The role of uncertainty on alternative disaster management strategies

The work presented in this paper is an outgrowth of a multi-year study at t he Wharton School of the University of Pennsylvania on Managing Catastrophi c Risks. We focus on tile role of homeowners and insurance companies in man aging the hazard from earthquake risk. Specifically, we consider alternativ e earthquake disaster management strategies for a typical homeowner and a s mall insurance company in the Oakland, California region. These strategies involve the adoption of mitigation measures and the purchase of earthquake insurance by the homeowner and the purchase of an indemnity contract (e.g.. excess-of-loss reinsurance) by the insurer. We focus on how uncertainty impacts these disaster management strategies Sp ecifically, we illustrate the impact of structural mitigation and risk-tran sfer mechanisms on the insurer's performance when there is uncertainty in t ile company's risk profile. This risk profile is captured through a loss ex ceedance probability (EP) curve, representing the probability that a certai n level of monetary loss will be exceeded oil an annual basis. Parameters c onsidered in the sensitivity analysis that will shift the loss EP curve inc lude: earthquake recurrence, ground motion attenuation, soil mapping scheme s. and the exposure and vulnerability of the residential structures. The pa per demonstrates how uncertainty in these parameters impacts tile cost effe ctiveness of mitigation and reinsurance on the insurer's profitability and chances of insolvency, as well as the number of policies the insurer is wil ling to issue.