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Do government backstops help or hinder?

Commercial market solutions may be better over time

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Do government backstops help or hinder?

NEW YORK — Government participation in the insurance market is a sign of market failure and often creates distortions that have wider economic consequences, according to several leading insurance executives.

While the programs often are well-intended, particularly federal programs that support some catastrophe risks, leaving the exposures to be handled by the market would likely create lasting solutions, they said.

However, some risks, such as terrorism and possibly some cyber exposures, cannot be covered adequately without government support.

Any argument for government involvement in commercial markets is a recognition that the markets have failed to provide a solution to a problem, said Peter Hancock, president and CEO of American International Group Inc. in New York.

And government programs such as the National Flood Insurance Program can lead to significant problems, he said during the Global Insurance Forum held last week in New York. The conference is sponsored by the International Insurance Society.

“The federal flood program subsidizes construction in flood-prone areas,” Mr. Hancock said. Yet if flood risks were covered more extensively by the private insurance market, insurers would be able underwrite the risks at realistic rates and offer loss prevention measures to facilitate coverage, which would lead to better risk management and fewer losses, he said.

The NFIP began with good intentions to protect poor families exposed to flood risk, but it has had unintended consequences, said William R. Berkley, chairman and CEO of W.R. Berkley Corp. in Greenwich, Connecticut.

More premiums paid into the program “come from million-dollar mansions along the coast than come from those poor people, and the deficit (of the program) is in the multiple billions of dollars. So a good idea gets distorted by the government,” he said.

On the other hand, the federal terrorism insurance backstop, created by the Terrorism Risk Insurance Act of 2002, is an example of a government program that is needed by insurers and businesses in general, Mr. Hancock said. Yet “TRIA very nearly didn't get renewed” after the last version of the law expired at the end of 2014, he said.

Tough to cover some risk

Though there is plenty of capacity in the insurance and reinsurance markets, it is still difficult to find capacity for risks that insurers and reinsurers feel unable to underwrite, said Britt Newhouse, chairman of reinsurance brokerage Guy Carpenter & Co. L.L.C. in New York.

In particular, the nontraditional capacity that has flooded into the reinsurance market recently is not being used to cover emerging risks, he said.

The new capital has “almost exclusively been focused on existing risk that's more fungible, easier to understand, easier to model ... the new capital (providers) almost always say, "I don't want anything to do with microinsurance, with terrorism, with cyber.' They are not underwriters, they are not innovators; they are trying to isolate and silo risk to invest in,” Mr. Newhouse said.

Although the insurance industry offers some coverage for cyber risk, often limited to breach response expenses, most cyber risks are tough to underwrite, several conference participants said.

“Traditionally, insurance has been a mechanism to protect people from fortuitous events, and cyber (insurance) bridges across to intentional events,” said Constantine Iordanou, chairman, president and CEO of Arch Capital Group Ltd. in Bermuda. “We've got a way to go to figure it out.”

Catastrophic cyber risk falls into the same category as the terrorism risks backed by the federal government via TRIA, Mr. Iordanou said.

Cyber risks should be included under TRIA to facilitate more coverages available to businesses, said Stephen Catlin, executive deputy chairman of XL Group P.L.C.

“If you have that backstop, you can work out that downside risk to capital,” he said.