The Value of Public Disaster Insurance

Pierre Mérel (UC Davis), with Joakim Weill (Federal Reserve Board)

We present a tractable model of disaster insurance markets. Spatially correlated shocks raise insolvency risk, leading to costly capital reserve requirements for private insurers. The model features risk-averse households and regional heterogeneity in disaster risk. We compare welfare under two market structures: one national insurer versus local regional insurers. We show that pooling risks across uncorrelated regions can lower total reserve requirements and reduce overall capital costs. We apply our framework to quantify effects of moving from the current federal National Flood Insurance Program to state-level insurers.