Costly Risk Bearing and the Supply of Catastrophic Insurance
JOURNAL OF RISK AND INSURANCE, Vol. 63, No. 4, December 1996
Posted: 5 Feb 1997
Efficient contracts for sharing risk will allocate risk according to comparative advantage. This article considers insurance markets for earthquake risk and how comparative advantage in risk bearing can explain the amount of business individual insurers write. The respective abilities of insurers to write this risk depend on the characteristics of their entire portfolio as well as on financial features that influence the costs of risk bearing. Several recent contributions have shown why risk is costly to corporations such as insurers. The costs of risk arise from tax convexity, principal agent relationships within the firm, and the costs of financial distress. We will show how these types of features jointly determine the capacity of insurers to write earthquake insurance. We derive and estimate a cross-sectional model of earthquake insurance, and the results support the hypothesis that firms with a higher imputed cost of risk bearing assume less earthquake risk.
JEL Classification: G22, D81, D82
Suggested Citation: Suggested Citation