance companies. The rest of us would see it as a sign of hope for our economic future after all."

He is right.

As I listened to Cindy McCain draw attention to those New Orleans residents who have been forced to flee, then will return, for the second time in three years, the absurdity of her observation hit me.

Back in my youth, the local Illinois river regularly flooded a low-lying area of squalid shacks a few miles upstream from Peoria. The newspaper and most of the town's citizens castigated the residents of those hovels for continually rebuilding in a designated flood zone. Eventually, flood insurance for the area was revoked, and the nonsense stopped.

Why should New Orleans be any different? As I noted in that earlier post, thanks to Holman Jenkins' initial observation, it was known as the Crescent City for a good reason. That crescent was the high ground which, in the days before the extensive levee system, was the only constantly-inhabitable, relatively safe area in which to reside.

When people flee and return to a weather- or other natural-disaster-prone area several times in a decade, it's time to end the insanity and cut off insurance and relief for those people. Anyone foolish enough to remain there should do so on their own hook. If businesses choose to locate there, then the resulting prices for their products had better cover their disaster losses. Meaning, of course, there'd better be something extremely differentiable and special about those products or services.

It's not a good thing that Jenkins and I are, three years after Katrina, lamenting the same idiocy regarding the rebuilding of troubled, ill-sited New Orleans.

About Those Credit Default Swaps Prices....

A recent Wall Street Journal article bemoaned the high price of MBIA and GM credit default swaps.

As if, somehow, the world was coming to an end because holders of debt of these two antiquated, flawed companies were paying up for default protection. And that maybe this suggested an overall continuing credit crisis.

It doesn't.

These prices ought to be higher now. Both firms are clearly in danger of bankruptcy, not to mention it's unclear that either is any longer needed in the US economy.

Other than the usual Congressional suspects, and the local economies around their production facilities, would anyone really miss GM if it just died? The market share will be filled in by some other auto maker, meaning replacement jobs and facilities. Only, this time, they might be ones with prospects for growth, rather than fear of how much they'll be shrinking due to CEO Wagoner's continuing inept management of the firm.

As for MBIA, it probably has a very small footprint, economically. As Doug Dachille noted on CNBC some months ago, the model for bond insurance is no longer viable. Between better information access and fully-priced risks in the underlying instruments, the kind of 'guarantee' that MBIA and its ilk offer is simply worth less today, if its even credible.

Plus, the industry didn't help itself by plunging into a risky area, mortgages, to try to stoke growth, as I noted in this post.

Sometimes it seems like the sky is falling, when, in reality, it's just a small piece of it.

Why don't people just let go and acknowledge that companies die. They sometimes lose their reason for being. Their approach to the market is wrong and out of date. They have become irrelevant.

Currently, it looks as if the bond insurers and America's poorly-run, largest automaker, GM, are either already there, or very close.

But that doesn't mean the entire financial market, nor the economy, is in crisis.

More On Bond Insurance

This morning's guests on CNBC provided some truly interesting and valuable insights on several topics.

One guest was T. Boone Pickens, opining on oil and natural gas prices, as well as longer term energy concerns. I'll be writing about his comments in my next post.

The other guest was one who I have seen once or twice before on Squawkbox- Doug Dachille. Mr. Dachille, from his title and the name of his firm, seems to be head of a not-large investment management firm. As I searched my prior posts, I found this post, dated exactly two weeks ago, in which Dachille's prior appearance (with Jim Cramer) is described.

I was, for the most part, impressed by Dachille. His grasp of macroeconomics left something to be desired, but his logic and comments on fixed income issues were refreshing and provocative.

This morning's appearance was no different, in terms of the quality and value of Dachille's remarks.

His focus was on the very hot topic of what is to become of AMBAC, MBIA, FGIC and other so-called financial instrument insurers.

The discussion began with remarks about noted short-seller William Ackman's proposed 'good insurer/bad insurer' plan, as well as NY State AG Dinallo's similar idea, both of which have put pressure on the insurers to do something prior to a rating agency re-evaluation of their credit ratings next week.

Dachille did an admirable job of cutting the Gordian knot surrounding the business of these bond insurers.

In essence, Dachille argued that their business is superfluous. Period. That their existence is now the result of some hoary old legislation or internal investment rules by various pension or government funds regarding the minimum rating which a security must have to be held in their portfolio.

Dachille noted that the insurers cost approximately 10-15bp for their function. In comparison, according to Dachille, fixed income managers are paid roughly 35bp.

Both fees are not necessary, according to Dachille, because only one 'due diligence' need be performed. If the insurers are truly taking the risk, via insurance, then at least a commensurate amount of fee should be removed from the managers, because their work is made easier, and risk removed for their customers.

Dachille questioned why an insurer whose financial resources are obviously inadequate to serve their obligations, whose stock price has fallen so much in the past year, and whose ratings are about to be changed to a level below many of their customers, should have any material affect on, or benefit to, a bond issuance?

Santelli agreed wholeheartedly. Both engaged in a brief dialogue suggesting that the bond insurers no longer serve an economic purpose, because they confer a sort of average risk rating, by virtue of their coverage, when buyers should really do their homework to more accurately price individually-issued municipal securities for risk.

Thus, Dachille's overall view is that there isn't really a crisis because these firms don't really add economic value now anyway.

Granted, he admits that banks holding suspect, effectively under- or soon-to-be-uninsured CDOs, will have to take further writedowns. On this note, he observed the parallel between the insurers' "crisis" and the super-SIV plans last fall.

Those plans, he noted, came to naught as banks began to just write down their losses. He feels the same should occur now, because, one way or another, the holders of these insured, but ineffectually so, instruments, will have to realize their lower values eventually.

I found much sense and value in Dachille's observations and recommendation. After years of a charade, the missteps by the bond insurers into non-municipal waters have accidentally exposed the lack of true economic utility of even their core business.

More on Bond Insurers, Insurance, and Swaps

Back on the last day of 2007, I wrote this post on AMBAC and MBIA. In that post, I concluded with,

"But mortgage insurance is far riskier. Compared to a municipality's ability to tax and raise fees, a mortgage is typically repaid from the borrower's far more risky and volatile personal income stream.

One has to wonder at the wisdom of AMBAC and MBIA jumping into the mushrooming world of mortgage-backed instrument guarantees. I'd be willing to bet that, compared with the sleepier, slower-growing world of municipal obligations, the burgeoning volumes of CDOs with mortgages underpinning them became too tempting for the two municipal bond insurance firms.

It probably seemed relatively simple to them to hire some experienced mortgage bond analysts, leverage their existing operations into the new sector, and watch the new income invigorate their stock prices.

Instead, both AMBAC and MBIA are ending the year down more than 60%.

It seems that financial excess wasn't limited to just the borrowers and lenders. Even the insurers got into the act. No wonder Warren Buffett has chosen this opportune time to enter the municipal bond insurance business- while the two major competitors are reeling from losses in unrelated market segments."

Now, after the weekend's downgrading of the fixed income insurers by rating agencies, and the Monday US financial markets holiday, investors panicked.

I recall when I first learned the mechanics of fixed-variable rate interest-bearing loan swaps. If I'm not mistaken, it was early in my tenure at Chase Manhattan Bank. Those were simple enough. One party wanted a floating-rate loan, and another wanted fixed. Obviously, they differed on outlook on the rate environment going forward. Essentially, each paid the other party's interest obligation each period.

Even here, it occurred to me that there were conditions under which a party might find their counterparty, who had opted for the variable rate payment, unable to make payments if rates rose too high.

When I learned about credit derivative swaps, I recall being very sceptical that these were reliable. The Wall Street Journal featured an article detailing the mechanics of such swaps last Friday in an article entitled, "Default Fears Unnerve Markets."

The piece describes credit swaps as,

"At the center of these concerns is a vast, barely regulated market in which banks, hedge funds and others trade insurance against debt defaults. This isn't like life insurance or homeowners' insurance, which states regulate closely. It consists of financial contracts called credit-default swaps, in which one party, for a price, assumes the risk that a bond or loan will go bad. This market is vast: about $45 trillion, a number comparable to all of the deposits in banks around the world.

Not everyone who buys one of these contracts has bonds to insure; because the value of an insurance contract rises or falls with perceptions of risk, some players buy them just to speculate. In much the way gamblers make side bets on football games, a financial institution, hedge fund or other player can make unlimited bets on whether corporate loans or mortgage-backed securities will either strengthen or go sour.

If they default, everyone is supposed to settle up with each other, the way gamblers settle up with their bookies after a game. Even if there isn't a default, if the market value of the debt changes, parties in a swap may be required to make large payments to each other.

This being Wall Street, the investors often use heavy borrowing to magnify their wagers."

This is clear enough, but poses the risk I immediately noticed- counterparty risk. In the world of financial instrument trading, there's a bright line dividing exchanges and over-the-counter, or 'bespoke' instruments. The latter require members to have collateral and/or credit sufficient to settle their outstanding obligations. This is policed by the exchange, resulting in low counterparty risk. When Wall Street brokers trade with each other, for their customers, everyone feels comfortable that the brokers are able to settle their trades. This works backward, in that the brokers require similar asset levels from their customers, because the former aren't in the business of taking that type of risk, although they will lend on margin, at rapacious rates.

In the over-the-counter market, of which credit swaps are one, there's no central location or crossing point for the instruments. In olden days, before computer screens, it was also called a 'telephone' market. POSIT and other "crossing networks" are modern-day equivalents. Bids and quotes are posted, but it's just a very efficient way of presenting, in one 'place,' a myriad of independent bids and asks on various custom instruments. As such, there's no guarantee of counterparty viability.

So, as long as nobody actually defaults, the game seems reasonably benign. Prices vary with risk assessments of the borrowers, but no contractual payoffs are involved, which might tax an issuer of a swap.

However, as the summer's credit crunch continued into the fall, according to the Journal piece,

"With many bond values falling and defaults rising, especially in the mortgage arena, some institutions involved in these trades are weakened. This has investors and regulators worried that, through such swaps, some market players could spread their own problems to the wider financial system.

"You are essentially counting on the reliability of strangers" to pay up on their contracts, notes Warren Buffett, the Omaha billionaire. In some cases, he says, market players can't determine whether their trading partners have the ability to pay in times of severe market stress.

The issue is raising broader concern among regulators and investors over what Wall Street calls "counterparty risk," the danger that one party in a trade can't pay its losses. A recent survey by Greenwich Associates found that 26% of investors were worried about counterparty risk, nearly double those who said so in a poll last March."

This side-bet casino ran with minimal supervision. But, in truth, even better regulation couldn't have mitigated the worries when a few thinly-capitalized insurance firms whose main business had been stable, solid municipal bond insurance, levered their balance sheets with these bets.

As I wrote in my prior linked post, it's a vastly different world to insure payment of mortgages from insuring a taxing authority's ability to repay its bonds.

That credit swap buyers ignored the difference, and the lack of balance sheet muscle of AMBAC, MBIA and ACA to actually absorb the full extent of their obligations was simply stupid business. Legal, but unwise.

And, of course, just like "portfolio insurance" in 1987, what seems fine in the abstract, isolated case of loss, works far differently when everyone defaults at once. Or seems to. The fallacy of composition comes into play, guarantors/counterparties, a/k/a the insurers, become overstretched, and the whole mess descends into default.

As the Journal noted, it's much more complex than an exchange,

"Sometimes it isn't clear who owes what. A tiny hedge fund sold a swap to a unit of Wachovia Corp. this spring and faced repeated demands for more collateral as the subprime market slid. The fund, CDO Plus Master Fund Ltd., says in a suit in New York federal court that it insured a $10 million security, but Wachovia eventually demanded more than $10 million of collateral -- even as the security's value dwindled. Wachovia called the suit "without merit."

Last fall, with the market for low-end subprime mortgages collapsing, investors worried about firms with exposure to them. Analysts zeroed in on ACA and other bond insurers that had assumed the risk on many such securities.

ACA appeared to be in the most precarious position, because its capital of $425 million seemed minuscule compared with the $69 billion of credit protection it had provided on corporate and mortgage debt. ACA had added about $20 billion of that exposure between April and September."

Now the state of New York is reputedly organizing some sort of private capital rescue of the swaps/bonds insurers. Even Jack Welch noted on CNBC the other morning that Warren Buffett's entry into the basic muni insurance business demonstrates it is a private, capital market solution, not a government bailout.

And Rick Santelli noted earlier this week that the one thing that will totally unglue financial markets is if those swaps insurers are allowed to fail.

All true. But they miss the fundamental point of the whole morass. MBIA, AMBAC and ACA launched themselves into unwise businesses with inadequate capital. Their counterparties blithely assumed obligations would simply be paid when due.

It reminds me of a story about auto insurance. I used to play squash with a guy from AIG. A few years back, AIG began underwriting auto insurance in my state. I asked Joe, the AIG guy, what he thought of it. The AIG price quotes for comparable insurance were much lower than the limited options available.

Joe laughed and said that neither he, nor any AIG employee whom he know, would touch an AIG auto policy. When I asked why, he explained that AIG makes much of its money by being stingy on payouts for claims. This tendency, he further explained, extends to auto insurance, too.

Since AIG employees were intimately familiar with the firm's culture regarding payment of claims, they all steered clear of the firm's auto insurance, at any price.

Usually, when something seems too good to be true, it is. The easy availability of credit swap insurance from the three firms must have seemed 'too good to be true.'

It was. The firms aren't properly capitalized to underwrite the huge risks related to subprime mortgage securities. When those securities stop paying, the premiums which the insurers have collected, and invested, aren't going to be sufficient to fulfill their policy obligations.

What I have to wonder is, what in God's name were the buyers of this 'insurance' thinking? Weren't they typically middle- to senior-level managers at well-regarded investment, commercial banks and asset management firms? Didn't they realize that insurance is only as good as the ability of the insurer to actually pay?

Evidently not. Or perhaps everyone simply assumed the worst case would never occur. Much like those using portfolio insurance.

I accept that a lot of inept fixed-income investment, via subprime mortgages, CDOs and swaps, have finally affected equity markets. I'm reasonably confident that, given some time, the larger effects of these problems on the equity markets will recede, leaving fixed-income investors with the large, enduring losses.

The question is, what would be a fair and effective manner in which to contain the damage to, and avoid the insolvency of the insurers?

Some have argued for a variant of the old, 1980s "good bank, bad bank" mortgage loan solution. The municipal businesses of AMBAC, MBIA and, if there is any, ACA, would be packaged up with sufficient capital, and spun out. The remainder would exist to handle non-municipal claims.

That seems reasonable and appropriate. After that, anyone who loses insurance protection due to their counterparty, the insurer's, inability to pay deserves what happens.

MBIA & AMBAC: Bond Insurers Went Astray

Among the casualties this year in the fixed income-related financial sector have been two bond insurers, MBIA & AMBAC. Both have become unstable and caused doubt as to their ability to stand behind their obligations due to mortgage-instrument related losses.


As the nearby Yahoo-sourced, six-month price chart of AMBAC, MBIA, and MGIC versus the S&P500 Index shows, all of these bond insurers have seen their stock prices plummet since July of this year. Why have the three firms suddenly lost so much value?

Mortgage Guaranty Insurance Corporation, MGIC for short, obviously came under pressure for its obligations to payoff on bad mortgage loans and related instruments.

But what about MBIA and AMBAC? I guessed that these firms were not originally in the mortgage-related instrument insurance business. Here's what I found when Googling both firms.


MBIA's history, which reads, in part,

1973
Municipal Bond Insurance Association (MBIA) forms. Managed by MISC, MBIA is formed by four major insurance companies: The Aetna Casualty and Surety Company, St. Paul Fire and Marine Insurance Company, Aetna Insurance Company (then part of Connecticut General and now part of CIGNA), and United States Fire Insurance Company, a Crum & Forster Company.

1971
Municipal Issuers Service Corp. (MISC) forms. It becomes the managing agency of the Municipal Bond Insurance Association, which was created in 1973.


AMBAC's site tells us,

1971
American Municipal Bond Assurance Corporation (Ambac) is founded in Milwaukee, Wisconsin as a subsidiary of MGIC Investment Corp. Ambac begins with $6 million in initial capital and receives a AA rating from Standard & Poor's (S&P). Ambac insures its first issue, a $650,000 general obligation bond for The Greater Juneau Borough (Alaska) Medical Arts Building Company. The issue funds construction of a medical arts building and a sewage treatment facility adjacent to the local hospital.

1974
Ambac's first competitor, Municipal Bond Insurance Association (MBIA), formed as a consortium of four major insurance companies, receives a AAA rating from Standard & Poor's.

As I surmised, both were originally municipal bond insurers. Now, as it turns out, a friend's daughter has the opportunity to interview for a municipal finance-related internship, among other choices, at a large investment bank. In order to help her choose from the options available to her, I gave her a description of what actually occurs in the process of financing a municipality's capital requirements.
Doing so reminded me of a key difference between municipal and mortgage bond insurance. Municipalities have a great degree of authority over the generation of income to pay interest on and, ultimately retire their obligations. True, the occasional situation arises, such as Cleveland, New York City, or Orange County, where mismanagement of the city causes solvency issues.

But mortgage insurance is far riskier. Compared to a municipality's ability to tax and raise fees, a mortgage is typically repaid from the borrower's far more risky and volatile personal income stream.

One has to wonder at the wisdom of AMBAC and MBIA jumping into the mushrooming world of mortgage-backed instrument guarantees. I'd be willing to bet that, compared with the sleepier, slower-growing world of municipal obligations, the burgeoning volumes of CDOs with mortgages underpinning them became too tempting for the two municipal bond insurance firms.

It probably seemed relatively simple to them to hire some experienced mortgage bond analysts, leverage their existing operations into the new sector, and watch the new income invigorate their stock prices.

Instead, both AMBAC and MBIA are ending the year down more than 60%.

It seems that financial excess wasn't limited to just the borrowers and lenders. Even the insurers got into the act. No wonder Warren Buffett has chosen this opportune time to enter the municipal bond insurance business- while the two major competitors are reeling from losses in unrelated market segments.

Florida's Bid To Make You Pay For Their Beachfront Home Insurance

Last Wednesday's Wall Street Journal's lead editorial, entitled "The Politics of Disaster," concerned Florida Governor Charlie Crist's lobbying to help pass the 'Homeowners' Defense Act.'

This bill, pushed by Florida Democratic Representative Ron Klein would, according to the Journal editorial,

"force the U.S. Treasury to issue below-market loans to state-insurance programs, while also creating a kind of Fannie Mae of disaster reinsurance, a federally chartered organization called the "National Catastrophe Risk Consortium."

According to Treasury Assistant Secretary Phillip Swagel, "Taxpayers nationwide would subsidize insurance rates in high-risk areas, which would be both costly and unfair."

I wrote about this trend early on in this blog, in a post here, and more recently here.

Honestly, I don't know whether to laugh, or cry about what the Floridians are attempting with this bill.

Basically, we have the following series of events.

Over years of benign hurricane seasons, people flock to the Southern Atlantic and Gulf Coasts, putting homes and businesses in harm's way. Then the hurricanes begin to return, and the losses mount.

As private insurers left the oceanfront markets, state governments, albeit foolishly, stepped in with their own funds.

Of course, if you know anything about insurance, you immediately realize that a state such as Florida, tapping its own resources, cannot self-insure against its hurricane risk. The very storms that are to be insured against by the state's taxpayers will damage the state's economic ability to generate income to....pay for that damage, via insurance claims.

So, having established an under-funded state insurance program, the state is now turning to the rest of us Americans, via federal legislation.

This means that even though you may not enjoy an ocean view from Key Biscayne, the other Keys, or the Florida Gulf Coast, you're going to paying for one soon.

There are several aspects to this story that should frighten all of us.

First, there's one state's attempt to force the rest of the country to subsidize their citizen's inability to afford insurance for the area in which they have chosen to build homes and businesses. Perhaps if they had to pay full freight, they would have located elsewhere, mitigating the entire problem.

Second, there's the unwise federalization of what has historically been a private insurance market. What business activity has the federal government ever performed better than the private sector that it replaced?

As I noted in the earlier linked post,

"The net effect of today's mess of homeowners insurance in hurricane areas is to make all Americans ultimately pay the tab for the difference between what local politicians feel they can ask their ocean-front-dwelling homeowners to pay for insurance, and what private insurers would actually demand for those risks. So you and I, if you don't have a beachfront home somewhere between North Carolina and Texas, pay a form of rent to those who do, but we never get to enjoy their view.

Common sense says that if it's too expensive for a person to afford privately-offered insurance to replace the value of a home built so near the ocean in hurricane territory, then the home shouldn't be built. Not that 'someone else' should step in and pay to make it affordable. How long can we, as a nation, afford this sort of economic idiocy?

This sort of market price signal distortion, on such a grand scale, is bound to come a cropper at some point. It's a good argument for simplifying the insurance market to become a national one, rather than 50 local ones, each hostage to local political appointees who try to beggar their neighbors by capping risk prices in their own states, and attempting to force the insurers to recover the true risk premiums 'somewhere else.'

The way things are looking, this would seem to cast doubt on the wisdom of investing in property and casualty firms anytime soon, if one expects consistently superior total returns."

Third, since the legislation intends to make the Federal loans to the state insurance funds 'forgivable,' you know what this means. Through the Federal treasury, we will all be subsidizing ever-riskier building in a variety of natural disaster zones, since there will be no check on the activity.

So there you have it. One state's dissatisfaction with the reasonable reaction of the private, publicly-owned insurers to their citizen's risky home- and business-building in the path of hurricanes has led us to this. A bill to replace the astute risk pricing and rationed capital with the boundless debt capacity and more (endlessly) forgiving insurance practices of the Federal government.

The only positive about this story is that it might warn one off investing in property and casualty insurers until this matter has been settled, one way or another.