Financial Model for Insuring against Catastrophic Storm Risks

Abstract

Risks and uncertainties represent an integral part of the construction process that negatively affects executed projects, contracting parties, and the industry as a whole. In fact, natural hazardous events become extremely important at construction developments that allow low or zero tolerance levels. Concerns regarding catastrophic losses have limited the commercialization of certain projects and activities. This paper proposes a financial model for insuring against catastrophic storm risks that affect construction projects through a cost-benefit analysis. The challenge with modeling such severe conditions is that they are so rare that it might take thousands of years of experimental data to ensure that all possible events have been properly measured and captured. Under this study, the historic data in relation to storm events in Mississippi between 5/31/2006 and 5/31/2008 was analyzed using Chandler et al. (2001) technique to estimate loss parameters. This dataset was then bootstrapped using Iman and Conover technique to impose correlation and generate simulated dataset of 5, 000 points. Finally, the bootstrapped data was modeled using a Monte Carlo simulation that is based on option theory to calculate the fair-valued premium for an interrelated insurance policy. This insurance product would: (1) fund any destructive effect in connection with construction projects; (2) allow comparing catastrophic risks against benefits by putting a dollar value to such risks; and (3) solve the non linearity problem between wind speed and associated losses. It is the author's hope that the developed model could be extended to form a nationwide insurance policy against catastrophic storm risk. Furthermore, the same principles exploited under the model beforehand could be slightly modified in order to be applied on other extreme weather events such as hurricanes and tornadoes.

Meeting Name

2009 Construction Research Congress - Building a Sustainable Future (2009: Apr. 5-7, Seattle, WA)

Department(s)

Civil, Architectural and Environmental Engineering

Keywords and Phrases

Catastrophic loss; Catastrophic risks; Construction development; Construction process; Construction projects; Data sets; Destructive effects; Developed model; Dollar value; Experimental data; Extreme weather events; Financial models; Hazardous events; Historic data; Insurance policies; Integral part; Mississippi; Monte Carlo Simulation; Non-Linearity; Risks and uncertainties; Storm events; Wind speed; Zero-tolerance, Computer simulation; Construction industry; Contracts; Cost benefit analysis; Insurance; Monte Carlo methods; Storms, Risk perception

International Standard Book Number (ISBN)

978-078441020-2

Document Type

Article - Conference proceedings

Document Version

Citation

File Type

text

Language(s)

English

Rights

© 2009 American Society of Civil Engineers (ASCE), All rights reserved.

Publication Date

01 Apr 2009

Link to Full Text

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