8.3.4.1. Adaptation Mechanisms: Risk-Spreading
Public and private insurance is inherently a risk-spreading mechanism. Insurers
also can spread risks through reinsurance, depending on its availability and
price. Losses associated with uninsurable risks, or unpaid claims in the event
of insurer insolvencies, often are partly spread to the community through disaster
relief or guaranty ("solvency") funds. State-managed guaranty funds—to
which insurers must contribute—are used for specified catastrophe losses
in France, Germany, Japan, The Netherlands, the UK, and the United States (III,
2000a; Swiss Re, 2000a). Of the 25 largest U.S. P/C insolvencies (amounting
to US$5 billion in claims), 29% of the losses were recoverable through guaranty
funds; national capacity was only US$3.4 billion as of 1998 (NCIGF, 1999). In
the United States, the property insurance residual markets known as Fair Access
to Insurance Requirements (FAIR Plans), Beach or Windstorm Plans, and joint
underwriting associations (JUAs) represented insured property value (exposure)
of US$24 billion in 1970 and US$285 billion in 1998 (III, 1999; Gastel, 2000).
Although risks also can be spread between public and private insurers, governments
have elected to cap their exposures by formally limiting government-paid losses
for weather-related events in the United States (GAO, 1994; Pullen, 1999b; III,
2000b) and earthquake losses in Japan (Gastel, 1999). Governments also are trying
to reduce their insurance and disaster recovery spending (ISO, 1994b, 1999;
FEMA, 2000).
Nonconventional "alternative risk transfer" (ART) mechanisms have begun to
emerge and are regarded by some banks and insurers as playing a role in the
continued viability of insurance (see Section 8.4). On
the other hand, some insurers, consumers, and members of the financial community
question the efficacy and attractiveness of these new risk-spreading mechanisms
(Tol, 1998; Peara, 1999; Swiss Re, 1999b; Bantwal and Kunreuther, 2000; Freeman,
2000; GAO, 2000a; Jamison, 2000; Nutter, 2000).
"Moral hazard"—a pervasive issue in the industry—results
when, by virtue of adaptation efforts or the very availability of insurance
(or reinsurance or government aid), the insured feels less compelled to prevent
losses (White and Etkin, 1997; Ryland, 2000). Government programs have been
faulted for unintentionally encouraging such maladaptation and risky behavior
(Anderson, 2000; Changnon and Easterling, 2000). For example, it is estimated
that one-quarter of the development over the past 20 years in at-risk areas
along the U.S. coastline is a result of the presence of the National Flood Insurance
Program (Heinz Center, 2000). Moral hazard also has been ascribed to primary
insurers or reinsurers who rely excessively on state-maintained guaranty funds
(Kunreuther and Roth, 1998; Swiss Re, 2000a).
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