Risk-layering and optimal insurance uptake under ambiguity: With an application to farmers exposed to drought risk in Austria.

Many risks we face today will very likely not stay the same over time. For example, it is expected that climate change will alter future risks of natural disaster events considerably and, as a consequence, current risk management and governance strategies may not be effective anymore. Large ambiguities arise if future climate change impacts should be taken into account for analyzing risk management options today. Risk insurance, while albeit only one of many risk management actions possible, plays an important role in current societies for dealing with extremes. A natural starting point for our analysis is therefore the question of how ambiguity may be incorporated in a world with changing risks. To shed light on this question, we study how ambiguity can affect the uptake of insurance and risk mitigation within a risk-layer approach where each layer is quantified using distortion risk measures that should reflect the risk aversion of a decisionmaker toward extreme losses. Importantly, we obtain a closed-form solution for such a problem statement which allows an efficient numerical implementation. We apply this model to a case study of drought risk for Austrian farmers and address the question how ambiguity will affect the risk layers of different types of farmers and how subsidies may help to deal with current and future risks. We found that especially for small-scale farmers the consequences of increasing risk and model ambiguity are pronounced and subsidies are especially needed in this case to cover the high-risk layer.

Infrastructure in developing and transition countries: risk and protection.

This article examines two possible strategies for financing post-disaster infrastructure rehabilitation in developing and transition countries: relying on ex ante financing instruments (including insurance, catastrophe bonds, and other risk-transfer instruments) and ex post borrowing or credit. Insurance and other ex ante instruments will increase a country's stability, especially if the government authorities have a difficult time borrowing or otherwise raising funds after a major disaster; however, these instruments have an opportunity cost and can reduce the country's economic growth potential. The cost-benefit tradeoff is therefore one between economic growth through infrastructure investment and added solvency and stability for the economy. This article develops a model to illustrate this tradeoff. The model, which views the infrastructure of a developing or transition country as a nondiversifiable portfolio that generates returns, can provide a basis for evaluating alternative financing options depending on the country's objectives in terms of growth, solvency, and stability.