Community Rating, Cross Subsidies and Underinsurance: Why So Many Households in Japan Do Not Purchase Earthquake Insurance
A theoretical framework and empirical evidence are presented to show the connection
between community uniform rating and cross-subsidies in earthquake insurance policy in
Japan. Cross-subsidies are defined as the difference between a fair actuarial premium and
the community uniform rate. The estimation result shows that the uniform community
rating may unintentionally cross-subsidize inhabitants in high risk areas at the expense of
inhabitants in low risk areas. Our simulation results indicate that replacing the current
community rating with the fair actuarial premium would increase the overall subscription
rate for earthquake insurance by about 3.7 percentage point, and that the increase is
particularly prominent in relatively less risky areas. We propose modifying the Japanese
earthquake insurance system by adopting a more refined risk rating system that more
closely reflects regional differences in earthquake risk.
