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Natural catastrophe insurance: How should the government intervene?

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  • Charpentier, Arthur
  • Le Maux, Benoît

Abstract

This paper develops a theoretical framework for analyzing the decision to provide or buy insurance against the risk of natural catastrophes. In contrast to conventional models of insurance, the insurer has a non-zero probability of insolvency which depends on the distribution of the risks, the premium rate, and the amount of capital in the company. When the insurer is insolvent, each loss reduces the indemnity available to the victims, thus generating negative pecuniary externalities. Our model shows that government-provided insurance will be more attractive in terms of expected utility, as it allows these negative pecuniary externalities to be spread equally among policyholders. However, when heterogeneous risks are introduced, a government program may be less attractive in safer areas, which could yield inefficiency if insurance ratings are not chosen appropriately.

Suggested Citation

  • Charpentier, Arthur & Le Maux, Benoît, 2014. "Natural catastrophe insurance: How should the government intervene?," Journal of Public Economics, Elsevier, vol. 115(C), pages 1-17.
    • Handle: RePEc:eee:pubeco:v:115:y:2014:i:c:p:1-17
    DOI: 10.1016/j.jpubeco.2014.03.004
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    7. Debora Zaparova, 2020. "Mutual or stock insurance: Solidarity in the face of insolvency," Working Papers of BETA 2020-06, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    8. Thomas G. Koch, 2017. "The Shifting Shape of Risk: Endogenous Market Failure for Insurance," Risks, MDPI, vol. 5(1), pages 1-13, January.
    9. Morteza Tavanaie Marvi & Daniël Linders, 2021. "Decomposition of Natural Catastrophe Risks: Insurability Using Parametric CAT Bonds," Risks, MDPI, vol. 9(12), pages 1-19, December.
    10. Alexis Louaas & Pierre Picard, 2021. "Optimal insurance coverage of low-probability catastrophic risks," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 46(1), pages 61-88, March.
    11. Wu, Yang-Che, 2020. "Equilibrium in natural catastrophe insurance market under disaster-resistant technologies, financial innovations and government interventions," Insurance: Mathematics and Economics, Elsevier, vol. 95(C), pages 116-128.
    12. Clarke,Daniel Jonathan & Wren-Lewis,Liam, 2016. "Solving commitment problems in disaster risk finance," Policy Research Working Paper Series 7720, The World Bank.
    13. Selene Perazzini, 2020. "Public-Private Partnership in the Management of Natural Disasters: A Review," Papers 2006.05845, arXiv.org.
    14. Menna Hassan & Nourhan Sakr & Arthur Charpentier, 2022. "Government Intervention in Catastrophe Insurance Markets: A Reinforcement Learning Approach," Papers 2207.01010, arXiv.org.
    15. Arthur Charpentier & Laurence Barry & Molly R. James, 2022. "Insurance against natural catastrophes: balancing actuarial fairness and social solidarity," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 47(1), pages 50-78, January.
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    More about this item

    Keywords

    Insurance; Natural catastrophe; Externalities; Government intervention; Strong Nash equilibrium;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • H11 - Public Economics - - Structure and Scope of Government - - - Structure and Scope of Government
    • H84 - Public Economics - - Miscellaneous Issues - - - Disaster Aid

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