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This paper investigates the rationale for public intervention in the terrorism insurance market. It argues that government subsidies for terror insurance are aimed, in part, at discouraging self-protection and limiting the negative externalities associated with self-protection. Cautious self-protective behavior by a target can hurt public goods like national prestige if it is seen as “giving in” to the terrorists, and may increase the loss probabilities faced by others by encouraging terrorists to substitute toward more vulnerable targets. It argues that these externalities are essential for normative analysis of government intervention and may also explain why availability problems in this market have engendered much stronger government responses than similar problems in other catastrophe insurance markets.
This paper is disseminated as part of the NBER working paper series and has not been peer reviewed.
This research was prepared for the RAND Center for Terrorism Risk Management and Policy by the RAND Institute for Civil Justice.
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