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Risk Awareness, Capital Markets and Catastrophic Risks

image of Risk Awareness, Capital Markets and Catastrophic Risks

The OECD contributes to the improvement of the financial management of major catastrophes both through the activities of the International Network on the Financial Management of Large-Scale Catastrophes and through the leadership of its High-Level Advisory Board. This publication compiles a series of reports reflecting the OECD’s extensive work in this field over recent years. These reports include: 1) a stocktaking of initiatives to promote natural hazard awareness and disaster risk reduction education, resulting in the publication of a policy handbook; 2) a review of and recommendations on catastrophe-linked securities and the role of capital markets in supporting the financial mitigation of large-scale risks, aimed at governments promoting these instruments; 3) a review of current mechanisms used to quantify catastrophe losses within the OECD; and 4) a review of hazard risk mapping efforts in South East Asian countries.

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Catastrophe Risks and the Role of Capital Markets

A Framework for Analysis

Insurance markets provide the means for individuals and organisations to transfer the risks of loss to insurers who pool the pure risks and, via the law of large numbers, make the unit loss more certain and the distribution less risky. The law of large numbers relies, however, on the independence of risks in the pool. Some perils (e.g., earthquake, flooding) in some countries abrogate that independence because the spatial correlation of risks diminishes the effectiveness of domestic insurers’ geographic diversification. While reinsurance does allow direct insurers to transfer risk to entities with a more geographically diversified pool of risks, reinsurance capacity is finite and any onward retrocession1 simply chases a diminishing capital capacity.

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