Insurability of Quake: A Model Risk Analysis for Small Business Concerns

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Recent public policy discussions have raised concerns over the insurability of quake damages and the extremely low level of earthquake insurance purchase by small business. At the same time, very theoretical issues have been raised about the use of deterministic loss estimates, especially worst-case ones, in insurance evaluation procedures, especially for earthquake. These theoretical issues suggest that deterministic decisions, decision made in ignorance of probabilities, may encourage adverse selection and discourage risk diversification, such as coverage of numerous small properties with geographical spread. To examine these issues, and also to clarify superior risk tools now available for earthquake, quantitative models for both insurers and small businesses will be developed and examined using these models to determine whether or not and under what types of program constructs earthquake insurance would be feasible for post-disaster recovery of small businesses. This quantitative approach should further assist in clarifying the concept of insurability.