By Matthew Boyle

(FORTUNE Magazine) – If you thought your business had a rough fall, consider Ed Liddy, CEO of Allstate, the second-largest property-and-casualty insurer in the U.S. The unprecedented hurricane season hit Allstate particularly hard, resulting in a $1.55 billion net loss in its most recent quarter. (The stock is 17% off its July high.) The straight-talking Liddy sat down with FORTUNE's Matthew Boyle to explain why private insurers need to be shielded from catastrophic events, and why for his team, Katrina was the Big Game.

Why do you think state and federal governments should help shoulder the cost of catastrophic events?

Insurance can work well over a long period, but what it can't always do is absorb the extreme shocks. Hurricane Andrew wiped out all the profit we had ever made in homeowners insurance in Florida. The four hurricanes in 2004 wiped out every penny we put into the state from 1992 to 2004. That's not a viable proposition. Above a certain level, you need to have a state fund such as the one that exists in Florida. And then for the extreme events you need a federal government backstop.

How would this program be funded?

You could add something, say $20, to every homeowners' bill in the country. You could also extract money from real estate transactions in the form of transfer fees.

Why not just raise your rates in areas that are subject to big claims?

The regulators won't allow us to. But let's say we could. For 30 years we'd charge you $30,000 a year. We would be obscenely profitable. And then one day a Category 4 hurricane would hit, and we'd give 96% of the profit back in 12 hours. I'm not sure the public would allow that kind of policy to exist.

Why get the feds involved?

The federal government is going to get involved anyway. My feeling is, why not be involved in a rational way instead of everyone being in helter-skelter mode after a substantial event?

What happens if Washington says no?

There's not going to be insurance available.

Not any affordable insurance, or not any insurance period?

Not any, period. Already, we are not taking on any new homeowners' risks anywhere in the state of Florida. We're not alone. Safeco pulled out, and State Farm is not taking on homeowners in southern parts of the state.

What portion of Katrina and Rita claims have you processed so far?

For autos, we are 50% to 60% done. For homeowners, leaving New Orleans out, we're 20% to 25% done. We expect over 300,000 claims from Katrina and Rita. So far we've closed about 50,000.

What does it take to get that done?

Our claims organization has 18,000 people. We had 1,500 stationed along the Gulf Coast before Katrina hit. We have taken that number up to 4,000. Our people are working ten hours a day, ten days on and four days off. For our claims employees, it's the Super Bowl.