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The Pricing of U.S. Catastrophe Reinsurance

In: The Financing of Catastrophe Risk

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  • Kenneth A. Froot
  • Paul G. J. O'Connell

Abstract

We explore two theories that have been advanced to explain the patterns in U.S. catastrophe reinsurance pricing. The first is that price variation is tied to demand shocks, driven in effect by changes in actuarially expected losses. The second holds that the supply of capital to the reinsurance industry is less than perfectly elastic, with the consequence that prices are bid up whenever existing funds are depleted by catastrophe losses. Using detailed reinsurance contract data from Guy Carpenter & Co. over a 25-year period, we test these two theories. Our results suggest that capital market imperfections are more important than shifts in actuarial valuation for understanding catastrophe reinsurance pricing. Supply, rather than demand, shifts seem to explain most features of the market in the aftermath of a loss.

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This chapter was published in:

  • Kenneth A. Froot, 1999. "The Financing of Catastrophe Risk," NBER Books, National Bureau of Economic Research, Inc, number froo99-1.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 7951.

    Handle: RePEc:nbr:nberch:7951

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    References

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    1. Kenneth A. Froot & Jeremy C. Stein, 1996. "Risk Management, Capital Budgeting and Capital Structure Policy for Financial Institutions: An Integrated Approach," NBER Working Papers 5403, National Bureau of Economic Research, Inc.
    2. Anne Gron & Deborah Lucas, 1995. "External Financing and Insurance Cycles," NBER Working Papers 5229, National Bureau of Economic Research, Inc.
    3. Anne Gron, 1994. "Capacity Constraints and Cycles in Property-Casualty Insurance Markets," RAND Journal of Economics, The RAND Corporation, vol. 25(1), pages 110-127, Spring.
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    Cited by:
    1. Zanjani, George, 2002. "Pricing and capital allocation in catastrophe insurance," Journal of Financial Economics, Elsevier, Elsevier, vol. 65(2), pages 283-305, August.
    2. Parente, Ronaldo & Choi, Byeongyong Paul & Slangen, Arjen H.L. & Ketkar, Sonia, 2010. "Distribution system choice in a service industry: An analysis of international insurance firms operating in the United States," Journal of International Management, Elsevier, Elsevier, vol. 16(3), pages 275-287, September.
    3. Baker, Malcolm & Savasoglu, Serkan, 2002. "Limited arbitrage in mergers and acquisitions," Journal of Financial Economics, Elsevier, Elsevier, vol. 64(1), pages 91-115, April.
    4. He, Zhiguo & Xiong, Wei, 2013. "Delegated asset management, investment mandates, and capital immobility," Journal of Financial Economics, Elsevier, Elsevier, vol. 107(2), pages 239-258.
    5. Darrell Duffie & Bruno Strulovici, 2009. "Capital Mobility and Asset Pricing," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 1478, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    6. Jeffrey R. Brown & J. David Cummins & Christopher M. Lewis & Ran Wei, 2004. "An Empirical Analysis of the Economic Impact of Federal Terrorism Reinsurance," NBER Working Papers 10388, National Bureau of Economic Research, Inc.
    7. Officer, Micah S., 2007. "Are performance based arbitrage effects detectable? Evidence from merger arbitrage," Journal of Corporate Finance, Elsevier, Elsevier, vol. 13(5), pages 793-812, December.
    8. Xiong, Wei, 2001. "Convergence trading with wealth effects: an amplification mechanism in financial markets," Journal of Financial Economics, Elsevier, Elsevier, vol. 62(2), pages 247-292, November.
    9. Cummins, J. David & Lalonde, David & Phillips, Richard D., 2004. "The basis risk of catastrophic-loss index securities," Journal of Financial Economics, Elsevier, Elsevier, vol. 71(1), pages 77-111, January.
    10. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008. "Carry Trades and Currency Crashes," NBER Working Papers 14473, National Bureau of Economic Research, Inc.
    11. Torben Andersen, 2001. "Managing Economic Exposures of Natural Disasters: Exploring Alternative Financial Risk Management Opportunities and Instruments," IDB Publications 8934, Inter-American Development Bank.
    12. David Hofman & Patricia Brukoff, 2006. "Insuring Public Finances Against Natural Disasters," IMF Working Papers 06/199, International Monetary Fund.
    13. Harrington, Scott E. & Niehaus, Greg, 2003. "Capital, corporate income taxes, and catastrophe insurance," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 12(4), pages 365-389, October.

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