The governments of different countries are in various stages of responding with organized “plans” that address these market issues.
United States of America:
In this country, state intervention has been made more urgent because, following the large losses created by hurricane Andrew in Florida in 1992 and the Northridge earthquake in California in 1994, insurance companies in the two states stopped writing hurricane or earthquake insurance on a voluntary basis. Both states responded by activating involuntary underwriting associations, originally created as assigned risk pools for special risks (as in auto insurance) to provide stopgap coverage.
Integrated State Plans:
The states of California, Florida, and Hawaii each have, or are in the process of creating, public entities (an “authority” in California and a “fund” in Florida and Hawaii) to provide the primary catastrophe coverage for the state. The liability of the private insurance companies would have a fixed upper limit, determined in the aggregate by the capitalized value of the plan and for each company by its paid-in capital in the plan.
The maximum liability of the Plans is also reduced by setting standard policy coverage that is lower than the amount previously available in the private markets. Policyholders bear the residual risk of loss for disasters where the aggregate losses exceed the Plans’ capital limits or where individual losses exceed individual policy limits.
Each of the plans uses part of its revenue to purchase reinsurance, both in traditional markets and using the new capital market instruments.
The premium rates in each plan are set by a public board of directors, which may limit the protests of consumer activists.
Federal Government Plans and Solutions:
The Federal government currently provides a form of catastrophe insurance through its various disaster relief programs such as Federal Emergency Management Administration (FEMA), small business loans, and special congressional appropriations. Although these programs may be considered highly desirable from a humanitarian perspective, they are far from ideal from the viewpoint of risk management. First, since the recipients pay no premiums for the anticipated “coverage”, the programs provide a federally subsidized incentive to take on risk (by building homes in high-risk areas). Second, government agencies undertaking “claims settlement” in the context of disaster relief are unlikely to verify the validity of “claims” with the efficiency of a private company, leading to fraud and waste. Proposals have also been offered for the Federal government to organize catastrophe insurance on a national basis. These proposals often make appeal to the potential for national risk-sharing across different types of catastrophe risks. Of course, in principle, the existing reinsurance markets should b providing the same risk-sharing facility, which raises the question of what special features the government brings to this activity. A cynical, but perhaps realistic answer, is that it is hoped that national insurance would be subsidized insurance. Such subsidies, of course, are resisted by the residents in states that do not face any of the covered catastrophes, which is perhaps why legislation on federal catastrophe insurance has so far proven difficult to enact.
The Turkish Catastrophe Insurance Pool (TCIP) and the Compulsory Earthquake Insurance Scheme:
Turkey is just one of many countries historically affected by natural disasters, especially earthquakes and floods. An earthquake map of Turkey shows that 96 percent of the country is susceptible to some degree of earthquake risk. The last two major earthquakes risk. The last two major earthquakes in 1999 (with magnitude of 7.4 and 7.2) in the Marmara region resulted in the loss of thousands of lives and placed an enormous financial burden on the economy and the government.
Before 2000, earthquake insurance in Turkey was provided mostly as an additional peril insured on fire and engineering policies. The coverage rate was also quite low, especially for residential buildings (5 percent). Impacts of such disasters and the low level of insurance coverage led the government to initiate studies to promote disaster insurance and establish a widespread and effective earthquake insurance system.
The legal framework of the new scheme was established by decree with the power of law. With this decree, earthquake insurance was made compulsory starting September 27, 2000 for all residential buildings that fall within municipal boundaries. The Turkish Catastrophe Insurance Pool (TCIP) was created to offer this insurance. The compulsory earthquake insurance scheme aims to limit the financial burden earthquakes place on the government budget, ensure risk-sharing by residents, encourage standard building practices, and establish long-term reserves to finance future earthquake losses.
The compulsory earthquake insurance scheme provides compensation to homeowners without reverting to the government budget. This effectively maintains social solidarity and risk-sharing by the payment of affordable insurance premiums. Meanwhile, a significant portion of the risk is ceded to international reinsurance markets until sufficient financial resources are accumulated within TCIP.
TCIP is a legal public entity managed through the TCIP Management Board. The board consists of seven members from academia and the public and private sectors. Although TCIP was originally designed as a multi-peril natural hazard insurer, it provides only compulsory insurance coverage for the time being. New products for other natural disasters such as floods and landslides will be provided in the future. Currently, 32 insurance companies are entitled to distribute TCIP policies.
The compulsory scheme covers only residential buildings that fall within municipal boundaries. Industrial and commercial risks as well as residential buildings in small villages (with no established municipality) can be insured on a voluntary basis. Eligible policyholders are the owners and tenants of dwellings that fall within municipal boundaries.
Compulsory earthquake insurance is a stand-alone product and it is sold separately from fire (homeowner’s) insurance. It covers building damage for the following risks:
Fires following earthquakes
Explosions following earthquakes
Landslides following earthquakes.
Insurance companies offer separate coverage for household assets and movables on a voluntary basis.
Limit of Coverage
The aim of TCIP is to provide an adequate level of protection with affordable premiums. Therefore, the maximum coverage of compulsory insurance is currently TL 40 billion (approximately US$ 30,000). This limit is adjusted annually according to changes in the construction price index. If the value of a dwelling exceeds this amount, policyholders can buy additional coverage from insurance companies.
Limit of Payment
When assessing claims, TCIP takes into account the replacement cost for each type of building. Any loss payment is limited to the sum insured. In the case of masonry-type buildings or small dwellings, the sum insured is usually below the maximum possible coverage amount. The sum insured is calculated by multiplying the total square meters of the dwelling by the relevant unit reconstruction cost. There is also a 2 percent deduction applied over the sum insured.
Pricing takes into account seismic risk and construction type. Prices range from 0.4 per mille at the lowest level to 5 per mille at the highest level. Thus, this differential pricing ensures proper risk- premium distribution through out the country.
Claims are directly paid by TCIP. Total claims payments have been approximately US$ 3.5 million since TCIP was established. TCIP’s claims paying capacity was almost US$ 1 billion for 2003.