Catastrophe Funds and Reinsurance

Frequently Asked Questions

Full Document Available in PDF

Nearly every region of America has to deal with the risk of natural disasters. From New Orleanians girding for hurricane season to Los Angelenos worrying about out-of-control summer wildfires, everyone knows that certain events can result in massive loss of homes, businesses, and lives. Almost all observers agree that the current system for dealing with catastrophes places large burdens on state governments, does not do enough to encourage people to secure structures against the worst, and poses significant financial risks to the insurance industry.

Everybody concerned with catastrophe-related insurance issues agrees that mitigation efforts to strengthen homes, businesses, and communities against natural disasters deserve more attention than they have gotten in recent years. Beyond that, however, widespread disagreement exists. This paper deals with that disagreement. All of these issues have significant implications for the type of insurance that insurers buy—reinsurance.

Discussions in Congress, state capitals, and at insurance industry events have revolved around proposals to transfer some or all “catastrophic” risk to the federal government. (Nobody has defined “catastrophic;” insurers have proposed everything from $10 billion to $300 billion as a catastrophic risk.) Most recent disasters have involved hurricanes, so for the most part, the issue is intertwined with the long-standing National Flood Insurance Program

Proponents of transferring some responsibility for wind insurance to the federal government—including several very large insurance companies, some emergency management professionals, and elected officials from hurricane-prone areas—argue that the private sector simply cannot deal with certain risks. They believe that only the government is big enough to take care of certain risks and that having the government take on these risks would protect both individuals and corporate owners.

Opponents of such risk transfers—including environmentalists, free market groups, some insurance companies, and nearly all reinsurance companies—argue that the private sector can handle these things on its own and that government-backed reinsurance would encourage unwise development.

During the 110th Congress, the Democratic-controlled House of Representatives passed measures that would have added wind coverage to the National
Flood Insurance Program and established a public-private consortium to provide reinsurance to states and private companies. The measures, however, did not move forward in the Senate. President-elect Obama also supports the idea of national reinsurance. However, for the most part, positions on reinsurance break down along regional rather than party lines: Prominent supporters of government-run reinsurance almost all come from hurricane- or earthquake-prone areas and draw equally from both parties.

This paper answers a number of questions about reinsurance in general, the types of legislation that Congress has considered in the past and may consider in the future, and alternative methods for improving America’s regulation of reinsurance. Finally, it cautions against rushing into new government-run mechanisms for addressing problems related to reinsurance.