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An Examination of the Geographic Aggregation of Catastrophic Risk

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Abstract

The debate in the United States about establishing a mechanism for insuring catastrophic wind risk at the national level pre-dates the intense 2004–2005 hurricane seasons. The prevailing argument against establishing any larger risk pool is that it would create a subsidy for the higher risk exposures. To determine whether benefits do accrue by aggregating catastrophic risk across increasingly wide geographic areas, the paper uses catastrophe models to evaluate the behavior of residential property portfolios within the state of Florida and for a larger risk pool that includes multiple combinations of coastal states in the southeastern United States. We find that geographic aggregation does not inherently subsidise high-risk exposures, reduces uncertainty, and reduces required reserves relative to total exposure for the least frequent and more severe events. This finding holds true for all state combinations evaluated in this study.

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Notes

  1. E.g. Rothschild and Stiglitz (1976).

  2. Ibragimov et al. (1999).

  3. Doherty (1997).

  4. Cummins and Trainar (2009).

  5. Jaffee and Russell (1997).

  6. Grove (2012).

  7. Woo (2001).

  8. Nyce and Maroney (2011).

  9. Cummins (2006).

  10. Paudel (2012).

  11. Engeström (1995).

  12. Watson and Johnson (1999, 2002, 2004, 2007), Johnson and Watson (2011).

  13. Sampson and Schrader (1997, 2000).

  14. Watson and Johnson (2004), Watson et al. (2004).

  15. Watson et al. (2012).

  16. These entries are abbreviated as aal, losscost, rp_aal, rp_1pct, and ra100, respectively in this and all subsequent tables in this paper.

  17. E.g. Nyce and Maroney (2011).

  18. U.S. Census Bureau (2009).

  19. Nutter (2002) provides some historical context of the difficulties that various private-public options for catastrophic risk have encountered in the time leading up to 9/11 and suggests that the role of government in financing catastrophes lacks a clear policy direction.

  20. Vaughan and Vaughan (2008).

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Acknowledgements

The authors would like express their appreciation to the International Insurance Society, The Geneva Association, Kyobo Life, FSC, and GNAIE. Financial support for this research was provided by the Florida Catastrophic Storm Risk Management Center.

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Authors and Affiliations

  1. Florida State University, Tallahassee, FL 32306-1110, USA

    Randy E Dumm

  2. University of Central Florida, Orlando, FL 32816-2370, USA

    Mark E Johnson

  3. Enki Holdings, LLC, Savannah, 31404, GA, USA

    Charles C Watson Jr

Authors
  1. Randy E Dumm
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  2. Mark E Johnson
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  3. Charles C Watson Jr
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Additional information

This paper has been granted the 2014 Shin Research Excellence Award—a partnership between The Geneva Association and the International Insurance Society—for its academic quality and relevance by decision of a panel of judges comprising both business and academic insurance specialists.

E.g. Long Term Solutions for Florida’s Hurricane Insurance Market, 2006.

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Dumm, R., Johnson, M. & Watson, C. An Examination of the Geographic Aggregation of Catastrophic Risk. Geneva Pap Risk Insur Issues Pract 40, 159–177 (2015). https://doi.org/10.1057/gpp.2014.20

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