Government and Industry Insurance Programs

Study guides: Exam 6C, Exam 6U, Exam GI-201

Government and Industry Insurance Programs are arrangements in which a government, or the insurance industry acting collectively under a legal mandate, provides, backstops or guarantees coverage that the voluntary private market will not supply at an acceptable price, or at all. Each exists to correct a specific market failure — correlated catastrophe risk, adverse selection, the availability problem created by compulsory insurance, or insurer insolvency.

\text{Loss} = \text{Retained} + \text{Private layer} + \text{Program layer}

• Reading the structure. Every program answers who pays which dollar of loss: the insured's retention, the private insurer's layer, and the program's layer. For social insurance the program takes the whole loss; for a backstop it takes only the tail; for a residual market it takes the risks, not a layer.
• Four roles a program can play:
  • Government as insurer — workers' compensation boards in Canada (and monopolistic state funds in a few U.S. states), public auto in four provinces, Employment Insurance and health care, the U.S. National Flood Insurance Program, federal crop insurance and Canada's AgriInsurance.
  • Government as reinsurer or backstop — TRIA for terrorism, the Florida Hurricane Catastrophe Fund, and post-disaster aid such as Disaster Financial Assistance Arrangements.
  • Industry residual markets — Canada's Facility Association, risk sharing pools and Quebec's PRR; the U.S. automobile plans, property FAIR plans and workers' compensation pools (see Residual Market).
  • Industry guaranty funds — PACICC in Canada and the state guaranty associations in the U.S., both largely funded by assessments after a failure (Guaranty Funds).
• Private delivery of public risk is common: NFIP policies are sold and serviced by private "Write Your Own" insurers, crop policies by private approved insurance providers reinsured by the federal government, and Facility Association policies by servicing carriers. The program bears the risk; the private sector supplies distribution and claims handling for a fee.
• Evaluating a program (Government Program Evaluation): does it meet its objective; is it solvent and sustainable without hidden subsidy; is it efficient and stable; how does it interact with the private market (crowd-out, complement or backstop); and how does it manage Moral Hazard — subsidised flood premiums, for instance, weaken the incentive not to build in floodplains.

Terrorism Loss Under TRIA An insurer's direct earned premium in TRIA-eligible lines last year was \$500 million. A certified act of terrorism causes it \$400 million of insured losses; industry losses exceed the \$200 million program trigger. The insurer deductible is 20\% of prior-year premium and the federal share is 80\% of losses above it. Split the loss.

Answer

\begin{align*}
\text{Deductible} &= 0.20 \times 500 \\
&= 100 \\[4pt]
\text{Federal share} &= 0.80 \times (400 - 100) \\
&= 240 \\[4pt]
\text{Insurer retains} &= 100 + 0.20 \times 300 \\
&= 160
\end{align*}

The insurer bears \$160 million (40\%), the Treasury \$240 million — and federal payments may later be recouped through surcharges on policyholders. By capping the tail, the program is what lets private insurers keep offering terrorism cover at all: it is a backstop to the voluntary market, not a replacement for it.

One Risk, Two Delivery Models Workplace injury is covered by a compulsory, no-fault program in both Canada and the United States. Contrast how the two deliver it and what that means for the private market.

Answer Canada: each province runs an exclusive board — a monopoly founded on the Meredith Principles. Employers pay assessments set by rate group with experience rating; private insurers write no primary workers' compensation. There is no residual market because there is no voluntary market to fall out of.

United States: in most states private carriers write the coverage in a voluntary market, alongside competitive state funds, self-insurance, and a handful of monopolistic state funds. Employers the voluntary market declines go to an assigned-risk residual mechanism whose results are shared among writers.

Evaluation: both keep the no-fault, exclusive-remedy bargain. The Canadian model trades competition for universal availability and low distribution cost, and pushes solvency risk onto the board's funding policy. The U.S. model preserves price competition but creates a residual market whose size signals rate adequacy — and a solvency exposure to private insurers that guaranty associations must stand behind.