Irrational Economist_ Making Decisions in a Dangerous World - Erwann Michel-Kerjan [152]
23 See Kunreuther, “The Case for Comprehensive Disaster Insurance,” esp. pp. 154- 157; and Moss, “Courting Disaster,” pp. 345-351. See also David Moss, Testimony Before the U.S. Senate Committee on Commerce, Science, and Transportation, Hearing on Insuring Terrorism Risks, Panel II, October 30, 2001.
Chapter 19 Jaffee: Catastrophe Insurance and Regulatory Reform After the Subprime Mortgage Crisis
1 See Kunreuther and Pauly (2006) and Jaffee, Kunreuther, and Erwann Michel-Kerjan (2008). The former considers possible government actions to rectify such shortcomings, including a comprehensive all-risk catastrophe insurance plan, whereas the latter examines the possible role of long-term insurance.
2 Direct losses on subprime mortgages have been estimated at about $500 billion, representing a one-time loss of only about 1 percent averaged across all U.S. investment portfolios. The systemic aspects of the crisis arose because the losses were highly concentrated in the portfolios of a small number of financial firms that were then threatened with bankruptcy, thereby creating a contagion to other interconnected financial firms and markets.
3 In most cases, insurers simply discontinued the coverage. One factor is that unexpected losses bring into question whether the proper model is being used, so ambiguity aversion may be involved. Capital market imperfections provide another set of factors. In particular, investors may be unwilling to provide new capital for fear it will be used primarily to pay off existing losses, a form of the debt overhang problem from corporate finance.
4 See Kunreuther and Michel-Kerjan (2009) for an extended discussion.
5 TRIA has created provisions for the U.S. Treasury that allow it to recapture some of its expenditures by imposing surcharges on all property and casualty insurance policies in subsequent years. It is unclear, of course, whether these fees will be imposed in the event of an actual terrorist act. In any case, they would apply to all policies and thus would not be risk-based.
6 TRIA does include biological, chemical, nuclear, and radiological risks, but insurers are not required to cover these risks under the “make available” clause, and very little such coverage is available.
7 The subprime mortgage crisis, however, has bankrupted large financial firms, whereas few insurers have been bankrupted in recent years as a result of natural disasters or terrorist attacks. Nine insurers reportedly became bankrupt as a result of the 1992 Hurricane Andrew, and one insurer of significant size, Poe, was bankrupted by Hurricane Katrina; on the other hand, no insurer or reinsurer bankruptcies occurred as a result of the 1994 Northridge attack or the 9/11 terrorist attack. The latter findings indicate that the catastrophe insurers were adequately capitalized for these events.
8 This is in line with earlier plans for governmental excess of loss insurance suggested for natural disasters. Alternatively, the problem could be solved if the lenders issued catastrophe bonds, but to date the markets for these bonds remain too inefficient for this application.
9 The American International Group (AIG)—in effect, a hybrid consisting of an insurer and an investment bank—also deserves comment, since it, too, has suffered enormous losses by insuring CDO and CDS subprime mortgage risks, and without appropriate regulatory controls. As a result, the firm has received an extremely costly government bailout. Literally, more taxpayer money was spent to save this company than was provided to victims of the 2005 hurricane season—the most devastating season in