Modeling Competition in a Market for Natural Catastrophe Insurance

We model the structure of the primary natural catastrophe insurance market using a static perfect information Cournot†Nash noncooperative game while integrating a state†of†the†art regional catastrophe loss estimation model. This approach, which generates an optimal operational cost surface, contributes to the creation of an internal risk model to measure the adequacy of a firm’s capital and financial risk management. We apply the modeling framework to a full†scale case study for hurricane risk (flood and wind combined) for residential buildings in eastern North Carolina. The results from our study indicate that the level of concentration in the primary insurance market can lead to significant differences in the firm’s operational decisions (e.g., choice in reinsurance and retained or capped surplus). As expected, a more competitive primary insurance market reduces the profitability of primary insurers, but is attractive to homeowners; hence there is an important balance to be maintained between covering as many properties as possible in the region while maintaining the profitability/solvency of the carriers. Further, our results suggest that encouraging catastrophe reserves for insurance companies can reduce their likelihood of insolvency.