Combined international and intergenerational disaster risk diversification: An innovative instrument for government intervention into the private disaster insurance program

Major catastrophic experiences since the 1990s and the rise in both frequency and severity of natural hazards have resulted in widespread concern about the financial management of disaster risk. Alternative risk transfer approaches have been designed to support the insurance industry in capping and insurability issues, among which capital markets as well as governments are expected to contribute. In this paper, the authors discuss the role of the government in supporting the market-based disaster risk financing approach. This is done using a one-good, two-country and two-period-overlapping-generation model. Agents living in the less developed and less damage resistant country can transfer their risk via the international private insurance market to the foreign agents. Disaster risk could also be diversified among generations through the intergenerational system operated by their government. The intergenerational framework uses the buffer stock strategy consisting of a disaster reserve and international loans. With the capital accumulated in the reserve, the government should intervene into the private international insurance market so that an optimum combination of the private and public sectors are reached. Numerical results show that through intervention Pareto improvement is achieved in terms of social welfare. Theoretically, the intervention could be conducted either in the form of public insurance or a government-sponsored private insurance program.