Federal Reinsurance for Disasters

1. Federal Reinsurance for Disasters A Congressional Budget Office Study

2. Prepared at request of Senate Budget Committee Analyzes proposals for federal reinsurance of risks from terrorism and natural disasters Contributors included: Rade Musulin - Florida Farm Bureau Richard Roth Other assistance from Dennis Kuzak - EQE Jack Nicholson - FHCF Stan Devereux - CEA Introduction

3. Auction reinsurance contracts to primary insurers and state-sponsored insurers considered after Hurricane Andrew and Northridge Earthquake offer reinsurance when coverage is in short supply, at market prices designed to cover governments cost Pay for losses directly, without reimbursement or only partial reimbursement considered for terrorism attacks after Sept. 11 Two types of federal proposals to increase supply of P/C insurance after a catastrophe

4. How the P/C industry would respond without federal intervention? would the supply of insurance rebound quickly? Is the risk of terrorism insurable w/o government’s assistance? Are there policies that could avoid undermining private activity while providing backstop? What would cost be to taxpayers and government? Key consideration

5. Large insured losses that are unanticipated reduce the supply of insurance and put pressure on private insurers to raise prices Higher prices generally attract new capital insurers reassess their risks supply increases prices decline to levels consistent with perceived risks Proponents contend that federal program needs to add capital to the market and then withdraw after market recovers Study brief:

6. Federal program would probably expose taxpayers to substantial risk $25B for natural disaster $100B for contingent liabilities from terrorism subsidies could lead to fewer preventative actions delay innovation that could increase private supply Study brief:

7. States’ experience with regulations has shown that controlling prices/requiring coverage can delay drop in supply and surge in prices if keeps prices below costs and crowd out private markets, insurance may be more expensive in long run issues with subsidization, reduce incentives for mitigation Since Sept. 11, supply of terrorism coverage has grown and coverage has become less restrictive Study brief:

8. Private insurers may not be able to pay claims and continue issuing coverage after every contingency Under current proposals for federal reinsurance of terrorism risks government initially pays for most of losses CBO estimates that government should charge insurers about $3 billion annually to cover costs Study brief:

9. As an alternative to providing reinsurance, Congress could consider other measures to encourage private sector to supply reinsurance following catastrophic events offering property owners incentives to mitigate risks reduce federal assistance after an event changing the tax treatment of loss reserves held by insurers limiting damage awards Study brief: