Catastrophe Risk Financing in the United States and the European Union: A Comparative Analysis of Alternative Regulatory Approaches

Article excerpt

ABSTRACT

The regulation of insurance companies in the United States and the European Union (EU) continues to evolve in response to market forces and the changing nature of risk but with somewhat different philosophies and at different rates. One important area where both economic realities and markets are changing is catastrophe risk and its financing. This article examines and compares regulatory and other government policies in the United States and the EU generally and their approaches to the financing of catastrophe risk specifically. It is important to understand the fundamental differences between the two systems to gain insights into their disparate treatment of catastrophe risk financing. Although policies could be improved in both jurisdictions, we argue that the much greater reform is needed in the United States relative to the EU regulatory policies that are being developed. We offer recommendations on how U.S. policies could be significantly improved as well as comment on issues facing the EU. We conclude with some observations on the needs for further progress in the U.S. and EU regulatory systems.

INTRODUCTION

The threat of "natural" and "man-made" disasters continues to grow in many parts of the world due to a confluence of factors, including population growth and economic development, climatic changes and weather cycles, geologic activity, and political unrest. At its core, the problem of catastrophe risk poses a number of challenges to mitigating its effects, financing the costs that are incurred, and responding to the needs of those affected.

The regulation of insurance and reinsurance companies, among other government policies, has significant implications for the management and financing of catastrophe risk. At present, the risk and costs of catastrophes are borne by many "stakeholders" in different ways through the interaction of the public and private sectors that affect their incentives and the efficiency of catastrophe risk management. This article examines the different regulatory systems and government policies of the United States and the European Union (EU) generally and how they address catastrophe risk financing specifically. The link between the fundamental philosophies and elements of these regulatory systems and their treatment of risk financing is important. Current policies and the prospects for reform depend on the government frameworks in which they reside.

The next two sections of this article review the basic regulatory philosophies and systems in the United States and the EU and how they differ. We then evaluate how regulatory policies in the United States and the EU address catastrophe risk financing and how these policies could be improved. We conclude with a summary of our analysis and a discussion of its implications for catastrophe risk management and the prospects for improving government policies.

SOLVENCY REGULATION IN THE UNITED STATES

Overview

Insurance regulation in the United States is rooted in its historical legacy. The states each retain the principal responsibility for regulating insurance--the federal government has the authority to supersede state regulation when it chooses but it has only done this selectively to date. (1) Principal responsibility for the financial regulation of an insurer is delegated to its domiciliary state but the other states still monitor (and can sanction) insurers operating in their jurisdictions. Each state is principally responsible for regulating the market practices of all insurers operating in its jurisdiction. The states use the National Association of Insurance Commissioners (NAIC) to coordinate and support their regulatory activities. The states are not compelled to adopt NAIC standards but have tended to do so in the financial regulation; with respect to market regulation the states have acted more independently.

The states apply a prescriptive or rules-based approach to regulating insurers' financial condition and market practices that is heavily influenced by an accounting perspective. …