A Mutual Catastrophe Insurance Framework for Horizontal Collaboration in Prepositioning Strategic Reserves

We develop a mutual catastrophe insurance framework for the prepositioning of strategic reserves to foster horizontal collaboration in preparedness against low-probability high-impact natural disasters. The framework consists of a risk-averse insurer pooling the risks of a portfolio of risk-averse policyholders. It encompasses the operational functions of planning the prepositioning network in preparedness for incoming insurance claims, in the form of units of strategic reserves, setting coverage deductibles and limits of policyholders, and providing insurance coverage to the claims in the emergency response phase. It also encompasses the financial functions of ensuring the insurer’s solvency by efficiently managing its capital and allocating yearly premiums among policyholders. We model the framework as a very large-scale nonlinear multistage stochastic program, and solve it through a Benders decomposition algorithm. We study the case of Caribbean countries establishing a horizontal collaboration for hurricane preparedness. Our results show that the collaboration is more effective when established over a longer planning horizon, and is more beneficial when outsourcing becomes expensive. Moreover, the correlation of policyholders affected simultaneously under the extreme realizations and the position of their claims in their global claims distribution directly affects which policyholders get deductibles and limits. This underlines the importance of prenegotiating policyholders’ indemnification policies at the onset of collaboration.