Decades in the Making, NAIC Outlines Natural Catastrophe 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.
According to the NAIC white paper, “Natural Catastrophe Risk: Creating a Comprehensive National Plan,” drafted by the NAIC Property and Casualty Insurance (C) Committee in 2008 and adopted nearly unanimously by the commissioners’ group at its Fall 2009 meeting, step five of that original recommendation read: “The Federal Government, in cooperation with the insurance industry and the NAIC, study and develop a mechanism that would provide additional capacity for catastrophe insurance and would allow for the accumulation of funds from which catastrophe losses could be paid without having those funds depleted by Federal income tax in loss-free years.”
Thirty-six years later, aside from the establishment in 1968 of the National Flood Insurance Program, such a national catastrophe insurance mechanism has yet to be finalized.
The only dissenting vote to the adoption of the white paper came from South Dakota Commissioner of Insurance Merle Schieber who has spoken publicly of his opposition to the idea of inland states subsidizing the risks of those who live near the nation’s coastlines. And the NAIC concedes that “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.” Another insurance regulator from the Midwest, Ohio Department of Insurance Director Mary Jo Hudson, echoed Scheiber’s sentiment when she told Insurance Journal late last year 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.” The white paper’s adoption by the NAIC, however, was championed by another Midwestern regulator, Michael McRaith of Illinois.
Can’t Go It Alone
In the introduction to “Natural Catastrophe Risk,” the NAIC notes that the federal Government Accountability Office (GAO) has determined the United States is not well equipped to handle large natural disasters, financially or in terms of emergency response. And the premise behind the NAIC’s 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 draft document approved by the regulators stems from a proposal originally developed by a group of state regulators, including those from California, Florida, Illinois and New York. It has been revised numerous times and the NAIC acknowledges that consensus has never been reached on some issues. However, it stipulated that a national plan should be based on “several guiding principles.” Among them:
- 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.
A public/private interface is envisioned by the plan but the NAIC stressed that “two layers of risk-bearing capacity before federal government resources are utilized. The federal government, represented in the third layer, would 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 calls for 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 paper states.
Not All About Hurricanes
While much of the attention related to catastrophes is focused on hurricanes, the NAIC notes that one of the most costly and destructive natural disasters in the past 20 years was the 1994 Northridge earthquake in California, which in 2007 dollars would have cost the insurance industry $17.9 billion. That figure may pale in comparison to the $42 billion in insured losses resulting from Hurricane Katrina in 2005, but it’s nearly four times larger than the $4.17 billion in insured losses from Hurricane Jeanne in 2004. The NAIC also said 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 describes the insurance and mitigation mechanisms developed by Japan, which 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.” 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.” Under the program, premium rates may be discounted based on a building’s location and construction methods.
Other Voices
The idea of a public/private partnership on the federal level to address catastrophic risks is generally supported by regulators from coastal states, especially those that border the Gulf of Mexico. Louisiana Insurance Commissioner Jim Donelon told Insurance Journal previously that he would like to see the federal government involvement, “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 pointed out, however, federal participation 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 detailed discussions and plans for “(1) relieving the tax burden on reserves for catastrophes, (2) requiring state-sponsored entities to charge actuarially sound premiums to receive federal financial support; and (3) enabling private insurers to require flood insurance as a prerequisite to issuance of wind and hail insurance coverage.”
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.”
The white paper also discusses disaster plans proposed by other entities. The NAIC summarized some of those plans as follows:
- Protecting America.org
- Gray Insurance Company Proposal
- The Travelers – “Four Pillars”
- Coastal Catastrophe Partnership
- Nationwide Enhanced Homeowner Insurance Policy (EHIP)
- The Utah Catastrophe Insurance Plan
The NAIC white paper, “Natural Catastrophe Risk: Creating a Comprehensive National Plan,” may be found online at www.naic.org/meetings0909/ex_plenary_materials.pdf. Attachment 10 begins on page 128.