Optimal insurance coverage of low-probability catastrophic risks

Alexis Louaas (1) , Pierre Picard (1)

1 CREST - Centre de Recherche en Économie et Statistique

Catastrophic risks are often characterised by a low probability , a high severity and a large number of affected individuals. Taking these specificities into account, we analyse the capacity of insurance contracts to provide coverage for those risks, independently from the market failures frequently observed in practice. On the demand side, we characterise individual preferences under which the willingness to pay for the coverage of large losses remains significant, although their occurrence probability is very small. On the supply side, the correlation between individual losses affects the insurance pricing through the insurers' cost of capital. Analysing the interaction between demand and supply yields the key determinants of insurability and of a socially optimal risk sharing strategy.

Mots clés: Disaster insurance; catastrophic risk; risk aversion; capital costs JEL classification: D81; D86; G22; G28 *

Domaines: Economies et finances; Finance [q-fin.GN]

Alexis Louaas, Pierre Picard. Optimal insurance coverage of low-probability catastrophic risks. 2020. ⟨hal-02875534⟩