Natural and Man Made Disasters

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Both natural and man-made disasters are considered as events that can cause a large amount of losses and correlated with a small probability. It is rational for the population to have insurance against such events because most people are risk adverse: a risk adverse person means that the person will not prefer risk and will try to minimalize it. However, there is only a proportion of the population taking insurance against such events , without having insurance against such risk of losses banks were finding it a problem to issue loans and mortgages because they are exposed to the risk. To explain why there are only a small proportion of people insured (using the US as an example); the first step is to understand the insurance models, then to consider the behaviors of the demand side and supply side.
To understand why people who are at risk and not insured against it, it is important to understand how insurance works. Insurance is made to reduce risks by the purchaser paying a certain amount of money called a premium collected by the insurer. The premium is calculated by the insurer based on the probability of the occurrence of the event, the amount losses of the event and additional administration charges. The insurer collects the premiums and set up a pool of capital which is used to pay the unfortunates as coverage. Therefore it reduces the potential risk to a certain (or near) amount of losses that the purchaser paid as premium. Hence it explains why insurance is favorable to most people because most people are risk- adverse, so they are willing to pay small amount money to reduce the potential risk of large losses.
However, if insurance is favorable then why are people not insuring it, especially where the losses from disas...

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...sions in the most Misunderstood Industry, Cambridge University
Press, especially Chapters 2, 5 and 9 (available in e-book form through the library website)

H. Kunreuther, R. Meyer and E. Michel-Kerjan (2007) “Strategies for Better Protection against Catastrophic Risks,” Risk Management and Decision Processes Center, The Wharton
School of the University of Pennsylvania, September 2007 available at: http://opim.wharton.upenn.edu/risk/library/WP2007-09-14.pdf E. Michel-Kerjan (2010) “Catastrophe Economics: The National Flood Insurance Program,”
Journal of Economic Perspectives, Vol, 24:4, p.165-86

H. Kunreuther and E. Michel-Kerjan (2004) “Policy Watch: Challenges for Terrorism Risk
Insurance in the United States” Journal of Economic Perspectives, Vol. 18:4, p. 201-14
C.Gollie(2005)”Some aspects of the economics of catastrophe risk insurance”CESIFO1409

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