A dip in the pool

Hurricane Charley has shown the value of the Florida Hurricane Catastrophe Fund, but it may also prove a timely example of pooled reinsurance as Tria comes up for renewal

Hurricane Charley may be second only to Hurricane Andrew in terms of losses, but the aftermaths for reinsurers of the two incidents are very different. Hurricane Andrew caused a capacity crisis in the reinsurance sector that only the new Bermudians were able to address. On a local level, in the face of uninsurable property in Florida, the government had to intervene. The Florida Hurricane Catastrophe Fund (FHCF) seems likely to cover most of the reinsurance requirement, beyond the retention held by insurers, according to AM Best.

Analysts agree that it is difficult to compare the two hurricanes because of the measures put in place after Andrew - an example of which is Citizen's Property/Casualty, which Morgan Stanley analysts describe as a"quasi-public insurance company with over $1bn of in-force premiums and more than 800,000 policyholders in the most catastrophe-exposed parts of the state." Between FCHF and Citizens, Morgan Stanley argues that as much as 33% of the loss could be absorbed.

The stability of the market in the aftermath of Charley is an endorsement for the government intervention and it has allowed the most hurricane-threatened areas of Florida to continue to develop. Morgan Stanley analysts comment that while the event is big enough to transform industry pricing, "we suspect this is more likely to stem the pace of decline rather than to create an outright turnaround ... the public entities will be a significant shock absorber for this loss."

The timeliness of this vindication of a government system is pertinent in terms of the Terrorism Risk Protection Act (Tria) which is due to expire on 31 December 2005 and, as such, is an issue for the 1 January 2005 renewals.

The Act, signed on 26 November 2002 was an attempt to ensure that the American economy would not suffer as a result of the lack of affordable terrorism cover. It means that the federal government would assume losses caused by a foreign terrorist attack above company-specific deductibles.

The Treasury Department has the option to extend the terrorism insurance mandate, known as the 'make available' provision for another year but it must make this decision by September 1 2004. Congress does not have a say in the decision although there has been an opportunity for it to express views.

For and against

The debate about whether or not Tria should be extended has become a heated one. The insurance industry, understandably, is very much in favour of its extension. The National Conference of Insurance Legislators (NCII), National Association of Mutual Insurance Companies (NAMIC) and the Property Casualty Insurers Association of America (PCI) have all been lobbying hard to influence the view that the extension should go ahead. In a letter to the Wall Street Journal in August, refuting points made in an article it ran by Holman Jenkins, Carl Parks senior vice-president of PCI argued, "The business, community, the entire insurance industry ... and informed members of Congress recognise that the programme is not a 'subsidy'. Rather, Tria is a vital economic safety net for the United States." He also argues, "It is far less expensive to 'be prepared' than to react afterwards."

The 'be prepared' argument is one that is frequently cited, as is the focus on avoiding the uncertainty that might prove damaging for the economy.

Furthermore, there is a suggestion that insurers will still have to cover terrorism, either because of the five states that have prevented insurers from excluding terrorism coverage or the 24 states that mandate 'fire-following' cover, which would effectively mean covering an attack similar to 9/11.

The arguments against the renewal focus on the fact that it was supposed to be a temporary measure to allow the (re)insurance industry to recover and build up reserves - so the extension would mean a permanent subsidy of the insurance industry. Critics of the extension would like to give the markets the opportunity to cover the risk, as they did in 2002, before Tria was enacted, through securitisation of the commercial lending.

Another issue is centred on whether Tria actually impedes the development of the reinsurance market for terrorism. A paper produced by the Republican Policy Committee says that at the time of compiling the bill, opponents argued that by changing it from an industry-wide reinsurance programme with a deductible of $10bn, as originally proposed, to an insurer-specific backstop where assistance can begin as low as $5m, there was almost a guarantee that no reinsurance would develop and the act would have to be extended.

European arrangements

Long-term pooling systems work effectively in London and Spain, a point dramatically proven by the Madrid bombs in March. The Spanish insurance pool - Consorcio de Compensacion de Seguros - covered all of the estimated 20m losses. The UK set its pool up in 1993 as the market withdrew cover after a series of IRA bombings.

For the US, the issue of Tria is not just about the hard business issues but also about coming to terms with the threat of terrorism. The natural catastrophes that are currently covered by some level of state intervention (hurricanes in Florida and earthquakes in California) are much less emotive issues. It also has to be noted that the deductibles for Florida homeowners are much higher than they were for Andrew (the Insurance Information Institute says the hurricane deductibles in coastal Florida areas range from 2%-5%) - so everyone takes a greater share of the risk. This is easy to comprehend when living in a high-risk area such as Florida, but harder to organise when the event has the unpredictable and random nature of terrorism.

For the American government, a decision on Tria looms - and in an election year, the need to avoid major controversy is paramount. The Florida hurricane arrangements, as well as European examples, show that pool arrangements can work. However, in the US, it seems the issue is whether the system is to be changed permanently or if there is only the political will for short-term change.

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