Stewart E. Sterk

Volume 74, Issue 3, 869-910

Local, national, and global catastrophes entail significant risk for landowners. The government-sponsored National Flood Insurance Program illustrates how subsidizing insurance against catastrophe risk can result in overinvestment in risk-prone properties. Government intervention, however, has largely been a response to the historical failure of the private insurance industry to provide adequate protection against correlated risks, a failure with the potential to generate underinvestment in land and devastate existing owners.

When data is available about the incidence and severity of potential disasters, improvements in technology have made it more feasible for insurers to calibrate premiums and discounts with greater accuracy, and sophisticated financial instruments not available until recent decades should be sufficient to provide insurers with the capital to overcome the correlated risk problems that might otherwise threaten their solvency. Government’s primary role should be on the demand side, educating owners about the need to purchase insurance.

When reliable data is unavailable, as it is not for pandemics and economic crises, private insurance may remain difficult to obtain. Even then, the efficiency case for government intervention is plausible in two limited circumstances: when failure to compensate would cause damage to the broader economy, or when government has played a significant role in creating losses. The distributive justice case for compensation to landowners as a class is also weak, although there may be a stronger case for compensating owners of modest means who have suffered catastrophic losses due to events for which insurance was not available.