Federal subsidies limit alternatives role in terrorism reinsurance: CBO

by Artemis on June 17, 2015

The involvement of the U.S. government in provision of terrorism insurance, through the Terrorism Risk Insurance Program under TRIA, limits traditional and alternative reinsurance capital’s ability to play a meaningful role, according to the Congressional Budget Office (CBO).

The availability of capacity for terrorism risk reinsurance has not been in doubt for a number of years now, with the traditional reinsurers and also alternative or capital markets players making it clear that capacity can be sourced to meet U.S. terrorism reinsurance needs.

There are doubts in some areas of the market about the ability to cover nuclear, biological and chemical risks (NBCR) in terrorism, hence Federal involvement is still seen as required. But there is an understanding that private reinsurance and capital markets could provide a significant proportion of the required terrorism capacity.

However the CBO, in a recently published update to its working paper on Federal Reinsurance for Terrorism Risk, highlights what is currently a key issue that prevents the private reinsurance and capital markets from getting more involved. Federal subsidy.

The working paper looks at options to change the structure of the Federal involvement in terrorism insurance and reinsurance, but notes that the level of subsidy at the moment is limiting the ability of private reinsurance or capital market alternatives to play a meaningful role.

While subsidy helps to make the terrorism insurance ultimately more affordable for many, levels the playing field in terms of costs and encourages businesses to buy terrorism cover, it also makes it very difficult for private markets to participate or compete.

Subsidised federal reinsurance protection; “Limits private-sector alternatives — both traditional reinsurance and newer capital market alternatives — even if it supports supply in the primary market,” the CBO explains.

The private reinsurance market, as well as the newer, capital market backed alternatives such as insurance-linked securities (ILS) players, cannot compete with the subsidised Federal reinsurance protection.

That leaves the private markets vying to cover the risks retained by private insurers, which while supporting the provision of terror insurance is not perhaps putting reinsurance capital to work in the most effective or efficient way.

The CBO notes that participation by private reinsurers allows risks to be shared and diversified globally, while also encouraging innovation in distribution that could improve the product and risk distribution in future.

Therefore by subsidisation largely locking private reinsurance and capital markets, or ILS players, out of the terror reinsurance space it is perhaps doing a disservice to the effectiveness of the terrorism insurance market as a whole.

Subsidies in Federal insurance and reinsurance provision is a hot topic right now, as with global reinsurance capital at a high and interest from capital market investors increasing all the time, the cost of reinsurance cover has perhaps never been cheaper.

That puts the onus on policymakers to establish whether now is the right time to try to reduce subsidies and shift more of the risk into private risk transfer markets. This conversation is ongoing with respect to Federal flood insurance (the NFIP) and also terrorism (with TRIA).

The CBO’s report notes that subsidies are not a permanent or essential part of any Federal insurance program, they could be eliminated if policymakers chose to, but they are common and often seen as the best way to increase affordability.

It’s not so much the existence of subsidy but where it sits in the terrorism risk insurance and reinsurance industry. Adjustments to the subsidy, increasing the trigger and making private market participants responsible for more of the risk, is not expected to affect uptake of terror insurance.

The fact is that rates of terrorism insurance have been coming down in line with other major catastrophic exposures, a function of the amount of capital in the reinsurance market. That suggests the time is right to look seriously at better ways to structure the whole program and level of subsidy in it.

Given the cost of risk capital is at or near all time lows, while the structures to create re/insurance products are more flexible than ever and risk models and technology improving all the time, it’s hoped that gradually it will be possible to reduce or restructure the Federal subsidy and enable the private markets to participate more meaningfully.

Also read:

In TRIA’s absence no shortage of terrorism reinsurance capacity: S&P.

Terrorism re/insurance availability helped by alternative capital inflow.

‘Reinsurance, capital markets reluctant to take on terrorism risk’.

S&P: Alternative reinsurance capital anticipated in terrorism risk.

Experts forecast a bigger role for ILS in terrorism insurance.

Is it time the capital markets helped out with terrorism risk transfer and reinsurance?

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