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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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Suggested Citation

  • Kenneth A. Froot & Paul G. J. O'Connell, 1999. "The Pricing of U.S. Catastrophe Reinsurance," NBER Chapters, in: The Financing of Catastrophe Risk, pages 195-232, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberch:7951
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    References listed on IDEAS

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    1. Anne Gron & Deborah J. Lucas, 1998. "External Financing and Insurance Cycles," NBER Chapters, in: The Economics of Property-Casualty Insurance, pages 5-28, National Bureau of Economic Research, Inc.
    2. Froot, Kenneth A. & Stein, Jeremy C., 1998. "Risk management, capital budgeting, and capital structure policy for financial institutions: an integrated approach," Journal of Financial Economics, Elsevier, vol. 47(1), pages 55-82, January.
    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.
    4. Froot, Kenneth A. & O'Connell, Paul G.J., 2008. "On the pricing of intermediated risks: Theory and application to catastrophe reinsurance," Journal of Banking & Finance, Elsevier, vol. 32(1), pages 69-85, January.
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