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The Market for Catastrophe Risk: A Clinical Examination

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Kenneth A. Froot

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Abstract

This paper examines the market for catastrophe event risk -- i.e., financial claims that are linked to losses associated with natural hazards, such as hurricanes and earthquakes. This market is in transition as new approaches for transferring risk are being explored. The paper studies several recent transactions by USAA which use reinsurance capacity from capital markets rather than only from reinsurers. We identify two puzzles concerning the cat protection purchased in these transactions: there is no coverage for the largest, most severe events; and premiums appear well above actuarial value. We demonstrate that both features deviate from what theory would predict, yet are characteristic of many transactions, not simply those of USAA. We then explore a number of possible explanations for the facts. The most compelling are combinations of capital market imperfections and market power on the part of reinsurers. Conclusions for broader capital market and risk management issues are discussed.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7286.

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Date of creation: Aug 1999
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Handle: RePEc:nbr:nberwo:7286

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G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Kenneth A. Froot, 1999. "The Financing of Catastrophe Risk," NBER Books, National Bureau of Economic Research, Inc, number froo99-1.
  2. Lee, Charles M C & Shleifer, Andrei & Thaler, Richard H, 1991. " Investor Sentiment and the Closed-End Fund Puzzle," Journal of Finance, American Finance Association, vol. 46(1), pages 75-109, March. [Downloadable!] (restricted)
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  3. Kenneth A. Froot & David S. Scharfstein & Jeremy C. Stein, 1992. "Risk Management: Coordinating Corporate Investment and Financing Policies," NBER Working Papers 4084, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. David M. Cutler & Richard J. Zeckhauser, 1999. "Reinsurance for Catastrophes and Cataclysms," NBER Chapters, in: The Financing of Catastrophe Risk, pages 233-274 National Bureau of Economic Research, Inc. [Downloadable!]
    Other versions:
  5. Dwight M. Jaffee & Thomas Russell, 1996. "Catastrophe Insurance, Capital Markets and Uninsurable Risks," Center for Financial Institutions Working Papers 96-12, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
  6. Kenneth A. Froot & Paul G.J. O'Connell, . "On the Pricing of Intermediated Risks: Theory and Application to Catastrophe Reinsurance," Center for Financial Institutions Working Papers 97-24, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
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  7. Neil A. Doherty & Clifford W. Smith, 1993. "Corporate Insurance Strategy: The Case Of British Petroleum," Journal of Applied Corporate Finance, Morgan Stanley, vol. 6(3), pages 4-15. [Downloadable!] (restricted)
  8. 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. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Erwann Michel-Kerjan, 2004. "Terrorisme à grande échelle : partage de risques et politiques publiques," Working Papers hal-00242918_v1, HAL. [Downloadable!]
  2. J. David Cummins & Georges Dionne & Robert Gagné & Abdelhakim Nouira, 2008. "The Costs and Benefits of Reinsurance," Cahiers de recherche 08-04, HEC Montréal, Institut d'économie appliquée. [Downloadable!]
  3. Doherty, Neil A. & Schlesinger, Harris, 2001. "Insurance Contracts and Securitization," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
  4. 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. [Downloadable!] (restricted)
  5. Xavier Gabaix & Arvind Krishnamurthy & Olivier Vigneron, 2005. "Limits of Arbitrage: Theory and Evidence from the Mortgage-Backed Securities Market," NBER Working Papers 11851, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. André SCHMITT & Sandrine SPAETER, 2004. "Insurance and Financial Hedging of Oil Pollution Risks," Working Papers of BETA 2004-14, Bureau d'Economie Théorique et Appliquée, ULP, Strasbourg. [Downloadable!]
  7. Victor Vaugirard, 2004. "A canonical first passage time model to pricing nature-linked bonds," Economics Bulletin, Economics Bulletin, vol. 7(2), pages 1-7. [Downloadable!]
  8. 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. [Downloadable!] (restricted)
    Other versions:
  9. Zhiguo He & Arvind Krishnamurthy, 2008. "A Model of Capital and Crises," NBER Working Papers 14366, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. José Penalva, 2003. "Implications of Dynamic Trading for Insurance Markets," Economics Working Papers 720, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
  11. André Schmitt & Sandrine Spaeter, 2004. "Insurance and Financial Hedging of Oil Pollution Risks," Working Papers of LaRGE (Laboratoire de Recherche en Gestion et Economie) 2004-05, Laboratoire de Recherche en Gestion et Economie, Université de Strasbourg (France). [Downloadable!]
  12. Kenneth A. Froot, 2003. "Risk Management, Capital Budgeting and Capital Structure Policy for Insurers and Reinsurers," NBER Working Papers 10184, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. Julien Hardelin & Sabine Lemoyne De Forges, 2009. "Raising capital in an insurance oligopoly market," Working Papers hal-00417573_v1, HAL. [Downloadable!]
  14. Sawada, Yasuyuki, 2006. "The Impact of Natural and Manmade Disasters on Household Welfare," 2006 Annual Meeting, August 12-18, 2006, Queensland, Australia 25750, International Association of Agricultural Economists. [Downloadable!]
    Other versions:
  15. André SCHMITT & Sandrine SPAETER, 2005. "Hedging Strategies and the Financing of the 1992 International Oil Pollution Compensation Fund," Working Papers of BETA 2005-12, Bureau d'Economie Théorique et Appliquée, ULP, Strasbourg. [Downloadable!]
  16. Oleg Sheremet & André Lucas, 2008. "Global Loss Diversification in the Insurance Sector," Tinbergen Institute Discussion Papers 08-086/2, Tinbergen Institute. [Downloadable!]
    Other versions:
  17. Haerdle, Wolfgang & Cabrera, Brenda Lopez, 2007. "Calibrating CAT bonds for Mexican earthquakes," 101st Seminar, July 5-6, 2007, Berlin Germany 9265, European Association of Agricultural Economists. [Downloadable!]
    Other versions:
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