Financing the Risks of Natural Disasters June 23, 2003

1
Financing the Risks of Natural DisastersJune
2-3, 2003

• Insurance Regulatory Issues Arising from Natural
  Disasters in South America
• Paul K. Freeman
• June 3,2003

2
Regulatory Issues Nature of Insurance being
Provided

• Regulatory issues are impacted by the core nature
  of the insurance being offered.
• Insurance may be traditional insurance product
  like property and casualty insurance. In this
  instance, regulatory issues are traditional ones
  associated with insurance.
• Insurance may be a tool to shift existing
  government obligations to private sector. If so,
  raises a much different set of issues.

3
Insurance as Form of Indirect Taxation

• If insurance is a tool to shift existing
  governmental obligations to private sector, then
  insurance program is substitute for an existing
  public good.
• Where the good is partially limited in its
  availability, like solely to homeowners, then a
  strategy to ensure that those that benefit for
  the good pay the most for the good is solid
  social policy.
• Insurance may be used as a tool to link payment
  to the receipt of the social good. This may be
  the case in Turkey with its mandatory insurance
  program.
• If so, the regulatory issue is not concerned with
  insurance principles but should be governed by
  issues associated with the equitable payment of
  limited public goods.
• Like other issues of taxation, this is concerned
  with the equitable and efficient imposition of
  taxes related to specific services.

4
Regulatory Issues Associated with Natural Hazard
Insurance

• If natural hazard insurance is a component of
  voluntary insurance offerings, it has a series of
  unique issues associated with its regulation.
• Primary amongst those is the covariant nature of
  natural hazard risk in many countries and the
  capital requirements necessary to absorb
  covariant risk.
• Much more capital is required to cope with
  covariant risk rather than independent risks.

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South American Insurance Markets

• 80 of all insurance is sold in Mexico, Brazil
  and Argentina.
• 85 of all insurance sold through brokers
• Expense ratios are very high in Argentina they
  equal 50 of premiums.
• Very low insurance penetration in region less of
  1 of GDP spent on non-life insurance.
• Non-life insurance is dominated by vehicle
  insurance. Life insurance and vehicle insurance
  is traditional insurance with independent risks.
• Property insurance in countries with high natural
  hazard risk (Mexico and Chile) is dependant on
  international reinsurance pricing and
  availability. As pricing increases, the sale of
  property coverage in those countries decreases
  proportionally.

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Key Regulatory Issues

• Pricing the risk. The necessary catastrophe
  modeling has not been done for many countries.
• It is unlikely that domestic companies can or
  should absorb much natural hazard risk based on
  existing capital structures. It is likely that
  international reinsurance will play critical
  role.
• High expense ratios will make offering
  competitive products more difficult.
• Distribution of insurance will be very difficult.

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Conclusion

• Regulatory issues are related to nature of
  insurance program. If insurance is a tool to
  shift existing government obligations to rebuild
  housing after a disaster to private sector,
  relevant issues are more related to discussion of
  provisions of public goods to limited parties
  than to traditional insurance issues.
• If natural hazard insurance is component of
  property insurance, main regulatory issues will
  be
• Pricing the risk through proper catastrophe
  modeling
• Understanding the nature of covariant risk and
  the capital requirements to absorb that type of
  risk
• Difficulty of developing strong markets for
  insurance when markets have very high expense
  ratios and very limited forms of product
  distribution. Both of these characteristics exist
  in South America.