Does Federal Disaster Assistance Crowd Out Private Demand for Insurance?

Established in 1984, the Wharton Risk Management and Decision Processes Center develops and promotes effective corporate and public policies for low‐probability events with potentially catastrophic consequences through the integration of risk assessment, and risk perception with risk management strategies. Natural disasters, technological hazards, and national and international security issues (e.g., terrorism risk insurance markets, protection of critical infrastructure, global security) are among the extreme events that are the focus of the Center's research. The Risk Center's neutrality allows it to undertake large‐scale projects in conjunction with other researchers and organizations in the public and private sectors. Building on the disciplines of economics, decision sciences, finance, insurance, marketing and psychology, the Center supports and undertakes field and experimental studies of risk and uncertainty to better understand how individuals and organizations make choices under conditions of risk and uncertainty. Risk Center research also investigates the effectiveness of strategies such as risk communication, information sharing, incentive systems, insurance, regulation and public‐private collaborations at a national and international scale. From these findings, the Wharton Risk Center's research team – over 50 faculty, fellows and doctoral students – is able to design new approaches to enable individuals and organizations to make better decisions regarding risk under various regulatory and market conditions. The Center is also concerned with training leading decision makers. It actively engages multiple viewpoints, including top‐level representatives from industry, government, international organizations, interest groups and academics through its research and policy publications, and through sponsored seminars, roundtables and forums. 1 We present the first causal estimates of the effect of federal disaster relief on insurance demand using a unique panel dataset of insurance contracts and disaster aid disbursements. We address endogeneity using instrumental variables that exploit political influence over aid amounts. We find that a $1 increase in average aid grants decreases average insurance coverage by about $6, with variation depending on aid amount. This crowding out effect is on the intensive, as opposed to the extensive margin; we find no impact on take-up rates. Government loans, as opposed to grants, have no effect on insurance demand on either margin and might thus be a better policy tool.). Michel-Kerjan thanks the Federal Emergency Management Agency (Recovery Directorate and the Federal Insurance and Mitigation Administration) and the US Small Business Administration for providing the datasets used here.