Insurance of Natural Catastrophes When Should Government Intervene ?

Arthur CHARPENTIER, Insurance of natural catastrophes: when should governments intervene ?
Insurance of Natural Catastrophes

When Should Government Intervene ?
Arthur Charpentier & Benoît le Maux
Université Rennes 1 & École Polytechnique
arthur.charpentier@univ-rennes1.fr
http ://freakonometrics.blog.free.fr/
Congrès Annuel de la SCSE, Sherbrooke, May 2011.
1
1 Introduction and motivation
Insurance is “the contribution of the many

to the misfortune of the few”.
The TELEMAQUE working group, 2005.
Insurability requieres independence

Cummins & Mahul (JRI, 2004) or C. (GP, 2008)
2
1.1 The French cat nat mecanism

=⇒ natural catastrophes means no independence
Drought risk frequency, over 30 years, in France.
3
GOVERNMENT
RE-INSURANCE COMPANY
CAISSE CENTRALE DE REASSURANCE
INSURANCE INSURANCE INSURANCE

COMPANY COMPANY COMPANY
4
GOVERNMENT

5
GOVERNMENT

6
2 Demand for insurance

An agent purchases insurance if
E[u(ω − X)] ≤ u(ω − α)

| {z } | {z }
no insurance insurance
i.e.
p · u(ω − l) + [1 − p] · u(ω − 0) ≤ u(ω − α)
| {z } | {z }
i.e.
E[u(ω − X)] ≤ E[u(ω − α−l + I)]
| {z } | {z }
Doherty & Schlessinger (1990) considered a model which integrates possible

bankruptcy of the insurance company, but as an exogenous variable. Here, we
want to make ruin endogenous.
7

 0 if agent i claims a loss
Yi =
 1 if not
Let N = Y1 + · · · + Xn denote the number of insured claiming a loss, and

X = N/n denote the proportions of insured claiming a loss, F (x) = P(X ≤ x).
P(Yi = 1) = p for all i = 1, 2, · · · , n
Assume that agents have identical wealth ω and identical vNM utility functions
u(·).
=⇒ exchangeable risks
Further, insurance company has capital C = n · c, and ask for premium α.
8
2.1 Private insurance companies with limited liability
Consider n = 5 insurance policies, possible loss $1, 000 with probability 10%.
Company has capital C = 1, 000.
Ins. 1 Ins. 1 Ins. 3 Ins. 4 Ins. 5 Total

Premium 100 100 100 100 100 500
Loss - 1,000 - 1,000 - 2,000
Case 1 : insurance company with limited liability
indemnity - 750 - 750 - 1,500
loss - -250 - -250 - -500
net -100 -350 -100 -350 -100 -1000
9
2.2 Possible government intervention
Ins. 1 Ins. 1 Ins. 3 Ins. 4 Ins. 5 Total

Premium 100 100 100 100 100 500
Loss - 1,000 - 1,000 - 2,000
Case 2 : possible government intervention
Tax -100 100 100 100 100 500
indemnity - 1,000 - 1,000 - 2,000
net -200 -200 -200 -200 -200 -1000
(note that it is a zero-sum game).
10
3 A one region model with homogeneous agents

Let U (x) = u(ω + x) and U (0) = 0.
3.1 Private insurance companies with limited liability

• the company has a positive profit if N · l ≤ n · α
• the company has a negative profit if n · α ≤ N · l ≤ C + n · α
• the company is bankrupted if C + n · α ≤ N · l
c+α
=⇒ ruin of the insurance company if X ≥ x = l
The indemnity function is


 l if X ≤ x
I(x) =
 c + α if X > x
n
11
I(X)
I
l
Positive profit Negative profit Ruin

[0 ; nα[ ]–cn ; 0[ –cn
cα
X
0 α αc 1
x
l l
Probability of no ruin: Probability of ruin:

F(x ) 1–F(x )
12
Without ruin, the objective function of the insured is V (α, p, δ, c) defined as

U (−α). With possible ruin, it is
Z
E[E(U (−α − loss)|X)]) = E(U (−α − loss)|X = x)f (x)dx
where E(U (−α − loss)|X = x) is equal to

P(claim a loss|X = x) · U (α − loss(x)) + P(no loss|X = x) · U (−α)
i.e.
E(U (−α − loss)|X = x) = x · U (−α − l + I(x)) + (1 − x) · U (−α)
so that Z 1
V = [x · U (−α − l + I(x)) + (1 − x) · U (−α)]f (x)dx
0
that can be written
Z 1
V = U (−α) − x[U (−α) − U (−α − l + I(x))]f (x)dx
0
And an agent will purchase insurance if and only if V > p · U (−l).
13
3.2 Distorted risk perception by the insured
We’ve seen that

Z 1
V = U (−α) − x[U (−α) − U (−α − l + I(x))]f (x)dx
0
since P(Yi = 1|X = x) = x (while P(Yi = 1) = p).

But in the model in the Working Paper (first version), we wrote
Z 1
V = U (−α) − p[U (−α) − U (−α − l + I(x))]f (x)dx
0
i.e. the agent see x through the payoff function, not the occurence probability
(which remains exogeneous).
14
3.3 Government intervention (or mutual fund insurance)
The tax function is


 0 if X ≤ x
T (x) =
 N l − (α + c)n = Xl − α − c if X > x
n
Then Z 1
V = [x · U (−α − T (x)) + (1 − x) · U (−α − T (x))]f (x)dx
0
i.e.
Z 1 Z 1
V = U (−α + T (x))f (x)dx = F (x) · U (−α) + U (−α − T (x))f (x)dx
0 x
15
4 The common shock model

Consider a possible natural castrophe, modeled as an heterogeneous latent
variable Θ, such that given Θ, the Yi ’s are independent, and

 P(Y = 1|Θ = Catastrophe) = p
i C
 P(Yi = 1|Θ = No Catastrophe) = pN
Let p? = P(Cat). Then the distribution of X is
F (x) = P(N ≤ [nx]) = P(N ≤ k|No Cat) × P(No Cat) + P(N ≤ k|Cat) × P(Cat)
k
X n j n−j ∗ j n−j ∗

= (pN ) (1 − pN ) (1 − p ) + (pC ) (1 − pC ) p
j=0
j
16
Cumulative distribution function F
1.0
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0.0 0.2 0.4 0.6 0.8 1.0
Share of the population claiming a loss

20
Probability density function f
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10
5
pN p pC
0
0.0 0.2 0.4 0.6 0.8 1.0
17
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0.0 0.2 0.4 0.6 0.8 1.0

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0.0 0.2 0.4 0.6 0.8 1.0

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19
4.1 Equilibriums in the EU framework
The expected profit of the insurance company is

Z x̄
Π(α, p, δ, c) = [nα − xnl] f (x)dx − [1 − F (x̄)]cn (1)
0
Note that a premium less than the pure premium can lead to a positive expected
profit.
In Rothschild & Stiglitz (QJE, 1976) a positive profit was obtained if and only if
α > p · l. Here companies have limited liabilities.
Proposition1
If agents are risk adverse, for a given premium , their expected utility is always higher
with government intervention.
Démonstration. Risk adverse agents look for mean preserving spread

lotteries.
20
Proposition2
From the expected utilities V , we obtain the following comparative static derivatives :
∂V ∂V ∂V ∂V
< 0 for x̄ > x∗ , < 0 for x̄ > x∗ , > 0 for x̄ ∈ [0; 1], =?
∂δ ∂p ∂c ∂α
for x̄ ∈ [0; 1].
Proposition3
From the equilibrium premium α∗ , we obtain the following comparative static
derivatives :
∂α∗
< 0 for x̄ > x∗ ,
∂δ
∂α∗
=? for x̄ > x∗ ,
∂p
∂α∗
> 0 for x̄ ∈ [0; 1],
∂c
21
Expected profit<0 Expected profit>0
0
−20
●
Expected utility
−40
●
−60
pU(−l)= −63.9
● ●
0.00 0.05 0.10 0.15 0.20 0.25
Premium
22
4.2 Equilibriums in the non-EU framework
Assuming that the agents distort probabilities, they have to compare two
integrals,
Z 1
V = U (−α) − Ak (x)f (x)dx
x
Expected utility
utility
U(–α)
Without government
intervention
(1–p)U(–α)+pU(c–l)
With government
intervention
U(c–l)
X
x 1
Probability density function
Slightly high correlation High correlation Very high correlation
X
x p p p 1
23
Expected profit<0 Expected profit>0
●
−20
●
Expected utility
−40
−60
pU(−l)= −63.9
● ●
0.00 0.05 0.10 0.15 0.20 0.25
Premium
24
5 The two region model

Consider here a two-region chock model such that
• Θ = (0, 0), no catastrophe in the two regions,
• Θ = (1, 0), catastrophe in region 1 but not in region 2,
• Θ = (0, 1), catastrophe in region 2 but not in region 1,
• Θ = (1, 1), catastrophe in the two regions.
Let N1 and N2 denote the number of claims in the two regions, respectively, and
set N0 = N1 + N2 .
25
X1 ∼ F1 (x1 |p, δ1 ) = F1 (x1 ), (2)

X2 ∼ F2 (x2 |p, δ2 ) = F2 (x2 ), (3)
X0 ∼ F0 (x0 |F1 , F2 , θ) = F0 (x0 |p, δ1 , δ2 , θ) = F0 (x0 ), (4)
Note that there are two kinds of correlation in this model,

• a within region correlation, with coefficients δ1 and δ2
• a between region correlation, with coefficient δ0
Here, δi = 1 − piN /piC , where i = 1, 2 (Regions), while δ0 ∈ [0, 1] is such that
P(Θ = (1, 1)) = δ0 × min{P(Θ = (1, ·)), P(Θ = (·, 1))} = δ0 × min{p?1 , p?2 }.
26
1.0
Cumulative distribution function
1−p*
0.8
− Correlation beween: 0.01
0.6
− Region 1: within−correlation: 0.5
0.4
0.2
0.0
pN1 p pC1
0.0 0.2 0.4 0.6 0.8 1.0

30
25
20
15
10
5
0
0.0 0.2 0.4 0.6 0.8 1.0
27
1.0
1−p*
0.8
0.6
0.4
0.2
0.0
pN1 p pC1
0.0 0.2 0.4 0.6 0.8 1.0

30
25
20
15
10
5
0
0.0 0.2 0.4 0.6 0.8 1.0
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1.0
1−p*
0.8
0.6
0.4
0.2
0.0
pN1 p pC1
0.0 0.2 0.4 0.6 0.8 1.0

30
25
20
15
10
5
0
0.0 0.2 0.4 0.6 0.8 1.0
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1.0
1−p*
0.8
0.6
0.4
0.2
0.0
pN1 p pC1
0.0 0.2 0.4 0.6 0.8 1.0

30
25
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15
10
5
0
0.0 0.2 0.4 0.6 0.8 1.0
30
Proposition4
When both regions decide to purchase insurance, the two-region models of natural
catastrophe insurance lead to the following comparative static derivatives :
∂Vi,0 ∂αi∗∗
> 0, > 0, for i = 1, 2 and j 6= i.
∂αj ∂αj∗∗
31
Study of the two region model

The following graphs show the decision in Region 1, given that Region 2 buy
insurance (on the left) or not (on the right).
50
50
● ●
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● ●
40
40
REGION 1 ●
● REGION 1 ●
●
● ●
BUYS ●
● BUYS ●
●
● ●
Premium in Region 2
Premium in Region 2
INSURANCE ●
● INSURANCE ●
●
● ●
● ●
30
30
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20
20
●
● REGION 1 ●
● REGION 1
● ●
●
● BUYS NO ●
● BUYS NO
● ●
●
● INSURANCE ●
● INSURANCE
● ●
● ●
10
10
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0
0 10 20 30 40 50 0 10 20 30 40 50
Premium in Region 1 Premium in Region 1
32
Study of the two region model

The following graphs show the decision in Region 2, given that Region 1 buy
insurance (on the left) or not (on the right).
50
50
● ●
● ●
● ●
● ●
● ●
● ●
● ●
● ●
● ●
● ●
40
40
REGION 2 ●
● REGION 2 ●
●
● ●
BUYS NO ●
● BUYS NO ●
●
● ●
Premium in Region 2
Premium in Region 2
INSURANCE ●
● INSURANCE ●
●
● ●
● ●
30
30
● ●
● ●
● ●
● ●
● ●
● ●
● ●
● ●
● ●
● ●
20
20
● ●
● ●
● ●
● ●
● ●
●
● REGION 2 ●
● REGION 2
● ●
●
● BUYS ●
● BUYS
10
10
● ●
●
● INSURANCE ●
● INSURANCE
● ●
● ●
● ●
● ●
● ●
● ●
● ●
● ●
0
0 10 20 30 40 50 0 10 20 30 40 50
Premium in Region 1 Premium in Region 1
33
Definition1
In a Nash equilibrium which each player is assumed to know the equilibrium strategies
of the other players, and no player has anything to gain by changing only his or her own
strategy unilaterally.
50
50
● ●
● ●
● ●
● ●
● ●
50
● ● ●
● ●
● ●
● ● ●
● ●
40
40
REGION 1 ● REGION 1 ● ●
● ●
● ● ●
BUYS ● BUYS ●
Premium in Region 2
●
Premium in Region 2 ●
●
●
●
● ●
INSURANCE ●
INSURANCE ●
● ● ●
● ●
30
●
30 ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
40
● ● ●
20
20
● REGION 1 ● REGION 1
● ●
● ● ●
● BUYS NO ● BUYS NO
● ● ●
● ●
● INSURANCE ● INSURANCE ●
● ●
● ●
● ● ●
10
10
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
0
Premium in Region 2
30
●
0 10 20 30 40 50 0 10 20 30 40 50 ●
●
●
Premium in Region 1 Premium in Region 1 ●
●
●
●
●
●
20
●
●
50
50
● ●
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
40
40
REGION 2 ● REGION 2 ● ●
● ●
● ●
BUYS NO ● BUYS NO ● ●
Premium in Region 2
Premium in Region 2
● ●
INSURANCE ●
●
INSURANCE ●
● ●
● ● ●
● ●
● ●
10
30
30
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
20
20
● ● ●
● ●
●
●
●
● ●
● ● ●
● REGION 2 ● REGION 2
● ●
● ● ●
● BUYS ● BUYS
● ● ●
10
10
● ●
● INSURANCE ● INSURANCE ●
● ●
● ●
●
0
● ●
● ●
● ●
● ●
● ●
● ●
● ●
0
0 10 20 30 40 50
0 10 20 30 40 50 0 10 20 30 40 50
Premium in Region 1 Premium in Region 1 Premium in Region 1
34
Definition2
In a Nash equilibrium which each player is assumed to know the equilibrium strategies
of the other players, and no player has anything to gain by changing only his or her own
strategy unilaterally.
1: insured, 2: insured 1: insured, 2: non−insured
50
50
● ●
● ●
● ●
● ●
● ●
50
● ● ●
● ●
● ●
● ● ●
● ●
40
40
● ● ●
● ●
● ● ●
● ●
Premium in Region 2
●
Premium in Region 2 ●
●
●
●
● ●
● ● ●
● ●
● ●
30
●
30 ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
40
● ● ●
20
20
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
● ● ●
10
10
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
0
Premium in Region 2
30
●
0 10 20 30 40 50 0 10 20 30 40 50 ●
●
●
●
●
●
●
1: non−insured, 2: insured 1: non−insured, 2: non−insured ●
20
●
●
50
50
● ●
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
40
40
● ● ●
● ●
● ●
● ● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
10
30
30
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
20
20
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
10
10
● ●
● ● ●
● ●
● ●
●
0
● ●
● ●
● ●
● ●
● ●
● ●
● ●
0
0 10 20 30 40 50
0 10 20 30 40 50 0 10 20 30 40 50
35
Possible Nash equilibriums

50
50
● ●
● ●
● ●
● ●
● ●
50
● ● ●
● ●
● ●
● ● ●
● ●
40
40
● ● ●
● ●
● ● ●
● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
30
30
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
40
● ● ●
20
20
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
● ● ●
10
10
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
0
0
●
Premium in Region 2
30
●
0 10 20 30 40 50 0 10 20 30 40 50 ●
●
●
●
●
●
●
20
●
●
50
50
● ●
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
40
40
● ● ●
● ●
● ●
● ● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
10
30
30
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
20
20
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
10
10
● ●
● ● ●
● ●
● ●
●
0
● ●
● ●
● ●
● ●
● ●
● ●
● ●
0
0 10 20 30 40 50
0 10 20 30 40 50 0 10 20 30 40 50

40
40
● ●
● ●
● ●
● ●
● ●
40
● ● ●
● ●
● ●
● ● ●
● ●
30
30
● ● ●
● ●
● ● ●
● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
20
20
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
30
● ● ●
10
10
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
0
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
−10
−10
● ●
● ●
●
20
●
−10 0 10 20 30 40 −10 0 10 20 30 40 ●
●
●
(−10:40)
●
●
●
●
10 ●
●
40
40
● ●
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
30
30
● ● ●
● ●
● ●
● ● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
20
20
●
0
● ●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
10
10
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
0
● ● ●
● ●
−10
● ●
●
●
●
● ●
● ●
● ●
● ●
−10
−10
● ●
● ●
−10 0 10 20 30 40
−10 0 10 20 30 40 −10 0 10 20 30 40
Premium in Region 1 Premium in Region 1 (−10:40)
36

40
40
● ●
● ●
● ●
● ●
● ●
40
● ● ●
● ●
● ●
● ● ●
● ●
30
30
● ● ●
● ●
● ● ●
● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
20
20
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
30
● ● ●
10
10
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
0
0
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
−10
−10
● ●
● ●
●
20
●
−10 0 10 20 30 40 −10 0 10 20 30 40 ●
●
●
(−10:40)
●
●
●
●
10
●
●
40
40
● ●
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
30
30
● ● ●
● ●
● ●
● ● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
20
20
●
0
● ●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
10
10
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
0
● ● ●
● ●
−10
● ●
●
●
●
● ●
● ●
● ●
● ●
−10
−10
● ●
● ●
−10 0 10 20 30 40
−10 0 10 20 30 40 −10 0 10 20 30 40

40
40
● ●
● ●
● ●
● ●
● ●
40
● ● ●
● ●
● ●
● ● ●
● ●
30
30
● ● ●
● ●
● ● ●
● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
20
20
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
30
● ● ●
10
10
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
0
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
−10
−10
● ●
● ●
●
20
●
−10 0 10 20 30 40 −10 0 10 20 30 40 ●
●
●
(−10:40)
●
●
●
●
10 ●
●
40
40
● ●
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
30
30
● ● ●
● ●
● ●
● ● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
20
20
●
0
● ●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
10
10
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
0
● ● ●
● ●
−10
● ●
●
●
●
● ●
● ●
● ●
● ●
−10
−10
● ●
● ●
−10 0 10 20 30 40
−10 0 10 20 30 40 −10 0 10 20 30 40
37

40
40
● ●
● ●
● ●
● ●
● ●
40
● ● ●
● ●
● ●
● ● ●
● ●
30
30
● ● ●
● ●
● ● ●
● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
20
20
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
30
● ● ●
10
10
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
0
0
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
−10
−10
● ●
● ●
●
20
●
−10 0 10 20 30 40 −10 0 10 20 30 40 ●
●
●
(−10:40)
●
●
●
●
10
●
●
40
40
● ●
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
30
30
● ● ●
● ●
● ●
● ● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
20
20
●
0
● ●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
10
10
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
0
● ● ●
● ●
−10
● ●
●
●
●
● ●
● ●
● ●
● ●
−10
−10
● ●
● ●
−10 0 10 20 30 40
−10 0 10 20 30 40 −10 0 10 20 30 40

40
40
● ●
● ●
● ●
● ●
● ●
40
● ● ●
● ●
● ●
● ● ●
● ●
30
30
● ● ●
● ●
● ● ●
● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
20
20
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
30
● ● ●
10
10
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
●
●
● ●
0
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
●
−10
−10
● ●
● ●
●
20
●
−10 0 10 20 30 40 −10 0 10 20 30 40 ●
●
●
(−10:40)
●
●
●
●
10 ●
●
40
40
● ●
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
30
30
● ● ●
● ●
● ●
● ● ●
Premium in Region 2
Premium in Region 2
● ●
●
●
●
● ●
● ● ●
● ●
● ●
20
20
●
0
● ●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
● ●
10
10
● ● ●
● ●
●
●
●
● ●
● ● ●
● ●
● ●
● ● ●
● ●
● ● ●
● ●
0
● ● ●
● ●
−10
● ●
●
●
●
● ●
● ●
● ●
● ●
−10
−10
● ●
● ●
−10 0 10 20 30 40
−10 0 10 20 30 40 −10 0 10 20 30 40
38
When the risks between two regions are not sufficiently independent, the pooling
of the risks can lead to a Pareto improvement only if the regions have identical
within-correlations, ceteris paribus. If the within-correlations are not equal, then
the less correlated region needs the premium to decrease to accept the pooling of
the risks.
39
α α α

α α α

α
α
α
α Q
P α α
Q P
0
0
a Starting situation: Q=P b Decreasing between-correlation
α α
α α α α

P α α
P
α α
α
α
Q Q
0

c Increasing between-correlation d Increasing within-correlation in Region 1
40

Insurance of Natural Catastrophes When Should Government Intervene ?

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Insurance of Natural Catastrophes When Should Government Intervene ?

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Arthur CHARPENTIER, Insurance of natural catastrophes: when should governments intervene ?

Insurance of Natural Catastrophes

Congrès Annuel de la SCSE, Sherbrooke, May 2011.

1 Introduction and motivation

Insurance is “the contribution of the many

The TELEMAQUE working group, 2005.

Insurability requieres independence

1.1 The French cat nat mecanism

Drought risk frequency, over 30 years, in France.

INSURANCE INSURANCE INSURANCE

INSURANCE INSURANCE INSURANCE

INSURANCE INSURANCE INSURANCE

2 Demand for insurance

E[u(ω − X)] ≤ u(ω − α)

Doherty & Schlessinger (1990) considered a model which integrates possible

Let N = Y1 + · · · + Xn denote the number of insured claiming a loss, and

P(Yi = 1) = p for all i = 1, 2, · · · , n

2.1 Private insurance companies with limited liability

Ins. 1 Ins. 1 Ins. 3 Ins. 4 Ins. 5 Total

2.2 Possible government intervention

Ins. 1 Ins. 1 Ins. 3 Ins. 4 Ins. 5 Total

(note that it is a zero-sum game).

3 A one region model with homogeneous agents

3.1 Private insurance companies with limited liability

The indemnity function is

Positive profit Negative profit Ruin

Probability of no ruin: Probability of ruin:

Without ruin, the objective function of the insured is V (α, p, δ, c) defined as

where E(U (−α − loss)|X = x) is equal to

And an agent will purchase insurance if and only if V > p · U (−l).

3.2 Distorted risk perception by the insured

We’ve seen that

since P(Yi = 1|X = x) = x (while P(Yi = 1) = p).

3.3 Government intervention (or mutual fund insurance)

The tax function is

4 The common shock model

Let p? = P(Cat). Then the distribution of X is

Cumulative distribution function F

0.0 0.2 0.4 0.6 0.8 1.0

Share of the population claiming a loss

0.0 0.2 0.4 0.6 0.8 1.0

Share of the population claiming a loss

Cumulative distribution function F

0.0 0.2 0.4 0.6 0.8 1.0

Share of the population claiming a loss

0.0 0.2 0.4 0.6 0.8 1.0

Share of the population claiming a loss

Cumulative distribution function F

0.0 0.2 0.4 0.6 0.8 1.0

Share of the population claiming a loss

0.0 0.2 0.4 0.6 0.8 1.0

Share of the population claiming a loss

4.1 Equilibriums in the EU framework

The expected profit of the insurance company is

Démonstration. Risk adverse agents look for mean preserving spread

Expected profit<0 Expected profit>0

0.00 0.05 0.10 0.15 0.20 0.25

4.2 Equilibriums in the non-EU framework

Probability density function

Slightly high correlation High correlation Very high correlation

Expected profit<0 Expected profit>0

0.00 0.05 0.10 0.15 0.20 0.25

5 The two region model

α α α

a Starting situation: Q=P b Decreasing between-correlation

c Increasing between-correlation d Increasing within-correlation in Region 1