On the Design of Regional Insurance Markets for East Asia

This chapter identifies the central issues in designing a possible regional insurance scheme or mechanism for East Asia with a focus on a risk sharing mechanism for catastrophe risks households in the region. I apply theoretical observations that provide a consistent explanation for the apparent anomalies concerning the demand for catastrophe insurance within the subjective expected utility framework. The key observation is that the number of observations would be inevitably insufficient to warrant a robust probability estimate for a rare event. The inherent lack of a robust probability estimate leads to diverse probability beliefs. I evaluate the various insurance schemes in terms of social welfare. In doing so, I adopt a measure that is based on the ex post social welfare concept in the sense of Hammond (Economica 48, 235–250, 1981), as the standard Pareto optimality criterion is problematic in the presence of diverse beliefs, for it ignores the regrets or pleasure ex post caused by ‘incorrect’ beliefs. Although the ex post social welfare may have an expected utility form, I only focus on the ex post utility frontier rather than specifying a particular social probability. A desirable insurance scheme is the one that eliminates any personal catastrophe state.