Insured Loss Inflation: How Natural Catastrophes Affect Reconstruction Costs

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. In the aftermath of a natural catastrophe, there is increased demand for skilled reconstruction labor, which leads to significant increases in reconstruction labor wages and hence insured losses. Such inflation effects are known as "Demand Surge" effects. It is important for insurance companies to properly account for these effects when calculating insurance premiums and determining economic capital. We propose an approach to quantifying the Demand Surge effect and present an econometric model for the effect that is based on 191 catastrophe events in the United States. Our model explains more than 75% of the variance of the Demand Surge effect and is thus able to identify the key drivers of the phenomenon. Terms of use: Documents inJEL classification: G22, J23, J31, Q54, R23

The Influence of Sellers on Contract Choice: Evidence from Flood Insurance

“…Insurers’ recommendations to overinsure by a “small” amount (relatively close to replacement cost) might be motivated by different considerations than insurers who recommend overinsuring by a large amount (e.g., selecting a $ 250,000 coverage limit on a home with a $ 150,000 replacement cost). For example, some insurers might recommend overinsuring out of concern for inflation risk and demand surge, which previous research shows can increase the cost to repair or rebuild a damaged property (e.g., Hallegatte, ; [Döhrmann, Gürtler, and Hibbeln], ). Based on our reading of this literature, we consider overinsuring up to 115 percent of the replacement cost as possibly motivated by concerns related to inflation risk and demand surge .…”

“…As the previous paragraph describes, it is possible (but rare) for a loss to exceed a home's estimated replacement cost. Such a situation may occur if the replacement cost is underestimated (e.g., due to software limitations), if post‐loss costs are unexpectedly high (e.g., demand surge following a catastrophe, as in Döhrmann, Gürtler, and Hibbeln, ), or if additional expenses reduce the available limit (e.g., debris removal) . Agents’ training and experience would seem to give them an advantage in valuing these risks, relative to households.…”

“…Hallegatte () calculates a demand surge of 13 percent due to Katrina. Döhrmann, Gürtler, and Hibbeln () estimate the 95th percentile of demand surge is 7–10 percent for catastrophes greater than $ 100 million. They also find that demand surge is higher when the construction sector has limited capacity, which was not likely the case in 2010.…”

Determining the Increase in a Building’s Appreciation Rate Due to a Reconstruction

“…Another reason in favor of the reconstruction of buildings is damage caused by natural events, the impact of which, according to Döhrmann, Gürtler, and Hibbeln [9], is reflected in significant increases in prices for construction works, which are usually not taken into account in insurance contracts. Probably the most common reason for reconstructions is simple wear and tear, the need to adapt a building´s functionality to current needs, or the need to save buildings from demolition.…”

Trading and liquidity in the catastrophe bond market

“…In addition, the severity of catastrophe events like hurricanes is increasing due to higher sea surface temperatures, leading to higher (insured) damages and inflated insured losses (Döhrmann et al, 2017).…”