Financing Losses from Catastrophic Risks: Working Paper 2008-09

Working Paper
November 11, 2008

Kent Smetters and David Torregrosa

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. One reason is that those policies often become outdated as markets innovate.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: an optional federal charter for insurers that would preempt states’ regulation of rates; regulatory reform of capital markets’ risk transfer mechanisms that substitute for reinsurance; changes in the taxation of reserves held by insurers against catastrophic risks; and auctions of federal reinsurance for supercatastrophic risks.