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NEW YORK-If and when a heavily populated region in the United States is hit with the Big One-a megacatastrophe generating $50 billion to $100 billion in insured losses-primary insurers' current risk transfer methods may be inadequate to respond, warns an official with the Insurance Services Office Inc.
With the industry already struggling to absorb a handful of so-called "one-in-100-year" catastrophes in the past five years alone, insurers inevitably will have to look beyond traditional reinsurance, guaranty funds and pooling arrangements to insulate themselves from a monster catastrophe, he said.
Speaking last week at ISO's annual meeting and business forum in New York, ISO Executive Vp and Chief Operating Officer Michael Fusco said the concentration of population in areas susceptible to large-scale catastrophes is creating exposure problems for certain insurers that cannot be remedied by a simple rearranging of policy distribution.
ISO conducted a study of 80 insurance groups and found that a megacatastrophe generating insured losses in excess of $100 billion could force anywhere from 7% to 50% of the insurers into insolvency, depending on where the catastrophe strikes, Mr. Fusco said.
Several insurance industry experts who joined Mr. Fusco on a panel agreed that insurers must begin exploring alternative methods of protecting themselves from high-level catastrophic losses.
"We definitely want to develop alternative sources of catastrophe property reinsurance. The need is centered on the fact that necessary risk transfer capacity is not being satisfied by reinsurance alone, especially in the high excess, supercatastrophic area," said Brian S. Murphy, managing director with Guy Carpenter & Co. in New York. "It's the capital markets that can provide reasonably priced, high-level catastrophe financing."
Noting that as much as $15 trillion is available in the capital markets, Richard L. Sandor, chairman of Centre Financial Products Ltd. in New York, said it should be the insurance industry's goal to access this vast pool of capital. But efforts to secure sums of money to function as reinsurance should be made "incrementally, not as part of some Big Bang."
"When you have eight of these supposed one-in-100-year events in just four or five years, that's too much" for the industry, traditional reinsurance and specialty catastrophe reinsurance to bear, he said.
There are several mechanisms that insurers can employ to access the capital markets, according to Mr. Sandor, including:
Private or public equity capital, such as the money that poured into Bermuda to back the property catastrophe reinsurance facilities.
Act of God bonds, which are debt instruments issued by insurers that, in the event of catastrophic losses, allow the issuer to forego part of the interest payments. Nationwide Insurance Group has issued such bonds (BI, May 29, 1995).
Catastrophe futures and options, which have been traded on the Chicago Board of Trade for several years.
Insurer "swaps," where insurers with different geographical exposures actually trade risk. For example, an insurer with California earthquake exposure could trade some of that for Florida windstorm exposure.
"The capital markets are already involved.*.*.they have been for some time," Mr. Sandor said.
But why would capital markets want any part of a potentially crippling risk?
Guy Carpenter's Mr. Murphy answered that question simply: A strong rate of return. In addition, "insurance risk can be considered an asset class. And it's diversification for investors," he said.
However, Jack Weber, executive director of the Natural Disaster Coalition in Washington, said that capital markets have shown little interest in getting into a California earthquake facility that has been seeking a total of $10.5 billion in capital. "That authority can't raise the money (from capital markets) because investors want a 30% to 40% return. The primary industry won't pay the necessary price to guarantee such a return," he said.
If capital from outside the industry proves to be unattainable in ample amounts, another possible solution is a legislative proposal for a national pool consisting of insurer-financed catastrophe funds that would have the federal government as a "backstop," said Mr. Weber.
"U.S. taxpayers have already paid out $50 billion in the last few years for disaster relief, so we're at a crossroads. The only questions that need to be answered are how much of a role would this pool play and what would be the level of acceptable participation from the government," he said.
Mr. Weber said once those important questions are answered, "Congress will pass it."
But the idea of the federal government taking a sizable role in catastrophe reinsurance does not thrill Centre Financial's Mr. Sandor. "I'm worried about the government intervening. Centralization is not a great idea. I support a private-sector solution to a public problem."
Another suggestion offered by moderator Myron Picoult, managing director and senior insurance analyst with First Manhattan Co. in New York, is that insurers be allowed to set up catastrophe reserves on a tax-free basis.
But panelists pointed out that such a suggestion would never fly through Congress at a time when spending cuts and a balanced budget are such hot topics.
The net cost to the government would be $15 billion to $20 billion, which would lead to additional spending cuts, noted Mr. Weber. "It's politically unfeasible in this day."