Optimal insurance coverage of low-probability catastrophic risks

Abstract

Catastrophic risks are often characterised by a low probability, a high severity and a large number of affected individuals. Taking these specificities into account, we analyse the capacity of insurance contracts to provide coverage for those risks, independently from the market failures frequently observed in practice. On the demand side, we characterise individual preferences under which the willingness to pay for the coverage of large losses remains significant, although their occurrence probability is very small. On the supply side, the correlation between individual losses affects the insurance pricing through the insurers' cost of capital. Analysing the interaction between demand and supply yields the key determinants of insurability and of a socially optimal risk sharing strategy.

Optimal Nuclear Liability Insurance

“…When π goes to zero, the certainty equivalents C i also tend to zero. However, they may remain significant (for example in percentage of expected loss) for π small but positive Louaas and Picard (2018). show that this is the case under Decreasing Absolute Risk Aversion if the index of absolute risk aversion is large in the loss state.…”

“…We consider the risk associated with one major accident on the French territory. 24 The 58 French nuclear reactors are gathered into 19 power plants. Based on Eeckhoudt et al (2000), we assume that 2 million people live around each power plant.…”

“…They deliver probability and cost estimates for various accident scenarios, presented inDreicer et al (1995) andMarkandya (1995). Additional studies from international agencies, such as the French Institute for Radioprotection and Nuclear Safety (IRSN, 2013) and the Nuclear Energy Agency (NEA, 2000), also develop the methodology for estimating the costs associated with the various accident scenarios predicted by PSA studies 24. The PSA studies, produced by nuclear safety agencies, develop scenarios of accident.…”

A Safe Governance Space for Humanity: Necessary Conditions for the Governance of Global Catastrophic Risks

“…reducing greenhouse gas emissions to mitigate climate change (Mason et al, 2017 ; Mattoo & Subramanian, 2013 ; Victor, 2016 ); taking actions that reduce uncertainty, both in practical terms (e.g. government guarantees, insurance [Louaas & Picard, 2020 ]) and in terms of community perceptions (Kuhlemann, 2019 ; Wachinger et al, 2013 ); steering the system away from tipping points (Galaz et al, 2016 ; for example, reducing the reproduction number R to below 1 so as to stop the spread of a pandemic (Nouvellet et al, 2021 ). …”

A re‐examination of the US insurance market's capacity to pay catastrophe losses

“…Jametti and von Ungern‐Sternberg (2010) do not consider the observed risk selection between the private and public sectors as optimal in cases where the private sector keeps acceptable or lower losses, and the public sector is limited to extreme losses. Louaas and Picard (2021) propose a new characterization of optimal insurance coverage for low‐probability catastrophic risks. They derive determinants of insurability and socially optimal risk sharing for events that have a low probability and high severity and that affect many individuals.…”