Actuaries Challenged by Terrorism, Natural Catastrophe Insurance Plans

October 11, 2007

Congressional consideration of renewing the federal terrorism risk insurance program poses a number of political and actuarial issues, while reserving actuaries continue to face significant challenges when dealing with large catastrophic events such as natural catastrophes, attendees of the Casualty Loss Reserve Seminar heard.

Michael McCarter, vice president of Industry and Regulatory Affairs, AIG, describes 9/11 as a sea-changing event that altered fundamental perceptions and operations of significant parts of the insurance industry.

“Prior to 9/11, we would have admitted the theoretical possibility of terrible terrorist attacks but insurer managements took few actions to manage or control their exposure to terrorist attacks,” he said.

McCarter noted that the extension of the Terrorism Risk Insurance Act (TRIA) expires on December 31, 2007, and that further extension by Congress will depend on a number of political and actuarial issues.

“It seems likely that TRIA renewal legislation should pass this year, but many potential contingencies could work to slow or defeat this legislation,” McCarter said.

Among the key political issues is the desire among various industry sectors including real estate for insurers to offer more chemical, nuclear, biological, and radiological (CNBR) coverage. The American Academy of Actuaries Terrorism Risk Insurance Subgroup has estimated that a CNBR attack involving a biological weapon released in New York City could result in a $700 billion potentially insurable loss.

“Numbers of this magnitude show the problem with the ideological approach of just leaving the problem to be solved by the competitive marketplace alone. $700 billion is just too big even for the insurance industry to handle, when the total capital supporting all U.S. property and casualty risks is only about $500 billion,” he said.

McCarter said the treatment of CNBR coverage under the extension legislation would be one of the biggest actuarial issues for insurers.
“H.R. 2671 significantly expands the mandate for CNBR coverage. Many insurers, and especially smaller insurers, are very uncomfortable dealing with it,” he said.

Another political consideration is the unwillingness of Congress to be perceived as increasing taxpayer obligations. McCarter noted that a Congressional Budget Office (CBO) report estimated that the House extension legislation (H.R. 2761) would increase the budget deficit by $200 million in 2008.

The desire to make maximum use of market mechanisms is another Congressional concern, while considering whether to maintain the post-funding approach under the terrorism risk program has major actuarial, competitive, and political implications. “One of the design considerations with TRIA is that there is no pre-funding. On a pre-event basis, it’s like free reinsurance provided by a highly creditworthy reinsurer. How can a normal reinsurer compete with that?” he said.

“Post-funding is politically advantageous because there is no need to determine the appropriate premiums, no need to determine how these premiums should be charged to policyholders, and no accumulation of funds that might be tempting for policymakers to borrow for other purposes,” McCarter explained.

“But the disadvantage is that everyone wants a competitive private market and if it’s post-funding you’re competing with free,” he added.
Christopher Bozman, consulting actuary, Towers Perrin gave an overview on the approaches to reserving for large natural catastrophe events.

“For the reserving actuary the question is: if an event occurs, should it be reserved for separately? For some events it is very clear – for example Hurricane Katrina – but for other events it is not as clear,” he said.

Bozman noted that the criteria should depend on a number of factors, including: the magnitude of the event, both to the company and industry; whether it would be a disclosure item on a 10K or in an earnings call; and unique features such as coverage issues.

“We had wind vs. water with Katrina. In the event of an earthquake there could be coverage issues with earthquake, which may not always be covered, vs. fire following. Then, some events are really multiple events, at least for the purposes of determining reinsurance coverage,” he said.

Understanding the potential for post-event assessments is one of the key considerations in reserving for large natural catastrophe events.
Such assessments could be used for funding of insurers of last resort and residual market plans such as Florida Citizens, state run reinsurers such as the Florida Hurricane Cat Fund
(FHCF), state guaranty associations, and the California Earthquake Authority.

Bozman explained: “This is becoming a bigger issue for all of us. It is important to understand the potential for post-event assessments and what mechanisms, if any, are in place for recoupment.”
What this means to the actuary is that any estimation of ultimate losses should include a projection of assessments. “Recent legislative changes have magnified the importance of this issue,” he added.

The Casualty Loss Reserve Seminar is jointly sponsored by the Casualty Actuarial Society and American Academy of Actuaries.

Source: Casualty Actuarial Society

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