Effects of Public Compensation for Disaster Damages on Private Insurance and Forest Management Decisions

Politicians have a tendency to compensate victims of natural disasters. This article explores the impact of such public relief programmes on a non-industrial private forest owner’s insurance expenditures or on forest management activities. We develop a theoretical model of insurance demand or forest management activities in a risky context with a finite number of states of nature and a loss proportional to the forest value. The model predicts the optimal private expenditures of insurance and forest management activities. The comparative static effects of variations in the level of insurance price, attitudes toward risk, stand value, and the magnitude and frequency of the public compensation on insurance expenditures and on forest management activities are also characterised, and their implications for government policies are examined. Providing public financial assistance after a natural catastrophe may reduce the incentives of nonindustrial private forest owners to invest in insurance and protective measures prior to a disaster.