Federal Financial Exposure to Natural Catastrophe Risk

Abstract

The objective of this paper is to estimate the expected annual costs to taxpayers of federal disaster-related expenditures to provide guidance to federal policymakers in budgeting and formulating disaster relief policy. Our estimates take into account recent trends in the generosity of federal disaster policy as well as statistical data on the frequency and severity of losses from natural catastrophes. Our estimates of the costs of disasters are based on two sources: (1) simulation analysis by Applied Insurance Research, a leading catastrophe modeling firm, and (2) historical data on insured catastrophe losses from Property Claims Services, an insurance industry statistical firm. We estimate the average expected federal expenditures for disaster assistance related to hurricanes, earthquakes, thunderstorms, and winter storms to be about $20 billion a year. In a bad year, corresponding to a catastrophic event of severity expected only once every century, the bill could exceed $100 billion. Given the current approach to disaster relief funding, we project an unfunded liability for disaster assistance over the next 75 years comparable to that of Social Security. The magnitude of the projected liability strongly suggests that government should adopt a proactive, ex ante approach to disaster relief policy rather than the current ad hoc reactive approach.

Keywords: catastrophes, disaster relief, federal budget, loss distributions

JEL Classification: H60, H68, G22, C16