Can insurers pay for the "big one"? Measuring the capacity of the insurance market to respond to catastrophic losses

This paper presents a theoretical and empirical analysis of the capacity of the US property liability insurance industry to finance catastrophic property losses in the $100 billion range. In our theoretical analysis, we show that the sufficient condition for capacity maximization, given a level of total resources in the industry, is for all insurers to hold a net of reinsurance underwriting portfolio which is perfectly correlated with aggregate industry losses. This result leads to a natural definition of industry capacity as the amount of industry resources that are deliverable conditional on an industry loss of a given size. Estimating capacity using insurer financial statement data, we find that the industry could adequately fund a $100 billion event. However, such an event would cause numerous insolvencies and severely destabilize insurance markets. (C) 2002 Elsevier Science B.V. All rights reserved.