Protecting U.S. Insurance Consumers and Taxpayers From the Financial Effects of Natural Disasters 12/8/00 The Public Policy Case for Policyholder Disaster Protection Reserves (AAA Hill Staff Briefing)
1994 Northridge Earthquake 1992 Hurricane Andrew 1993 Midwest Floods 1989 Hurricane Hugo
Miami 40 miles North In 1992, Andrew resulted in $15.5 B of insured damage. Ten insurers failed. Homestead AFB Nearly $500 M in unpaid claims were ultimately paid by other insurance consumers or taxpayers. But, if Andrew had passed 40 miles North, insured losses would have exceeded $50 B.
Insurance Services Office Study Effect of $50 Billion Industry Catastrophe Š Up to 36% of Insurers Insolvent Š Up to $56 Billion in Unpaid Losses Š Reinsurance, Guaranty Funds Not Adequate Š Not Ready for a Mega-Cat
National Mega-Catastrophe Exposures $13 Billion Earthquake Pacific Northwest $77 Billion Earthquake San Francisco $20 Billion Earthquake Salt Lake City $21 Billion Hurricane Northeast Region $71 Billion Earthquake Los Angeles $115 Billion Earthquake New Madrid Region $17 Billion Hurricane Southeast Region Sources: Risk Management Solutions, ISO, USGS, Utah Geological Survey $22 Billion Hurricane Houston-Galveston $76 Billion Hurricane Florida Region
National Mega-Catastrophe Exposures $13 Billion Earthquake Pacific Northwest $77 Billion Earthquake San Francisco $20 Billion Earthquake Salt Lake City $21 Billion Hurricane Northeast Region $71 Billion Earthquake Los Angeles $115 Billion Earthquake New Madrid Region $17 Billion Hurricane Southeast Region Sources: Risk Management Solutions, ISO, USGS, Utah Geological Survey $22 Billion Hurricane Houston-Galveston $76 Billion Hurricane Florida Region Policyholders in Other States Can Be Affected by a Mega-Catastrophe that Causes Multi-state Insurers to go Insolvent
Does the Current System Encourage or Allow Insurers to Prepare for Large, Infrequent Disasters?
Current Tax, Accounting Rules for Property Casualty Insurance Reserves Insurance Accounting Rules: Š Do not allow reserves for future catastrophes U.S. Tax Code: Š Only allows deduction for post-event reserves Rules
The Effect of Current Tax, Accounting Prohibition of Pre-event Reserves Insurance premiums include a future disaster charge If no disaster loss, premium goes to income, is taxed Š Insurers seek to recover tax by raising rates Š Or, if cannot raise rates, will reduce coverage As a result, disaster insurance is either: Š less affordable, or Š less available than it would be if future reserving were allowed The tax disincentive is greatest in high risk areas
What Other Countries Do Equalization, Stabilization Reserves Tax-Free Jurisdictions Catastrophe Reserves Most have insurers hold reserves for future cats. Each has its own rules for setting up the reserves. But, in all cases the reserves are tax-deferred.
Policyholder Disaster Protection Reserve Structure Pre-Event Reserves Voluntary; Capped as a % of Premiums Contribute Funds to Cover Reserve (Pre-tax ) Tax Deferred Segregated Account; Investment Income Taxed Release Funds to Cover Qualifying Losses (Taxable) Pay Insureds Cat Claims Annual Losses Exceed High Level Trigger
Policyholder Disaster Protection Reserve Calculation of Reserve Cap Insurer may establish the reserve up to these maximum levels: Fund Cap Multiplier of Line of Business Net Written Premium Fire Allied Lines Farmowners Multiple Peril Homeowners Multiple Peril Commercial Multiple Peril Earthquake Inland Marine Auto (non-liability).25 1.25.25.75.50 13.00.25.01 Designed to yield a maximum $40 billion industry-wide reserve; Evaluating inclusion of reinsurance lines of business
Policyholder Disaster Protection Reserve Qualifying Catastrophe A catastrophe that is: Š Declared by the President per the Stafford Act, Š Declared by a state or territorial governor, or Š Reported as a Cat by Property Claim Services And is caused by: Š Earthquake Š Tsunami Š Wind Š Flood Š Volcanic Eruption Š Snow/Ice/Freezing Š Fire Š Hail
Policyholder Disaster Protection Reserve Proposal Exposure-Based: Capped: Funded: Income Taxed: For Mega-Losses: Tax Deferred: Insurer may set reserve per estimated cat exposure or as state regulator may require Cannot exceed a max % of premiums. Varies by coverage type; 20 year phase-in Funds are set aside, segregated, invested per state insurance investment law Investment income on funds set aside is included in insurer s taxable income Funds only available for losses from official cats above high level trigger Funds set aside are tax-deductible; funds withdrawn are taxable
Policyholder Disaster Protection Reserve Drawdown Criteria ( Trigger ) Trigger for Reserve Drawdown Insurer Reserve Cap Insurer Surplus Qualifying Losses 100 % Trigger Lesser 30% Trigger May be Drawn from Reserve Reserve Trigger Paid from Surplus
Policyholder Disaster Protection Reserve Second Event Trigger Second Event Trigger Insurer Reserve Cap Insurer Surplus Qualifying Losses in any of the 3 Years After Reserve Drawdown 33 % Trigger Lesser 10% Trigger May be Drawn from Reserve Reserve Trigger Surplus
PDPA - Sum of 1999 Triggers and Caps for All Companies in a State/Region - $ Billions $ Billions 80 70 60 50 40 30 20 10 0 U.S. NM 8 NM 5 TN KY Seismic States AR MO IL OH IA IN CA WA UT FL TX Wind States LA NC SC GA NY VA MI MN OK Sum of all Fund Caps Sum of all Triggers Based on 1999 Net Written Premiums
PDPA - Sum of 1999 Triggers and Caps for All Companies in a State/Region - % Surplus 35 Seismic Wind 30 % Surplus 25 20 15 10 5 0 U.S. NM 8 NM 5 TN KY AR MO IL OH IA IN CA WA UT FL TX LA NC SC GA NY VA MI MN OK Sum of all Fund Caps Sum of all Triggers Based on 1999 Net Written Premiums
Policyholder Disaster Protection Reserve Benefits Reliability: Availability: Fairness: Efficiency: Regulated System: Fewer insolvencies; More protection of policyholders after a major disaster More readily available cat coverage for homeowners and small businesses Helps taxpayers, other policyholders to avoid paying for other s cat losses Policyholder payments used in an effective manner to keep costs down Strong governmental controls, audits to ensure funds are used as intended
Policyholder Disaster Protection Reserve From the Federal Perspective Lower Risk That the Private Market Will Fail to Protect Insured Public From Losses Due to a Mega-Catastrophe $20-30B Long-Term, Pre-Funded Coverage Against Mega-Cats What the Federal Government Gets (After Ten Years) More Available and Reliable Private Disaster Coverage What it Gives Up Temporary Deferral of Federal Tax Revenue as Reserve Builds Up
National Catastrophe Exposures Today s Methods of Coverage $B Mega-Catastrophe Exposure? 60 50 40 30 20 10 Self Insurance Pre & Post Loss Prevention (in process) % 0 20 40 60 80 100
National Catastrophe Exposures Today s Methods of Coverage $B Mega-Catastrophe Exposure? 60 50 40 30 20 10 Surplus of Primary Insurers Self Insurance Pre & Post Loss Prevention (in process) % 0 20 40 60 80 100
National Catastrophe Exposures Today s Methods of Coverage $B Mega-Catastrophe Exposure? 60 50 40 30 20 Surplus of Primary Insurers Traditional Reinsurance Markets 10 Self Insurance Pre & Post Loss Prevention (in process) % 0 20 40 60 80 100
National Catastrophe Exposures Today s Methods of Coverage $B Mega-Catastrophe Exposure? 60 50 Capital Markets (in process) 40 30 20 Surplus of Primary Insurers Traditional Reinsurance Markets 10 Self Insurance Pre & Post Loss Prevention (in process) % 0 20 40 60 80 100
National Catastrophe Exposures Today s Methods of Coverage $B Mega-Catastrophe Exposure? 60 50 Capital Markets (in process) 40 30 20 Surplus of Primary Insurers Traditional Reinsurance Markets 10 Self Insurance Pre & Post Loss Prevention (in process) % 0 20 40 60 80 100
National Catastrophe Exposures Today s Methods of Coverage $B? 60 50 Mega-Catastrophe Exposure State and Federal Governments (Taxpayers and Future Policyholders) Capital Markets (in process) 40 30 20 Surplus of Primary Insurers Traditional Reinsurance Markets 10 Self Insurance Pre & Post Loss Prevention (in process) % 0 20 40 60 80 100
National Catastrophe Exposures Coverage Policyholder Disaster Protection Reserve $B? Mega-Catastrophe Exposure State and Federal Governments (Taxpayers and Future Policyholders) 60 50 40 30 20 10 Policyholder Disaster Protection Reserve Surplus of Primary Insurers Capital Markets (in process) Traditional Reinsurance Markets Self Insurance Pre & Post Loss Prevention (in process) % 0 20 40 60 80 100
Policyholder Premiums Are the Ultimate Source of Funding Taxpayer? Policyholder Federal Support State Pools/Funds Capital Markets Private Reinsurers Primary Insurers
Policyholder Disaster Protection Reserves Principal Objective Protect Policyholders and Taxpayers
HR 2749 Bill Status and Strategy Introduced in House 8/99 Referred to Ways & Means Rep Mark Foley (R-FL) Rep Robert Matsui (D-CA) 74 Co-sponsors; bi-partisan, multi-regional 21 Ways & Means Members One Element of a Major Tax Bill
Questions/Discussion (Backup Slides Follow)
$ Billions PDPA - Sum of Individual Insurer Triggers for All Companies in a State/Region - 1999 40 35 30 25 20 15 10 5 0 Region/State U.S. New Madrid 8 New Madrid 5 TN KY AR MO IL OH IA IN CA WA UT FL TX LA NC SC GA NY VA MI MN OK Based on 1999 Net Written Premiums Seismic Wind
PDPA - Sum of Individual Insurer Fund Caps for All Companies in a State/Region - 1999 50 40 Seismic Wind $ Billions 30 20 10 0 Region/State U.S. New Madrid 8 New Madrid 5 TN KY AR MO IL OH IA IN CA WA UT FL TX LA NC SC GA NY VA MI MN OK Based on 1999 Net Written Premiums
PDPA - Sum of Individual Insurer Triggers for All Companies in a State/Region - 1997 $ Billions 35 30 25 20 15 10 5 0 Seismic Region/State Wind U.S. New Madrid 8 New Madrid 5 TN KY AR MO IL OH IA IN CA WA UT FL TX LA NC SC GA NY VA MI MN OK Based on 1997 Net Written Premiums
PDPA - Sum of Individual Insurer Fund Caps for All Companies in a State/Region - 1997 50 40 Seismic Wind $ Billions 30 20 10 0 Region/State U.S. New Madrid 8 New Madrid 5 TN KY AR MO IL OH IA IN CA WA UT FL TX LA NC SC GA NY VA MI MN OK Based on 1997 Net Written Premiums