States Back Federal Role in Insuring Natural Catastrophes

After Decades of Discussion, States Adopt 3-Tired Plan

Though it may seem like the debate over the creation of a national catastrophe insurance plan is a relatively recent phenomenon, the National Association of Insurance Commissioners actually began addressing the issue as early as 1973. In a report from NAIC proceedings that year the group recommended a five-step program to address the problem of insuring against national catastrophes.

Now, 36 years later, the NAIC has adopted a white paper, “Natural Catastrophe Risk: Creating a Comprehensive National Plan,” which sets forth guidelines for actually achieving such a plan.

The federal Government Accountability Office (GAO) has determined the U.S. is not well equipped to handle large natural disasters, financially or in terms of emergency response. The premise behind the NAIC plan is that the private insurance industry alone “cannot be expected to provide comprehensive catastrophe coverage without adequate financial backstops for the most extreme events.”

The document approved by the regulators stems from a proposal originally developed by a group from California, Florida, Illinois and New York. It has survived numerous revisions and the NAIC acknowledges that consensus has never been reached on some issues. However, it stipulates that a national plan should be based on “several guiding principles” including:

• It should promote personal responsibility among policyholders.
• It should support reasonable building codes, land-use development plans and other mitigation tools.
• It should maximize the risk-bearing capacity of the private markets.
• It should provide quantifiable risk management by the federal government.

The plan envisions a public/private interface but the NAIC stressed that there would be two layers of risk-bearing capacity before federal government resources are utilized. The federal government, represented in the third layer, would only become financially involved if the catastrophic losses exceed the capacity of the first two layers.

The first layer of the three-tiered proposal addresses mitigation, restructuring the insurance contract and enhancing capacity.

The second layer would include a state-level public/private partnership and state-specific mechanisms to address the particular exposures faced by individual states.

The final layer includes limited involvement by the federal government to assist in implementing a public/private risk pooling mechanism. The purpose of this layer would be to provide a mechanism for spreading the timing of catastrophic event insured losses. To that extent, the plan only considers insured losses, the white paper states.

The only dissenting vote to the adoption of the white paper came from South Dakota Commissioner of Insurance Merle Schieber who opposes the idea of inland states subsidizing the risks of those who live near the nation’s coastlines.

The NAIC concedes that the politics of the issue are difficult. “No other issue in the current debate has polarized the regulatory community, the industry, consumer groups, legislators and other parties as much as how to finance and insure against future catastrophic risks,” the group says.

Another insurance regulator from the Midwest, Ohio Department of Insurance Director Mary Jo Hudson, echoed Scheiber’s sentiment when she told Insurance Journal last year that she doesn’t “feel that [Ohio] taxpayers should have to share the burden with folks that live in much riskier areas and choose to live there.”

Adoption of the white paper by the NAIC, however, was championed by another Midwestern regulator, Michael McRaith of Illinois.

Not All About Hurricanes

While much of the attention related to natural catastrophes is focused on hurricanes — especially the difficult problem of determining whether damages were caused by wind or water as a result of such a storm — the NAIC notes that one of the top 10 most costly and destructive natural disasters in the past 20 years was the 1994 Northridge earthquake in California that in 2007 dollars would have cost the insurance industry $17.9 billion. Though that figure may pale in comparison to the $42 billion in insured losses resulting from Hurricane Katrina in 2005, it’s nearly four times larger than the amount of insured losses from Hurricane Jeanne in 2004, which came in at around $4.17 billion.

The NAIC also points out that it’s been estimated that if an earthquake similar to the one that hit San Francisco in 1906 were to occur in that area today, losses would amount to some $400 billion, with $200 billion of those being insured losses.

In addressing earthquake risk, the NAIC white paper describes the insurance and mitigation mechanisms developed by Japan in response to earthquake exposure in residential properties there. Japan has a “functioning public/private partnership between the Japanese property insurance industry, offering the policies, and the Japanese government, providing a form of reinsurance backstop,” the NAIC says. Earthquake insurance must be offered on residential insurance policies, however, the insured may choose to decline the coverage. In addition, economic incentives are offered “to encourage the building of earthquake resistant residences,” an option that was developed after the Hyogoken-Nanbu earthquake in Kobe, Japan, in 1995 caused $700 million in insured losses and “triggered the first government reinsurance program payout.” Under the program, premium rates may be discounted based on a building’s location and method of construction.

As might be assumed, the idea of a public/private partnership on the federal level to address catastrophic risks is generally supported by insurance regulators from coastal states.

Louisiana Insurance Commissioner Jim Donelon has urged the federal government to “get into the business of assisting companies in providing that coverage, whether that’s to allow tax-free reserving for cat losses; a single policy to include flood, earthquake, and wind, and terrorism, modeled after what they did post-9/11 in creating a terrorism reinsurance act, or cat fund if you will; or the State Farm-Allstate proposal.” Donelon has cautioned, however, the involvement of the federal government in a national catastrophe plan should not be used as an “excuse to deregulate and remove jurisdiction from the states that allows [states] to protect consumers.”

The viewpoints of various state regulators, including Connecticut and Louisiana, were published in the white paper. Louisiana opined that any proposal should include more detailed discussion of relieving the tax burden on reserves for catastrophes and requiring state-sponsored entities to charge actuarially sound premiums.

Connecticut recognized that while it is a small state, it is densely populated and is the sixth largest state when it comes to overall coastal hurricane property value exposure. Regulators there are opposed to the “creation of state catastrophe funds backed up by the U.S. Government.”

However, Connecticut conceded that a federal backstop for natural catastrophes along the lines of the Terrorism Risk Insurance Act (TRIA) is appropriate provided the trigger is limited to the “mega-catastrophe” range so it would not displace the already functioning market.

Topics Catastrophe Louisiana Connecticut Hurricane Market Japan