Climate Change and Effective Catastrophe Risk Management Mechanisms: A Law and Economics Analysis of Insurance and Alternative Approaches

Abstract

Climate change represents one of the epic issues of our time and it is likely to cause catastrophic damages. How to efficiently manage climate change catastrophe risk is the worldly challenge. After assessing three basic mechanisms, we find out that private catastrophe insurance generally produces optimal outcomes in which consumers maximize utility and insurers maximize profits, but it faces market failure in both supply and demand of catastrophe exposures; Insurance-linked securities (ILS) is a great tool to increase insurers’ supply of catastrophe insurance by enhancing insurers’ capability, but it still faces the anomalies of insurance demand; government intervention has the potential to solve the anomalies of private insurance, but government itself also faces government failures. It implies that private market merits with government intervention is — at least has the potential to be — the optimal mechanism to manage catastrophe risk.