[aero142]

There is an issue with correlated vs uncorrelated risks. This is the reason that only the federal government can offer FDIC insurance for banks and disaster insurance in Florida. When banks fail, they tend to all fail at the same time and there is no insurer that could hold enough reserves to actually pay out if they all fail together. Private insurance can cover fire insurance for homes, but is unlikely to have enough in reserves to pay if a category 5 hurricane floods half the homes in Florida.

[harimau777]

To make sure that I'm following, is what you are saying that the risk is that there's a big enough disaster that the insurance company(s) can't pay everything that's owed to those who have been harmed?

[aero142]

Correct. I'm saying that private insurance is good at insuring uncorrelated risks, like car wrecks, but usually, only the federal government can enable insuring correlated risks. Suggesting that mandatory liability insurance can a good policy alternative to regulation is correct, but if you are regulating something large enough with correlated risks, only the federal government can every really provide insurance. Banks pay FDIC insurance, and bank failures are usually covered by this, but it's pretty clear that the pool of money to save banks is backstopped by the federal government in case of a cascading failure. Even for uncorrelated risk, if the payout event is bad enough, it can't be insured. For example, insurance on a nuclear plant is backstopped by the federal government, because no private insurer could ever really insure the worst case scenario.