Financing the Risks of Natural Disasters June 2-3, 2003

1. Financing the Risks of Natural DisastersJune 2-3, 2003 Insurance Regulatory Issues Arising from Natural Disasters in South America Paul K. Freeman June 3,2003

2. Regulatory Issues: Nature of Insurance being Provided • Regulatory issues are impacted by the core nature of the “insurance” being offered. • Insurance may be traditional insurance product like property and casualty insurance. In this instance, regulatory issues are traditional ones associated with insurance. • Insurance may be a tool to shift existing government obligations to private sector. If so, raises a much different set of issues.

3. Insurance as Form of Indirect Taxation • If insurance is a tool to shift existing governmental obligations to private sector, then insurance program is substitute for an existing public good. • Where the good is partially limited in its availability, like solely to homeowners, then a strategy to ensure that those that benefit for the good pay the most for the good is solid social policy. • Insurance may be used as a tool to link payment to the receipt of the social good. This may be the case in Turkey with its mandatory insurance program. • If so, the regulatory issue is not concerned with “insurance principles” but should be governed by issues associated with the equitable payment of limited public goods. • Like other issues of taxation, this is concerned with the equitable and efficient imposition of taxes related to specific services.

4. Regulatory Issues Associated with Natural Hazard Insurance • If natural hazard insurance is a component of voluntary insurance offerings, it has a series of unique issues associated with its regulation. • Primary amongst those is the covariant nature of natural hazard risk in many countries and the capital requirements necessary to absorb covariant risk. • Much more capital is required to cope with covariant risk rather than independent risks.

5. South American Insurance Markets • 80% of all insurance is sold in Mexico, Brazil and Argentina. • 85% of all insurance sold through brokers • Expense ratios are very high: in Argentina they equal 50% of premiums. • Very low insurance penetration in region: less of 1% of GDP spent on non-life insurance. • Non-life insurance is dominated by vehicle insurance. Life insurance and vehicle insurance is traditional insurance with independent risks. • Property insurance in countries with high natural hazard risk (Mexico and Chile) is dependant on international reinsurance pricing and availability. As pricing increases, the sale of property coverage in those countries decreases proportionally.

6. Key Regulatory Issues • Pricing the risk. The necessary catastrophe modeling has not been done for many countries. • It is unlikely that domestic companies can or should absorb much natural hazard risk based on existing capital structures. It is likely that international reinsurance will play critical role. • High expense ratios will make offering competitive products more difficult. • Distribution of insurance will be very difficult.

7. Conclusion • Regulatory issues are related to nature of insurance program. If insurance is a tool to shift existing government obligations to rebuild housing after a disaster to private sector, relevant issues are more related to discussion of provisions of public goods to limited parties than to traditional insurance issues. • If natural hazard insurance is component of property insurance, main regulatory issues will be: • Pricing the risk through proper catastrophe modeling; • Understanding the nature of covariant risk and the capital requirements to absorb that type of risk; • Difficulty of developing strong markets for insurance when markets have very high expense ratios and very limited forms of product distribution. Both of these characteristics exist in South America.