Earthquake insurance portfolio analysis of wood-frame houses in south-western British Columbia, Canada

Earthquake disasters affect many structures and infrastructure simultaneously and collectively, and cause tremendous tangible and intangible loss. In particular, catastrophic earthquakes impose tremendous financial stress on insurers who underwrite earthquake insurance policies in a seismic region, resulting in possible insolvency. This study develops a stochastic net worth model of an insurer undertaking both ordinary risk and catastrophic earthquake risk, and evaluates its solvency and operability under catastrophic seismic risk. The ordinary risk is represented by a geometric Brownian motion process, whereas the catastrophic earthquake risk is characterized by an earthquake-engineering-based seismic loss model. The developed model is applied to hypothetical 4000 wood-frame houses in south-western British Columbia, Canada, to investigate the impact of key insurance portfolio parameters to insurer’s ruin probability and business operability. The analysis results indicate: (i) the physical effects of spatially correlated ground motions and local soil conditions at insured properties are significant; (ii) the insurer’s earthquake risk exposure depends greatly on insurance arrangement (e.g. deductible and cap); and (iii) the maintenance of sufficient initial surplus is critical in keeping insurer’s insolvency potential reasonably low, while volatility of non-catastrophic risk is the key for insurer’s business stability. The results highlight the importance of adequate balance between business stability under normal conditions and solvency under extreme conditions for efficient earthquake risk management. Flexibility for determining an insurance arrangement would be beneficial for insurers to enhance their portfolio performance and to offer more affordable coverage to their clients.

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