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GOVERNMENT INSURANCE

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GOVERNMENT INSURANCE. What is it? ... Defining Features of Government Insurance ... The insured pay a small fee called a premium to the government insurance program. ... – PowerPoint PPT presentation

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Title: GOVERNMENT INSURANCE


1
GOVERNMENT INSURANCE
2
What is it??
3
A tool through which governments compensate
individuals or firms for losses from certain
specified events
  • Eligible recipients are usually charged a fee, or
    premium, to participate
  • Participation is often mandatory
  • Government insurance programs can be operated
    directly by government agencies or indirectly
    with the aid of private insurers.
  • Whether directly or indirectly involved,
    government typically bears the financial
    responsibility for covering any claims that
    exceed the pool of resources assembled in the
    program

4
Defining Features of Government Insurance
  • The risk of suffering a potential financial loss,
    usually of a relatively large amount, is shifted
    from a single household or firm to a central
    organization ie. Government agency
  • The potential loss is transferred through a
    technique called risk pooling (next slide
    explains risk pooling)
  • The insured pay a small fee called a premium to
    the government insurance program.
  • In return, the insurer agrees to pay up to a
    pre-specified amount to the insured when the
    event causing the covered financial loss occurs
    and the insured submit a claim.
  • Up until this point, same features are share with
    private insurance
  • What differentiates government insurance from
    private insurance
  • Because of certain unique powers of government,
    such as its ability to tax and compel
    participation in government programs, government
    insurance tends to be offered for risks against
    which private firms way be unwilling to insure
    (example flood insurance)
  • Private firms offer insurance to earn profits,
    insurance is often used by government to achieve
    other economic or social goals such as raising
    the income of certain constituents

5
What is risk pooling?
  • Shifting risk from one party to another (ex. From
    a car driver to a car insurer)
  • Risk pooling involves a group of individuals or
    firms agreeing to split losses when a particular
    event, such as a car crash occurs
  • The margin of error becomes smaller as the group
    sharing losses gets larger
  • (So many people involved in the pool, chances
    are low that any one participant will suffer an
    extreme loss decreases after the participant
    enters into a risk).

6
Direct vs. Indirect Government Involvement
  • Direct Government collects fees, managines the
    resulting resources, settles claims
  • Indirect Method Government enlists private
    agents to carry out some of the basic tasks-risk
    collection, risk management, and claim
    settlement.

7
Relation to Key Tool Features
  • Directness-measures the extent to which the
    entity authorizing or inaugurating a program is
    involved in executing it. (When directly run,
    the govt designs the program and retains the
    powers that determine potential govt loss
  • Automacity-measures the extent to which a tool
    utilizes an existing administrative structure to
    produce its effects rather than having to create
    its own administrative apparatus
  • Coerciveness-Measures the extent to which a tool
    restricts individual or group behavior as opposed
    to merely encouraging or discouraging it.(Govt
    can reward those insured with subsidies, but can
    also punished the undeserving by reducing their
    financial benefit
  • Visibility-Measures the extent to which the
    resources devoted to a tool show up in the normal
    budget process (Insurance is one of the LEAST
    visible policy tool. Feds do not report claims
    on taxpayers until losses occur

8
Design Features
  • What will be insured?? What will not? Ex. U.S.
    Federal crop insurance covers damage from weather
    but not poor plowing. Also covers damage to
    wheat, but not lettuce
  • How much loss protection to be offered?
  • The govt insurance program must cap the coverage
    supplied, but cap can change. US deposit example
  • Establishing if Losses are Shared
  • Theory that when an event happens the insured
    should bear some lossWhy? If the insured face a
    cost to make an insurance claim, they have an
    incentive to remain vigilant and avoid actions
    that increase the chance of making a claim.
  • Total amount of loss is capped by government.
  • Insured may have to pay a co pay or deductible

9
Design Features (cont.)
  • Who is eligible to participate?
  • Government insurance programs do not
    significantly restrict eligibility (Bank deposit
    example vs. lettuce grower)
  • Premiums vs. Cost
  • The essence of insurance is the transfer of a
    large potential loss in exchange for the payment
    of small premiums. Implicit is the notion that
    premiums will bear some reasonable relation to
    expected claims.
  • Government insurance often seeks to achieve
    social goals through the insurance tool.
  • The government can deliver subsidies to targeted
    groups by not charging the insured the amount
    needed to cover future claims. This
    undercharging represents a subsidy since no
    private firm would offer insurance at below
    market premiums.

10
Pattern of Tool Use
  • Government insurance usually provided at a very
    large scale
  • In the US, exposure is in the trillions!
  • Provision of insurance is restricted to a select
    group of risks
  • Included are risks that certain types of firms
    will go insolvent and the risk that certain
    natural or man-made disasters will damage
    property (Usually provided by National Government
    rather than state)
  • Trends-government insurance programs are large
    and continue to grow. Two biggest programs
    insure depositors and second protects households
    and businesses against a variety of natural
    disasters.
  • Government who is insuring is exposed to possible
    huge loss

11
Firm Insolvency
  • Two Types
  • 1) Insurance for depositors against the failure
    of their financial intermediaries, including
    commercial banks, firms that specialize in
    housing finance such as thrifts, and cooperative
    intermediaries such as credit unions. (100K
    guarantee to depositors)
  • 2) Insurance for pensioners against the
    insolvency of the firm that had promised them
    pension benefits. (When a firm terminates a
    pension plan that has assets insufficient to
    cover its liabilities, the federal pension
    insurer becomes the plans trustee, takes over
    plan assets, and pays the pension to plan
    participants

12
Natural and Man-Made Disaster Insurance Two
Types
  • 1) Crop Insurance-protects agricultural producers
    against losses from low yield and crop quality
    due to adverse weather and unavoidable damage fro
    insects and disease
  • 2) Natural Disaster (Flood Insurance)--covers
    losses to property from floods

13
U.S. State and Local and International Government
Insurance
  • U.S. State governments provide insurance against
    failure of a financial firm.
  • International--hard to generalize other
    countries programs, but they generally mirror
    that of the United States

14
Insurance Program Mechanics
  • Writing the Insurance Contract/Rules
  • First, policymakers establish the general rules
    on risks to be covered, eligibility, forms of
    risk sharing etc. when designing insurance
    program.
  • These features cannot remain ambiguous because
    insurance programs are legally enforced.
  • The contract and program rules allow the
    insured/insurer to understand what is expected of
    each other.
  • Hence, language is important. Legal staff is
    involved, administrative procedures, etc

15
Pricing
  • Premium rates may be the most important factor
  • (An insurance program cannot finance itself
    unless assessments charged equal expected costs)
  • Pricing influences those insured--A lower than
    appropriate premium may encourage the insured to
    take on too much risk
  • Traditionally, government insurance programs
    charge flat rate premiums
  • Even today, most U.S. insurance programs still
    rely on flat rate premiums in order to subsidize
    the insured
  • In extreme cases, state insurance programs do not
    charge premiums but try to raise revenue as
    needed
  • Some government insurance programs have taken
    steps to price factoring risk-based premiums

16
Distribution
  • Used when govt insurance programs must sell
    their products
  • When insurance is voluntary, selling method is
    the same as established by private firms
  • Govt crop and flood insurance rely on private
    companies to distribute product
  • Private firms also answer questions based on
    policies, etc for govt
  • With increased technology, many alternatives for
    private insurers to offer products--(ex. Call
    centers and internet)
  • Government must verify that third parties who
    sell their insurance do not violate industry and
    legal guidelines

17
Underwriting Will insurance be offered and in
what form?
  • At some point, the insurer must apply its
    contract and pricing schedule to a particular
    firm or household
  • Programs that use the private sector provide
    detailed guidance about how to apply the policies
    and procedures of the program
  • Nonetheless, underwriters must use subjective
    judgment--It would cost government too much money
    if they second-guessed each decision of private
    agents
  • Some practices may include screening, credit
    reports to get client info

18
Administration of Insurance, Investing Premiums,
and Reviewing Claims
  • Administration aka back office
    functions--management inflow and outflow of info
    and funds
  • Examples are accounting, customer service,
    premium collection, disbursement of claims
    premiums
  • Investing Premiums- Government insurance programs
    must determine how they invest the funds they
    receive
  • Unlike private companies, government can invest
    in its own debt because of its ability to tax and
    thus raise funds to pay off insurance claims if
    they exceed collections in any given year
  • Reviewing claims- Must determine the validity of
    claims and the amount the insurer owes the
    insured party (Called claims adjustment)
  • This can be done by private entities or
    government
  • Monitoring and Response- must be reviewed in case
    insurance for particular households or groups
    changes over time
  • Finally, managing capital is important--How much
    to hold? Insurer must have enough money on
    hand to pay claims

19
Tool Selection
  • Three major reasons why governments establish and
    manage insurance programs
  • 1) to overcome market failures
  • 2) to achieve broader social goals such as the
    prevention of banking panics
  • 3) to Foster favor with influential interest
    groups

20
Market Failure Rationale
  • Basic premise of insurance is that a number of
    people who are in the same pool will not submit a
    claim at the same time as others in the pool
  • If many in the same pool all submit claims, risk
    for the insurer could be catastrophic
  • Examples of this In the event of flood,
    earthquake, crop failure
  • If this does happen, government can borrow that
    they can repay by means of taxes
  • Government can also force participation which
    will diversify the time of a disaster or loss
  • Some factors that are uncontrollable (moral
    hazards). Ex if a family builds a house closer
    to a river despite flooding threat

21
Broader Goals
  • Ultimate goal for government insurance is the
    potential to serve a larger societal goal
  • Ex of Deposit Insurance- Banks cannot sell their
    assets quickly enough to pay off all depositors
    at the same time. Banking panic can cause mass
    public hysteria.
  • Governments also justify insurance as being a
    cheaper method of providing government services
    than alternative tools. (It is cheaper for
    government to charge premiums than provide
    after-the-fact insurance when a disaster occurs
    such as flooding). Providing insurance allows
    government to make rules and restrictions for
    those insured, ex building codes, etc
  • Government insurance can lead to good of the
    nation. If private ships, airplanes are
    insured, they are more prone to government use in
    wartime efforts

22
Political Rationale
  • Several attributes that make govt insurance
    popular for elected officials and beneficiaries
  • Indirect nature of some government programs can
    provide benefits to policymakers.
  • Low visibility- The public budget and the budget
    process put a spotlight on the costs of many
    tools of government.
  • Costs of the program show up in the budget when
    the government makes a payment to the firm or a
    person submitting a claim.
  • The premiums show up in the budget when paid
  • Policymakers can find this attractive as it
    appears that the program is a moneymaker
  • Self-Financing- The insured pay the government a
    nominal amount for insurance provided makes this
    tool attractive to policymakers. NFIP example
    page 206 in Salomon.
  • Political Benefits of Indirect Government-
    benefits to other stakeholders in the political
    process-ex private insurance firms in
    distribution and adjustment creates money and
    business
  • Local governments benefit and support government
    insurance- Ex, the flood insurance program
    provides subsidies to some property owners in
    flood plains, encouraging development and
    property tax revenue

23
Providing Insurance in an Environment of
Correlated Losses, Adverse Selection, and Moral
Hazard
  • Virtually all government insurance programs have
    the problem of correlated losses exposing the
    insurer to very large losses
  • If this happens, it can be hard to set a fair
    premium if losses occur in bunches
  • Moral Hazards
  • The insurer can share losses through caps,
    deductibles, copayments
  • The insurer can refuse to cover certain claims
    that occur due to certain actions- ex of a
    beneficiary killing insured for policy money
  • Insurer can sharply raise premiums after a claim

24
Other Management Challenges
  • Lack of Demand--Flood and crop insurance are
    voluntary purchases to some degree
  • Participation rates for both have been below
    desired levels
  • Also, those targeted for government insurance
    traditionally have received federal support even
    without purchasing insurance.
  • Ex. Disaster insurance limited the incentive for
    agricultural producers to purchase insurance
  • Individuals also convert the low chance of loss
    from disasters to zero loss
  • Government has combated this by marketing efforts
    to show loss from floods, etc
  • Lack of Data- It is hard to predict the
    likelihood of a disaster
  • In addition, there will be no information on how
    the provision of insurance will make future
    results different from past results
  • Challenges on Third Party Provision- It is hard
    for government to rely on third parties to do
    the right thing, and support the reason the
    program was started
  • Ex.- Reimbursement rates. Crop insurance program
    reimbursement is based on premium income. This
    gives companies incentive to sell to large firms,
    leaving out small mom and pop farmers

25
Providing Insurance in a Public-Sector Environment
  • Responsiveness-Insurance programs require
    frequent modifications to keep losses within
    desired ranges
  • Elected bodies are not often capable of making
    timely decisions to keep program in decent fiscal
    shape
  • Personnel--Government insurance programs require
    personnel with analytical, back-office, and
    distribution skills.
  • Private pays more-This could make it hard for
    government to find and retain employees

26
Overall Assessment
  • Mixed Results
  • Many social and larger economic goals achieved
  • However, many managerial and political challenges
  • Many success stories- protects households and
    firms from financial loss
  • Examples of flood insurance and depositor
    insurance
  • However, these may be viewed differently. If a
    household or firm suffers a loss, the loss gets
    transferred to the government. In turn,
    government must pay for these losses and charge
    others in society
  • Under pricing could lead to excessive risk
    taking. Example of crop planting in areas than
    cannot support plant growth
  • Some analyses suggest that government insurance
    programs have led to societal losses. Losses
    could exceed benefits

27
Efficiency, equity, and Legitimacy
  • Efficiency--the ability of insurance to act as
    the lowest-cost method for achieving goals
    remains an open question
  • Equity--A government can structure the program to
    target those most deserving
  • The often indirect method by which governments
    provide subsidies through insurance is
    inconsistent with efforts to target benefits to
    the deserving as traditionally defined.
  • Such is the case with the farmer that plants high
    risk crops.
  • Legitimacy--Government insurance programs are
    typically rare in the U.S. and abroad, although
    the scope of the few programs that exist is
    large. The fact that the insured pay premiums
    help clarify legitimacy (vs. grant programs)

28
Real Life Example
  • Floodsmart.gov
  • Floodsmart.gov frequently asked questions
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