Revised Risk Assessments

2017 proved to be one of the costliest disaster years on record.  Total damages in the US for the year are estimated to exceed $300 billion.  Insured losses for all natural disasters in 2017 will total around $135 billion.

Do events like these cause (re)insurers to update their risk assessments?  How do firms, consumers, and government respond to a perceived change in risk?  Carolyn Kousky examines these questions in a book chapter titled “Revised Risk Assessments and the Insurance Industry” in the recently released Policy Shock, edited by Edward J. Balleisen, Lori S. Bennear, Kimberly D. Krawiec, and Jonathan B. Wiener.  The chapter limits its attention to disaster insurance.

Insurers understand risk.  For them, one disaster is unlikely to change their assessments if it is seen as a draw from a reasonably well characterized distribution.  There are at least three circumstances, however, when a disaster could provide new information leading to an updating of risk perceptions.

The first is for risks that are unknown and characterized by much uncertainty.  The second is for risks that are changing over time.  In this case, the occurrence of a disaster may provide information on how the risk is shifting.  And the third is when a disaster demonstrates a new risk that had not been previously recognized.  Of course, these need not be mutually exclusive.

In the chapter, Kousky gives examples of disasters that fit one or more of these three criteria and led to an updating of risk perceptions in the insurance industry.  She goes on to explore how insurers, consumers, and policymakers respond to shifts in understanding and perception of risk.  Companies may alter pricing, coverage conditions, underwriting strategies, and/or capital management in response a new understanding of a risk.  Consumers may increase their demand for disaster coverage.  And large events are responsible for government interventions in disaster insurance markets.  All these changes may cause only temporary adjustments or they may cause new equilibrium conditions in the market. Some may lead to permanent government interventions.

Book chapter is available here.