Disaster insurance for governments

The condo building collapse in Florida made me wonder about something. Individuals can get insurance for just about anything, if they’re willing to pay for it. Standard homeowner’s or renter’s insurance will cover damage or loss from a lot of causes, and then there’s stand-alone policies, such as flood insurance. There’s also policies of various kinds for businesses and business needs.

What about local governments? I know that some, at least, are self-insured for many things. But what about disasters? Taking this building collapse as an example, that will impose unexpected costs on the local government. Is there any kind of standard market analogous to homeowner’s insurance, where a city or a county can go to an insurance company, and say, “We know that a tornado/major sinkhole/whatever is just a matter of time, and we would like an insurance policy to help cover those costs to our budget, whenever they occur”?

Disaster insurance rarely works. Insurance works when 1000 houses pay for (say) fire insurance and one house per year burns down.

That gets turned on its head if 900 houses burn down at the same time.

I have seen insurance companies sell insurance for things like hurricanes but I cannot think of a time where they have been able to payout on those policies if such a disaster hits. 50,000 people asking for $250,000 each to rebuild their home is more than any company can afford. The insurance company usually runs to court and/or the government and tell them they literally do not have the money to make good on those policies.

Governments can buy insurance same as anyone else for (say) an individual building they own but insurance to cover major disasters…I doubt anyone out there will sell a policy for that. Maybe they could go to something like Lloyds of London which specializes in odd insurance policies but the premiums would likely be so high as to not be worth doing.

I’m not sure that’s necessarily right. If 1000 homeowners in one community buy flood insurance from one company and the dam breaks and washes the town away, the company may not be able to pay.

But they don’t, or shouldn’t, work that way. An insurance company should insure a bunch of homes, but not too many. Other companies can insure other homes. If the homeowners are buying their insurance from a bunch of different companies, then it can work.

At the same time, no one insurance company should be selling their insurance into just one community. Those companies selling flood insurance should be selling flood insurance into a great many communities all over. Then if one community floods, the insurance companies are not wiped out.

Insurance companies accomplish somewhat the same thing by “re-insurance”, that is, by insuring one another. Then if one company gets hit with massive claims, other insurance companies are going to be helping pay for it.

I was going to mention reinsurance, which is insurance for insurance companies.

The key word here is re-insurance. Insurers who underwrite very large risks, such as hurricanes, get their own insurance in turn from another insurance company (or several of them, distributing the risk among a larger group). This is called re-insurance, and the market certainly exists. Specialised re-insurers are financial behemoths owing to the enormous amount of reserves they build up as long as the risk they’re taking up doesn’t materialise; it’s simply that the general public is often not aware of them, because as a private customer you wouldn’t ever have a chance to deal with them. The global market leaders in this highly specialised field of finance are Swiss Re and Munich Re; the latter, founded in 1880, has kind of a legendary reputation because it underwrote large parts of the 1906 San Francisco earthquake, and survived the hit.

In the UK, and I suspect that also in the US, Governments don’t insure anything. There comes a point at which the premiums just aren’t a good investment, and if you have sufficient funds to cover most of the worst that can happen, it is superfluous.

Local government may well rely on being bailed out by Central government but they will have (or should have) a contingency fund to cover most eventualities.

The reinsurance mentioned above is exactly the same as a bookie laying off bets if their risk is more than they can bear.

I don’t think this is true in this sweeping generality. NASA, for instance, buys insurance for the launches to the ISS which it conducts (or rather, contracts to be conducted by private companies, since NASA does not currently have its own capabilities to shuttle payload to the ISS). There are highly specialised insurers for this kind of activity. See here.

The biggest issue with hurricanes is the idiotic distinction that insurance policies make between “wind and rain” and “flood” damage. Most homeowners policies will cover damage caused by wind and rain – i.e. rainwater blown into your home through a broken window. But you need a separate flood insurance policy for damage caused by rising floodwaters entering your home, and those policies are only required in certain areas at higher-risk for flooding. For Hurricane Harvey, about 80% of homes suffering flood damage did not have flood insurance.

From a quick read of the link, The government bears the loss of the payload while SpaceX, a non-government body, insures their losses.

In this case, since SpaceX was handling a government payload, the U.S. government bore the cost of the cargo directly, which was $110 million according to CNBC. In the event of the loss of the rocket itself, there are space insurers who provide policies for these scenarios. In this particular incident with SpaceX, Starr Aviation insured them.

Sure, but since SpaceX is a contractor of the government, whatever cost SpaceX has will be factored into their pricing. NASA as a government agency has the choice between two options: Buying the launch from an uninsured contractor, or buying it from an insured one. In the latter case the risk will be higher but the price lower (since the cost of the insurance policy doesn’t get factored into the price NASA pays). Economically it’s the same thing as if NASA buys the policy directly.

I’d be very surprised if that happens routinely. Insurance companies know they shouldn’t write policies for every home in an earthquake zone. Sometimes they write too many and get in trouble. The Northridge earthquake in California 20 (or so) years ago was an example. One major insurance company got hammered. People alleged they started playing hardball on claims to avoid huge losses. There were many lawsuits. But I don’t recall any effort by the company to run to the government or courts to relieve them of the burden they freely accepted when people were paying premiums.

Some companies do get in over their heads after a major disaster. It’s a big deal and usually taken very seriously. It’s not just shrugged off.

Receivership proceedings are usually commenced against insolvent or financially impaired insurer in the insurer’s
domiciliary state (the state in which the insurer is incorporated) and in specific courts within that state, generally
either the court in the judicial district encompassing the state’s capital or the judicial district of the insurer’s
principal office. The NAIC Model Acts require that the chief insurance regulator of the insurer’s domiciliary state
be appointed receiver of the insurer to administer the receivership under court supervision.

I somehow doubt that there are many rivals for the business.

When placing a contract of this magnitude, insurance would possibly be a factor, but it would be a long way down the list. In any case, Other potential contractors would need to hedge their bet in some way.

I recall that in the UK, there have been multimillion Pound contracts placed where the government act as an insurer, effectively guaranteeing any potential loss. This is not generally considered to be good practice but some things are effectively uninsurable.

It’s true that many governments, as part of a policy of promoting exports, will guarantee to indemnify domestic producers for losses that they suffer in cross-border deals as a result of political risks (e.g., a foreign government expropriating assets of that producers located in the foreign government’s jurisdiction); the German government does this, for instance, under the Hermes brand. My point is simply that the scope of uninsurable (on the private market) risks is much smaller than one might be inclined to think at first glance; commercial insurance cover is available even for very large-scale risks. Those are tailor-made rather than off-the-shelf policies, of course, but they exist. Re-insurance is the mechanism by which insurers will pass off parts of the risk to others if it’s too large to be borne by one single company. A notorious example is provided by the Piper Alpha incident of 1988, when an oil rig in the North Sea exploded. The $1.4bn insurance bill ended up wrecking a number of Lloyd’s of London syndicates (which, at the time, still included many private individuals as members with unlimited liability).

Another example is provided by catastrophe bonds. Essentially, they’re bonds - issued and sold on the securities markets - that contain a clause according to which the bond will not (or only partially) be repaid if a specified disaster occurs. This risk is, of course, factored into the coupon of the bond. It’s a speculative tool, but it is used to distribute very large losses amongst a very large number of investors.

Quite generally, insuring risks (and putting a price tag on this insurance) is something that financial markets do routinely. They don’t always get the pricing right, but it is done.

Generally speaking, state and/or federal governments step in when the city/county governments can’t handle the disaster.

Another thing to consider is that the costs may not be as high as you think; in Dallas when there was a severe thunderstorm and a tornado hit a couple of years ago, the city costs were almost all centered around tree removal and disposal, as well as whatever police and fire costs were associated with the immediate aftermath. There was one fire station that was pretty well destroyed, but most of the damage was to non-City buildings and infrastructure. From what I could tell, it wasn’t outside of the City’s existing budget to handle- the hardest part was getting enough crews and space to actually remove the trees and dispose of them in a timely fashion- they had to hire out of state crews and companies to come do it for months on end.

Disclosure: I work for an insurance company, but not in claims or underwriting, but it rubs off on me.

We certainly have governments (school districts, one example) to which we provide property insurance, including “catastrophe” coverage. And indeed we have paid claims to them for hurricanes.

Some have mentioned reinsurance, and that is certainly the primary, easiest way of spreading risk. There are different ways to structure a reinsurance contract (called a treaty). For example, the primary insurer could cede anything over $500K in value, so that a $2 million claim would only hit them for the first $500K. Or get a catastrophe reinsurance treaty where any catastrophe as defined (could be hurricane, tornado, earthquake, wildfire) is covered, or at least shared.

For expensive properties needing many millions of dollars of coverage, there is layering: for example, suppose a $100 million dollar hotel. My company make take the coverage for the $25M to $30M layer; if a loss causes only $15M in damage, we don’t pay a loss on the claim; if it’s a complete loss, we’re “only” out $5M.

Beyond reinsurance, money is set aside (“incurred but not yet reported”) for those rainy days. Just how much to set aside is determined by teams of actuaries and data scientists. Insurers have many, many, many millions set aside (invested in Treasuries, etc) for these unexpected, once-in-a-hundred-years losses.

Just to comment that in New Zealand, there is a Earthquake and War Damages Commission, which has been in existence since 1945, and ensures that insurers can pay out claims for natural disasters like earthquakes. This commission is funded by a levy on property insurance premiums paid, which is used for both it’s own funds and to purchase reinsurance. The New Zealand Government is the insurer of last resort in the event that the EQC cannot meet it’s obligations.

As a result of the Canterbury earthquake sequence and the Kaikoura earthquake, the fund is currently in a rebuilding stage. Hopefully none of the Auckland volcanos decide to erupt before 2030 …