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Understanding Fat Tails in Insurance Risks: Challenges and Solutions

This article explores the complex dynamics of fat tails in insurance risks, highlighting significant loss years exemplified by the National Flood Insurance Program (NFIP). It addresses the concerns surrounding the high cost of insuring these risks and presents a comparative analysis of rates of return on net worth for homeowners’ insurance in the U.S. versus Florida. With historical insights into catastrophic events like hurricanes Wilma, Dennis, and Katrina, it emphasizes the importance of risk mitigation strategies to manage expenses associated with fat tails effectively.

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Understanding Fat Tails in Insurance Risks: Challenges and Solutions

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  1. Fat Tails Can we insure these risks? Cooke and Kousky nsf# 0960865 Micro Correlations Tail Dependence

  2. These risks have big loss years: NFIP example

  3. And even bigger losses can be expected

  4. Insuring Risks is EXPENSIVE

  5. Rates of Return on Net Worth for Homeowners Ins: US vs. Florida Measure of firm profitability Source: NAIC; 2005/6 US and FL estimates from the Insurance Information Institute.

  6. Rates of Return on Net Worth for Homeowners Ins: US vs. Florida Averages: 1990 to 2006E US HO Insurance = -0.7% FL HO Average = -38.1% 4 Hurricanes Wilma, Dennis, Katrina Andrew Source: NAIC; 2005/6 US and FL estimates from the Insurance Information Institute.

  7. MITIGATION(aka ‘get out of the way’) Thin the tails De-couple risks Reduce insurance costs

  8. Fat Tails THANKS for viewing! Cooke and Kousky nsf# 0960865 Micro Correlations Tail Dependence

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