Federal natural catastrophe backstop debated in the U.S.

Because of a natural catastrophe’s high cost to society, some are debating whether or not the U.S. federal government should provide a program to backstop losses for natural catastrophes, Standard & Poor’s (S&P’s) says.
In the current market, federal government participation through a natural catastrophe backstop program could limit the amount of losses for insurance carriers while increasing the availability of coverage to residents of hurricane-prone areas, S&P’s said in its paper: ‘Is a US Federal Natural Catastrophe Backstop Necessary? Desirable?’
The amount of government involvement and its financial support would vary under different scenarios, the report says.
One proposal is the creation of reserves for natural catastrophes, whereby insurers will earmark funds to pay for catastrophe losses on a tax-deferred basis. “This could make more insurance companies willing to underwrite policies, and insurance regulators might be more willing to approve rate increases to appropriate levels given that there are premiums set aside to pay out future claims,” the article continues.
Supporters of a backstop also maintain it would have the ability to stabilize rates after a major catastrophe, S&P’s reports. “Insurance carriers might be less likely to raise rates because the companies have already set up a natural catastrophe reserve or the federal government would provide financial support after a major storm,” the article reads.
However, pundits argue the private market has enough capacity and has performed well given the recent natural catastrophes, such as the ones in 2004 and 2005.
“If the federal government were to get involved, some insurance carriers could suffer financially because of inappropriate pricing and might be crowded out of the market,” S&P’s reported.
Furthermore, the article continues, there will be less innovation, as companies have less motivation to improve their products or catastrophe modelling.