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.
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