The Better Trigger: Insuring Against Disaster Risk

50 Pages Posted: 3 Mar 2014 Last revised: 19 Nov 2014

See all articles by Tse-Ling Teh

Tse-Ling Teh

Columbia University - School of International & Public Affairs (SIPA)

Christopher Woolnough

New York University (NYU)

Date Written: October 16, 2014

Abstract

Index triggers have enabled the extension of insurance to disaster risks by providing a simple mechanism to determine insurance payment. Disaster risks are notoriously difficult to insure against due to the covariant nature of risks, moral hazard and adverse selection. Index based risk transfer minimizes these obstacles by not fully insuring the risk. However, such incompleteness generates basis risk, that is the risk that claims do not match losses. This paper analyzes the upside basis risk (receiving a claim without a loss) and downside basis risk (having a loss but no claim) to determine a partial order ranking of indices for any risk averse individual. The partial ranking allows the selection of an index that is optimal for any individual with unknown risk aversion. Results demonstrate that correlation and covariance can provide incorrect comparisons between indices.

Keywords: catastrophes, index based risk transfer, basis risk, partial ranking, insurance

JEL Classification: D14, D81, G22, O16

Suggested Citation

Teh, Tse-Ling and Woolnough, Christopher, The Better Trigger: Insuring Against Disaster Risk (October 16, 2014). Available at SSRN: https://ssrn.com/abstract=2327234 or http://dx.doi.org/10.2139/ssrn.2327234

Tse-Ling Teh (Contact Author)

Columbia University - School of International & Public Affairs (SIPA) ( email )

420 West 118th Street
New York, NY 10027
United States

Christopher Woolnough

New York University (NYU) ( email )

Bobst Library, E-resource Acquisitions
20 Cooper Square 3rd Floor
New York, NY 10003-711
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
74
Abstract Views
674
rank
374,759
PlumX Metrics