The economics of catastrophe risks are fundamentally different from those of risks covered by standard insurance contracts. Size alone is not necessarily the critical difference, nor is the sporadic and unpredictable nature of catastrophes. The key unconventional features needed to deal with the large, time-varying, asymmetric risks inherent in catastrophes are
- between-group trades across time, not just within-group, pay-as-you-go risk pooling;
- in normal times, payments by the risk-prone group to the relatively safe group;
- when catastrophe strikes, large payments to the risk-prone group by the relatively safe group;
- payments by the risk-prone group that may need to be more than "actuarially fair";
- incentives to mitigate risks and curtail investments in risk-prone regions.
Disaster Zone [complete article]