Abstract
The role of risk classification as a remedy for asymmetric information market failure is widely recognized and adverse selection is commonly expected to cause market failure also in natural disaster insurance market. Actually, natural catastrophe insurance is a hot topic for the fact that national governments need to build a system to face the high cost of disaster assistance and damage compensation. But an efficient natural disaster insurance is based also on a coherent risk classification and this is the key point of the paper. We argue that issues of risk classification should be a major concern in the design of natural disaster insurance, especially in countries, such as Italy, with a so low penetration of this kind of insurance. The paper is structured as follows. Section 2 provides information on the Italian NatCat insurance. Section 3 describes risk classification looking at the demand side of the market. Section 4 analyses adverse selection in NatCat insurance market and the role of risk classification. Section 5 concludes.
Highlights
Natural catastrophe (NatCat) insurance is a hot topic for the fact that national governments need to build a system to face the high cost of disaster assistance and damage compensation (Porrini, Schwarze, 2014)
Insurance could play an important role in managing natural hazard risks and promoting recovery from disasters, but insurance coverage may result in moral hazard if insured individuals take fewer measures to limit risk if they expect that insurers will compensate their damage irrespective of their mitigation
Adverse selection may obstruct the adequate functioning of natural disaster insurance markets if mainly individuals who face a high risk demand insurance, and insurers do not adequately factor such risks into higher prices because of information asymmetries between the insurer and the insured
Summary
Natural catastrophe (NatCat) insurance is a hot topic for the fact that national governments need to build a system to face the high cost of disaster assistance and damage compensation (Porrini, Schwarze, 2014). Adverse selection may obstruct the adequate functioning of natural disaster insurance markets if mainly individuals who face a high risk demand insurance, and insurers do not adequately factor such risks into higher prices because of information asymmetries between the insurer and the insured. Risk classification can play a role as a remedy for adverse selection and moral hazard, as it is widely recognized (Hoy, 1982; Abraham, 1985). This is not the only role in the case of building an efficient natural disaster insurance national system.
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