Report

Sharing and Reducing the Financial Risks of Future “Mega-Catastrophes”

Robert E. Litan

Abstract

While policymakers and leaders continue to debate the rebuilding of Gulf areas devastated by Hurricane Katrina, a much greater loss looms on the horizon. Katrina exposed more than problems with poverty, emergency management, and infrastructure. The storm also illustrated the inability of private insurance markets to handle large-scale losses. “Mega-catastrophes” are catastrophic events, like Katrina, whose costs are so large and unpredictable that private insurers either are unwilling to insure against them, or charge premiums so high that significant numbers of customers do not want or cannot afford the insurance.

Without policy solutions, federal taxpayers in particular face unnecessarily large burdens for future disaster relief. The time has come for the federal government to convert what is de facto insurance — relief provided “after the fact” — into a formal re-insurance system that assesses the cost of such catastrophic risks before such events occur. This paper includes proposals to establish an independent federal office to operate a catastrophic reinsurance program. In short, the federal government should formally acknowledge and implement what it already has become: an insurer of last resort for mega-catastrophes.

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