
Contents
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6.1 The Concept of Insurability 6.1 The Concept of Insurability
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6.2 Determining Whether to Provide Coverage 6.2 Determining Whether to Provide Coverage
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6.3 Setting Premiums 6.3 Setting Premiums
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Ambiguity of the Risk Ambiguity of the Risk
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Adverse Selection Adverse Selection
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Moral Hazard Moral Hazard
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Correlated Risks Correlated Risks
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6.4 Importance of the Cost of Capital 6.4 Importance of the Cost of Capital
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6.5 The Role of Rating Agencies 6.5 The Role of Rating Agencies
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6.6 Measuring Exposure to Natural Disasters: The Role of Catastrophe Models 6.6 Measuring Exposure to Natural Disasters: The Role of Catastrophe Models
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History of Catastrophe Modeling History of Catastrophe Modeling
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Nature of Catastrophe Models Nature of Catastrophe Models
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Constructing Exceedance Probability Curves Constructing Exceedance Probability Curves
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Application to Florida: Focus on Hurricane Risks Application to Florida: Focus on Hurricane Risks
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Summary Summary
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Appendix 6A: Treatment of Natural Catastrophic Risk by the Rating Agencies Appendix 6A: Treatment of Natural Catastrophic Risk by the Rating Agencies
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6 Private Insurers’ Decision Making for Supplying Coverage
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Published:June 2009
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Abstract
This chapter considers how insurers and reinsurers decide whether to cover a risk and what premiums to charge. The recent catastrophes have forced insurers and reinsurers to reevaluate their ability to provide protection against wind damage from hurricanes and to determine whether these events are insurable. To understand the concept of insurability, one may look at a standard policy whereby insurance premiums are paid at the beginning of a given time period to cover losses during this interval (typically a year). Premiums tend to be higher if the manner of estimating the likelihood and consequences of a risk is ambiguous. The unpredictability and significant losses associated with catastrophes mean that insurers must spend more for insurance coverage to cover the losses in the tail of the probability distribution. Although catastrophes are generally considered low-probability, high-consequence events, they might be much more frequent than in the past.
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