The Risk Sharing Implications of Disaster Insurance Funds

48 Pages Posted: 28 Nov 2009 Last revised: 1 Aug 2011

See all articles by Alex Boulatov

Alex Boulatov

HSE Moscow; University of Houston - C.T. Bauer College of Business

Stephan Dieckmann

University of Pennsylvania - Finance Department

Date Written: May 1, 2011

Abstract

We study the risk sharing implications that arise from introducing a disaster relief fund to the cat insurance market. Such a form of intervention can increase efficiency in the private market, and our design of disaster relief suggests a prominent role of catastrophe reinsurance. The model predicts buyers to increase their demand in the private market, and the seller to lower prices to such an extent that her revenues decrease upon introduction of disaster relief. We test two predictions in the context of the Terrorism Risk Insurance Act (TRIA). It is already known 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 towards possible distortions in which a firm may even be overhedged upon introduction of disaster relief.

Keywords: Catastrophe Risk, Government Intervention, TRIA, Reinsurance

JEL Classification: D42, G22, H30

Suggested Citation

Boulatov, Alex and Dieckmann, Stephan, The Risk Sharing Implications of Disaster Insurance Funds (May 1, 2011). Available at SSRN: https://ssrn.com/abstract=1514648 or http://dx.doi.org/10.2139/ssrn.1514648

Alex Boulatov

HSE Moscow ( email )

26 Shabolovka
Moscow
Russia

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States
713-743-4618 (Phone)

Stephan Dieckmann (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

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