Revised Risk Assessments and the Insurance Industry

Abstract

Insuring disaster risks can be challenging, due to spatial correlations and fat-tailed loss distributions. This chapter examines catastrophe insurance with a particular focus on events that alter risk assessments in the insurance industry. It addresses two questions: (1) What types of events lead the (re)insurance industry to update risk assessments? (2) How do companies, consumers, and the government respond to updated risk assessments? Updating is more likely to occur for risks with unknown or changing loss distributions. When an extreme event leads to altered assessments of the risk, insurance firms will reevaluate their pricing, exposure, underwriting policies, and capital management practices. Severe events that lead to this type of risk updating, however, also often lead to updating on the part of consumers and governments. This chapter traces how all three sectors may respond when they assess a risk as higher than they did previously. This may lead to temporary adjustments, or it could cause new equilibrium conditions in the market or permanent government interventions.