Community Rating, Cross Subsidies and Underinsurance: Why so many Households in Japan do not Purchase Earthquake Insurance
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A theoretical framework and empirical evidence are presented to show the connection between community uniform rating and cross-subsidies in earthquake insurance policy in Japan. Cross-subsidies are defined as the difference between a fair actuarial premium and the community uniform rate. The estimation result shows that the uniform community rating may unintentionally cross-subsidize inhabitants in high risk areas at the expense of inhabitants in low risk areas. Our simulation results indicate that replacing the current community rating with the fair actuarial premium would increase the overall subscription rate for earthquake insurance by about 3.7 percentage point, and that the increase is particularly prominent in relatively less risky areas. We propose modifying the Japanese earthquake insurance system by adopting a more refined risk rating system that more closely reflects regional differences in earthquake risk.
KeywordsEarthquake insurance Cross-subsidization Risk Japan
We are grateful to the National Research Institute for Earth Science and Disaster Prevention (NIED) for generously providing us with the data on earthquake hazard information. We also thank K. W. Chau, Dwight M. Jaffee, an anonymous referee and participants at the Asia-Pacific Real Estate Research Symposium (APRES) for their helpful comments and suggestions. The first author (Michio Naoi) acknowledges a Grant-in-Aid (#19730183) for Young Scientists (B) from the Ministry of Education, Culture, Sports, Science and Technology. Also, the second and third authors (Miki Seko and Kazuto Sumita) acknowledge a Grant-in-Aid (#19530157) for Scientific Research (C) from the Ministry of Education Culture, Sports, Science and Technology.
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