An Examination of the Geographic Aggregation of Catastrophic Risk

• Published in: Geneva papers on risk and insurance. Issues and practice 2015-01, Vol.40 (1), p.159-177
• Main Authors: Dumm, Randy E., Johnson, Mark E., Watson, Charles C.
• Format: Article
• Language: English
• Subjects: Capital markets; Catastrophes; Cyclones; Disaster insurance; Diversification; Economics and Finance; Finance; Hurricanes; Insurance; Insurance industry; Market penetration; Original Article; Property & casualty insurance; Public policy; Reinsurance; Risk exposure; Risk Management; Shin Research Excellence Award-Winning Papers; Studies
• ISSN: 1018-5895; 1468-0440
• DOI: 10.1057/gpp.2014.20

The debate in the United States about establishing a mechanism for insuring catastrophic wind risk at the national level pre-dates the intense 2004–2005 hurricane seasons. The prevailing argument against establishing any larger risk pool is that it would create a subsidy for the higher risk exposures. To determine whether benefits do accrue by aggregating catastrophic risk across increasingly wide geographic areas, the paper uses catastrophe models to evaluate the behavior of residential property portfolios within the state of Florida and for a larger risk pool that includes multiple combinations of coastal states in the southeastern United States. We find that geographic aggregation does not inherently subsidise high-risk exposures, reduces uncertainty, and reduces required reserves relative to total exposure for the least frequent and more severe events. This finding holds true for all state combinations evaluated in this study.