In their assessments of the likely losses the Tohoku earthquake caused to Japanese non-life insurers, prognosticators revealed the companies had accumulated significant residential catastrophe reserves—something that could not be said of insurers in the United States should a similar event happen here.
U.S. generally accepted accounting principles (GAAP) prohibit the use of catastrophe reserves for future events. American International Group Inc. (AIG) referenced this fact when it provided a look at how the earthquake will cause potential losses for Fuji Fire and Marine Insurance Co. Ltd., in which AIG holds a 54.66 percent equity stake.
Fuji Fire and Marine established a catastrophe reserve of about $482 million for claims associated with earthquake damage to personal dwellings, AIG says.
According to the General Insurance Association of Japan (GIAJ), insurers must set aside catastrophe reserves for every class of general insurance except earthquake and compulsory automobile liability insurance.
Insurers in Japan are required to build up reserves until the amount reaches predicted losses from a 1-in-70-year event for natural catastrophe risks covered by a fire policy.
U.S. companies are only permitted to set aside loss reserves for events that have already occurred. Throughout at least the last decade, state regulators in one form or another have endorsed the idea of letting insurers set up catastrophe reserves, but accounting and tax provisions to make it worthwhile to insurers have not been enacted.
“There is no incentive to do it,” says Thomas Mount, assistant vice president at rating agency A.M. Best Co. Even if insurers were allowed, “the [Internal Revenue Service] doesn’t recognize it as an expense. There’s no tax benefit.”
Nor is there any incentive for insurers to write catastrophe insurance if they had to set aside cat reserves, the industry has said. Capital would be trapped for one line of business, unable to support other lines. Plus, any investment earnings related to the reserve would also be taxed.
A committee within the National Association of Insurance Commissioners (NAIC) several years ago contemplated revisiting the issue of catastrophe reserves and former N.Y. Superintendent of Insurance Eric Dinallo proposed a regulation for a state-specific catastrophe reserve fund. Congress has entertained proposals, normally after a busy hurricane season or a particularly destructive storm.
The insurance and reinsurance industries came out against the ideas from New York and the NAIC. The National Association of Mutual Insurance Companies (NAMIC) wrote to the N.Y. Insurance Dept. saying companies already retain underwriting gains in the form of policyholder surplus.
“The objective of having insurers put money aside for catastrophes in years in which they do not experience catastrophic loss is already being done,” NAMIC’s letter says.
The Reinsurance Association of America (RAA) and the Property Casualty Insurers Association of America (PCI) each wrote to the NAIC, saying there was no benefit to the public to require insurers to set aside assets for future catastrophe losses.
“Requiring the segregation of existing assets for the payment of catastrophe losses, with no additional capital being provided from a tax deduction, does not increase an insurer’s surplus, and would actually limit its ability to manage its capital for paying all claims by trapping capital that would be available only for the payment of catastrophe losses,” reads the June 2008 PCI letter to NAIC.
The reserve converts a portion of profit into a liability, the RAA says in its letter written at the same time. This would reduce surplus and the ability to write new business, which could then impact price and availability of catastrophe-exposed insurance, the letter reads.