The Optimal Structure of Incentive in Catastrophe Risk Securitization

Abstract

Catastrophe Risk Securitization has risen as a promising solution to the increasingly severe problem of risk financing and compensation in the recent two decades. In the special structure of Catastrophe Risk Securitization, the relationship between the reinsurer and Special Purpose Vehicle is a decisive yet sensitive one, as principal and agent, potential incentive disorder between them can render the securitization mechanism fail to fulfill its task. This paper sets out to examine the optimal structure of incentive between the reinsurer and the SPV, by the use of expected utility maximization paradigm, this paper developed the necessary condition for a dynamic catastrophe risk securitization mechanism, including individual rationality condition and incentive-compatibility condition, and further discovered that the optimal incentive parameter and the risk averse extent is negatively correlated. Based on these findings, this paper propose advice concerning the world risk securitization practice and suggest that the Special Purpose Vehicle in this operation should have its independent interest and compete for the right to securitize.