Pricing Flood Insurance with a Hierarchical Physics-Based Model

Abstract

Floods account for a large part of global economic losses from natural disasters. As a result, the private insurance sector is increasingly participating in the financial risk sharing, thus expanding the role of actuaries to flood risk management. In this article, we investigate pricing and spatial segmentation of flood risk in the context of private insurance, meaning that individual risk assessment should minimize adverse selection. As such, we design a hierarchical flood risk model that allows an assessment at the individual level. Our model relies on a chain of physics-based climate, hydrological, and hydraulics modules combined with civil engineering methods to map the distribution of individual flood losses at high resolution. Building on such approach, we design pricing and segmentation methods tailored for flood risk management. We then apply the methods to study flood risk in a small city in the province of Quebec. We calculate premiums, analyze the impacts of risk sharing, set pricing territories consistent with the spatial flood risk, and finally, quantify the impact of greenhouse gas emission scenarios on individual and aggregate losses, premiums, and tail risk measures.

ACKNOWLEDGMENTS

The authors are thankful for the help and support of all experts who shared their time and their knowledge with them: Charles Malenfant and Simon Ricard (MDDELCC, help with hydrological data and the Atlas hydroclimatique du Québec), Joëlle Bérubé and Audrey Lavoie (MDDELCC, hydraulic scenarios of floods), Stéphane Comtois (MDDELCC, help with spatial data and geographic information systems), and Travis Logan (Ouranos, help with the manipulation of raster files). We also thank Marco Braun (Ouranos), who generated the climate scenarios used in this study.

The authors also give their warm thanks to the members of the monitoring committee: Nathalie Bleau (Ouranos), Pascal Marceau (MSP), Laurent Da Silva (Ouranos), Anne Blondlot (Ouranos), and Pascal Sarrazin (MDDELCC/DGPE). Your feedback has been appreciated.

Finally, special thanks to Diane Chaumont (Ouranos) and Jean Francoeur (MDDELCC) for their precious help in the initial stages (and the launch) of this project.

Discussions on this article can be submitted until January 1, 2021. The authors reserve the right to reply to any discussion. Please see the Instructions for Authors found online at http://www.tandfonline.com/uaaj for submission instructions.

Notes

1 There are plenty of analyses of the impact of climate change on floods in general; for example, see IPPC (2013).

2 The water or hydrological cycle is the set of processes that describe the circulation of water in the Earth and atmosphere. They include infiltration, evaporation and evapotranspiration, plant uptake, etc. A watershed is a drainage basin: an area of land in which water converges to a common outlet such as a river.

3 Discharge, or downstream river flow, is the flux of water flowing through a cross-sectional area at a certain point of a river, measured in cubic meters per second.

4 Measurement of underwater depth of water bodies.

5 A property is affected if its two-dimensional coordinates are located within the polygon representing a flood map.