Paul R. Kleindorfer

Regulation and Markets for Catastrophe Insurance

This paper discusses some of the problems associated with the efficient economic design of markets for catastrophe insurance and the regulation of private companies offering such insurance. The paper first considers the elements of the problem, on both the demand and supply side. On the demand side, we point to well-known difficulties of consumers and small businesses to evaluate the benefits of insurance relative to other approaches to risk bearing and risk mitigation. On the supply side, we note the inherent problems of insuring losses from natural hazards because of the correlated structure of the underlying loss distributions. Finally, regulatory problems associated with solvency, price and entry regulation for catastrophe insurance are analyzed. The paper concludes that the volatile mix of demand-side failures, supply-side complexities and regulatory manipulation are likely to make this area an important and difficult one for efficient economic design.

Interdependency of Science and Risk Finance in Catastrophe Insurance and Climate Change

This paper describes the interdependencies of science and risk finance for catastrophe insurance. While the basic arguments here apply to all catastrophe risks, including seismic and terrorism risks, I will focus on risks associated with climate change. This traditional logic of actuarial science is the starting point for the present paper. This logic calls for sound science as the foundation of risk-based rates for insurance and related securitized products anchoring national responses to natural hazards and project financing. Lack of sound science would run counter to objective insurability criteria as well as undermining the identification and implementation of cost-effective mitigation and longer-term adaptation measures. Building on this general line of thinking, the paper explores some additional complexities of science-catastrophe risk linkages related to climate change. These include the sizeable epistemic risks associated with scientific uncertainties surrounding climate change and the implications for choices of owners of vulnerable assets and for uncertainty loadings in insurance contracts and for adaptation measures. I also discuss the consequences of the same scientific uncertainty in exacerbating the problem of communicating an understanding of the financial consequences of climate change risks to policy makers and to owners of assets vulnerable to these risks. Finally, I briefly consider the implications of this discussion for the products and services that a market-oriented private insurer could offer to clients facing climate change risk. The most important new client on the block under climate change will surely be governments, which will face potentially very large new liabilities from climate change. I argue that a continuing close relationship between science and risk finance will be essential to promote viable insurance products for catastrophe risks, whether the risk capital is public or private, as well as an informed public dialog on how to face the increasingly evident risks of climate change.

Collaborative Innovation for Sustainable Fleet Operations: The Electric Vehicle Adoption Decision

We study the impact of collaboration on the adoption of electric vehicles (EVs) among commercial fleets. Using cooperative game theory, we characterize the joint payoffs for the primary stakeholders in the EV adoption decision - the fleet manager, auto manufacturer, and electricity supplier - to determine the conditions under which EVs become economically feasible for commercial eets. We do so in two settings. We first analyze a scenario where all three stakeholders cooperate in the EV adoption decision, a setting pertinent in regions such as France where a national electricity supplier makes such an arrangement feasible. We next analyze a scenario where the fleet manager and auto manufacturer cooperate but the electricity supplier participates as an independent actor, a setting pertinent in regions such as the United States where no single electricity supplier possesses sufficient market scope to become involved in the EV decision on a national scale. We show that convex per unit EV production costs drive a boundary solution for both the two- and three-party coalition EV adoption decision. We also illustrate the impact of carbon and operating cost advantages of EVs relative to internal combustion vehicles on the adoption of EVs and complementary vehicle-to-grid technology. Comparing the regions of EV adoption within the two coalition settings provides insights into the value of the electricity suppliers cooperation and the conditions under which intermediation to promote such cooperation can add value.

Sustainable Fleet Operations in the Postal Sector

Fleet optimization for postal operators (POs) is an important effort towards sustainable transportation in several ways. First, of course, is its direct economic impact through investment, amortization and operating costs. Second, is its impact on the carbon footprint of the PO. While the evaluation of alternative fleet traction systems (e.g., fossil-fuel, hybrid and electric) is in many respects a relatively straightforward financial investment problem, there are additional complexities that make this problem an interesting research problem for sustainable energy. These include the uncertainties in market prices for various sources of energy, including emission credits for carbon leveraging of investments; the problem of infrastructure and support for new technologies; the intangible/reputation benefits of sustainable energy investments for POs; the problem of new technologies and learning effects and, finally; the nature of strategic partnerships and risk sharing that may be needed to achieve the requisite scale of operations to make low-carbon vehicles a feasible alternative for major fleet operators and for the automotive industry. Taking these features into account, this paper will describe a strategic framework for evaluating the possible transformation of postal fleet operations to hybrid or (pure) electric vehicles and present some initial results for this problem. .

Risk Management for Energy Efficiency Projects in Developing Countries

The present paper addresses risk management fundamentals for energy efficiency (EE) projects in developing countries. The starting point for this paper is that there are many profitable EE projects in nearly every industrial enterprise that are simply not implemented. Four problems are often identified as the culprits for failing to harvest such projects: 1) lack of a rational and feasible approach to finance these projects; 2) lack of a rational internal management approach in the enterprise to package these projects in such a manner that they can be identified and implemented while the “plant is running”; 3) the high perceived risk of these projects; and 4) the fact that management is often simply unaware of the existence of EE projects of value. This paper is primarily focused on the third of these failure factors, risk, but touches also on the fourth factor since reducing project risk is predicated on understanding and measurement of EE benefits. The paper begins with a simple framework that emphasizes two dimensions of the organizational and contractual environment of EE projects. The first dimension is the energy intensity (measured, say, in terms of the ratio of energy costs to the total cost of goods sold) for the focal company initiating an EE project - the higher the energy intensity, the larger the potential payoff from EE, and the greater the ease of focusing management attention on EE. The second dimension is the level of organizational and contractual complexity of a project. Generally, the larger the number of external parties involved in a project (both financial and technical), the greater the complexity of assuring the ability to satisfy constraints necessary for successful project completion and the greater the transactions costs of contracting. After elaborating this framework and providing examples to illustrate required risk management, the paper discusses best practices for EE project risk management with illustrative case studies. Thereafter behavioral and other impediments to effective risk management are described, together with methods for overcoming these impediments. The paper then considers the role of carbon offsets as a possible source of co-financing of EE projects, and the risks associated with obtaining such carbon offsets under the CDM process. Finally, the paper considers the role of Energy Service Companies (ESCOs) in identifying profitable EE projects, in managing these projects and in reducing their risks. The paper concludes with recommendations for both companies executing EE projects as well as for international organizations like UNIDO attempting to promote EE in industry in emerging economies.

Climate Change and Insurance: Integrative Principles and Regulatory Risks

In medicine, an iatrogenic risk is a risk that arises from the medical treatment itself, such as side effects of surgery or drugs. The same phenomenon arises in the process of regulatory and legislative actions intended to facilitate mitigating and financing of catastrophic risks. Unanticipated regulatory or legislative fiats can have fundamental effects on insured risks. Moreover, economic disruptions in the much more densely interdependent global economy can also have systemic effects well beyond their direct locus of impact. These systemic risks are likely to become more evident in the catastrophe risk area in the years ahead, as the effects of climate change become more apparent. One can expect as a result increasing demands on regulators and parliamentarians who, in turn, are likely to look to the insurance and reinsurance industries for solutions. This paper describes the challenges likely to arise in this process, with a particular focus on catastrophe risks that may result from climate change (of course, weather-related events will continue to occur whether or not discernible climate change the culprit). These challenges include the magnitude of the hazards themselves, the complex interactions of mitigation with the Kyoto-driven carbon economy and the uncertainties associated with climate change itself. I review some principles that derive from the economics of insurance regulation and from the decision sciences. Some of these have been recently put forward as policy recommendations at the World Economic Forum and in the OECD Advisory Board on Financial Management of Large-scale Disasters. These recommendations on the role of insurance in mitigation and financing of catastrophe risks must be seen as part of a larger international debate on these issues. They are set against the background of increasing losses from catastrophes due to increased assets and population in vulnerable areas, the increased scale of weather-related events, possibly related to climate change, and increased interdependencies in the global economy. Given the magnitude of these risks, there is growing recognition on the importance of greater collaboration between the public and private sectors in identifying and quantifying risks from large-scale catastrophes and in the design of mitigation and residual risk financing mechanisms to cope with them. I argue here that it is essential that the insurance industry take a leadership role in developing principles and actions to address these risks.