Trump’s Strait of Hormuz insurance plan gambles with taxpayer dollars

As wars and skirmishes escalate, the risks to commerce increase and are reflected in market prices. In past conflicts, shipping firms faced soaring premiums as insurers incorporated risk, yet insurance was still generally available. In the current conflict with Iran, however, many insurers simply canceled coverage for ships in the Strait of Hormuz altogether just hours after hostilities began.

Foreign insurance regulations have significantly contributed to this situation. CEI Director of Finance Policy John Berlau recently pointed out in the Washington Post that Europe’s Solvency II rules rely on unrealistic risk scenarios and increase the capital required for insurers to cover high-risk maritime activity. As a result, private insurance capacity in conflict-prone regions such as the Strait of Hormuz is reduced beyond what many consider justified.

In response to disruptions in transit through the Strait, the Trump administration has put in place a $40 billion political risk insurance facility backed by the government’s Development Finance Corporation (DFC) that shifts risks private insurers will not bear onto US taxpayers.

The desire to assist commercial vessels is understandable, given threats of aggression from Iran and regulatory red tape. Yet providing cheap insurance while ignoring the reasons private insurers retreat from these markets is not the answer. This scheme could leave US taxpayers exposed to unlimited losses without addressing the underlying causes of the crisis in the Strait.

By underwriting $40 billion in political risk insurance, the DFC squarely puts taxpayers in the line of fire. DFC’s Corporate Capital Account of $250 million is far below the promised coverage. If losses exceed that capital, the US Treasury would foot the bill.

Because the facility operates on a rolling basis, its $40 billion limit functions as a reusable pool of coverage. As policies expire or underlying exposures end, the government backing is released and can be used to support new guarantees.

The program has already expanded from $20 billion to $40 billion in a matter of weeks, with the additional capacity provided by participating insurers. Even if taxpayer exposure is not increased one-for-one by this change, the rapid scaling illustrates how quickly the size and complexity of government-backed insurance arrangements can grow. This is especially true when capacity is continuously recycled and expanded through additional participation.

The National Flood Insurance Program (NFIP) provides a well-documented example of how government-backed insurance imposes long-term costs on taxpayers. Created to expand flood coverage, the NFIP has been criticized for subsidizing high-risk development while shifting costs onto taxpayers. CEI has long opposed the NFIP on these grounds.

The NFIP has accumulated billions in debt to the US Treasury because premiums have not reflected true risk and the program has repeatedly borrowed to cover catastrophic losses. It now owes $22.5 billion to the Treasury and continues to struggle with solvency.

The NFIP’s problems go beyond solvency. Government-backed insurance can distort incentives and encourage risk-taking, a phenomenon known as moral hazard. Empirical research shows NFIP subsidies have encouraged development in flood-prone areas. By underpricing risk, the program encourages additional exposure, increasing both total losses and taxpayer costs.

The NFIP is not the only government-backed insurance program where moral hazard appears. CEI Senior Economist Ryan Young has pointed to the Overseas Private Investment Corporation (OPIC), which is the predecessor of DFC. Young argues that OPIC’s political risk insurance created moral hazard by subsidizing investment in unstable or predatory countries. Unlike private insurers, OPIC shifted losses onto taxpayers while weakening incentives for sound economic policy.

My recent piece about government-backed deposit insurance shows similar incentive distortions. Across these cases, artificially low-risk coverage encourages decisions that can impose real financial harm on the public, a pattern that the DFC threatens to repeat.

Risk does not disappear when government attempts to absorb it. Instead, markets exist to price risk. The retreat of private insurers reflects both the physical hazards in the Strait and regulatory constraints such as Europe’s Solvency II regime, which increases the cost of underwriting war-risk exposure.

The administration proposes shifting that risk onto a government-backed facility. This distorts insurance pricing by offering coverage below private market rates. As with the NFIP and OPIC, the DFC facility suppresses the signals that guide capital and manage exposure while reinforcing the moral hazard that arises when losses are socialized.

There are actions the administration could pursue to aid commercial ships that are within the scope of its defense powers. President Trump also proposed that the US military could escort tankers through the Strait if necessary. President Reagan pursued a similar policy during the Iran-Iraq War of the 1980s. The wisdom of such a policy in this conflict is subject to debate, but it would not be a departure from past practices in wars and conflicts.

However, by ignoring market signals and offering “reasonable” rates for war zones below what the market will bear, the administration effectively writes a check with the American people as co-signers for a risky scheme that does not address the real obstacles to restoring commercial traffic in the Strait.

Instead of putting taxpayers on the hook for potentially large insurance losses, the Trump administration should push Europe to relax or suspend Solvency II while also removing domestic regulatory barriers that impede shipping. In hazardous waters, a subsidized insurance scheme simply makes conditions choppier.