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Interdependency of science and risk finance in catastrophe insurance and climate change

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This paper describes the interdependencies of science and risk finance for catastrophe insurance. While the basic arguments apply to all catastrophe risks, including seismic and terrorism risks, it focuses on risks associated with climate change. The traditional logic of actuarial science calls for sound science as the foundation of risk-based rates for insurance and related securitized products anchoring national responses to natural hazards and project financing. The paper explores some additional complexities of science-catastrophe risk linkages related to climate change. These include the sizeable epistemic risks associated with scientific uncertainties surrounding climate change and the implications for choices of owners of vulnerable assets and for uncertainty loadings in insurance contracts and for adaptation measures. I also discuss the consequences of scientific uncertainty in exacerbating the problem of communicating an understanding of the financial consequences of climate change risks to policy makers and to owners of assets vulnerable to these risks. Finally, I briefly consider the implications of this discussion for the products and services that a market-oriented private insurer could offer clients facing climate change risk. The most important new client on the block under climate change will surely be governments, which will face potentially very large new liabilities from climate change. I argue that a continuing close relationship between science and risk finance will be essential to promote viable insurance products for catastrophe risks, whether the risk capital is public or private, as well as an informed public dialogue on how to face the increasingly evident risks of climate change.

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