How CBO Analyzes Public-Private Risk Sharing in Insurance Markets

In some insurance markets, the federal government and private insurance companies share the financial risk of covering insured parties. In this report, the Congressional Budget Office outlines how it analyzes three different forms of public-private risk sharing that are used to provide terrorism insurance, crop insurance, and flood insurance. The agency also describes how each form of risk sharing affects the federal budget.

• For terrorism insurance, the federal government assumes most of the catastrophic risk by reinsuring (that is, by supplying insurance for insurers) against the risk borne by private insurers. By reinsuring against only the catastrophic risks rather than bearing all the risk, the government decreases its budgetary costs. (Catastrophic risks stem from events that have a low probability of occurring but that are very consequential when they do occur.) The government is required to recover most or all of its outlays by assessing a tax on all commercial policyholders after a terrorist attack occurs.
• For crop insurance, the government and private insurers share in the gains and losses from the insurance policies. In general, budgetary costs can be lower when risks are shared than when the government bears all the risk. But in the federal crop insurance program, risk sharing increases budgetary costs because private insurers are allowed to selectively retain most of the premiums and the opportunity for gains on low-risk policies.
• For flood insurance, the government initially assumes all the risk associated with covering policyholders and then transfers some of it to private companies and investors by purchasing reinsurance and using catastrophe bonds (securities that allow the government to forgo scheduled payments of interest and principal, in part or in full, in the event of specified losses from floods). Because the government must pay market prices when it transfers the risk, that form of risk sharing increases expected budgetary costs.