Catastrophe Insurance, Capital Markets and Uninsurable Risks

Dwight M. Jaffee and Thomas Russell

Center for Financial Institutions Working Papers from Wharton School Center for Financial Institutions, University of Pennsylvania

Abstract: This paper examines the causes of the failure of the private market for catastrophe insurance and examines some public solutions. Although the standard explanations of insurance market failure (adverse selection and moral hazard, large imprecise risks) are present, we argue that the primary explanation for the failure of this market lies in the inability of insurance companies to arrange for the level of capital necessary to settle a large loss. We examine four reasons for this: a) accounting provisions which preclude the setting up of reserves against losses anticipated but not yet incurred, b) the absence of tax incentives to reserve, c) management fear of loss of control associated with takeovers of companies with large stocks of free cash, and d) reluctance of regulators to raise the rates of firms with large holdings of cash. We examine new capital instruments (catastrophe options, contingency bonds) but find that these new instruments at present fail to provide adequate quantities of capital to meet a large loss. We then examine public schemes in California, Florida, and Hawaii, and argue that if the accounting, tax and regulatory advantages enjoyed by these schemes were made available to the private sector, private corporations would be likely to reenter this market.

This paper was presented at the Financial Institutions Center's May 1996 conference on "

Date: 1996-05
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (94)

Downloads: (external link)
http://fic.wharton.upenn.edu/fic/papers/96/9612.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 404 Not Found (http://fic.wharton.upenn.edu/fic/papers/96/9612.pdf [301 Moved Permanently]--> https://wifpr.wharton.upenn.edu/fic/papers/96/9612.pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wop:pennin:96-12

Access Statistics for this paper

More papers in Center for Financial Institutions Working Papers from Wharton School Center for Financial Institutions, University of Pennsylvania Contact information at EDIRC.
Bibliographic data for series maintained by Thomas Krichel ().