Earthquake insurance in Iran: solvency of local insurers in light of current market practices

Abstract

Abstract. Owing to its geographical position within one of the most seismically active zones globally, Iran has experienced numerous historically impactful earthquakes. To finance a part of these losses and reconstruction expenses, earthquake insurance has been offered as a rider on fire insurance policies by Iranian insurers. This mechanism, if operated well, can substantially contribute to disaster risk management. On the other hand, if the pricing and management of catastrophe risk lack sound, risk-modeling-based practices, it might add to the problems and act to the detriment of disaster risk management. In this paper, we first compare the current earthquake insurance pricing and risk management in the Iranian insurance industry to a state-of-the-art insurance regulation in the European Union (Solvency II). Then, we examine the consequences of following each approach in terms of business profitability and viability by conducting a numerical analysis on a hypothetical portfolio of property risks in Iran. In so doing, a seismic risk model has been developed by adopting the Earthquake Model of the Middle East (EMME) and a peer-reviewed vulnerability model and by developing an exposure model for residential dwellings in Iran. The results suggest that modeled earthquake premium rates are about 5 times larger than the rates currently used in the market. Furthermore, a comparison between solvency capital calculated following the methods specified by the European Solvency II policy and the Iranian Directive 69 indicates a visible underestimation of earthquake solvency capital by the Iranian insurers. It seems that maintaining the current insurance pricing and risk management practices in Iran will probably lead to a substantial accumulation of earthquake risk for domestic firms and eventually endanger the solvency of these companies in the event of large-scale earthquake losses in the future.