An Imperfect Storm: Fat-Tailed Hurricane Damages, Insurance and Climate Policy

We perform two tests that estimate the thickness of the tails of the distribution of aggregate US hurricane damages. Both tests reject the hypothesis that the distribution of damages is thin tailed at the 95% confidence level, even after correcting for inflation, population, and per capita income growth. Our point estimates of the shape parameter of the damage distribution indicate that the distribution has finite mean, but infinite variance. In the second part of the paper, we develop a microfoundations model of insurance and storm size that generates fat tails in aggregate hurricane damages. In the model, the distribution of the number properties within a random geographical area that lies in the path of a hurricane drives fat tails in hurricane damages, and we confirm that the distribution of coastal city population is fat tailed in the US. We show empirically and theoretically that other random variation, such as the distribution of hurricane strength and the distribution of damages across individual properties do not generate fat tails. We consider policy options such as climate change mitigation, policies which encourage adaptation, reducing subsidies for coastal development, and disaster relief policies, which distort insurance markets. Such policies can reduce the thickness of the tail, but do not affect the shape parameter or the existence of the fat tail.