Research Agenda

In 1997, the Wharton Financial Institutions Center—in collaboration with Wharton's Risk Management and Decision Processes Center—initiated a multi-year research initiative to examine the management and financing issues linked to catastrophic risks associated with natural disasters. The program —led by Wharton's Franklin Allen and Richard Herring, David Cummins, Neil Doherty, Howard Kunreuther and Paul Kleindorfer—has been working with a group of insurers, re-insurers and bankers to examine a range of issues associated with the management and financing of catastrophic risks linked to natural disasters. Of special note, this research effort is also complemented by the involvement of three of the leading firms in the field of disaster modeling as well as a technical advisory committee drawn from the scientific and public policy communities.

The program's agenda spans a number of research themes. These include:

• Understanding the scope and capacity of the insurance and re-insurance sectors to finance risk from natural disasters: Can insurers pay for the "Big One?"
• Identifying cost-effective, pre-disaster mitigation strategies to help reduce loss.
• Examining the roles of regulation and industry structure in support of market-driven solutions.
• Exploring the role of scientific modeling in providing more effective measurement and pricing tools.
• Assessing the potential for the capital markets to diversify catastrophic risks more efficiently.

Key Findings

• In securitization of CAT risk, the most successful innovation to emerge in addressing moral hazard has been the development of index-based hedges.
• The industry is much better capitalized than it was prior to Hurricane Andrew, but funding "the Big One" would still seriously disrupt the functioning of insurance markets.
• New evidence shows that it is not necessary for an insurer to be large in order to hedge effectively using index-linked contracts.
• Utilizing scientific risk estimates and models effectively serves to reduce uncertainty and forms the basis to develop common understanding between buyers and sellers of catastrophic risk-transfer instruments.
• Appropriate mitigation practices can be demonstrated to reduce losses substantially, increase underwriting capacity, and lower the probabilities of insurance insolvency from natural disasters

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