‘Girly Men’ and the Real World: The Public Role in Extreme Risk-Sharing

The Wharton School professor argued that insurance companies are not “girly men” when it comes to providing coverage for extreme risks such as hurricanes and terror attacks. It’s the federal government’s “triple” layer of taxation on reserving that scares insurers away and prevents build-up of needed capacity.

Tax reform might fix the capacity shortfall that keeps insurers from covering certain extreme risks but it would not completely excuse the federal government from an insurance role in the “real world,” countered a New York insurance company president and other industry leaders. In the case of terrorism, for instance, the government has information and tools private markets do not have, they noted.

Thus went a lively exchange during the 109th annual meeting of the National Association of Mutual Insurers (NAMIC) in Washington D.C. last month. Panelists were asked to discuss the proper relationship between the federal government and private insurance in the handling of society’s riskiest situations during a segment titled “Socioeconomic Risk: Insuring the Uninsurable.”

Kent Smetters, associate professor of insurance and risk management at the University of Pennsylvania’s The Wharton School in Philadelphia, who placed considerable faith in private markets, had his hands full beating back the arguments of insurance industry leaders including Warren Heck, president of Greater New York Mutual Insurance Co., who knows first hand what insurance markets were like in New York after the 9/11 terror attacks.

Smetters insisted that private industry could insure against catastrophic events including terror attacks. He noted that the private market is now providing coverage for hurricanes and earthquakes, even though the government has gotten involved, which sometimes discourages private capital. Capital is even trickling into terrorism insurance, he added.

“Insurers are not ‘girly men’ when it comes to covering extreme risks,” he said. “They are willing to take them on.”

But government policy gets in the way of those big and brave enough to entertain extreme risks, he argued. He said current laws penalize insurers for dealing with catastrophic risks and discourage the formation of private capital. There is no tax-free reserving as in Europe and the U.S, makes onshore capitalization more difficult than it should be, he maintained.

“The problem is government policy,” Smetters said.

New York ‘real world’

Heck’s company, Greater New York Mutual, specializes in writing commercial properties. Despite its expertise, that wasn’t easy after 9/11.

“Financial markets are large and vigorous now. But after 9/11 there were no private markets. Some large skyscrapers went without coverage. What coverage was available was hugely expensive,” Heck recalled.

Differing with Smetters, Heck suggested it would be irresponsible to expose the insurance industry and the nation’s economy to the financial danger of another terrorism attack or an extreme risk. The oft-cited $350 billion industry capacity is “irrelevant” to the argument over terrorism insurance, Heck maintained, because most of it is earmarked for other lines and coverages.

Heck agreed that federal government participation in insurance should be opposed in most situations but that it could not always be avoided in the real world. “There are events that are beyond the capacity of the industry. We have the creativity and the tools but not the capacity,” the New York executive said.

He said that if the federal government had not gotten involved through the federal Terrorism Risk Insurance Act (TRIA), his company would have had to exit the commercial insurance business just as a number of insurers left the workers’ compensation market after 9/11. While large players might be able to raise money from financial markets, smaller insurance companies would not, he added.

Changes in tax policies would help but not solve the problem, Heck said.

The bottom line for the insurance executive: “In the end, we do need the government to be a backstop because none of us knows how serious a terror attack would be.”

Constitutional issue

Gordon Stewart, president, Insurance Information Institute, New York, said the “extreme risk” question goes to heart of what is insurable by private industry.

He also noted that because the industry argues against government interference anywhere, it assumes “a high burden” when it seeks an exception to that rule, as with terrorism or hurricanes.

From an economic angle, intervention of the government may not be necessary. For example, commercial markets were eventually able to diversify and figure out ways to handle terror after 9/11.

But Stewart sided with Heck that the capacity issue is real. Of the $350 billion surplus, at least two-thirds is personal lines and not involved in terror or TRIA. There just isn’t sufficient surplus to cover a catastrophic event like 9/11, he said.

The risk of terrorism is not just an economic matter; it’s also a matter of politics, national security and the U.S. Constitution, according to Stewart.

“Terrorists don’t register with the SEC,” he quipped, pointing out that the federal government has a military force and access to classified information about terrorism that private industry does not, along with constitutional responsibilities regarding national security and war.

“The role of government itself is unique in terms of terror. Government can’t prevent hurricanes or earthquakes but some believe that government has a role in preventing terrorism and has some superior intelligence and advantages to predict, prevent or attack terrorists. Private markets have no such advantages; they have no military to attack terrorists. So how can government expect the insurance industry to insure against terrorism?”

Since it is a “war against terrorism,” it is appropriate for the federal government to play a role, he said.

Stewart agreed with Smetters that the existing federal tax and regulatory framework does not support private markets and he acknowledged that TRIA is imperfect. But, he noted, in the real world of Washington, TRIA is something that can get done, whereas sweeping regulatory and tax changes would take time and are unlikely to happen.

Smetters returned to the capacity argument, acknowledging that capacity as it stands now is inadequate. But it has and will grow, he insisted. “It’s not a fixed capacity. It’s now small relative to what’s out there. The problem is the triple layer of taxation on insurance for holding capital,” he argued.

Smetters also acknowledged that government has access to information and power over terrorism that private industry does not have but he rejected the notion that this means the government does a better job of covering the risk. Instead, the government should be sharing that information with private industry and selling contracts for coverage, in his view.

Smetters, who helped write TRIA, now opposes its renewal.

Sophe Korczk, a political analyst based in Washington, D.C., pointed out that the nation has a history of the federal government stepping in where private markets fear to tread, including with floods and terrorism.

However, she noted, most of what are called government insurance programs are not really insurance the way the private sector views it. “Just because there is a federal program does not mean that the federal government is in the insurance business,” she said.

Korczk cautioned against expecting capital markets to respond to the need for terror coverage, arguing that unlike other risky undertakings such as initial public offerings (IPOs) where investors can see what they are getting into, there is no history or transparency surrounding the risk of terrorism.

Topics Catastrophe Carriers New York Hurricane Washington Market