Insuring catastrophes and the role of governments

Abstract

In this paper we model the cost of providing insurance coverage against natural and man-made hazards. We propose an insurance market model that explains (1) the use of reinsurance to help finance the cost of catastrophic events and (2) the implicit (or explicit) presence of government entities acting as (re)insurers of last resort. Using an economic model, we show how insurance programmes should be designed to cover the losses due to a possible catastrophic natural hazard. Our results show that the optimal structure of a reinsurance programme minimizes the cost of offering insurance protection. We also show how government intervention can reduce the cost of insurance against natural catastrophes and increase policyholders' welfare. Our paper therefore offers public policy implications as to the role and presence of government as an insurer of last resort and the minimum insurance premium necessary to cover the cost of catastrophic events

The Structure of Reinsurance Contracts

“…24 Sommer (1996). 25 See Ibragimov and Walden (2007); Ibragimov et al (2009) and Boyer and Nyce (2013) for more on the topic. 26 Culp and O'Donnell (2009).…”

“…26 Culp and O'Donnell (2009). 27 See Boyer and Nyce (2013) for an industrial organisation model of the reinsurance market. 28 Financial economists will recognise this payoff function as a bull spread (selling a call option with a strike price P, and purchasing a call option with strike price P+L) on the underlying security x.…”

Financial performance analysis of GIC Re

“…Finally, they suggested that if the pre-determined criteria were fulfilled an optimum reinsurance structure can be constructed. Boyer and Nyce (2013) evaluated the optimum reinsurance coverage cost and the role of government in such cases. They used a classic economic approach and showed the structure of reinsurance program for given catastrophic risk exposure to minimise the cost of such natural hazards to policyholders.…”

Preface: Current advances in analysis, modelling and mitigation of the costs of natural hazards

“…A flexible but consistent European framework should be developed that applies best practices from existing models while providing room for including necessary regional adjustments. Brémond et al (2013) review damage functions for agriculture which were used in 42 studies which undertook economic appraisals of flood management projects. As a basis for the analyses, a conceptual framework of damage categories is proposed for the agricultural sector.…”

“…In their contribution to this special issue, Boyer and Nyce (2013) model the cost of providing insurance coverage against natural hazards, considering explicitly the presence of governments as a third layer of last-resort insurance (following primary insurers and reinsurers). The welfare effects of a government supplying insurance are far from trivial since such public intervention will affect the price of insurance and will also impact the tax base needed, which is modelled with citizens becoming investors of government (re)insurance.…”