A Public–Private Insurance Model for Disaster Risk Management: An Application to Italy

Abstract

This paper proposes a public–private insurance model for earthquakes and floods in Italy in which the insurer and the government co-operate in risk financing. Our model departs from the existing literature by describing an insurance scheme intended to relieve the financial burden that natural events place on governments, while at the same time assisting individuals and protecting the insurance business. Hence, the business aims at maximizing social welfare rather than profits. Given the limited amount of data available on natural risks, expected losses per individual are estimated through risk-modeling. In order to evaluate the insurer’s loss profile, spatial correlation among insured assets is included. Our findings suggest that, when not supported by the government, private insurance might either financially over-expose the insurer or set premiums so high that individuals would fail to purchase policies. This evidence is stronger for earthquake risks, but it is considerable for floods too. We found that jointly managing the two perils alleviates the burden on public capitals by lowering the amount of capitals required and by keeping the probability of additional capital injections into the insurance reserves relatively low.