Insurance and Risk-Reducing Activity in Forestry : A Theoretical Approach

This article presents a theoretical model of private forest owner’s prevention and insurance choice in presence of natural risk. In France, evidence shows that non-industrial private forest owners rarely invest in prevention or insurance activities to reduce possible damages caused by natural risks. A natural risk in forest is represented by an infinite number of states of nature and is characterised by a loss function proportional to the forest value. We define optimal forest risk-reducing activities and insurance activities. We find some comparative static results and we analyse the impact of public financial assistance after a natural catastrophe on the forest owner’s decision. We show that a higher stand value has generally an ambiguous effect on risk-reducing activity. Indeed, this impact depends on three effects: the risk, wealth and loss effects and the net effect may be ambiguous. We show that the impact of an increase in the risk-reducing activity cost on optimal risk-reducing activity depends on the attitudes toward risk and on the relationship between the marginal return of risk-reducing activities and the random severity of a natural disaster. We prove that, if prevention activities are risk-reducing (risky) investment, then more risk-averse forest owners use more (less) risk-reducing activities. Providing public financial assistance after a natural catastrophe may reduce the incentives of non-industrial private forest owners to invest in insurance and forest risk management activities