Should the Government Insure Private Markets?

AEI volume explores the risks and benefits of public insurance
against natural catastrophe, bank failure, crop loss, pension fund shortfalls, and terrorism

FOR IMMEDIATE RELEASE: November 2010

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For decades, American tax dollars have supported the world's largest health care insurance programs (Medicare and Medicaid), as well as the world's largest pension and disability insurance program (Social Security)--making the U.S. government the largest insurance provider in existence. The ongoing economic crisis has led the government to dramatically increase its insurance role by assuming large equity positions in private firms and bailing out troubled mortgage buyers and sellers. Do these public insurance programs improve social welfare? Or does government intervention risk moral hazard and result in inefficient programs that would be better handled by the private sector?

In Public Insurance and Private Markets (AEI Press, 2010), University of Illinois finance professor Jeffrey R. Brown and a group of leading economists critically examine whether the government should increase its role in five private insurance markets: pension fund shortfalls, crop losses, property damage from floods and other natural catastrophes, bank failure, and terrorism.

Brown and his coauthors draw the following conclusions about the ideal role of government in private insurance sectors:

  • Government intervention must be economically justified. The federal government is uniquely situated to mandate, regulate, or incentivize optimal behavior and to diversify risk across generations through fiscal policy. Government, however, is not always in a position to overcome a market failure. Because it operates according to political rather than market imperatives, government is often unable to effectively transfer economic risk.

  • Risk-adjusted premiums are essential. All public insurance programs should be priced on a risk-adjusted basis. Like private entities, government should trade off the cost of insuring against the cost of mitigating risk. Insurance prices that are too low can result in over-insurance and inadequate risk mitigation, thereby increasing society's exposure to risk.

  • Policymakers must recognize the true taxpayer burden. The costs of public insurance programs can be substantial, yet the actual expense borne by taxpayers cannot be accurately predicted in the federal budget. The failure to formalize these liabilities, however, does not mean that policymakers should fail to consider taxpayer burden when weighing the costs and benefits of expanding public insurance.

  • Markets can transfer risk efficiently. Federal insurance programs such as the FDIC, the Pension Benefit Guaranty Corporation, and the National Flood Insurance Program were created decades ago. The world has since witnessed a massive shift in the way private markets can package and transfer risk, presenting possibilities for reform that did not exist in years past.

Public Insurance and Private Markets demonstrates how poorly designed public insurance programs can lead to resource misallocation, excessive risk-taking, and potentially enormous burdens on current and future taxpayers. This timely volume offers market-based guidelines for the proper scope of government intervention in the design of public insurance programs that will improve the efficiency of risk allocation in the U.S. economy and protect the resources of present and future generations.

Jeffrey R. Brown is Professor of Finance and William G. Karnes Professor of Finance and Director of the Center for Business & Public Policy at the University of Illinois, Urbana-Champaign.

Contributors: Andrew G. Biggs, Jeffrey R. Brown, Mark J. Browne, Barry K. Goodwin, Martin Halek, Dwight Jaffee, Howard C. Kunreuther, Erwann O. Michel-Kerjan, George G. Pennacchi, Thomas Russell, and Vincent H. Smith

INTERVIEW REQUESTS: For interview requests, please contact Jeffrey R. Brown directly at brownjr@illinois.edu (217.333.3322). For all other media inquiries, please contact Véronique Rodman at vrodman@aei.org (202.862.4871) or Sara Huneke at sara.huneke@aei.org (202.862.4870).

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