Climate Change and Effective Catastophe Risk Management Mechanisms: A Law and Economics Analysis of Insurances and Alternative Approaches by Qihao He GroupWork : Prof. Paolo Fabbri Palma Emanuela Lombardi Jennifer Tierney Mirko Vasta

Climate change risk and consequences

The mechanism of insurance to cover disasters Catastrophe risk The concept of risk Fundamental and particular risk RISK MANAGEMENT DEFINITION RISK AVERSION

ROAD MAP OF THE PAPER MARKET FAILURE OF PRIVATE INSURANCE INSURANCE-LINKED SECURITIES JUSTIFICATION OF GOVERNEMENT INTERVENTION

MARKET FAILURE OF PRIVATE INSURANCE FOR COVERING CATASTROPHE RISK RESTRICTIONS ON THE SUPPLY OF CATASTROPHE INSURANCE CAPACITY RESTRICTIONS OF THE INSURANCE INDUSTRY PROFITABILITY CONSTRAINTS ON INSURERS INSURABILITY RESTRICTIONS OF CATASTROPHE RISK PREDICTABILITY

Market infancy of ILS in distributing catastrophe risk ILS (Insurance-linked securities) ART SECURITIZATION Assets Liability Cash flow Conveying financial interests

Main product of ILS We have 3 types of ILS: 1. CATASTROPHE DERIVATIVES EXCHANGE-TRADED DERIVATIVES FUTURES OPTIONS FUTURE OPTIONS O.T.C. DERIVATIVES CONTRACTS SWAPS FORWARDS CREDIT DERIVATIVES

2. CONTINGENT CAPITAL FINANCIER CAPITAL INSURER CONTINGENT CAPITAL CONTINGENT DEBIT CONTIGENT DEBIT FACILITIES CONTIGENT SURPLUS NOTES CONTIGENT EQUITY CATASTROPHE EQUITY PUT OPTIONS PUT PROTECTED EQUITY

3. CATASTROPHE BONDS Risked-linked securities that transfer catastrophe risks from INSURERS INVESTORS through Fully-collateralized Special purpose vehicles (SPV) SPV IS USUALLY CREATED BY AN INSURANCE COMPANY OR A REINSURANCE COMPANY

STRUCTURE AND TRIGGERS OF CATASTROPHE BONDS CATASTROPHE BONDS ARE ALSO CALLED : CAT BONDS ACT OF GOD BONDS ISSUANCES SPV SPR  THE INSURES PAYS A PREMIUM FOR THE CONVERAGE TO SPV  THE INVERSTORS WILL PURCHASE CATASTROPHE BONDS FROM SPV TRIGGERS  INDEMNITY TRIGGER  INDEX TRIGGER  PARAMETRIC TRIGGER

JUSTIFICATIONS OF GOVERNMENT INTERVENTION IN MANAGING CATASTROPHE RISK When private markets fail governments should: 1. Assure that each individual maximizes expected utility 2. Individuals are risk-averse 3. Goverment provides coverage for losses and spread the losses over taxpayers Governments Libertarian Paternalistic Libertarian- paternalistic

Criticisms of government intervention 1. Premiums not reflect the risk being assured 2. Lies in mandatory nature compared to private insurance 3. Moral hazard induced by government criticism

Types of government intervention in covering catastrophe risk Providing direct compensation to victims (Flood of the century) Bundling compensation for catastrophes with other social insurance (Social security, Medicare) Requiring a mandatory cover on voluntary insurance policies (Code des assurances) Supplying government-supported (re) Insurance (NFIP)

Which is the optimal mechanism for efficient Catastrophe Risk Management? Comparing Private insurance, ILS and government intervention the best solution is : Put on the baseline Private insurance with goverment intervention

Thank you for your attention….