Swiss Re Sigma Study Examines Government/Private Sector Coverage

Swiss Re’s latest sigma study – “State involvement in private insurance” – examines the increasing symbiosis between governments and the private insurance sector. The report notes that “more and more governments are leveraging private insurance skills and the growing capacity of the sector to cover catastrophe losses as well as a wide range of other risks.

As an example the Japanese earthquake “caused more than $200 billion in total property losses, but only $30 billion was covered by private insurance.” However, of the losses caused by the earthquakes in Christchurch, New Zealand, “private insurers will pay about US$ 9 billion of the US$12 billion in total property losses.”

There really aren’t any common parameters for state/private involvement in insurance, as they differ “widely between countries and product lines. It includes setting the regulatory frameworks within which insurance companies operate, explicitly underwriting some types of products, making some types of insurance mandatory and responding after an event as insurer of last resort.”

Swiss Re explained that “central governments mainly self insure government property and activity while smaller government subdivisions are able to find economies in pooling risks with others through private insurance.” Government self insurance is “quite common for state property, such as roads, bridges, and buildings.”

Rudolf Enz, Swiss Re economist and author of the study, explained: “While many governments self insure or pool risks, there are opportunities for states to leverage the skills and growing capacity of private insurance to allocate risks efficiently and retain only the portion that is truly uninsurable.” By employing such a strategy, “risks become a budgeted cost and the impact of adverse events can be shared with private insurers.”

Enz also points out that “governments are rethinking catastrophe insurance coverage. Japan, Turkey and Taiwan have come up with innovative earthquake catastrophe schemes. Mexico issued a MultiCat bond to smooth the impact of disasters on their annual budget. This allows Mexico to make a quarterly payment to investors in exchange for $290 million earthquake and hurricane cover.”

In providing for some form of private coverage governments acquire “some additional protection from private insurers and capital markets.” Ultimately, as the “insurer of last resort,” they lessen their overall exposure to the impact of major catastrophes.

The report also points out that “this has become increasingly necessary because, as the sovereign debt crisis has shown, there are limits to how much financial market investors are willing to loan to governments, especially when fiscal balance sheets are stretched.”

The sigma study found that by subsidizing insurance in natural hazard prone areas the cost of the coverage is substantially reduced and it may be easier to obtain it. However, there’s a downside as well, as it may encourage development in areas, such as coastal zones, that are more exposed to natural catastrophes.

Enz also explains that “subsidies like this have the unintended consequence of forcing some taxpayers – living inland or on higher ground – to subsidize the insurance of the owners of expensive beachfront homes. A damaging hurricane this summer would place severe strains on governments with such subsidies at a very inopportune time,”

As a result he recommends that governments “eliminate subsidies for coverage that private insurers are willing to extend, thus conserving increasingly scarce government resources for investments in infrastructure that reduce losses when catastrophes occur and to provide coverage only for risks that truly are uninsurable.”

Public/private coverage for catastrophes differs substantially from the types of coverage, such as liability, which most governments have made compulsory in the interest of making sure injured parties are compensated. The most common is auto insurance, which is obligatory in most countries.

“People might not have savings or borrowing capacity to compensate someone they accidentally seriously injure,” Enz points out. By pooling the risks insurers diversify their exposures, and by making insurance mandatory, the government ensures that the pool is large enough to cope with the needs of the victims. In addition, the cost of insurance provides an incentive for people to reduce risky behavior.

In addition, the study notes, most governments “either provide or mandate health, disability, workers’ compensation, unemployment, and pension coverage.” Enz indicated that such programs “ensure all citizens are provided with a minimum level of protection against risks to their income or assets and often provide subsidies for the chronically ill, elderly or low income segments of the population.

“These programs are usually mandatory, so that the more affluent segments of society effectively help to finance the subsidy.” However, the study also concludes that “public support for social security systems with distributional elements can erode if they are perceived to be excessive.

“In a bid to contain the overall costs of such benefits, especially given the current strains on government finances, states are beginning to target benefit payments more narrowly by means testing, so that only low-income households receive financial support, and to privatize part of these social insurance programs.”

Source: Swiss Re