The Irrational Economist by Erwann Michel-Kerja

Author:Erwann Michel-Kerja
Language: eng
Format: epub
Publisher: PublicAffairs

Lesson 4: Public-Private Insurance Partnerships Can Be Attractive

This lesson can be illustrated by reference to the TRIA legislation, first passed in November 2002 to provide federal reinsurance for qualifying losses from a terrorist attack. Since TRIA provides a useful starting point for developing government reinsurance plans to cover financial catastrophes, I provide a summary of its key and relevant features below.4

• Industry Loss Trigger. The government’s terrorism reinsurance is triggered only when the industry’s aggregate losses for a qualifying terrorist attack exceed a specific amount (currently $100 million).

• Government Excess of Loss Coverage. Each insurer has a deductible amount as a percentage of its premiums written for commercial property and casualty insurance. The insurer must pay all losses up to this deductible, and must also pay co-insurance (15 percent) for the losses above this deductible (to an event limit of $100 billion).5 The deductible and co-insurance have the effect that private insurers will receive little or no government reimbursement except for the largest terrorist attacks. This leaves insurers with a strong incentive to use risk-based pricing and to induce property owners to take action to mitigate the risks where possible. The government’s reinsurance, however, is provided without charge and thus the overall program does retain an element of subsidy; the subsidy offsets the incentive for property owners to mitigate their risks.

• The “Make Available” Requirement. This legislation requires that all property and casualty insurers continue to “make available” terrorism coverage on the same conditions (but not at the same prices) they offered prior to 9/11.6 Perhaps surprisingly, the result has been a well-functioning and reasonably priced market for terrorism insurance. Indeed, the industry has enthusiastically supported the program through two renewals. It is possible that the “make available” clause helped to coordinate a new diversified equilibrium in which all firms desire to participate knowing that all other firms must also participate.

• Crowding Out. Since the government reinsures the top tier of risk at no charge, it clearly crowds out any private reinsurance market for these risks. However, it is unclear whether any reinsurance firms would offer such coverage even in the absence of the government program. The experience of European countries is telling: Reinsurers have reentered this market but their participation is always extremely limited and embodied in public-private programs (e.g., Gareat in France, Extremus in Germany). Moreover, under TRIA, private insurers bear the major risks below that threshold, and it could be said that the government is “crowding in” the private markets, since private terrorism insurance might not exist in the absence of TRIA.

Download

Copyright Disclaimer:
This site does not store any files on its server. We only index and link to content provided by other sites. Please contact the content providers to delete copyright contents if any and email us, we'll remove relevant links or contents immediately.