Insurance Regulators and Catastrophic Risk

1. Insurance Regulators and Catastrophic Risk Session IX Financing the Risks of Natural Disasters World bank - June 2003

2. 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

3. 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

4. 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

5. Who Pays? Only two possibilities in long run: • Policyholders • Taxpayers – somewhere

6. 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

7. 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.

8. Results • Lack of capacity • Transfer of cat. reserves to IRS and shareholders • Increased potential for insolvency

9. 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.

10. Lines proposed to be covered • Fire and allied • Earthquake • Homeowners • Farm owners • Commercial • Auto • Workers Comp.?

11. 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

12. 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.