Financing Losses from Catastrophic Risks

${image_title}$

Released: June 2008 • Discussion Paper

Authors:

Kent Smetters • Boettner Associate Professor of Insurance and Risk Management, Wharton School at the University of Pennsylvania
David Torregrosa • Principal Analyst, Congressional Budget Office

Catastrophe insurance helps spread risks and increases the ability of policyholders and the economy to recover from both natural disasters and terrorist attacks. Government policies, however, may unintentionally limit the role of the private sector in insuring against catastrophic losses. Several such policies at both the state and the federal level reduce the amount of private capital supplied to insure or hedge against catastrophic risks. Although government policies are typically motivated by clear and reasonable objectives when initially implemented, they often become outdated as markets innovate. Policymakers have several different options to increase private-risk bearing capacity and improve the effectiveness of federal involvement. The benefits and potential costs of four options are examined: 1) an optional federal charter for insurers that would bypass states’ regulation of rates; 2) regulatory reform of capital markets’ risk transfer mechanisms that substitute for reinsurance; 3) changes in the taxation of catastrophic reserves to lower the cost of catastrophe insurance; and 4) and auctions of federal reinsurance for super-catastrophic risks.