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Insurance and Financial Hedging of Oil Pollution Risks

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  • André SCHMITT
  • Sandrine SPAETER
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    Abstract

    The current international regime that regulates maritime oil transport calls for financial contributions by oil firms once an oil spill has occurred. Their percentage contribution to the International Oil Pollution Compensation Fund depends only on their level of activity. In this paper, we show that this compensation regime would be more efficient if contributing oil companies adopted financial strategies to hedge against oil pollution risks. The optimal coverage contract is such that standard insurance is useful to manage small and medium oil spills, while investments on financial markets help to cover large oil spills, less frequent but much more catastrophic for society. We also show that the prevention of oil spills increases when insurance is combined with a financial hedging strategy. This positive effect on prevention is further enhanced if firms have the opportunity to send signals about their risk-reducing activities to potential investors.

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    Bibliographic Info

    Paper provided by Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg in its series Working Papers of BETA with number 2004-14.

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    Date of creation: 2004
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    Handle: RePEc:ulp:sbbeta:2004-14

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    Keywords: oil spill; legislation; insurance; capital markets; prevention; catastrophe.;

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    1. Cormier, Denis & Magnan, Michel, 1997. "Investors' assessment of implicit environmental liabilities: An empirical investigation," Journal of Accounting and Public Policy, Elsevier, Elsevier, vol. 16(2), pages 215-241.
    2. Schlesinger, Harris, 1999. "Decomposing catastrophic risk," Insurance: Mathematics and Economics, Elsevier, vol. 24(1-2), pages 95-101, March.
    3. Ringleb, Al H & Wiggins, Steven N, 1990. "Liability and Large-Scale, Long-term Hazards," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 98(3), pages 574-95, June.
    4. Dionne, G. & Spaeter, S., 1998. "Environmental Risk and Extended Liability: the Case of Green Technologies," Ecole des Hautes Etudes Commerciales de Montreal-, Ecole des Hautes Etudes Commerciales de Montreal-Chaire de gestion des risques. 98-12, Ecole des Hautes Etudes Commerciales de Montreal-Chaire de gestion des risques..
    5. Lanoie, Paul & Laplante, Benoit & Roy, Maite, 1998. "Can capital markets create incentives for pollution control?," Ecological Economics, Elsevier, Elsevier, vol. 26(1), pages 31-41, July.
    6. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
    7. Kenneth A. Froot, 2001. "The Market for Catastrophe Risk: A Clinical Examination," NBER Working Papers 8110, National Bureau of Economic Research, Inc.
    8. Blacconiere, Walter G. & Patten, Dennis M., 1994. "Environmental disclosures, regulatory costs, and changes in firm value," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 18(3), pages 357-377, November.
    9. Raviv, Artur, 1979. "The Design of an Optimal Insurance Policy," American Economic Review, American Economic Association, American Economic Association, vol. 69(1), pages 84-96, March.
    10. André SCHMITT & Sandrine SPAETER, 2002. "Improving the Prevention of Environmental Risks with Convertible Bonds," Working Papers of BETA, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg 2002-14, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
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    Cited by:
    1. André SCHMITT & Sandrine SPAETER, 2005. "Hedging Strategies and the Financing of the 1992 International Oil Pollution Compensation Fund," Working Papers of BETA, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg 2005-12, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.

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