natural catastrophe planning |
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Bob Detlefsen, NAMIC: I’m neither an underwriter nor an actuary, but my understanding is that with the exception of flood and earthquake risk in areas that are exceptionally prone to these hazards, HO losses from natural disasters would generally be insurable in a private market that was free from government rate suppression.
Virtually any type of loss is insurable as long as sufficient information exists about a peril to enable insurers to predict the frequency and severity of losses, and as long as they are allowed to charge an adequate premium.
Ed Collins, ProtectingAmerica.org: In the case of U.S. natural catastrophe risk, there is no realistic premium that could account for the timing risks associated with high severity, low frequency events like massive natural catastrophes.
While pricing freedom is an important element in the market dynamics, the fact is that the market - policyholders, insurers and reinsurers - cannot adequately or efficiently absorb the timing risk of major earthquakes or enormous hurricanes. Because of the market’s inability, insurers have been forced to limit coverage or leave the market and prices have skyrocketed in many places; homeowners, unless legally bound to carry coverage, often choose to go uninsured. In other cases, regulators have stepped in
and artificially suppressed rates.
All of these circumstances have combined to create, with respect to catastrophe coverage, a market that is ineffective, as evidenced by the large numbers of potential policyholders who go without coverage and the private market contractions in most exposed areas. A market that is inefficient as evidenced by the astounding increases in the cost of reinsurance to deal with timing risk and global capital markets.
The current system is a bailout-in-waiting.
Robert Hartwig, III: Even in markets with no rate regulation there will always be risks which are, by definition, uninsurable in the private market. Throughout the United States today there are many structures that by virtue of their location, design and/or construction are almost certain to be damaged or destroyed by a natural disaster. Obvious examples include poorly constructed homes along hurricane-prone stretches of coastline or homes built in areas that have been repeatedly threatened by wildfire.
Franklin Nutter, RAA: Property coverage, including catastrophe risk, is insurable in the private market. The reinsurance market has remained committed to the property market throughout the 90’s and the current decade. As a competitively priced market, it is ample proof that property risk is insurable when market forces are allowed to work.
Bob Detlefsen, NAMIC: The answer depends on what one means by “large” and also on what one means by “afford.” Undoubtedly some households in catastrophe-prone areas would have to reduce discretionary spending-perhaps significantly-to pay higher property insurance premiums in the absence of price controls. Society would have to decide which homeowners are truly unable to afford risk-based premiums and what should be done to help them. There is ample precedent in government social welfare policy for dealing with this type of problem. For example, government could provide direct assistance to help low-income property owners pay risk-based premiums by offering insurance grants or vouchers similar to food stamps and Section 8 housing vouchers.
Ed Collins, ProtectingAmerica.org: The situation in California indicates that large numbers of homeowners cannot afford coverage or are unwilling to afford it given the value proposition they calculate. In fact, only about one-in-ten homeowners who can and should carry coverage from the California Earthquake Authority have done so.
The answer is not to artificially suppress rates-that would only create market disruption and lead to hugely indebted residual markets.
The most reasonable way to address this situation is to remove some of the costs from the system, and the most sensible cost to eliminate from the system is the timing risk and other costs that are built into reinsurance rates.
One way to reduce these costs would be a private public partnership that leverages the best of the private marketplace and some of the unique abilities of the public sector. Making insurance more available and more affordable is possible by fostering what the private sector does best and maximize the ability of the public sector to deal with timing risk and adding capacity and stability to the market.
This is where government involvement is the only practical solution, because the government does not have to charge for the risk of exposing capital to catastrophic events. Reinsurance offered by State and National catastrophe funds can be priced based on expected losses and a modest expense provision, and this can supplement private reinsurance and the layers of exposure retained by primary insurers, both of which contain provisions for the expected losses and significant risk provisions.
Robert Hartwig, III: “Affordable” is a subjective term.
In general, however, most homeowners would be able to afford coverage in a world in risk-based pricing that has been and remains the norm in catastrophe-prone areas. This is because the cost of insurance would have always been explicitly considered from the time that home was built or purchased.
This means that only people who could afford the insurance would buy the home in the first place. The cost of insurance would be evaluated by the homebuyer along with all other costs of homeownership-taxes, utilities, maintenance and upkeep.
If the prospective buyer could not afford the costs of homeownership, the home would not be purchased. If there are homes for which the cost of insurance was prohibitively high, then market forces would provide incentives for these homes to be built to a more stringent standard (enabling them to withstand the catastrophe), to invest in mitigation or would not be built at all.
Were risk based-pricing to be suddenly implemented in an area where subsidized rates are the norm, then some people will find the cost to be unaffordable. It is a matter of public policy how to handle the affordability issue. If the property is truly uninsurable, the traditional means for handling such risks is through residual market mechanisms.
Franklin Nutter, RAA: Persons with limited resources or on fixed income should be provided assistance for their principal residence from the state government in which the property resides. In order to have a viable private market, insurance should be risk based and not politically based. It should be recognized of course that certain people may need assistance from public programs just as they are with other basic needs.
Bob Detlefsen, NAMIC: I would argue that there is little justification for any type of government role in financing homeowner losses from natural catastrophes, with the possible exception of extreme mega-catastrophes, and even then only under certain conditions (see my response to the next question).
It’s extremely important that government not interfere with economic signals about the risks associated with living and doing business in catastrophe-prone regions. That said, government can reduce future catastrophe losses through sensible land-use planning, stringent building codes (combined with vigorous enforcement), and by creating incentives for homeowners to invest in mitigation measures.
Ed Collins, ProtectingAmerica.org: All of these stakeholders, including homeowners themselves, have appropriate roles to play. The important issue to keep in mind is that these roles must be balanced and complement one another.
Extremely large amounts of capacity are needed to cover the mega-catastrophic events that unfortunately are inevitable, and each of these stakeholders has an important role in maximizing the capacity available to repair damage to dwellings from these large events and to take responsible steps to prevent and mitigate losses before they occur.
The current system needs to be changed before the next mega-catastrophe occurs and leads to another economic disaster or systemic failure in the industry.
Private insurers are best equipped to deliver the primary coverages and services to consumers, with the support of private reinsurance; the state and national governments can help provide a backstop for major events, absorbing timing risk and adding capacity and stability for higher magnitude events.
Through this stronger public-private partnership, the key components of a better approach can more effectively be effectuated as well - prevention/mitigation, preparedness, helping first responders, consumer education and protection, oversight and continuous improvement. Homeowners themselves need to take personal responsibility for being prepared and protecting themselves and their property as well.
Robert Hartwig, III: Private insurers and reinsurers are tasked with the role of measuring and quantifying risk and converting that assessment into an actuarially fair, risk-based premium that allows buyers of insurance to transfer that risk.
The role of states is to regulate insurers for the purposes of solvency to ensure that they are financially able to honor the terms of the policies they write.
The role of the state and federal government in terms of actually financing catastrophe losses is subject to a great deal of debate within and outside the insurance industry. Those opinions range from a belief that government should play little or no role in the financing of catastrophic loss to a role that government should be the lead provider of such coverage.
Franklin Nutter, RAA: The federal and state governments should address immediate disaster response, emergency aid and evacuation and clean up services. In addition government should address public infrastructure needs and repairs. Government should address building codes, mitigation and land use planning with natural catastrophes taken into consideration. The private sector should provide insurance protection.
Bob Detlefsen, NAMIC: If the federal reinsurance program was designed to backstop private insurers (as in the TRIA program) rather than state-run insurance mechanisms, such a program might be appropriate, but only for situations involving mega-catastrophes that produce losses of a magnitude that would overwhelm private insurance and reinsurance capacity and state guaranty funds. An example would be an event similar to the 1926 Miami hurricane, which according to some estimates would result in losses in the neighborhood of $180 billion if it were to occur today.
Ed Collins, ProtectingAmerica.org: Yes, with a key distinction which is to pre-fund the backstop based upon an actuarially sound premium instead of waiting for an event to occur and then collecting funds in a retrospective fashion. The TRIA model is primarily post-event funded. We think pre-funding and starting to build the backstop now is a far better approach, especially in the realm of natural catastrophe coverage because, as we all know, it is only a matter of time before the next catastrophe strikes.
Robert Hartwig, III: While there are some differences of opinion, most would agree that large scale acts
of terrorism are fundamentally different from acts of God.
Acts of terror are not random events; the potential frequency of such events is effectively unknown; the severity under some scenarios exceeds the claims paying capacity of the (re)insurance industry, and the probability of occurrence of such events is affected by government policy and a variety of other factors beyond the ability of insurers to evaluate.
That being said, there are those who advocate for a federal backstop for natural catastrophe risk, arguing that the liquidity needed for large scale events can only be provided by the federal government. There are, of course, others who believe that the private markets are fully capable of assuming the risk.
Franklin Nutter, RAA: Prior to and post 9/11 there was no market for terrorism coverage; therefore a government program was necessary to create a safety net in order to facilitate a market. In contrast, coverage for property losses, including catastrophe losses, has been available for decades. A government program that subsidizes property insurance will only serve to encourage more development in high risk areas and further insurance subsidies for homeowners.
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Federal financing? 
