Federal Reinsurance for Disasters

A Congressional Budget Office Study

Introduction

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

Two types of federal proposals to increase supply of P/C insurance after a catastrophe

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

Key consideration

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?

Study brief:

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:

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:

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:

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:

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