Welfare consequences of persistent climate prediction errors on the insurance markets against natural hazards

• Autor(a) principal: Gilvan Ramalho Guedes
• Data de Publicação: 2018
• Outros Autores: Rodrigo Raad
• Tipo de documento: Artigo de conferência
• Idioma: por
• Título da fonte: Repositório Institucional da UFMG
• Texto Completo: http://hdl.handle.net/1843/54214; https://orcid.org/0000-0001-8231-238X; https://orcid.org/0000-0003-3974-3517
• topic: Natural disasters; Climate change; Errors in climate prediction; Private insurance model under uncertainty; Heterogeneity in agents’ priors; Desastres ambientais; Mudanças climáticas; Mudanças climáticas - Previsão

This paper proposes a two-period model of private insurance under climate uncertainty with endogenous prices to explain how the coexistence of agents’ heterogeneity regarding ability to predict future occurrence of natural events may deviate market prices from the fundamentals, leading to reduction in social welfare in the long run. Based on survey data related to self-insurance against floods and perception on change in local climate parameters, coupled with historical meteorological data from local weather stations, we identified the existence of a group of individuals making persistent errors in the anticipation of climate events. Econometric models further suggest that the probability of belonging to this group varies significantly by sociodemographic and geophysical attributes of the sampled respondents. This empirical finding of heterogeneity within and between groups helps explain why there is no market supply of information on natural events. The absence of firms providing this type of information occurs because price discrimination via product differentiation is economically unfeasible in private markets. Therefore, we propose a theoretical model with heterogeneous agents and taxation to finance a public technology providing information on natural events. Results from our insurance model with incomplete markets show that the group with accurate expectations price the insurance as the fundamentals, while agents with inaccurate expectations distort insurance prices in the long run. The closed form solution suggests that agents making persistent mistakes on the process of anticipation of climate events are not driven out from the market. By including a central planner providing a technology for access to accurate information, our example illustrates that public intervention (via taxation) would only be feasible if public expenditure in the provision of this technology did not exceed 9.188% of the aggregate income earned by agents with inaccurate expectations. This threshold is computed based on a relative measure of social welfare that is robust to scale transformations.