5th International Disaster and Risk Conference IDRC 2014 Integrative Risk Management - The role of science, technology & practice 24-28 August 2014 in Davos, Switzerland

1. Modeling Government
Interventions in a Natural
Catastrophe Insurance Market
5th International Disaster and Risk Conference IDRC 2014
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
Yang Gao1, Linda Nozick2, Rachel Davidson3, Jamie Kruse4
1Cornell University, Ithaca, New York, U.S.A.
2Cornell University, Ithaca, New York, U.S.A.
3University of Delaware, Newark, Delaware, U.S.A.
4East Carolina University, Greenville, North Carolina, U.S.A.
Supported by the National Institute for Standards and
Technology, U.S. Department of Commerce

2. 5th International Disaster and Risk Conference IDRC 2014
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
• Goal: Compare the effect of government interventions
designed to reduce uninsured losses.
• Model insurance market with explicit representation of the
key stakeholders:
– Homeowners
– Primary insurers
– Reinsurer
– Policy maker
• Government intervenes through premium price supports,
acquisition decisions.

3. • Integrative (Economics, Decision Science, Engineering)
• System-of-Systems
• Full information on probabilities and loss distribution based
5th International Disaster and Risk Conference IDRC 2014
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
on structural characteristics and location of structure.
• Demand for insurance is generated by rational risk averse
homeowners.
• Reinsurance is pricing formula-based
• Game theoretic representation of firm(s) in primary insurance
market (Cournot)
• Game theoretic representation of policy maker (Stackelberg)

4. 5th International Disaster and Risk Conference IDRC 2014
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
Modeling Framework

5. Case study-Region of North Carolina, USA
5th International Disaster and Risk Conference IDRC 2014
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
Loss Model
• Total inventory of 931,902 structures. (1536 types of
construction)
• Joint probability distribution estimation of annual loss for
each type of building under each possible hurricane event.
• 2000 scenarios, 97 types of hurricane events, 30 year
duration.
• Take-up rate on insurance at a given price generates book of
business with expected loss and cost function for primary
insurer based on loss model.
– Two further constraints
• Affordability: total policy price may not exceed 5% of total value of home.
• Insurer will not service a policy at a total policy price less than $100

6. 5th International Disaster and Risk Conference IDRC 2014
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
Government interventions
• Government can subsidize insurance or acquire homes in the
high risk region. With a 30 year budget for public expenditure.
– None
– $300 million
– $500 million
– $1 billion
– $3 billion

7. 5th International Disaster and Risk Conference IDRC 2014
120%
100%
80%
60%
40%
20%
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
0%
1.36
1.48
1.60
1.72
1.84
1.96
2.08
2.20
2.32
2.44
2.56
2.68
2.80
2.92
3.04
3.16
3.28
3.40
3.52
3.64
3.76
3.88
4.00
4.12
4.24
4.36
4.48
4.60
4.72
4.84
4.96
5.08
5.20
5.32
Insurance penetration rate
Price per dollar expected loss - pH
Unaided
$300 Million
$500 Million
$1 Billion
$3 Billion

8. 5th International Disaster and Risk Conference IDRC 2014
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
$-
1 2 3 4 5 6 7 8 9 10
Equilibrium Price per dollar expected loss - pv
Number of Insurers - n
No support
$300M support
$1B support

9. 5th International Disaster and Risk Conference IDRC 2014
$180
$160
$140
$120
$100
$80
$60
$40
$20
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
$-
1 2 3 4 5 6 7 8 9 10
Average Annual Net Profit (million)
Number of Insurers = n
No support
$300M support
$1B support

10. 5th International Disaster and Risk Conference IDRC 2014
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
Total expected insured loss (a)
and equilibrium penetration rate (b)

11. 5th International Disaster and Risk Conference IDRC 2014
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
Conclusions based on case study
• Subsidization
– Increased insurance take up rate.
– Increased equilibrium penetration rate.
– Reduced uninsured losses.
– Produced little change in primary insurer
profits.
• Future Work includes
– Boundedly rational homeowner decisions
– Temporal response to recent events
– Policy that is responsive to behavioral biases.

12. Added value for the Post 2015 Framework for
5th International Disaster and Risk Conference IDRC 2014
‘Integrative Risk Management - The role of science, technology & practice‘ • 24-28 August 2014 • Davos • Switzerland
www.grforum.org
Disaster Risk Reduction
• How did your work support the implementation of the Hyogo
Framework for Action:
– This research supports the goal in the Hyogo Framework for Action that
calls for “development and strengthening of institutions, mechanisms and
capacities to build resilience to hazards.”
• From your perspective what are the main gaps, needs and further
steps to be addressed in the Post 2015 Framework for Disaster Risk
Reduction in
– Research: work that integrates human behaviour and the temporal
aspects of hazard mitigation. Analysis of behaviourally informed policy.
– Education & Training: educate scientists on
• how to communicate research result
• assess policy implications of their works
• how to receive messages from the stakeholder public on compelling research
needs.
– Implementation & Practice:
– Policy: policy that is effective in light of behavioral biases