Compulsory ‘All-Perils’ Coverage Would Worsen Disaster Insurance Problems

NAMIC Comments on Regulators’ Proposed National Program for Insuring Catastrophic Risk

INDIANAPOLIS (Jan. 9, 2006)—A “Natural Catastrophe Risk Plan” drafted by the National Association of Insurance Commissioners (NAIC) has the potential to “damage private insurance markets and exacerbate the very problems it seeks to correct,” warned the National Association of Mutual Insurance Companies (NAMIC) in comments submitted to the NAIC over the weekend.

The NAIC plan is described in a 10-page white paper the organization released shortly before its annual winter meeting in December. The plan calls for the creation of a multi-layered system of risk-bearing capacity to finance losses due to large-scale natural disasters. The first layer of protection, provided by the private insurance industry, would be backstopped by a second layer consisting of a network of state and regional catastrophe reinsurance funds. The second layer would be backstopped by a third layer, consisting of a federally-funded reinsurance program to be administered by a new federal agency.

A central feature of the plan is a provision that would require property insurers to sell, on a nationwide basis, an “all-perils” homeowners policy “containing no exclusions except for acts of war.” NAMIC’s comment stresses that the plan fails to disclose whether the price of the policy would be determined by market forces or by government fiat. “If the latter,” said NAMIC Public Policy Director Robert Detlefsen, “coverage for property owners in high-risk regions would likely be subsidized by property owners in low-risk regions.” NAMIC’s comment identifies three negative consequences that would ensue if insurers were compelled to offer all-perils coverage at prices suppressed through regulation:

• “Unless all homeowners are required to purchase an identical all-perils policy, the plan will lead to adverse selection. An all-perils policy whose price does not reflect the greater risk associated with particular perils in particular regions will attract a disproportionately large number of high-risk buyers and a disproportionately small number of low-risk buyers, thus increasing the likelihood that losses will outstrip private sector capacity and trigger recourse to the taxpayer-funded reinsurance mechanisms envisioned by the plan.
• “If, on the other hand, all homeowners are required to purchase an all-perils policy, the plan will be unfair to policyholders who choose not to live in high-risk areas.
• “The plan would increase the potential loss costs from natural disasters by decreasing incentives for risk mitigation and aggravating moral hazard. For some individuals, the optimal risk mitigation strategy may be to avoid owning property in certain regions altogether. A plan that combines mandatory coverage, cross-subsidies through price suppression, and taxpayer-funded government reinsurance will ultimately discourage risk mitigation. Moreover, if premiums in high-risk areas are artificially low to begin with, providing mandatory discounts and tax credits to policyholders who invest in risk mitigation measures could actually make matters worse.”

“Instead of using regulation to force insurers to offer comprehensive homeowners coverage, NAMIC urges policymakers to consider removing government barriers that prevent insurers from offering such coverage voluntarily,” said Detlefsen. These include insurers’ inability to create dedicated tax-deferred catastrophe reserves, as well as “the current system of government price controls that prevents insurers from pricing coverage based on risk.”

NAMIC's comment acknowledges that in high-risk areas, the risk-based price that insurers would need to charge for comprehensive coverage may prove unaffordable for some property owners. In such cases, policymakers “could determine which government interventions, if any, are appropriate.” While the NAIC plan represents one possible approach, NAMIC urges that others be considered as well. “For example, programs could be created to provide direct financial assistance to individuals whose insurance costs society wishes to subsidize. Such subsidies could be provided on a means-tested basis and would operate much like current government programs that provide food and housing subsidies for low-income individuals.”

“There are a variety of potential public and private responses to the problem of managing and financing natural disaster risk,” NAMIC’s comment concludes. “All are worthy of careful study and deliberation.”

For further information, contact
Robert Detlefsen
Director of Public Policy
(317) 875-5250 Tel
(317) 879-8408 Fax
rdetlefsen@namic.org

Posted: Monday, January 09, 2006 12:00:00 AM. Modified: Monday, January 09, 2006 1:38:04 PM.