Public-Private Partnerships Bring Solutions to Covering Emerging Risks Worldwide
Novel classes of risk on the horizon could create a situation that is just too large for the insurance industry to handle on its own. Partnerships between the public and private sectors, such as those in Florida and California, could step in as needed to fill any gaps.
- Terrence Dopp
- November 2021
- Problem: Climate change has made a host of extreme weather, such as California wildfires and rain storms in the Northeast U.S., both more severe and more costly.
- Potential: Insurers could balk at covering emerging risks if they deem them too large or price them out of the reach of many consumers.
- Solution: The answer could lie in the creation of new partnerships between the public and private sectors designed to defray the costs involved in covering these risks.
Tim Richison remembers the night in 1996 in a San Francisco hotel bar when he and a group of others from California's insurance industry, Legislature and state regulators jotted down on several cocktail napkins the initial structure that would form the California Earthquake Authority.
The problem was simple: After the 1994 Northridge earthquake, homeowners insurers were balking at providing the earthquake coverage California required them to offer along with normal property policies. Some pondered pulling out of the homeowners market altogether. As a result, the public sector created a structure where, in partnership with the private sector, it would aggregate the risk and provide that component of an insurance policy.
As Richison, the former chief financial officer of the CEA, sees it, the organization is a good example of a tailored approach used to alleviate a localized or regional issue rather than creating one overarching insurance solution under the climate change heading.
With climate change accelerating catastrophes and exacerbating some historical perils such as hurricanes and wildfires, the insurance industry is likely to explore new public-private partnerships to cover a range of hazards that have grown too large for companies to take on themselves, Richison said.
Insurers and government entities in the U.S. and Europe have begun working on public-private partnerships to address pandemic risk. Convex Chief Executive Stephen Catlin last year called on the insurance community to be proactive in finding a long-term solution to pandemic losses that has become known as Pandemic Re. It was designed to develop a public-private partnership solution for pandemic losses. Catlin said the effort would be a natural follow-up to Pool Re, the U.K.'s terrorist pool.
Meanwhile, in the U.K, Pool Re launched Re:New, an advisory group it said will explore how to protect the U.K. economy from systemic risks. Bringing together experts from insurance, government, industry, academia and elsewhere, Re:New will examine how the insurance industry, private sector, public sector and the public can work to better protect the United Kingdom from the economic consequences of systemic risks such as climate change and cyberterrorism, Pool Re said in a statement.
Re:New will develop recommendations in the form of reports focusing on how the country can become more resilient before the next systemic risk strikes, considering the intellectual, commercial and political challenges faced by the insurance industry and related fields, Pool Re said.
AM Best believes a combination of innovation, public-private partnerships and third-party investors can create the conditions for insurers to consider coverage of what are now uninsurable risks, AM Best Senior Director Carlos Wong-Fupuy said during an AM Best Rendez-Vous de Septembre market briefing. In the meantime, third-party investors have shown more interest in assuming some risk because interest rates remain low, he said. Analysts at the briefing also said the new entrants to the market have shown underwriting discipline that has benefited reinsurers with healthy pricing.
In the Northeast U.S., Richison said, emerging patterns may cause concerns over the intensity of thunderstorms or flooding situations. An example of the growing peril came in September when Hurricane Ida lashed the U.S. and its remnants caused heavy rains and flooding across the Northeast. Verisk's AIR estimated Ida-related damage would total $30 billion.
In the West, the issue involves droughts and resulting wildfires that have proven more costly than in the past. Since the beginning of the year, more than 7,800 wildfires have burned more than 2.48 million acres in California, according to Cal Fire.
“You can break the climate risk down into components as it affects each particular region of the United States,” said Richison, who helped found and lead the CEA. “When you do that, then it becomes a risk that you can get your arms around a little bit and you can put some science behind it. And you can possibly be able then to provide insurance from a public-private perspective and then spread the risk around the world through the reinsurance industry.”
Richison said public-private partnerships make sense when facing new perils for which the industry doesn't have a wide swath of experience to model things like frequency, severity and accurate pricing. Like the changing planet, public-private partnerships also are not a monolithic bloc and can take on various structures or forms.
AM Best believes a combination of innovation, public-private partnerships and third-party investors can create the conditions for insurers to consider coverage of what are now uninsurable risks.
Two states have emerged as shining examples of public-private partnerships to solve problems that had stymied the industry.
In California, the intent was to have the state assume a portion of coverage, the aforementioned earthquake policies, that private insurers argued had become too costly for them to handle on their own.
In Florida, where hurricanes have long been a damaging and costly issue, the state took two parallel measures to address adverse impacts on both the industry and cost of coverage.
It created the Florida Hurricane Catastrophe Fund, a tax-exempt state trust fund that provides reimbursement to residential property insurers for a portion of their Florida catastrophic hurricane losses. Funding is derived primarily from premiums paid by residential property insurance companies, and, in some circumstances, revenue bonds backed by emergency assessments on a variety of property and casualty insurance premiums.
The Sunshine State also created Citizens Property Insurance Corp., an insurer of last resort that provides homeowners policies to those who are unable to secure them on the private market. The costs of that program are then spread to all statewide policyholders through post-catastrophe assessments.
On the federal level, the biggest example is the National Flood Insurance Program, which was created to fill the void left when private insurers were no longer willing to take on flooding risk in areas where it is a repeated threat. Under the program, homeowners pay premiums to the agency and, as needed, the agency can petition Congress to replenish its funds.
Christopher Graham, senior industry analyst with AM Best, said states have used public-private partnerships in areas such as workers' compensation or automobile insurance, which are ripe for such structures because they are compulsory. Risk is growing more expensive in some cases, he said.
Graham cited flooding coverage in areas where hurricanes are most prominent in both frequency and severity. Florida serves as a case in point: While it has about a third of the value at risk, only 15% of all private U.S. flood insurance is written in the state. Texas and Louisiana also stand out as states where the amount of insurance written is less than the property exposed, he said.
In a recent Best's Market Segment Report, Appetite for Flood Risk Among Private Insurers Still Small, Graham found the flood coverage market is slowly shifting toward more private sector involvement, although 70% of overall flood premium is commercial exposure.
“It seems that where the private carriers have gotten involved in flood coverage, it's been away from the coastal areas,” he said. “That tells me there's a little bit of hesitancy on the part of the private carriers to get involved with flood insurance in hurricane-prone states.”
He pointed to the remnants of Hurricane Ida as an example of distinct perils arising in different locations. States such as New Jersey and New York, which are not typically associated with frequent hurricane flooding, were hit more acutely than the usual suspects.
“It's hard to forecast flood,” he said. “This is why it's always been deemed commercially uninsurable by the insurance industry in general. I think we're seeing it here.”
In the case of the two Florida entities, both have benefited from having the ability to levy post-event assessments on all homeowners policies statewide if they need to replenish their accounts. As for the NFIP, it retains the ability to take in federal money if it finds itself low on funding.
Glenn Pomeroy, the current chief executive officer of the CEA, said those funding mechanisms are strong points of the programs. Ensuring such a structure is vital to the long-term viability of any public-private undertaking, he said.
Regardless of the structure, he said, entities such as the CEA serve a vital purpose and will prove an important part of the larger insurance industry.
Pomeroy said as risks continue to grow and the insurance industry struggles to juggle consumers' needs for coverage with its own ability to effectively provide it, he sees public-private partnerships stepping into the breach as in his home state.
“You couldn't just sit by while all the companies just decided to not sell homeowners insurance anymore,” Pomeroy said. “You wouldn't have any housing market pretty soon.”