Blog Post

Space Launch Indemnification

Jan 4, 2013 | Molly K. Macauley, Timothy J. Brennan

The “fiscal cliff” isn’t the only issue Congress is addressing largely on a temporary basis. Reauthorization of the 1988 Commercial Space Launch Act was due by December 31 and, just in time, the US Senate and the House of Representatives agreed to extend the Act for one year (after some disagreement as to one versus two years). The Act partially indemnifies companies that launch satellites and other cargo into space. The indemnification is for some kinds of damages to third parties (for example, people beneath the flight path of the launch and other uninvolved people and property) in amounts between $500 million and $1.5 billion (adjusted for inflation).

The Act as frequently reauthorized has always included sunset provisions. Whether yet another temporary measure—extending a law that has been "temporary" for over a quarter century—makes sense depends on three things. These considerations should figure into debate this year over any further extension of the Act.

First, competitiveness arguments have always been used to justify subsidizing the insurance costs of U.S. launch companies if their foreign competitors receive similar subsidies. However, the line between competitiveness and protectionism is easy to cross. If foreign governments want to subsidize launches, U.S. consumers of satellite services (telecommunications, navigation and maps, earth observations and weather forecasts) benefit. And the U.S. is unlikely to lose the fundamental technology and know-how of space launches because our national security requirements require us to retain some capacity.

Second, the importance of this subsidy remains unclear. One argument in favor is that it protects firms from catastrophic losses. But it may not do that in practice. The Federal Aviation Administration imposes safety regulations for launches—which mostly occur at launch ranges where the US Air Force also is involved in launch safety—designed to reduce the risk of harm to third parties to a figure on the order of one in ten million. If these regulations are effective, therefore, the $1.5 billion indemnity cap implies that the maximum expected loss per launch is $150. A U.S. launch has never caused third-party harm, so this number might seem high. But on the other hand the sample size is low—only a few hundred launches—so an insurance company might expect the chances of third-party harm to be much, much greater, with greater risk exposure. If so, then indemnifying launch companies for only the $500m-$1.5bn “doughnut hole” isn’t enough to protect them against catastrophic loss.

Launch companies might also declare bankruptcy rather than pay a huge judgment. If so, the subsidy might be a tacit admission that the government would have to pay for large damages anyway (though the $1.5bn cap remains hard to explain). Alternatively, the indemnification could serve to avoid legal costs of the launch company and the government suing each other in the event of an accident. In any case, at some point in further deliberations over the coming year, Congress should clarify these inconsistencies and be clear about the purpose of the subsidy.

Third, if indemnification matters, it is not simply a matter of a subsidy to launch companies. To the extent that any firm is insulated from risk, its incentives to exercise care to avoid risk are somewhat attenuated—what economists call “moral hazard.” Along with others, we examined this issue in detail in a 2010 paper. One needs to be careful not to exaggerate this possibility. Risk might also be attenuated with private insurance, although the insurance companies have methods (copayments, deductibles, contingent claims) to limit moral hazard. In the event of an accident, the public reaction could be so large as to lead to restrictions or even outright bans on launches. In addition, launch companies remain subject to FAA safety regulations, with a track record of virtually no harm to third parties.

These three points all suggest that in its deliberations later this year over reauthorizing the act, Congress carefully consider the justifications for indemnification, clarify the size of the subsidy, and assess the possibility—even if remote -- that indemnification could have any unintended consequences such as increasing the risk of third party harms from commercial launches.