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  • COMPARISON OF ALTERNATIVENATIONAL RISK TRANFER SYSTEMS:

    A fundamental view

    JOANNEUM RESEARCH Graz Institute of Technology and Regional Policy (InTeReg)

    Joint Seminar of the University of Innsbruck and alpSFinancial Risks of Natural Hazards: Markets and the Role of the State

    INNSBRUCK, July 5-6, 2007

    Franz Prettenthaler & Nadja Vetters

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    Designing national risk transfer mechanisms is a matter of dynamic mechanism design

    Mechanisms implement social choice functionsThe Fundamentals of RTMs therefore are to be found in Dynamic Social Choice theory under risk

    Harsanyi (1955) shows that VNM axioms imply utilitarianism Myerson (1981) shows the problem of dynamic inconsistencies

    in egalitarian social choice Mongin (1995) generalises Harsanyis results for SWFL Prettenthaler (2002) shows the coherence of Myersons and

    Mongins resultsFacing natural catastrophies, egalitarianism is a popular viewAre egalitarian RTMs necessarily dynamically inconsistent and therefore inefficient?

    Motivation

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    Setting the fundamental scene for RTMs Mechanism Design based on Social Choice Theory VNM axioms and Social Choice Theory Dynamic Consistency & Utilitarianism vs. Egalitarianism

    Numeric Example To expose the problem To set up the comparative framework

    Some national RTMs

    A fundamental comparison

    Overview

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    Theory behind: a numerical example (1)

    Two individuals A, B

    3 periods

    Period 1 & 3: society decides

    Period 2: nature decides

    The result after period 3 is evaluated from an ethical perspective

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    nF x (4,4)

    y' (0,10)

    x' (4,4)x F

    y' (12,2)

    x' (4,4)nF

    yy' (2,10)

    x' (4,4)

    F y' (10,0)

    Period 1 Period 2 Period 3Potential flood

    disaster

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    2 Social Welfare Functions

    Utilitarian: Wu(UA,UB) = UA+UBEgalitarian: We(UA,UB) = min {UA,UB}

    Evaluation of results

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    nF x (4,4)

    y' (0,10)

    x' (4,4)x F

    y' (12,2)

    x' (4,4)nF

    yy' (2,10)

    x' (4,4)

    F y' (10,0)

    contingent policy plans: e.g. (x; y,y)

    Period 1 Period 2 Period 3

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    Evaluation of the EXPECTED result (1)

    E.g. ex ante approach

    Utilitarian: Wu(EUA,EUB)

    Egalitarian:We(EUA,EUB)

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    511(6,5)(y;y',y')310(3,7)(y;y',x')29(7,2)(y;x',y')48(4,4)(y;x','x')612(6,6)(x;y',y')29(2,7)(x;y',x')311(8,3)(x;x',y')48(4,4)(x;x',x')

    We(EUA,EUB)Wu(EUA,EUB)(EUA,EUB)Policy Plan

    Max :

    Therefore choose :

    Evaluation of the EXPECTED result (2)

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    nF x (4,4)

    y' (0,10)

    x' (4,4)x F

    y' (12,2)

    x' (4,4)nF

    yy' (2,10)

    x' (4,4)

    F y' (10,0)

    We(4,4) = 4

    We(4,4) = 4

    We(12,2) = 2

    We(0,10)= 0

    Period 1 Period 2 Period 3

    While:

    But:

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    nF x (4,4)

    y' (0,10)

    x' (4,4)x F

    y' (12,2)

    x' (4,4)nF

    yy' (2,10)

    x' (4,4)

    F y' (10,0)

    Wu(4,4) = 8

    Wu(4,4) = 8

    Wu(12,2) = 14

    Wu(0,10)= 10

    Period 1 Period 2 Period 3

    Whereas:

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    Egalitarianism seems to be in conflict with dynamic consistency

    Up to now the ex ante approach was chosen

    Ex post approach would mean: First, the social welfare is calculated from the final

    result Secondly the expected value thereof is maximized

    Oberservation

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    111(y;y',y')310(y;y',x')29(y;x',y')48(y;x','x')212(x;y',y')29(x;y',x')311(x;x',y')48(x;x',x')

    EVe(UA,UB)EVu(UA,UB)Policy Plan

    Ex post evaluation

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    Observation

    Egalitarianism is not in conflict with dynamic consistency but

    Ex ante ex post equivalence

    Under the ex post approach, egalitarians can choose dynamically consistent

    Price to pay: ex ante preferences of individuals cannot be fully respected

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    Switzerland

    Cantonal Property Insurance mandatory (automatic) extension of coverage to

    include natural hazards Obligation to contract (monopoly position) Unlimited coverage, low premiums Reinsurance plus insurance pool (IRV, IRG) Important role in prevention and spatial planning

    Private insurance market (GUSTAVO cantons) mandatory extension of coverage Premiums not risk related Elementary damage pool

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    France

    The CAT NAT insurance scheme Private insurance carrier but regulated mandatory extension of coverage to include

    exceptional natural hazards risk independent premium surcharge (in %) Compensation demands governmental decision Unlimited government reinsurance by CCR (adverse

    selection problem stimulated reform) Sliding scale for deductibles in communities without

    risk prevention plans No extension of coverage for new buildings in risk

    zones after the publication of risk prevention plans

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    Spain

    Consorcio de Compensacin de Seguros Automatic coverage of extraordinary events

    (compulsory insurance) when underwriting certain insurance contracts

    Monopoly position Premiums risk independent Profits and interests paid into a reserve pool Distributed via private insurance companies, claim

    settlement by the Consorcio Unlimited state guarantee Not very actively involved in prevention

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    USA

    National Flood Insurance Program Optional coverage of flood damage in communities

    participating in the Program Communities have to develop risk management plans Risk mapping via NFIP Premiums depending on flood risk and quality of the

    risk, partly subsidized Distribution/claims settlement via licensed agents and

    private insurance companies State guarantee (loan of up to 1,5 billion US$) Different incentives for communities and individuals

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    Turkey

    Turkish Catastrophe Insurance Pool Launched 2000 with assistance from the World Bank Compulsory insurance coverage for all residential

    dwellings Stand alone insurance policy Risk related premiums (based on risk zone and type

    of building) Management outsourced to reinsurance company Distribution through private insurance companies,

    independent loss adjustors tax-exempt Actively involved in prevention and awareness raising

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    Austria

    private insurance market + public compensation fund

    private insurance market: low insurance penetration very limited coverage extended coverage only outside flood risk areas Premiums are risk independent

    catastrophe fund: tax financed compensation and prevention compensation is limited

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