Earthquake Cover

Last year, I wrote, more than semi-humourously, about my lack of earthquake cover. (In the meantime, my insurer has told me that I *do* have it - but that's not what the policy document says).

Per David Rossmiller , I now learn of another effort to justify the position:

... J. David Cummins and Neil A. Doherty of the Wharton School, University of Pennsylvania, explained this stuff a while back in a scholarly paper much better than I could, so I'll let them do the talking. Here's their explanation ...:

1) High-frequency, low-severity losses. These are losses that are numerous and small relative to industry resources. A good example is automobile collision losses. Although such losses may be considered a serious financial hardship to the individual insured, they are very small relative to the resources of the industry. Moreover, there are large numbers of such losses, most of which are statistically independent, meaning that the occurrence of any one accident is not usually associated with other, related accidents. For types of insurance where there are many statistically independent losses, insurers can exploit the statistical property known as the "law of large numbers.” The law of large numbers essentially says that when large numbers of statistically independent events are observed, the average loss becomes highly predictable. Or, in other words, the chances become small that the actual observed losses will deviate from expected losses by an amount which is large relative to the overall expected value of loss. This is the type of loss the insurance industry handles most effectively. By pooling together the losses of many individuals with statistically independent risk exposures, the industry is able to charge premiums which reflect the expected or average loss plus expenses and a relatively modest charge for risk bearing. The industry’s equity capital is more than adequate to absorb any adverse fluctuations in losses of this type.

(2) Low-frequency, high-severity losses. The second major type of loss is the type represented by large catastrophes, i.e., events that occur infrequently and are large relative to the resources of the insurance industry. This type of loss is much more difficult for the insurance industry to handle because the usual pooling mechanisms do not apply. The events are simply not sufficiently frequent for the law of large numbers to operate. For this type of loss, the insurer is essentially in the same position as the policyholder in the usual insurance transaction, i.e., the insurer faces a loss that amounts to a high proportion of its resources and that is highly uncertain or unpredictable. Low-frequency, high-severity losses cannot be handled effectively by the insurance industry acting alone. However, these losses can be diversified by pooling them with other economic events that are not usually the subject of insurance . . . .

I think that that confirms that it is most unlikely that I really have earthquake cover.