Insurance Regulators and Catastrophic Risk

Session IX

Financing the Risks of Natural Disasters

World bank - June 2003

Knowledge is Uncomfortable

• Numerous mega losses have occurred in the last decade

• Modeling shows that they are more likely than we thought

• Insurers are underinsured at higher levels

• Terrorism adds another dimension

The problem with people and politicians

• They cannot deal cognitively with infrequent events

• They think insurers are good sources of tax revenue

• They do not understand insurance economics

• They don’t like insurers anyway

The problem with reinsurers

• They apply heavy loadings to the expected loss at the higher levels

• Their governments are making it harder for them to smooth pricing

• They try to make up mega catastrophic losses in a hurry leading to huge pricing swings

• They are getting choosy

Who Pays?

Only two possibilities in long run:

• Policyholders

• Taxpayers – somewhere

What can regulator do?

• Require that capacity exists to pay all but most extreme events

• Ensure that capacity is secured

• Get support from accounting and tax authorities

• Support development of cat. risk transfer markets

Example: NAIC Cat. Reserve Proposal

• US accounting and tax rules do not recognize catastrophe reserves, although there is an implicit allowance under RBC, but

• 7 potential events with return periods of less than 500 years are in excess of $15 billion, 4 of which are in excess of $65 billion

• Total allocated capital is probably less than $200 billion.

Results

• Lack of capacity

• Transfer of cat. reserves to IRS and shareholders

• Increased potential for insolvency

Proposal

• Require minimum catastrophe paying ability• Can be met through internal funding of tax

deductible reserves, reinsurance or issuance of cat bonds

• Caps set through formula (some flexibility) or subject to actuarial certification

• Accounting and tax rules adjusted accordingly.

Lines proposed to be covered

• Fire and allied• Earthquake• Homeowners• Farm owners• Commercial• Auto

• Workers Comp.?

Formula

• Factors by line and state

• Applied to net premiums

• Capped at 20 times current annual contribution

• Released by roll off after 40 years

• Can be used to forestall general insolvency

Other issues• Appropriate return periods• Definition of catastrophe for release purposes• Interaction with RBC• Who ultimately owns tax effective reserves –

shareholders, policyholders, government?• Pricing approach - affordability• Who can certify?• Voluntary of compulsory?• Global approach to risk or separate issue?• Government as reinsurer of last resort.