Insurance companies providing homeowners, business and other property insurance in New York State would be required to create a catastrophe reserve fund to help pay claims caused by hurricanes and other natural disasters under a new regulation proposed by Insurance Superintendent Eric Dinallo.
“Most people probably think that the extra money they pay on their homeowners insurance for hurricane protection goes into a ‘very rainy day fund’ to pay claims when hurricanes hit,” Dinallo said. “In fact, because of current insurance accounting and tax rules, if there is no hurricane, the extra money goes to insurance companies’ profits. That leaves the companies with no reserves to pay huge claims from big hurricanes and consumers angry over ballooning profits and rising premiums.”
Dinallo said he thinks a private solution to the need for catastrophe coverage is better than a public fund. His plan would require insurers to set aside a portion of premium for a catastrophe fund.
He said eventually the reserves could be exempt from taxes.
“This reserve fund will help pay the claims if and when hurricanes and other disasters do hit,” Dinallo said. “Catastrophe reserves will provide increased transparency that will be good for the industry and consumers. Consumers will see where the money they pay for hurricane protection goes. They will see if it is not enough and there is a need for higher premiums. And they will see if the reserve is large and untouched and can then question the need for higher premiums.”
He said he believes people are willing to pay a relatively small amount to ensure that whoever does have a catastrophe loss is protected.
Insurance companies set aside reserves to cover claims for incidents that occur in a given year. For example, for auto insurance, a company can set aside what it will pay only for accidents that occur that year. Dinallo said this works with auto accidents because there is predictable historical data on the number of claims every year and the cost of those claims.
But, he adds, the problem for big catastrophes such as hurricanes is that there are a very small number of very costly events that are spread out over many years. So sharing risk in one year does not work. “Effectively spreading the risk of hurricane losses requires not only sharing among many people, but also across several years,” he maintains.
Under current accounting and tax rules, insurance companies are discouraged from setting up a reserve to fund losses from events that have not yet occurred, such as those from future hurricanes. Companies can deduct from this year’s revenues money reserved for claims resulting from events that occur this year. That reduces this year’s taxes. Statutory accounting considers those reserves an operating expense. But if a company does not know when the event will occur, then money placed in reserve is not considered an expense in the current year by statutory accounting and is subject to federal and state taxes.
“I’m in favor of tax-deferred reserves for hurricanes, but the industry will only achieve that change if it acts first and gains credibility,” Dinallo said. “Meanwhile, we need to start building protection against the potentially huge costs of hurricanes now.”
The new reserve would cover losses related to natural catastrophes such as hurricanes, wind, hail, earthquake, winter storms (snow, ice, freezing) or tsunami. The regulation would require companies to reserve the amount they now charge policyholders for catastrophe protection, less any taxes paid and the cost of reinsurance.
Dinallo’s department is circulating a working draft of the proposed regulation to the insurance industry and consumers. It said the regulation will then go through the formal proposal process, which includes publication in the New York State Register and a formal 45-day comment period for written comments.
“I believe a hurricane reserve fund is an important part of the solution. But I am happy to start a discussion with insurance companies, consumers and legislators about possible improvements to this proposed regulation and to develop other ideas. A decision to do nothing would be a bad decision. The current system doesn’t work for companies or consumers,” Dinallo said.
A copy of the working draft of Dinallo’s proposal is available at:
Source: New York State Insurance Department
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