S&P: Pros And Cons of a U.S. Federal Natural Catastrophe Backstop

June 18, 2008

Because of a natural catastrophe’s high cost to society, some believe that the U.S. federal government should provide a program to backstop losses for natural catastrophes, said an article published by Standard & Poor’s Ratings Services.

In the current market, residents of catastrophe-prone areas face a significant challenge in obtaining affordable coverage. Federal government participation through a natural catastrophe backstop program could limit the amount of losses for insurance carriers while potentially increasing the availability of coverage to these residents, according to a new article published by Standard & Poor’s Rating Services. A federally backed program might also supplement the insurance the private market provides and encourage insurance companies to provide more coverage for natural disasters, says S&P.

The article, titled “Is A U.S. Federal Natural Catastrophe Backstop Necessary? Desirable?” says that politicians, academia, and the private sector have debated and discussed the idea of a federal natural catastrophe backstop program and other state or federal alternatives for many years. Standard & Poor’s also held a panel during its 2008 Insurance Conference (June 1-3) in which attendees debated the issue. The article reviews some arguments for and against a federal backstop, as discussed at Standard & Poor’s most recent insurance conference.

Overall, it is up to the insurance market participants, (re/insurance carriers, regulators, states, the federal government, etc.) to determine what role the government should play in managing natural catastrophe risk. Most agree that taxpayers shouldn’t be the source of the funding for a federal-backed program.

From an industry standpoint, a federal-sponsored natural catastrophe reinsurance program could be viewed the same way as other similar existing federal insurance programs, such as the National Flood Insurance Program and the Federal Crop Insurance Program. If the government provides reinsurance, it could be considered as another form of reinsurance from a ‘AAA’ reinsurer. As a result, potential participant insurers of this program might have improved risk-adjusted capital adequacy if they take part in this program rather than obtaining coverage from lower-rated reinsurance carriers.

However, an offsetting factor is the potential loss of revenue for companies that underwrite natural catastrophe re/insurance. These companies would be competing with the federal government, which could materially hinder their operating performance and weaken their competitive position.

Source: Standard & Poor’s

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