Congress has appropriated $40 billion as a down payment on the recovery from the World Trade Center disaster, with $2.5 billion expected to help prop up the hard hit airline industry. But with that much money up for grabs, some lawmakers have begun suggesting that the insurance industry should also receive a bail-out from this appropriation.
Now, I can understand helping the airline industry; their losses weren’t even directly caused by the terrorists, but by the resulting shutdown of U.S. airspace as a security measure. But the insurance industry? Isn’t that their business, to take the risk? Why should they be bailed out? They received billions in premiums from the insured, which they presumably have invested. Why should the U.S. taxpayer assume the risk and foot the bill, and the insurance industry gets to keep the premium? If this is the case, why do we need insurance companies at all, if the ultimately the U.S. government is going to insure everybody against catastophic terrorist losses? I think this would set a terrible precedent that would send the insurance industry to the teat of government bail-outs every time we have a catastrophic loss (earthquake, hurricane, etc).
Actually, the industry is expecting a huge drop off is air travellers as a result of the hijackings. ABC reported that some carriers expect an initial 50% drop off in new bookings in the first few months.
Insurance companies don’t keep reserves to cover all possible incidences. If they did, your premiums would increase by a factor of at least 10.
There are a variety of ways of establishing appropriate reserves. But as a rule of thumb, the aim is to keep the probability of insolvency down to less than 1%
Now this may sound like a small chance. But if you think about it, it’s really saying that you expect insolvency around about once a century. Surely this is a problem?
The answer is no, because insurance companies know that a country’s economy relies critically on a healthy insurance industry. They further know that the kind of events that lead to the once-a-century disaster are the exact events that will mean that ALL the insurance companies will be in similar financial dire straits. The government cannot allow the insurance industry to fold, so it must bail it out.
The whole thing is a kind of symbiosis. It allows premiums to remain at an acceptable level so that companies can continue to manage their risks and it means that the insurance companies don’t need to be paralysed by fear. It’s a kind of informal unspoken reinsurance arrangement.
The Complicated Answer
You really don’t want the 1000 word treatise on the insurance industry. Trust me on this one.
I’m going home now. If it seems that tomorrow the hastily sketched graph argunment above hasn’t sufficed, we’ll have to proceed to the calculus side of the argument instead.