The Complementary Roles of Mitigation and Insurance in Managing Catastrophic Risks

Paul Kleindorfer and Howard Kunreuther

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

Abstract: This paper examines the impact that specific risk mitigation measures (RMMs) could have on reducing losses from hurricanes and earthquakes as well as improving the solvency position of insurers who provide coverage against these hazards. We first explore why relatively few individuals adopt cost-effective RMMs by reporting on the results of empirical studies and controlled laboratory studies. We then investigate the impact that an RMM has on both the expected losses and those from a worst case scenario in two model cities---Oakland (an earthquake-prone area) and Miami/Dade County (a hurricane-prone area) which were constructed respectively with the assistance of two modeling firms—Risk Management Solutions and Applied Insurance Research.

The paper then explores three programs for forging a meaningful public-private sector partnership: well-enforced building codes, insurance premium reductions linked with long-term loans, and lower deductibles on insurance policies tied to mitigation. We conclude by briefly examining four issues for future research on linking mitigation with insurance: regulatory issues facing insurers, uncertainty issues in estimating risks, tradeoffs between reinsurance and mitigation and the impact of mitigation on capital market instruments.

Date: 1997-12
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