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Optimal insurance coverage of low-probability catastrophic risks

Author

Listed:
  • Alexis Louaas

    (CREST-Ecole Polytechnique)

  • Pierre Picard

    (CREST-Ecole Polytechnique)

Abstract

Catastrophic risks are often characterised by a low probability, a high severity and a large number of affected individuals. Taking these specificities into account, we analyse the capacity of insurance contracts to provide coverage for those risks, independently from the market failures frequently observed in practice. On the demand side, we characterise individual preferences under which the willingness to pay for the coverage of large losses remains significant, although their occurrence probability is very small. On the supply side, the correlation between individual losses affects the insurance pricing through the insurers’ cost of capital. Analysing the interaction between demand and supply yields the key determinants of insurability and of a socially optimal risk sharing strategy.

Suggested Citation

  • 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.
    • Handle: RePEc:pal:genrir:v:46:y:2021:i:1:d:10.1057_s10713-020-00049-w
    DOI: 10.1057/s10713-020-00049-w
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    Cited by:

    1. Georges Dionne & Denise Desjardins, 2022. "A re‐examination of the US insurance market's capacity to pay catastrophe losses," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 25(4), pages 515-549, December.
    2. Len Fisher & Anders Sandberg, 2022. "A Safe Governance Space for Humanity: Necessary Conditions for the Governance of Global Catastrophic Risks," Global Policy, London School of Economics and Political Science, vol. 13(5), pages 792-807, November.
    3. Adlane Haffar & Éric Le Fur & Mohamed Khordj, 2023. "Securitization of pandemic risk by using coronabond," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 37(2), pages 209-229, June.

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    More about this item

    Keywords

    Disaster insurance; Catastrophic risk; Risk aversion; Capital costs;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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