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The Complementary Roles of Mitigation and Insurance in Managing Catastrophic Risks

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  • Paul Kleindorfer
  • Howard Kunreuther

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.

Suggested Citation

  • Paul Kleindorfer & Howard Kunreuther, 1997. "The Complementary Roles of Mitigation and Insurance in Managing Catastrophic Risks," Center for Financial Institutions Working Papers 98-14, Wharton School Center for Financial Institutions, University of Pennsylvania.
    • Handle: RePEc:wop:pennin:98-14
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    File URL: http://fic.wharton.upenn.edu/fic/papers/98/cat04.pdf
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    References listed on IDEAS

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    1. Jerry A. Hausman, 1979. "Individual Discount Rates and the Purchase and Utilization of Energy-Using Durables," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 33-54, Spring.
    2. Johnson, Eric J & Hershey, John & Meszaros, Jacqueline & Kunreuther, Howard, 1993. "Framing, Probability Distortions, and Insurance Decisions," Journal of Risk and Uncertainty, Springer, vol. 7(1), pages 35-51, August.
    3. Colin F. Camerer & Howard Kunreuther, 1989. "Decision processes for low probability events: Policy implications," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 8(4), pages 565-592.
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    1. Schwarze, Reimund & Wagner, Gert G., 2005. "Versicherungspflicht gegen Elementarschäden: Ein Lehrstück für Probleme der volkswirtschaftlichen Politikberatung," Discussion Papers 2005/4, Technische Universität Berlin, School of Economics and Management.

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