How To Manage Long‐term Financial Self‐sufficiency of a National Catastrophe Insurance Fund? The Feasibility of Three Bailout Programmes

AuthorJo‐Yu Wang,Ming Jing Yang,Wen‐Lin Wu,Yang‐Che Wu
Date01 October 2017
DOIhttp://doi.org/10.1111/eufm.12111
Publication Date01 October 2017
How To Manage Long-term Financial
Self-sufciency of a National
Catastrophe Insurance Fund? The
Feasibility of Three Bailout
Programmes
Jo-Yu Wang and Wen-Lin Wu
Department of International Trade, College of Business, Feng Chia University, Taichung 40724,
Taiwan
E-mail: jywang@fcu.edu.tw; wlwu@fcu.edu.tw
Yang-Che Wu and Ming Jing Yang
Department of Finance, College of Finance, Feng Chia University, Taichung 40724, Taiwan
E-mail: wuyangche@fcu.edu.tw; mjyang@fcu.edu.tw
Abstract
This paper shows the feasibility that a national catastrophe insurance fund (NCIF)
may achieve nancial self-sufciency via three bailout programmes, including pre-
funding, loan-nancing and equity-nancing, to support the insurers during the
bad years. Under such programmes, different accounting procedures for the
insurers and NCIF are developed to simulate their 30-year cash ows based on the
best-tting loss model calibrated by the global insured loss data. The numerical
analysis results indicate that the proposed programmes can balance the nancial
revenue and expenditure of NCIF in the long term, and this conclusion implies the
authority can develop similar schemes as NCIF to smooth the peak risk of natural
catastrophes.
Keywords: national catastrophe insurance fund, pre-funding bailout programme,
loan-financing bailout programme, equity-financing bailout programme
JEL classification: C15, G32, G11
The authors are grateful to the Editor (John Doukas), two anonymous referees, and
participants of the European Financial Management Association (EFMA) 2016 Annual
Meeting (Basel, Switzerland) for their helpful comments and valuable suggestions.
[Correction added on 17 January 2017, after first online publication: the phrase natural
catastrophe insurance fundhas been corrected to national catastrophe insurance fundin
the Abstract, the keywords and the Conclusion section.]
European Financial Management, Vol. 23, No. 5, 2017, 951974
doi: 10.1111/eufm.12111
© 2016 John Wiley & Sons, Ltd.
1. Introduction
Natural catastrophes (NatCats) have become more frequent over the past three decades,
and they have caused a number of losses. A country needs an insurance mechanism to
respond to the economic consequences of NatCats. Kunreuther (1996) suggested a
disaster-management insurance programme to minimise losses from infrastructure
damage. It was also suggested that a new form of reinsurance coverage against
catastrophic losses from natural disasters should be created to protect insurers against
potential insolvency. Froot (2001) examined the clinical data in the US and proposed
eight explanations for why the prices of reinsurance are so high while the demand for
reinsurance is so low. Dacorogna et al. (2013) indicated that, according to the US version
of Generally Accepted Accounting Principles (GAAP) and new IFRS, insurers are
forbidden to carry equalisation reserves over to future business if no loss has occurred.
This restriction might weaken insurerscapability to respond to NatCats.
Most governments have allocated substantial resources for the improvement of
preventing and forecasting NatCats. A catastrophe insurance fund offers a different
trade-off between risk and return than the insurance products offered in the private
market, and it can increase efciency in the private market (Boulatov and Dieckmann,
2013). Cummins (1988) also suggested that guaranty funds with at premiums create
adverse incentives in insurance markets. Therefore, it would be more prudent to establish
a national catastrophe insurance fund (NCIF)
1
(or a scheme with similar functions) to
manage the large claims or losses caused by NatCats. For example, Boulatov and
Dieckmann (2013) illustrated that the involvement of disaster insurance funds and the
well-designed insurance in the NatCat market could increase the demand in the private
market. In the real world, there are many similar funds, including the National Flood
Insurance Program and the Hawaii Hurricane Relief Fund in the US; the Natural Disaster
Fund in New Zealand; the National Catastrophe Insurance Fund in Thailand; PT.
Asuransi MAIPARK in Indonesia; and the Earthquake Insurance Pool in the Philippines.
Generally, these funds have some advantages. For example, they protect policyholders
by ensuring the affordability and availability of the insurers. Furthermore, a majority of
the funds are set and operated by the government, so they will not fail even if they have
extreme losses. In this circumstance, the government needs to budget some reserves to be
used in future claims. Governments certainly cannot always cover the loss claims after
each disaster. Intuitionally, if a government must constantly pay for reconstruction in the
aftermath of every large NatCat, the countrysscal position could be weakened (Keen
et al., 2003). Generally, NCIFs and similar schemes offer some advantages in
minimising NatCat risk. NatCat risk can be diversied to insureds, insurers and
reinsurers because NCIFs would offer insurers different types of bailouts to cover large
claims. The insurers could be allowed to pay back in instalments or newly issued equity.
Thus, NCIF could be viewed as a mechanism to encourage the insurance industry to
regain normal operations after a NatCat. An NCIF ensures capacity to insurance
companies at a reasonable price in different manners.
From the perspective of NatCat risk, the actual claim size easily exceeds the expected
size by a signicant margin recently in large-NatCat years, and the annual premium is
1
In this study, the national catastrophe insurance fund (NCIF) is established as a non-prot
organisation.
© 2016 John Wiley & Sons, Ltd.
952 Jo-Yu Wang et al.

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