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ART versus reinsurance: the disciplining effect of information insensitivity

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  • Silke Brandts
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    Abstract

    We provide a novel benefit of ¶Alternative Risk Transfer¶ (ART) products with parametric or index triggers. When a reinsurer has private information about his client’s risk, outside reinsurers will price their reinsurance offer less aggressively.� Outsiders are subject to adverse selection as only a high-risk insurer might find it optimal to change reinsurers. This creates a hold-up problem that allows the incumbent to extract an information rent. An information insensitive ART product with a parametric or index trigger is not subject to adverse selection. It can therefore be used to compete against an informed reinsurer, thereby reducing the premium that a low-risk insurer has to pay for the indemnity contract. However, ART products exhibit an interesting fate in our model as they are useful, but not used in equilibrium because of basis-risk.

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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/dp545.pdf
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    Bibliographic Info

    Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp545.

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    Date of creation: Oct 2005
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    Handle: RePEc:fmg:fmgdps:dp545

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    Web page: http://www.lse.ac.uk/fmg/

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    Cited by:
    1. Darius Lakdawalla & George Zanjani, 2006. "Catastrophe Bonds, Reinsurance, and the Optimal Collateralization of Risk-Transfer," NBER Working Papers 12742, National Bureau of Economic Research, Inc.

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