Financial health includes not assuming more risk or liability for future claims than is prudent, given the amount of capital available to support it, i.
The principal value of reinsurance to a ceding company the purchaser of reinsurance for regulatory purposes is the recognition on the ceding company's financial statement of a reduction in its liabilities in terms of two accounts: its unearned premium reserve and its loss reserve.
The unearned premium reserve is the amount of premiums equal to the unexpired portion of insurance policies, i. The loss reserve is made up of funds set aside to pay future claims. The reduction in these two accounts is commensurate with the payments that can be recovered from reinsurers, known as recoverables.
By statute or administrative practice, all states but with considerable variation recognize and grant credit on the financial statement for the reduced financial responsibility that reinsurance transactions provide. An alien company can also participate in the U. For many years, few people outside the insurance industry were aware that such a mechanism as reinsurance existed. The public was first introduced to reinsurance in the mids, during what has now become known as the liability crisis.
A shortage of reinsurance was widely reported to be one of the factors contributing to the availability problems and high price of various kinds of liability insurance.
These investigations culminated in a widely read report, "Failed Promises: Insurance Company Insolvencies," published in February The publicity surrounding the investigations and the poor financial condition of several major life insurance companies prompted proposals for some federal oversight of the insurance industry, particularly insurers and reinsurers based outside the United States. However, no federal law was enacted. While a large portion of the insurance industry opposes federal regulatory oversight, many U.
A critical tool for evaluating solvency is the annual "convention" statement, the detailed financial statement submitted by all insurance companies to the NAIC. In , for the first time, the annual statement required insurers ceding liability to unauthorized reinsurers those not licensed or approved in a designated jurisdiction to include the amount of incurred but not reported IBNR losses in addition to known and reported losses.
IBNR losses are losses associated with events that have already occurred where the full cost will not be known and reported to the insurer until some later date. This requirement reflects regulators' concern that all liabilities are identified and determined actuarially, including IBNR losses, and that IBNR losses are secured by the reinsurer with additional funds or a larger letter of credit than otherwise would have been required.
In the mids, some reinsurance companies that had entered the reinsurance business during the period of high interest rates in the early s left the market, due to insolvency or other problems. Those that fail to pay attention to the riskiness of the business they are underwriting may end up undercharging for coverage and going bankrupt as a result. Consequently, some of the insurers that reinsured their business with these now-defunct companies were unable to recover monies due to them on their reinsurance contracts.
The rule helps regulators identify problem reinsurers for regulatory actions and encourages insurers to purchase reinsurance from companies that are willing and able to pay reinsured losses promptly. Concern about reinsurance recoverables led to other changes in the annual financial statement filed with state regulators, including changes that improve the quality and quantity of reinsurance data available to enhance regulatory oversight of the reinsurance business.
Reinsurers subsequently reassessed their position, which in turn caused primary companies to reconsider their catastrophe reinsurance needs. When reinsurance prices were high and capacity scarce because of the high risk of natural disasters, some primary companies turned to the capital markets for innovative financing arrangements.
The shortage and high cost of traditional catastrophe reinsurance precipitated by Hurricane Andrew and declining interest rates, which sent investors looking for higher yields, prompted interest in securitization of insurance risk.
Funds to pay for the transaction should money be needed, are held in U. Surplus notes are not considered debt, therefore do not hamper an insurer's ability to write additional insurance. In addition, there were equity puts, through which an insurer would receive a sum of money in the event of a catastrophic loss in exchange for stock or other options. Commercial banks and other lenders have been securitizing mortgages for years, freeing up capital to expand their mortgage business.
Insurers and reinsurers issue catastrophe bonds to the securities market through an issuer known as a special purpose reinsurance vehicle SPRV set up specifically for this purpose. These bonds have complicated structures and are typically created offshore, where tax and regulatory treatment may be more favorable. SPRVs collect the premium from the insurance or reinsurance company and the principal from investors and hold them in a trust in the form of U.
Treasuries or other highly rated assets, using the investment income to pay interest on the principal. While the insurance companies do not deny the inherent benefit of such measures, their concerns center on the complexities and costs of implementation, particularly as reinsurers are seen as unlikely to share in such costs. They view leadership role on mitigation measures as a government function. Caribbean insurance regulators who guard market solvency are rightly concerned with the paucity and untimely delivery of meaningful data from companies, many of which are perceived as undercapitalized.
Regulators are also pushing for needed upgrading of their powers and modernization of insurance laws and regulations. The insurance markets appear intensely competitive for property insurance--a competition primarily seeking reinsurance commission revenues rather than underwriting or "risk taking".
The larger Caribbean insurance markets contain insurance companies with sizable market shares that form part of broader commercial groups. Observation suggests that insurance-market participants could be saturated while undercapitalized.
This, however, is not yet substantiated, because the unavailability of credible statistics makes it impossible to determine asset strength. Apart from the inadequacy of industry statistics in almost all markets particularly balance-sheet information , there is little commonality among information systems, in either individual markets or the area as a whole. Outside of the Caribbean, insurance is a highly information-intensive industry and software systems abound, including those for regulatory reporting purposes.
Given the more recent easing of reinsurance prices, Caribbean insurers should see to it that long-term interests are best served by strengthening all elements of the industry infrastructure to meet the reasonable expectations of policyholders, taking into account market capacity for coverage at different premium price levels.
This strategy should include enhanced contributions by the insurance industry to the promotion of hazard and vulnerability mitigation measures--positive as well as negative incentives--through discriminatory premium pricing.
Also envisioned is more effective regulation of the business to ensure, inter alia, adequate solvency margins. Both the development of mitigation measures and the improvement of regulation can be expected to qualify for technical and financial assistance from international aid agencies. Since premiums are paid to provide for the possibility of future claims, insurance companies in areas prone to natural hazards have a particular responsibility to display their stewardship of premium moneys received and their fiscal performance.
In particular, the insurance regulator needs timely, accurate, and full disclosure of pertinent data so as to fulfill the solvency vigilance role see Appendix C. Compared with other markets, most of those in the Caribbean are unduly reticent about disclosing the data required for public and regulatory demonstration of fiscal performance. Visits and discussions during with regulators, companies, and the Insurance Association of the Caribbean IAC revealed that the data reported are inadequate to permit a description here of the industry's current fiscal position.
In particular, data reporting was seen as unduly delayed up to two years or more , and very scanty indeed on balance-sheet elements necessary to identify key fiscal ratios or early-warning signs of perilous trends. The present report has therefore been limited to basic fiscal considerations relating to natural hazard insurance. Insurance-company reserves fall into two basic categories: first, the shareholders' capital and free "surplus" reserves, and second, the insurance or "technical" reserves.
The latter are customarily tax-deductible, constituted for known liabilities such as pre-paid annual unused premiums or payment of reported but unpaid claims. In effect, the capital and free reserves represent the solvency margin and are intended as the last asset resource should the technical reserves prove inadequate.
Two factors in particular apply in relating these considerations to natural-hazard. First, although catastrophes are accepted as severe but infrequent events in accounting principle terms Generally Accepted Accounting Principles, or GAAP , their timing or magnitude cannot be precisely forecast, so that it is difficult to determine the optimal amount and investment instruments for reserving purposes. Until recently, Caribbean insurers were discouraged by existing tax laws from setting up specific reserve provisions for catastrophes before the event.
Several Caribbean countries are now permitting tax deductibility for such dedicated reserves. Without this dispensation, very little of paid premiums becomes available to meet future catastrophe claims liabilities under the policies issued.
Hence, in the policyholder's interest, it is recommended that dedicated, properly monitored tax-deductible catastrophe reserves be allowed. The second challenge, that of reinsurance security, is of greater consequence than the first and is exacerbated by the recent turmoil in major foreign reinsurance markets e.
Caribbean insurance companies, as never before, must exert every proactive effort at their disposal to determine the ability of reinsurers to deliver their reinsurance commitments fully and on time see Appendix D. Inadequate reinsurance security is tantamount to gambling the solvency and survival of a primary insurance company.
Reinsurance security similarly has to be a focal point for the regulator's scrutiny. A single Caribbean reinsurance security "clearing house" would be advantageous in terms of effectiveness and efficiency; perhaps the Caribbean Association of Insurance Regulators could examine a potential role for itself in this function.
Reserves held by insurers contemplate several self-insurance practices that do not involve customary insurance mechanisms, in a standard "risk taking" sense. The most basic form of self-insurance is concerned with claim deductibles under policies. The Leeward Island storms demonstrated that policy deductibles can almost relieve insurance companies of providing any coverage at all. Self-insured deductibles can also be significant to commercial policyholders; furthermore, they find that they need to be largely self-insured for business-interruption loss moss of profit".
Some larger and special-risk categories e. On occasions, such entities have voluntarily devised very high self-insured deductible levels aimed at covering the potential loss damage and separate self insurance funding for business interruption.
Furthermore, the insurance cost and availability difficulties have prompted trade associations e. The extent to which reserves exist for varieties of self-insurance is not known, but tax deductibility for commercial enterprises to pre-fund catastrophe provisions is conceptually the same issue as for insurance companies and is likewise recommended.
For home properties, mortgage and other lending institutions can help finance the self-insurance portion resulting from the application of claims deductibles and underinsurance penalties so as to assure timely repairs on their collateral.
A catastrophe insurer's gross potential liabilities the sums insured under its policies can run into hundreds of millions, if not billions, in any currency. The gross liabilities are reducible to net liabilities though reinsurance. A critical management challenge to insurers is a meticulous assessment of the commitment liabilities, both gross and net of reinsurance.
This assessment includes the closest scrutiny of reinsurance contract provisions, including the clarity and accuracy of the information supplied to reinsurers. Catastrophe commitments deserve clear tabulation, with segregation both for disaster types hurricane, earthquake, etc.
Provision also needs to be made for so-called "Second Event" scenarios as reinsurance contracts customarily vary from primary policy provisions by placing limits on the amounts of protection available for second subsequent catastrophes during any one reinsurance contract period. The hurricane season has given examples of unexpectedly high storm frequencies, and some insurance companies are understood to be faced as at October with difficult decisions regarding reinstatement of their reinsurance contract limits for the remainder of the period most expire at year end.
The reinstatement premiums quoted, if at all, will be at very high "adversity" levels. Clearly, a company's capital and free reserves, plus any dedicated catastrophe reserves, need to be demonstrated as sufficient and readily realizable for these purposes.
The assets held to cover a company's insurance or "technical" reserves should not be considered available for the payment of catastrophe claims because they are constituted customarily to cover prior known reported outstanding claims or unexpired pre-paid annual premiums.
Consideration also needs to be given to the assets and investment instruments employed for covering reserves set up to meet an insurance company's liabilities net of reinsurance under natural hazard policies. Since the liabilities emanate from insurance policy contracts, the corresponding reserves and their covering assets are held by the company in a fiduciary capacity for the benefit of policyholders.
In consequence, the investment instruments selected should be those that best meet the purposes for which policyholders purchase their insurance. One consideration has to be the secondary potential of natural hazard events to affect local financial markets adversely at the time liquidity is required.
It is recommended that specific regulation support the view that preferred instruments are found in hard-currency financial markets least likely to be affected by natural catastrophes.
The basic principle governing natural hazard claims settlement and reinsurance recovery practices is that claims should be met fairly, speedily, and openly. The key new challenge facing claims settlement involves restrictions on the scope of policy coverage. The Hurricane Gilbert claims in Jamaica were met with admirable speed and fairness with assistance from teams of imported adjusters and close supportive involvement by reinsurers. With reinsurers' agreement, Gilbert's claims, for the most part, were settled without applying the "average" clause; furthermore, few policies then contained significant deductibles.
It has to be accepted that the settlement process will be much more protracted and potentially acrimonious than formerly, as policyholders might express shock at these fine-print coverage limitations. In summary, astute planning to deal with this novel scenario is recommended in order to avoid procedural and public-relations nightmares.
Practice drills for all personnel likely to be involved in the claims process are recommended to insurance companies. It is important that internal systems be tailored to catastrophe eventualities, because the overall claims settlement and reinsurance recovery processes are very information-intensive. Practice drills will hone management, public relations, and other skills to allow the transparency of operations essential to maintaining all round good will. Particularly important is the advance marshaling and training of an effective staff of adjusters to enable a company to portray a proactive, rather than reactive, response to claimants.
The public relations function merits special focus, since the post-event image of an insurance company will depend on the image gained during adversity. A trained and energetic 24 hour "help desk" function goes a long way toward this objective. Policyholders need to know how to put together the information they need to press their claims and where to get practical help to safeguard their belongings.
A company's claims-management function should have a close involvement in reinsurance negotiations, especially on the contractual wording referring to claims procedures. Agreements should be reached with reinsurers, in advance of an event, as to the precise sequence of procedures, documentation requirements, and provisional payment arrangements.
Such agreements should be in writing and should be made directly with the reinsurers, rather than rely on representations of intermediary reinsurance brokers. Reputable reinsurers will respect primary insurance companies for attention to detail on these aspects. Delayed reinsurance remittances can wreak havoc with a primary insurer's efforts to satisfy policyholders' reasonable requirements.
In other major markets, natural hazard experiences have prompted insurance regulators to take greater initiative in advancing multi-sector catastrophe protection approaches. Regulators have devised novel techniques and procedures based mainly on information technology for the necessary fiscal integrity and compliance matters. Most revised approaches enjoy the support of the regulated companies which share with the regulator a common interest in publicly demonstrating key fiscal and compliance performance indicators using common, cost-efficient, computerized formats.
The effective professional insurance regulator will be perceived publicly as a fair and diligent umpire between policyholders and insurers. This regulator will also guard the broader public interest served by the insurance industry, particularly the industry role in national capital markets see the Puerto Rico example in Appendix E. It is recommended that pertinent government circles more readily recognize in practice that the strength, growth, and social responsiveness of the industry will be directly commensurate with the strength, growth, and social responsiveness of the industry's regulatory function.
A natural hazard event has the characteristics of low frequency and high severity. The adage "When the wind doesn't blow, nobody wants or needs , to know" may have had some historical validity.
However, catastrophes around the world in recent years have prompted insurance regulators to reassess their roles. The regulatory attitude or driving force recommended is one of encouraging and enforcing efforts to maximize the economic mitigation and protection available through the insurance mechanism without denying insurers a fair expectation of profit. There is a parallel with financial services regulation, where the "hazard" to be mitigated is a liquidity crunch with potential for a run on a banking system.
A natural hazard could provoke a run on an insurance system, along with the secondary "hazard" of public recriminations. In terms of delivering on their policy commitments, the issue of reinsurance security deserves the closest attention see Appendix D. Regulators could consider adopting a risk-management philosophy approach to this challenge.
Such an approach holds that the risks to be managed must first be identified and measured, and then be eliminated, minimized or transferred by means of appropriate techniques. From meetings with Caribbean regulators and companies, it was evident that significant activity aimed at modernizing insurance laws and regulations is going on.
Several findings called for improved regulatory effectiveness covering the regulators' institutional framework, statutory status, and enforcement powers, as well as financial, human, equipment, and facility resources. While these initiatives are very welcome, they imply that, generally, the regulator's function has not kept up with the times and that existing tools are not perceived as adequate.
Furthermore, there was the implication that the regulatory improvement process itself is too slow-moving. It is recommended that, to be strong and effective, insurance regulation include the following:.
Incentives and requirements including tax concessions to build catastrophe reserve funds up to minimum levels. Accurate verification and valuation of companies' balance-sheet entries to ensure adequate financial capacity to cover claims. Requirements that the security and reliability of overseas reinsurers that take on portfolios of local coverage be verified.
Linkage of insurance regulation to require compliance with building codes before insurance coverage can be provided. Recommendations for institutional strengthening of the regulatory function would include the following:. Focused training and contracting of adequately skilled staff to develop, implement, and enforce procedures supporting the execution of regulatory reform.
Upgrading information technology capabilities and computer equipment to allow for more automated compilation and analysis of insurance industry data, as well as timely reporting. Setting up "twinning" arrangements with superintendencies that have undergone or are undergoing successful institutional and regulatory reform e. The initiative from Trinidad and Tobago is encouraging. The Government has commissioned with World Bank funding a respected Canadian public accounting firm to produce proposals for the management criteria, status, and practices of the insurance regulatory function Appendix F.
It is recommended that these methods be adopted by other Caribbean nations as a "best practices" approach. The port's concrete jetty was destroyed and debris littered all island roads. The three main hotels were put out of business for at least four months. Agricultural crops were destroyed, and the fishing sector lost boats, buildings, and pots. The total damage exceeded five years of GDP. The impacts on the public, social, and economic sectors were widespread. The advance forecasting of a catastrophe's overall costs is indeed a complex exercise, but appropriate, so as to discern which sectors require and deserve priority focus for disaster mitigation efforts.
International aid and development funding agencies, besides sharing consternation at delays, disruptions, and increased costs, have the strong view that wisely planned hazard mitigation efforts and funding before a catastrophe pay excellent dividends in reducing the economic impacts; mitigation expenditures are a very small fraction of the funds spent on reconstruction in the aftermath. For this purpose, regional governments might consider implementing policies to a make vulnerability reduction a national strategy covering all sectors, b institutionalize vulnerability reduction at the operational level via a multi-sectoral cabinet-level council linked to national disaster management agencies and serving as an information "clearing house", and c develop comprehensive hazard maps of each country, available to business and home developers, architects, engineers, and insurance companies.
Caribbean insurance companies have traditionally assessed the potential impact of catastrophe losses in closest collaboration with their reinsurers, and generally the latter's views prevail. These approaches have included tabulating insured risks on catastrophe maps that display perceived hurricane tracks and seismic zones. Total exposures, split by distinctive catastrophe peril, are compiled. A Probable Maximum Loss PML percentage factor is applied to reflect assumptions as to the vulnerability of distinctive areas, construction types and structure occupancies.
It is from this PML, or expected aggregate catastrophe risk exposure in an insurance company's portfolio of issued policies that reinsurers determine the premium amount they require.
As has been said, reinsurers have additionally seen fit to insist on policy restrictions such as deductibles and full insurance. Methodologies for assessing insurance risk, while widely used if not mandated by reinsurers , are imperfect in two aspects.
First, they result in broad-brush applications for individual risk characteristics and premium ratings. The technology for the assessment of vulnerability to risk has advanced to allow much more accurate and meticulous estimations for particular locations and structures, but existing practices do not provide for rational discriminatory premium ratings to reward the better-protected risks and penalize the poorer risks. Second, the absence of such discriminatory pricing discourages policyholders from taking steps to reduce vulnerability.
Active study to implement discriminatory catastrophe premium rating for individual risk characteristics is recommended in order to provide more accurate market pricing signals from both the insurance provider and the policyholder.
Before getting into the question of sectoral needs, it is germane to point out that throughout the Caribbean, natural hazard insurance is perceived to be unaffordable by much of the population.
Although statistics are unavailable, it is recognized that most homeowners, except perhaps in Barbados, do not carry insurance except when required to do so by lending institutions.
This is also thought to be true of the majority of small and even, to a significant extent, mid-sized businesses. Additionally, underinsurance is widespread and in the early s many policies were allowed to lapse in response to high premium increases and the coverage restrictions discussed above.
The needs and demand for insurance and reinsurance protection exist and are not being met largely because of affordability constraints. For the most part, government physical assets such as buildings, schools, libraries, roads, and some hospitals appear to be underinsured or uninsured. Exceptions include Barbados and the government-owned Insurance Corporation of Barbados responsible for insuring public assets.
Additional exceptions are thought to include properties owned by statutory corporations such as port and airport authorities, as well as utility companies that have independent access to the insurance markets. Although in the conceptual stage, the program's principal elements are as follows:.
The CDB and other multilateral organizations provide contingent financing in the form of a line of credit during the formative years of the fund. As the fund grows, the utility companies rely less on the line of credit until it eventually becomes a standby support to be used only if the fund is depleted from claims arising out of a catastrophe. By year-end , the company's fund will be capitalized at a level recommended by an overseas risk-management firm based on an engineering study.
The fund is composed of cash and committed lines of credit. As in the regional approach, the lines of credit are to be used only after the cash portion of the fund is depleted. The company estimates very significant annual savings in the premium cost. The adoption of such sound risk-management approaches is recommended throughout the public and private sectors. Lucia Electricity Services Ltd. This audit is now being used as a pilot study to generate guidelines for all Caribbean utilities on how to reduce their exposure to natural hazards, and will be used by CARILEC in training utility engineers.
A concerted effort by electrical utilities to reduce exposure and eventual disaster losses, as a means to significantly strengthen any self-insurance or catastrophe fund mechanism for the sector, is recommended. A computer-generated wind study performed by a sub-contractor of the risk-management firm provided a probable maximum loss profile of the region and divided the Caribbean into six different risk zones, suggesting that there appeared to be enough diversification of risks among these zones to allow a regional insurance company for the CHA properties.
With the PML information as the starting point, and using its own financial modeling capabilities, the risk management firm determined a capitalization figure for a regional insurance company to sell "all risks" property insurance to each of the some 1, CHA members.
The firm then created, and today manages, a Bermuda insurance company whose exclusive clientele are members of the CHA. However, members of the CHA are policyholders.
CHA members are not obligated to buy the product; they can shop for competitive rates and coverage. Similarly, the insurance company can market to third parties, although it is not currently doing so. The risk-management firm was successful in attracting international institutional investors, portfolio managers, and venture capitalists. In addition, it was able to obtain multi-year reinsurance support from the global reinsurance community.
In total, the program took roughly 18 months to put in place. For many homeowners, the answer to soaring insurance rates, over the last five years, has been to reduce or eliminate their coverage.
With the lack of statistics, it is impossible to measure the degree to which capital stocks are underinsured, although industry and government officials interviewed agree that underinsurance is substantial. From an insurance industry perspective, underinsurance is business lost that would otherwise carry little incremental operating cost. Governments are, of course, concerned, since the more people who are uninsured or underinsured , the longer it takes for the local economy to recover from catastrophic events.
It is recommended that the insurance industry, through the Insurance Association of the Caribbean, create a forum, with other sectors, to explore ways to expand the availability and affordability of catastrophe insurance to homeowners. Although well-managed local insurers have enjoyed high profits during the last five years of high premium levels, most have continued their traditional practice of paying out profits in dividends rather than reinvesting them to increase net worth and capital structure to allow an increase in risk retention capacity net of reinsurance.
Two local trends, as yet slowly evolving, may suggest some change in strategy in the markets: a tax-deductible dedicated catastrophic reserve funds are being set up by a few insurers, though, given current levels, it will take a long time to reduce reliance on reinsurance, and b there is some increase in the buying of "excess-of-loss" reinsurance, as opposed to the traditional "proportional" reinsurance 4.
The former is perceived as more costly up front, making this strategy affordable only for the financially stronger companies. Other trends include several nations' regulatory reforms, which embrace very much-needed increases in minimum capital requirements and tighter solvency ratios for insurance companies. The immediate need to adopt legislation to increase capital requirements to realistic levels to ensure prudential and sustainable risk management practices, is strongly emphasized.
However, strengthening the financial health of local companies does not necessarily mean that they will opt to increase their risk retention. They could simply continue to write more business based on the required increased capital, and continue to reinsure the same level. Financial strengthening of the industry is recommended for the benefit of the industry itself, the policyholders, and the government sector in that the regional capital stock deserves the highest quality of insurance protection--for property, business, and economic development and related social impacts--against natural hazards.
Regulations allowing tax deductibility of catastrophe reserves would also encourage insurance companies to retain a higher level of profits within their business. The idea of creating regional reinsurance pools for local primary insurers has been debated often in the Caribbean. There are several options for their design, although key aspects to take into account are whether the creation of a pool gives incentives to primary carriers to reduce dependence on commercial international reinsurers and to what extent a pool itself would need to cede part of its coverage to international reinsurers a retrocession agreement.
Both these issues will help to determine the success and functionality of an insurance pool. In essence, it is recommended that the critical criteria should be the extent to which any pool arrangement is able to generate genuine additional capacity, rather than merely reshuffle existing capacity, and to promote more efficient market behavior.
In addition to these "structural" issues, there are various public-sector regulatory aspects of a reinsurance pool that would need to be coordinated among several regional governments, a process that is not always guaranteed to result in consensus, especially given the differences in insurance industry development and disaster-proneness in the various Caribbean countries.
However, there are ways of basing contributions to a regional pool on objective criteria such as country-wide PML assessments and expert forecasts of disaster probabilities by subregions. Some of these techniques could be developed with technical assistance at a regional level, as described further below. While premiums paid into the pool fund would support its capitalization, regional governments might also need to make initial contributions or guarantees to arrive at a minimum level of capital for insurance risk-taking requirements.
Thus, governments might have initial shareholdings in the pool, which would diminish as premium income paid by private carriers increased its equity base. In the long run, it is recommended that the pool be privatized once public-sector financial support was no longer required. In terms of financial benefits, the establishment of a regional reinsurance pool could potentially:.
While the reinsurance pooling concept appears worth pursuing, harder dimensional information would be required to permit an informed opinion on the available options. It is therefore recommended that a separate technical study be commissioned seeking financial and technical support from a multinational institution. Suggested terms of reference for such a study would include the following:.
The purpose would be to identify sustainable methods of increasing the availability of affordable catastrophe insurance protection and risk-funding mechanisms while reducing the volatility in the price of coverage, and to increase the deployment of measures to reduce vulnerability to disasters.
The study would adopt the following:. Sectoral-level reinsurance pooling or limited direct funding for uninsured public-sector and underinsured private-sector exposures, on a country-by-country or a regional basis. Identification of dimensions for catastrophe exposure hazards, through comprehensive hazard mapping and actuarial input on risk probabilities including event return periods and estimation of probable loss parameters using engineering methods.
Identification of priority coverage classifications for the existing shortage of catastrophe insurance, including funding provisions. Identification of practical real-sector vulnerability reduction measures, and their potential impact in reducing catastrophe losses.
Identification of appropriate legal structures and administrative, financial, and operating environments including public, quasi-public, and private entities. Recommendation of opportunities and their relative merits for improving existing reinsurance purchasing practices for the region, to ensure full market access to reputable reinsurance companies.
The financial implications of setting up a regional reinsurance pool, however, present some concerns from both the public and the private sectors. From the public-sector point of view, the establishment of a pool that would reinsure national carriers implies some sort of financing contribution to initially capitalize the pool.
It also enables it to limit its requirements in terms of equity. Finally, reinsurance ensures a certain degree of financial stability in the world insurance sector. For example, if the reinsurance system had not existed, the American insurance system might have collapsed after the events at the World Trade Center due to a lack of the necessary funds to meet its commitments.
Indeed, just to compensate the owner of the Twin Towers, 4 billion dollars had to be paid out. To this was added 7 billion dollars in compensation for the families of the victims, plus several billion dollars for the insurance companies of American Airlines and United Airlines, the various companies who rented offices in the Twin Towers, shops and businesses in the immediate surroundings, etc.
Because of ever increasing globalisation, today the vast majority of insurance companies are reinsured. Thus, when a catastrophe occurs in one country, hundreds of companies from the world over, reinsurance companies, are involved and contribute to reimbursing the damage suffered. Premiums are paid to these reinsurance companies by various insurance companies, without distinction to nationality. When an earthquake happens in Japan, for example, Japanese insurance companies are not the only ones involved, they are helped by insurance and reinsurance companies from all four corners of the Earth.
Quite simply by diversifying their portfolio of risks as much as possible and by being present the world over to ensure they are never endangered by the same events.
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