As a result of climate change, technological development, and other variables, natural and technological catastrophes have increased dramatically. (1) Moreover, due to infrastructural issues, such as building in floodplains, damages resulting from catastrophes have increased as well. (2) The massive earthquake and tsunami that occurred in Japan on March 11, 2011 are still fresh in people's memories, providing sobering illustrations of the extensive reach of such catastrophes.
After a catastrophe, which is defined for the purposes of this Article as an accident with large losses in either the number of victims or the amount of property damage, governments often intervene in the compensation of catastrophe victims. However, the organization of government intervention in the compensation varies from one country to another and from one disaster to another. Governments intervene either because no satisfying solution is available in the private market or to fulfill the requirements of existing compensation schemes. Political pressure for such intervention may also be large.
Private insurance markets for catastrophic risks may fail for a variety of reasons, and governments may try to intervene to stimulate the insurability of catastrophic risks or to take over insurance functions when markets fail. Demand for catastrophe insurance may be too low even though such insurance would result in increased utility for potential victims (as in the case of flood insurance). In other cases, risk-modeling calculations may be difficult or the damage that could potentially be caused by a catastrophe may overwhelm the capacity of insurance markets.
Government intervention in compensation for catastrophe victims can take a variety of forms. In some cases (for example, in France), the government forces potential victims to purchase comprehensive insurance; in others (for example, in the case of the California Earthquake Authority), the government replaces the primary insurer and directly provides coverage to potential disaster victims. In yet other situations (for example, with terrorism risk), the government acts as a reinsurer of last resort and intervenes when the magnitude of loss exceeds a specific threshold. The government may also provide an additional insurance layer--for example, in nuclear liability conventions, the government supplements compensation provided by the operator of the power plant. Finally, the government may provide direct compensation to victims of catastrophes either through structural fund solutions or on an ad hoc basis.
These various forms of government intervention have been criticized in the literature. Most of the criticism concentrates on government provision of ex post compensation on an ad hoc basis. (3) However, some critics also address the type of government intervention on which we focus in this Article--on the government acting as a facilitator of insurance markets or as a reinsurer of last resort. (4) Notwithstanding the criticism, schemes in which the government facilitates the insurability of catastrophic risks--including terrorism and natural disasters--are on the rise. The importance of compensating victims of catastrophes (after 9/11, the focus was strongly on terrorism; after Katrina, flooding came to the forefront; and after the Japanese earthquake and tsunami, compensation for victims of those risks soared on the political agenda) gives rise to the question whether such a government role should indeed be considered problematic, especially when compared with the alternative of providing outright ex post compensation to victims on an ad hoc basis. This is the main question we will address in this Article.
Our paper is structured as follows: we first identify the various types of government intervention in compensating victims of catastrophes. Next, we focus specifically on the types of government intervention that stimulate insurability of catastrophic risks and analyze how these forms of intervention can be considered from a law-and-economics perspective. …