Risk transfer beyond reinsurance: the added value of CAT bonds

Abstract

Reinsurance and CAT bonds are two alternative risk management instruments used by insurance companies. Insurers should be indifferent between the two instruments in a perfect capital market. However, the theoretical literature suggests that insured risk characteristics and market imperfections may influence the effectiveness and efficiency of reinsurance relative to CAT bonds. CAT bonds may add value to insurers’ risk management strategies and may therefore substitute for reinsurance. Our study is the first to empirically analyse if and under what circumstances CAT bonds can substitute for traditional reinsurance. Our analysis of a comprehensive data set comprising U.S. P&C insurers’ financial statements and CAT bond use shows that insurance companies’ choice of risk management instruments is not arbitrary. We find that the added value of CAT bonds mainly stems from non-indemnity bonds and reveal that (non-indemnity) CAT bonds are valuable under high reinsurer default risk, low basis risk and in high-risk layers.

Evaluation of effectiveness of disaster risk transfer mechanisms in Sri Lanka

“…According to the article (Tobias Götze et al, 2021) likely discusses CAT (Catastrophe) bonds as a type of financial instrument used in DRT. CAT bonds are a type of insurance-linked securities that transfer the risk of loss from a catastrophic event from the insurer or reinsurer to capital market investors.…”

“…(Tobias Götze et al, 2021) • The ability of the DRT to be selfsustaining and operate effectively and efficiently in the long term.…”

“…11. Sustainability: The concept of sustainability of DRT according to the article " (Tobias Götze et al, 2021) refers to the ability of the DRT mechanism to continue providing its intended benefits over time without incurring undue financial burden or causing harm to the environment or society. In other words, it is the ability of the DRT to be self-sustaining and operate effectively and efficiently in the long term while also promoting sustainable development and environmental protection.…”

A re‐examination of the US insurance market's capacity to pay catastrophe losses

“…Some reinsurers are more positive but argue that this new environment is very complex and that the reinsurance industry is learning how to improve its participation in these new environmental and economic realities (Drexler & Rosen, 2022; Kessler, 2015). Insurance‐linked securities (ILS) are becoming important in the reinsurance market for catastrophe losses related to climate risk and earthquakes (Carayannopoulos et al, 2022; Götze & Gürtler, 2022; Lakdawalla & Zanjani, 2012). They are not very prevalent in the insurance market.…”

“…Insurance‐linked securities (ILS) are becoming important in the reinsurance market for catastrophe losses related to climate risk and earthquakes (Carayannopoulos et al, 2022; Götze & Gürtler, 2022; Lakdawalla & Zanjani, 2012). They are not very prevalent in the insurance market.…”