Policy Proposals

Financing Losses from Catastrophic Risks

June 1, 2008
Effective Government

The Problem

With the aim of protecting consumers who face major calamities such as terrorist attacks and weather-related disasters, the U.S. government has tended to intervene in the catastrophic risk insurance market. This often leads to high-risk policyholders not paying the full cost of their risk, but instead being subsidized by lower-risk policyholders; to the interest on company’s reserves being taxed at the corporate and individual levels; and to a lack of innovation around catastrophic risk insurance products.

The Proposal

In this proposal, the advantages and disadvantages of four reform options are explored: an optional national charter that eliminates the need to navigate a complex, fifty-state series of regulations; provisions for insurers to receive credit for purchasing nontraditional reinsurance products that reduce catastrophic risk exposure; tax reform that allows insurers to maintain larger reserves; and the auction of federal reinsurance for catastrophic risk.


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policies are typically motivated by clear and reasonable objectives when initially implemented, they often become outdated as markets innovate.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.