The risk implications of insurance securitization: The case of catastrophe bonds (original) (raw)
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This paper discusses the most recent developments in insurance securitization and assesses the potential for growth in the insurance-linked securities (ILS) market and in insurance-linked derivatives. In particular, the authors analyze the motivations of security sponsors and investors to participate in the catastrophe (CAT)– linked capital market, and identify the key components of growth and its impediments. Finally, this article
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Insurance: Mathematics and Economics, 2018
We provide a novel explanation for the low volume of securitization in catastrophe risk transfer using a signaling model. Relative to securitization, reinsurance features lower adverse selection costs because reinsurers possess superior underwriting resources than ordinary capital market investors. Reinsurance premia, however, reflect markups over actuarially fair premia due to the additional costs of underwriting. Insurers' risk transfer choices trade off the costs and benefits of reinsurance relative to securitization. In equilibrium, low risks are transferred via reinsurance, while intermediate and high risks are transferred via partial and full securitization, respectively. An increase in the loss size increases the trigger risk level above which securitization is chosen. Hence, catastrophe exposures, which are characterized by lower probabilities and higher severities, are more likely to be retained or reinsured rather than securitized.
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Social Science Research Network, 2005
We identify a new benefit of index or parametric triggers. Asymmetric information between reinsurers on an insurer's risk affects competition in the reinsurance market: reinsurers are subject to adverse selection, since only high-risk insurers may find it optimal to change reinsurers. The result is high reinsurance premiums and crosssubsidization of high-risk insurers by low-risk insurers. A contract with a parametric or index trigger (such as a catastrophe bond) is insensitive to information asymmetry and therefore alters the equilibrium in the reinsurance market. Provided that basis risk is not too high, the introduction of contracts with parametric or index triggers
Product Intervention as a Macroprudential Tool: the Case of Catastrophe Bonds
The George Washington International Law Review, 2019
One effect of the financial crisis of 2007-2009 was to jump-start a focus on macroprudential supervision, a supervisory approach which adopts a bird's-eye view in assessing and addressing systemic threats to financial stability. In addition to the threats to the financial system posed by the financial reach and exposure of large systemically relevant corporations, threats can also come from broader financial activity such as the design and distribution of innovative financial products within financial markets. Thus, product intervention powers may be useful in the future to financial supervisors attempting to address systemic risk deriving from financial innovation and growth. The utility of product intervention can be demonstrated by using the catastrophe bond markets as a case study. Extreme climate-related events are increasing in magnitude and frequency as a result of climate change and consequent losses are likewise increasing. The need to transfer these risks is leading to a growth in demand for insurance and the demand is beginning to exceed the capacity of traditional insurance and reinsurance. This has led to a type of beneficial financial innovation-the creation of instruments which transfer these catastrophe risks to the capital markets. The prevalence of catastrophe bonds in the financial markets is therefore growing, with the number of issues increasing steadily year-on-year. On the back of this, a number of catastrophe-linked derivatives are beginning to be traded in the markets. This Article argues that a number of features of the design and distribution of these financial instruments may render them systemically relevant in the future. This is so particularly in view of the potential for significant common exposures to develop, which, should
Securitization as an Alternative Way of Managing the Risk of Catastrophic Events
НОВИ ЕКОНОМИСТ, 2019
Catastrophic events caused by naturaldisasters and human activities pose a uniquechallenge for insurers, because they make itdifficult to estimate expected claims and can causedisruption to the insurance market and imposesignificant costs on government, businesses andindividuals. The lack of available coverage ofthese risks in the market, due to the insolvency orunwillingness of insurers to ensure catastrophicevents, can significantly impede the economicrecovery and development of the country. For thisreason insurers have sought alternative ways ofcovering these extreme losses, and one of them, atransfer of the risk of insurance to the capitalmarkets represents the main subject of thisresearch. The aim of this maneuver is to presentthe advantages and disadvantages of theinstruments through which the transfer ofinsurance risk to financial markets is carried out,as well as to indicate the legal and otherassumptions necessary for the functioning anddevelopment of this market.
Securitization, Insurance, and Reinsurance
Journal of Risk and Insurance, 2009
This article considers strengths and weaknesses of reinsurance and securitization in managing insurable risks. Traditional reinsurance operates efficiently in managing relatively small, uncorrelated risks and in facilitating efficient information sharing between cedants and reinsurers. However, when the magnitude of potential losses and the correlation of risks increase, the efficiency of the reinsurance model breaks down, and the cost of capital may become uneconomical. At this juncture, securitization has a role to play by passing the risks along to broader capital markets. Securitization also serves as a complement for reinsurance in other ways such as facilitating regulatory arbitrage and collateralizing low-frequency risks.
Catastrophe Bonds and Financial Risk: Securing Capital and Rule through Contingency
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a b s t r a c t This paper uses the example of catastrophe bonds to investigate how exposures to geophysical, biological, and meteorological catastrophic events are constituted as securitizable and exchangeable financial risks in the insurance-linked securities (ILS) market. It discusses the techniques of catastrophe modeling as a pivotal mobile methodology for the calculation and creation of contingent assets out of the fabric of insured environmental and financial vulnerabilities. Catastrophe models are shown to enable economic exchange of contingent futures belonging to ontologically and geographically disparate orders. Pension funds are then introduced to illustrate how biological lives and retirement savings have become deeply entangled in the creation and extension of the ILS market. Pension funds are both major institutional investors in catastrophe bonds and also the principal sellers of ''longevity risk'' posed by pensioners. The extent to which labor both profits from and embodies securitized insurance risks illustrates the growing importance and ambivalence of contingency as a modality of accumulation and rule.
Valuation of catastrophe reinsurance with catastrophe bonds
Insurance: Mathematics and Economics, 2007
This study develops a contingent-claim framework for valuing a reinsurance contract and examines how a reinsurance company can increase the value of a reinsurance contract and reduce its default risk by issuing catastrophe (CAT) bonds. The results also show how the changes in contract values and default risk premium are related to basis risk, trigger level, catastrophe risk, interest rate risk, and the reinsurer's capital position.
Business and Economic Horizons, 2018
We analyse the effectiveness of catastrophe bonds for the financial management of catastrophic risk in the transport and infrastructure industries. We illustrate how these financial instruments are becoming a valuable tool for non-financial firms in the risk management of catastrophic events, supplementing the traditional insurance/reinsurance channel, especially during times of constraints in the insurance industry. We also review cat bond issues sponsored by infrastructure and transport companies, highlighting the usefulness of these structured financial instruments in the management of the catastrophe exposure in these industries. Policy indications are finally given.