The Risk-Sharing Implications of Disaster Insurance Funds

Authors

  • Alex Boulatov,

    1. Alex Boulatov is affiliated with the Higher School of Economics in Moscow. Stephan Dieckmann is affiliated with the Wharton School at the University of Pennsylvania. The authors can be contacted via e-mail: aboulatov@hse.ru and sdieckma@wharton.upenn.edu, respectively. We thank Georges Dionne, Dwight Jaffee, Praveen Kumar, Howard Kunreuther, Olivier Mahul, three anonymous referees, and participants at the NBER 2009 Insurance Workshop and the University of Houston for comments and suggestions.
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  • Stephan Dieckmann

    1. Alex Boulatov is affiliated with the Higher School of Economics in Moscow. Stephan Dieckmann is affiliated with the Wharton School at the University of Pennsylvania. The authors can be contacted via e-mail: aboulatov@hse.ru and sdieckma@wharton.upenn.edu, respectively. We thank Georges Dionne, Dwight Jaffee, Praveen Kumar, Howard Kunreuther, Olivier Mahul, three anonymous referees, and participants at the NBER 2009 Insurance Workshop and the University of Houston for comments and suggestions.
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Abstract

We study the risk-sharing implications that arise from introducing a disaster insurance fund to the cat insurance market. Such a form of intervention can increase efficiency in the private market, and our design of disaster insurance suggests a prominent role of catastrophe reinsurance. The model predicts buyers will increase their demand in the private market, and the seller will lower prices to such an extent that their revenues decrease upon introduction of disaster insurance. We test two predictions in the context of the Terrorism Risk Insurance Act (TRIA). It is already known that the introduction of TRIA led to negative abnormal returns in the insurance industry. In addition, we show this negative effect is stronger for larger and for low-risk-averse firms—two results that are consistent with our model. The seller’s risk aversion plays an important role in quantifying such feedback effects, and we point toward possible distortions in which a firm may even be overhedged upon introduction of disaster insurance.

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