Testing of a Probabilistic Model of Seismic Risk in China to Enable Micro-Insurance Viability and Promote Mitigation

Abstract eng:
Index-based insurance has been recognised as a means to increase the viability of micro-insurance systems. In agriculture insurance, such schemes have already been tested successfully (Levin, 2007 et al.). In index-based schemes loss payouts to farmers are based on an index calculated from a measureable parameter, such as rainfall, that is correlated to the loss experienced, rather than on individual losses. One of the greatest challenges of index-based insurance is defining parameters that are highly correlated with loss, in order to reduce the differential between the payouts to the insured and the individual loss experienced, also known as basis risk. This paper shows the strengths of a probabilistic earthquake loss model used as a tool to design an index-based earthquake insurance product in China, particularly for homeowners micro-insurance where the high resolution model can reduce basis risk. For an example location, with a portfolio of buildings, loss payouts are modelled based on parameters of earthquake magnitude and distance, providing fundamental metrics to design indexed payout structure. The pure premium is also computed and reflects the risk, as an average annual loss and allows pricing of the risk. The same metrics are also generated for buildings with improved seismic resistance showing how index-based insurance can be used to promote mitigation. This study brings tools and a framework for risk quantification which complements existing studies on the implementation challenges by the growing micro-insurance community.

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