RiskProf

Optional Federal Charters

As I mentioned last week, we finished a study for the ACLI available at ssrn.com, on the economic effects of an OFC.  I was interviewed for a podcast by Ray Lehmann for AM Best and the podcast came out Friday.

Here is the abstract for our study...

We examine the likely effects of an Optional Federal Charter (OFC) regulatory system on competition in the life insurance and annuities industry and related markets. Increasingly, many US insurers advocate the creation of an OFC and the associated regulatory framework for several reasons. Primarily, they believe that the adoption of an OFC would reduce the costs and impediments imposed by the current state-based regulatory system. Further, they believe that the adoption of an OFC structure will facilitate interstate operations and enhance the industry's competitiveness relative to other financial service providers and international insurers. The proposal of an OFC system has generated an intensive debate on a number of issues, including its implications for market competition and the associated effects on consumers. Based on our analysis, we conclude that the life insurance industry is structurally competitive based on its inherent characteristics but that many insurers have not fully achieved maximum efficiency due, at least in part, to the barriers and costs caused by state regulation. Our analysis further leads us to the opinion that the creation of an OFC, properly structured and implemented, would likely increase competition in the US life insurance industry, the broader market for financial services, and international insurance markets.

The report itself is quite long (about 150 pages) with tables and charts.

Clearing the Decks

We've had a busy fall so far here at Riskprof.  A number of papers and studies have come out on topics of interest.  Posting will resume shortly, but I thought I'd provide some links to the things we have done most recently.  We have mix of selections sure to please the academic, the policy wonk, and the geek in us all.

• Grace on some insurance aspects of the California wildfires (On Marketplace 10/23).  Hear the Riskprof.  Is that really what my voice sounds like?
• Grace and Robert W. Klein on an Optional Federal Charter for the Insurance Industry.  I will post it on SSRN asap, but for now there is a link here.  This project was funded with a grant from the American Council on Life Insurers who favor an optional federal chartering plan.  We speak only for ourselves and not necessarily for the ACLI.
• Grace and Andreas Milidonis on Tax Deferred Catastrophe Reserves forthcoming in the ASTIN Bulletin at SSRN.  This is not like the recent proposal touted by the NY Insurance Superintendent which no one likes.  Our analysis is on a tax deductible reserve that I think everyone likes (except the U.S. Treasury).
• Grace and Richard Phillips on Regulator Performance in the Journal of Banking and Finance forthcoming [ungated at SSRN].  [We test whether the past or future labor market choices of insurance commissioners provides
  incentives for those in states with significant price regulation to favor or oppose the industry by allowing prices that differ significantly from what would otherwise be the competitive market outcome.  So is there a revolving door?  Read and find out.]
• Grace and Robert W. Klein on Facing Mother Nature in Regulation.  A pithy discussion of why Florida insurance regulation and markets are "messed-up."  [N.B. I think "messed-up" is now a proper technical term for the situation in Florida.]
• Lars Powell on the Assault on the McCarran-Ferguson Act and the Politics of Insurance Post-Katrina for the National Association of Mutual Insurance  Companies. The title tells it all!
• Ty Leverty, Yijia Lin &  Hao Zhou, WTO and the Chinese Insurance Industry at SSRN.  Membership in the WTO didn't seem to impact the impressive productivity gains made by the Chinese industry over years 1999-2004.

Wharton-Georgia State Project in NYTimes

One of the reasons my posting has been so slow this summer is that I have been working on a project with colleagues at Wharton and at GSU.  We get a nice mention in a Op-ed in yesterday’s New York Times.  The Op-ed was written by Howard Kunreuther, our fearless project leader, and I’d like to discuss the principals our project is taking as a basis for our analysis.

Principle 1: Risk-Based Premiums. Insurance premiums should be based on risk to encourage individuals to reduce their vulnerability to catastrophes.

Principle 2: Dealing With Equity and Affordability Issues. Any special treatment given to lower-income residents in hazard-prone areas should come from general public funding and not through artificially low rates.

These two principles are, of course, strongly related.  One can’t have risk based prices with subsidies.  What is interesting about the principles is most policy makers seem to think that these are not all that important.  It may be because everyone in Florida wants someone else to pay for their unique Florida risks.  Second, many also think that the insurance industry should “pay” for affordability merely because they had profits last year.

What is interesting is that by separating the affordability issue from the risk based pricing principle, we expressly do not socialize insurance.  If affordability is a social problem, then it is a social problem and not something to force the private market to fix.  Second, if we have risk based prices, the people in high risk areas have an incentive to change their behavior to reduce risk. 

A program with a similar set of policy principles is the food stamp program.  The government doesn’t force “Big Potato”,“Big Beef” or even “Big Veggie” to keep prices low because people can’t afford food.  Instead, for those of limited means, an income subsidy is provided for a certain amount of food.  One can argue that food is a greater necessity than wind insurance and that we haven’t attempted to socialize food production.  We already know that experiment has been undertaken and has a 0.000 batting average.  What makes one think it would be any different with wind insurance? 

Global Warming Redux

I was quoted in yesterday's Financial Times ($).  Allianz and the World Wildlife Fund came out with a joint study that said the insurance industry should do more to provide a solution.

Here are some insurance company highlights...

American International Group (AIG) unveiled a new climate change strategy on May 15, 2006. AIG is the first U.S. insurer to publicly state a belief that there are risks and opportunities as a result of climate change, and their new program includes: improved sophistication of catastrophe exposure modeling; allocation of additional private equity investments to projects, technologies, and other assets that contribute to GHG emission mitigation; generation of tradable carbon credits; development of risk management/derivative products to support the carbon market; continued offering of environmental remediation and environmental liability insurance; among many other things.

Fireman’s Fund Insurance Company is in the final stages of developing several new “green”products that seek to minimize environmental and climate impact, while also garnering bottom-line benefits for FFIC and its customers.The first product is a new property insurance policy for LEED or Green Globes Certified buildings. This new  coverage will specifically apply to the unique attributes of green buildings not covered by conventional property policies, such as solar panels, green roofs, and recycled water supply systems. Because green buildings are proven to be less prone to water damage, electrical fires, or full loss due to fire, FFIC will offer a rate credit of 5% to these building owners.

Traveler’s Auto Insurance announced in February, 2006 that it would offer a 10% discount on auto insurance to drivers of hybrid-electric vehicles. The company also developed an online community for hybrid drivers called www.hybridtravelers.com. The firm sees this move as an opportunity to gain market share with the LOHAS (Lifestyles of Health and Sustainability) market, a $227 billion market segment.

AIG's activities sound impressive, but probably are not going to have a big effect on global warming as other than the tradable carbon market, AIG is focusing on understanding risks better and pricing them more accurately.  Travelers approach looks like a marketing campaign, but it is not clear if "greens" drive more safely than "browns". The one which seems to make a bit of sense is the program by Firemans Fund to reduce premiums (due to lower expected loss costs) for green buildings.  However, the green buildings according to the Risque-wife are "wicked" expensive.  Evidently there are only 500 of these certified green buildings --in part due to their expense.  So, whether there is any large effect on climate change it is not likely to be testable. 

I wonder what is driving this insurance/global warming linkage.  I am in favor of the industry pricing risk better but it is not likely to  be a source of a social subsidy for high cost low carbon project unless the projects have a lower risk of loss.