U.S. accelerating move toward disaster insurance reform
Premium increases, against a backdrop of increasing weather disasters and strained state finances, will focus Congress’s attention on weaknesses in the current U.S. catastrophe insurance framework; this is likely to stimulate reform, leading to the creation of a national disaster insurance/reinsurance pool and federal guarantees for certain catastrophe bonds
The United States is one of the only wealthy economies that lacks a comprehensive government-backed disaster insurance plan, and instead relies on a patchwork of private and public insurance schemes. Oxford Analytica offers an analysis, saying that the current U.S. system:
- relies unduly on expensive, retrospective government financing of disaster relief, rather than cheaper, prospective mechanisms; and
- allocates benefits on a pro rata basis, regardless of whether a homeowner or business purchased any insurance coverage
U.S. policy has shifted in recent years, however, to allow a broader federal role in providing specialty risk insurance. During the administration of President George W Bush, Congress twice passed terrorism risk insurance legislation, bringing U.S. practice more in line with international norms. The current framework expires at the end of 2014.
Oxford Analytica says that the move toward reform is accelerating. Here are a few examples:
- New regulator? Legislation passed by the House of Representatives on 2 December 2009 would establish a Federal Insurance Office (FIO) within the Treasury Department charged with monitoring all aspects of the insurance industry. It would identify gaps in regulation of insurers that could increase systemic risk in the financial system. The FIO would have no authority to regulate the business of insurance, nor would it be empowered to pre-empt state insurance regulations. The proposal is a reaction to AIG’s near-collapse.
- International negotiator? The FIO is intended to provide a unified U.S. voice on insurance matters in international negotiations; the FIO and the U.S. Trade Representative would share authority to negotiate international agreements.
- Pending legislation. The House Financial Services Committee remains the primary driver of insurance reform discussions. The Homeowners’ Defense Act, House legislation introduced by Florida Democrat Ronald Klein, is the most significant proposal currently on the table. Its measures include:
- Federal reinsurance. Broader, less expensive reinsurance is crucial to improving accessibility — both in terms of scope and price — for catastrophe insurance. The bill would create a National Reinsurance Program.
- Federal catastrophe bond guarantee. Although some state catastrophe bond operations stem from separately capitalized, stand-alone entities, state fiscal crises have raised market concerns about their safety and soundness. Federal Catastrophe Obligation Guarantees could reduce risks to state finances.
- Federal disaster fund. The bill would create a National Catastrophe Fund, financed by proceeds from sales of reinsurance, to provide investment income to private disaster assistance groups.
- National Catastrophe Risk Consortium. State governments might elect to participate in this multi-state pool, which would perform many monitoring and information-gathering functions, and issue various financial instruments, including securities, linked to insured or re-insured catastrophe risks
Oxford Analytica notes that there many factors driving reform. States such as California, Florida, Louisiana, and Texas have created standalone entities that provide disaster insurance. Such entities, however, pay very high rates for reinsurance. Moreover, some state disaster relief is financed post hoc, and highly strained state finances make such efforts difficult to sustain.
In addition, the coalition behind Klein’s proposed reforms includes insurance companies — State Farm, Allstate — large (non-insurance) corporations, small businesses and realtors, as well as the American Red Cross.
What is the outlook for disaster insurance reform? “Premium increases, against a backdrop of increasing weather disasters and strained state finances, will focus Congress’s attention on weaknesses in the catastrophe insurance framework. This is likely to stimulate reform, leading to the creation of a national disaster insurance/reinsurance pool and federal guarantees for certain catastrophe bonds,” Oxford Analytica concludes.
To read an extended version of this analysis, log on to Oxford Analytica’s Web site.
