Seismic Risk Management of Insurance Portfolio Using Catastrophe Bonds (original) (raw)
Related papers
Earthquake Spectra, 2013
This study investigates the effectiveness of two trigger mechanisms for parametric earthquake catastrophe bonds: scenario-based and station intensity-based approaches, in terms of basis risk. Advantages of the station intensity-based method are that balanced solutions with low total trigger errors and with similar positive and negative errors can be obtained. Two methods are applied to a case study for 2,000 conventional wood-frame houses in southwestern British Columbia. The results indicate that the station intensity-based method performs at least as well as the scenario-based method in terms of total trigger error. Moreover, model risks, as part of basis risk, are assessed by considering different spatial correlation models of peak ground motions. The use of incorrect spatial correlation models results in additional errors of the catastrophe bond trigger mechanisms.
Seismic risk management using soft and hard measures: seismic retrofitting and catastrophe bonds
Seismic risk management of building portfolios can be improved by combining risk mitigation and transfer measures effectively. To investigate the effects of different options on earthquake risk exposure in terms of seismic loss curve, a case study for wooden houses in Vancouver, Canada, is carried out. For risk mitigation measures, structural upgrading of lateral load resisting systems is considered, whereas parametric earthquake catastrophe (CAT) bonds are focused upon as a risk transfer tool. For parametric CAT bonds, a station-intensity-based trigger method is adopted. The results from the case study indicate that seismic upgrading provides an effective way to decrease potential seismic risk physically, although possibility of catastrophic risk cannot be entirely eliminated. The risk transfer measures can complement this by altering the shape of the seismic risk curve. Therefore, a combination of seismic upgrading and CAT bonds with a high loss trigger threshold may constitute an attractive solution.
Pricing risk-based catastrophe bonds for earthquakes at an urban scale
Scientific Reports
Catastrophe risk-based bonds are used by governments, financial institutions and (re)insurers to transfer the financial risk associated to the occurrence of catastrophic events, such as earthquakes, to the capital market. In this study, we show how municipalities prone to earthquakes can use this type of insurance-linked security to protect their building stock and communities from economic losses, and ultimately increase their earthquake resilience. We consider Benevento, a middle-sized historical town in southern Italy, as a case study, although the same approach is applicable to other urban areas in seismically active regions. One of the crucial steps in pricing catastrophe bonds is the computation of aggregate losses. We compute direct economic losses for each exposed asset based on high spatial resolution hazard and exposure models. Finally, we use the simulated loss data to price two types of catastrophe bonds (zero-coupon and coupon bonds) for different thresholds and maturit...
Engineering the finance of earthquake risk
The insurance industry has traditionally provided the method of hedging losses from earthquakes plus other natural and human-induced catastrophes. But in the wake of recent catastrophes the insurance industry has demonstrated that it has a limited capacity to absorb large financial losses. Thus, instead of utilising reinsurance, the global capital markets have been used in conjunction with Alternative Risk Transfer (ART) products which provide immediate access to capital for prompt recovery action. However, the pricing of these products has been mostly associated with the hazard frequency and intensity; little recognition is made of the riskiness of the structure to be indemnified. This study proposes a valuation methodology for catastrophe-linked ART products based on a four-step engineering loss model. The approach provides a more transparent method in which the risks and value can be directly linked to the characteristics of the insured portfolio of large constructed facilities. The results show a highly nonlinear relationship between the structural (strength and deformation) parameters and financial parameters
Calibrating CAT Bonds for Mexican Earthquakes
Journal of Risk and Insurance, 2010
The study of natural catastrophe models plays an important role in the prevention and mitigation of disasters. After the occurrence of a natural disaster, the reconstruction can be financed with catastrophe bonds (CAT bonds) or reinsurance. This paper examines the calibration of a real parametric CAT bond for earthquakes that was sponsored by the Mexican government. The calibration of the CAT bond is based on the estimation of the intensity rate that describes the earthquake process from the two sides of the contract, the reinsurance and the capital markets, and from the historical data. The results demonstrate that, under specific conditions, the financial strategy of the government, a mix of reinsurance and CAT bond, is optimal in the sense that it provides coverage of USD 450 million for a lower cost than the reinsurance itself. Since other variables can affect the value of the losses caused by earthquakes, e.g. magnitude, depth, city impact, etc., we also derive the price of a hypothetical modeled-index (zero) coupon CAT bond for earthquakes, which is based on a compound doubly stochastic Poisson pricing methodology. In essence, this hybrid trigger combines modeled loss and index trigger types, trying to reduce basis risk borne by the sponsor while still preserving a non-indemnity trigger mechanism. Our results indicate that the (zero) coupon CAT bond price increases as the threshold level increases, but decreases as the expiration time increases. Due to the quality of the data, the results show that the expected loss is considerably more important for the valuation of the CAT bond than the entire distribution of losses.
2008
A specific catastrophic risk model has been developed to evaluate, building by building, the probabilistic losses and pure premiums of different portfolios, taking into account the seismic microzonation of cities. Understanding probable losses and reconstruction costs due to earthquakes creates powerful incentives for countries to develop planning options and tools to cope with risk, including allocating the sustained budgetary resources necessary to reduce those potential damages and safeguard development. This model has been used to evaluate the fiscal contingency liabilities of the government and to build an optimal structure for risk transfer and retention, considering contingent credits, reserve funds, insurance/reinsurance, and cat bonds. In addition, an innovative insurance mechanism has been implemented for private housing, using the estate-tax payment and covering the all low-income homeowners through cross subsidies. Lastly, the model allows the evaluation of an exceedance...
Earthquake insurance pricing: a risk-based approach
Disasters, 2017
Flat earthquake premiums are 'uniformly' set for a variety of buildings in many countries, neglecting the fact that the risk of damage to buildings by earthquakes is based on a wide range of factors. How these factors influence the insurance premiums is worth being studied further. Proposed herein is a risk-based approach to estimate the earthquake insurance rates of buildings. Examples of application of the approach to buildings located in Taipei city of Taiwan were examined. Then, the earthquake insurance rates for the buildings investigated were calculated and tabulated. To fulfil insurance rating, the buildings were classified into 15 model building types according to their construction materials and building height. Seismic design levels were also considered in insurance rating in response to the effect of seismic zone and construction years of buildings. This paper may be of interest to insurers, actuaries, and private and public sectors of insurance.
2019 Winter Simulation Conference (WSC), 2019
The social and economic impact of natural catastrophes on communities is a concern for many governments and corporations across the globe. A class of financial instruments, parametric hedges, is emerging in the (re)insurance market as a promising approach to close the protection gap related to natural hazards. This paper focuses on the design of such parametric hedges, which have the objective of maximizing the risk transferred subject to a budget constraint. With Greece as a case study, one of the most seismic prone European regions, with limited seismic insurance penetration, this paper proposes a biased-randomized algorithm to solve the optimization problem. The algorithm hybridizes Monte Carlo simulation with a heuristic to generate a variety of solutions. A simulation stage allows for analyzing the payout distribution of each solution. Results show the impact of the problem resolution on the transferred risk and on the distribution of triggered payments.