Reinsurance for Natural and Man‐Made Catastrophes in the United States: Current State of the Market and Regulatory Reforms

ABSTRACT U.S. insurers are heavily dependent on global reinsurance markets to enable them to provide adequate primary market insurance coverage. This article reviews the response of the world's reinsurance industry to recent mega-catastrophes and provides recommendations for regulatory reforms that would improve the efficiency of reinsurance markets. The article also considers the supply of insurance and reinsurance for terrorism and makes recommendations for joint public-private responses to insuring terrorism losses. The analysis shows that reinsurance markets responded efficiently to recent catastrophe losses and that substantial amounts of new capital enter the reinsurance industry very quickly following major catastrophic events. Considerable progress has been made in improving risk and exposure management, capital allocation, and rate of return targeting. Insurance price regulation for catastrophe-prone lines of business is a major source of inefficiency in insurance and reinsurance markets. Deregulation of insurance prices would improve the efficiency of insurance markets, enabling markets to deal more effectively with mega-catastrophes. The current inadequacy of the private terrorism reinsurance market suggests that the federal government may need to remain involved in this market, at least for the next several years. INTRODUCTION The 2004 and 2005 hurricane seasons created unprecedented losses for U.S. property insurers. The insured losses from the largest 25 hurricanes on record in the United States are shown in Table 1. Six of the top 10 hurricanes in terms of insured losses occurred in 2004 and 2005. Total insured losses from the 2004-2005 events were $67.9 billion, accounting for 46 percent of the total losses of the top 25 events. Because losses of this magnitude are not diversifiable based on the spread of risk in the United States alone, U.S. insurers are critically dependent on the global reinsurance market to provide coverage and pay claims. Although 2006 was a calm year in terms of catastrophic events, it is clear that escalating insurance exposures and the recurrence of mega-hurricanes and other events will continue to expand the demand for reinsurance capacity. The increasing frequency of mega-catastrophes and the global interdependence between U.S. insurers and world reinsurance markets raises two important questions: (1) How well did world reinsurance markets perform in sustaining the recent catastrophic losses and how are these markets likely to respond in the future? (2) Are there significant impediments to the efficiency of world reinsurance markets that could be remedied through changes in regulatory rules? The objective of this article is to address these two issues by providing an analysis of the status of the global reinsurance market and by proposing regulatory changes that could enhance the efficiency of this market. In addition to natural catastrophes, the United States is also exposed to catastrophic losses due to terrorism. Indeed, the terrorist attack on the World Trade Center (WTC) on September 11,2001, was the largest disaster in terms of insured losses prior to Hurricanes Katrina, Rita, and Wilma in 2005. World reinsurers substantially withdrew from the terrorism insurance market following WTC, and U.S. primary insurers followed suit by inserting terrorism risk exclusions in most commercial lines property-casualty policies. Congress responded to the lack of coverage by passing the Terrorism Risk Insurance Act of 2002 (TRIA), which requires insurers to "make available" terrorism coverage and creates a federal reinsurance backstop that limits the losses of private insurers in the event of a major loss. There are significant questions about the availability of private insurance coverage if TRIA were eventually allowed to expire. Accordingly, this article also reviews the available evidence about the adequacy of private terrorism reinsurance and makes recommendations concerning public policy options regarding terrorism reinsurance. …