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A dynamic model of extreme risk coverage : resilience and efficiency in the global reinsurance market

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  • Lemoyne de Forges, Sabine
  • Bibas, Ruben
  • Hallegatte, Stephane

Abstract

This paper presents a dynamic model of the reinsurance market for catastrophe risks. The model is based on the classical capacity-constraint assumption. Reinsurers choose every year the quantity of risk they cover and the level of external capital they raise to cover these risks. The model exhibits time dependency and reproduces a market dynamics that shares many features with the real market. In particular, market price increases and reinsurance coverage decreases after large shocks, and a series of smaller losses may have a deeper impact than one larger loss. There is a significant oligopoly effect reducing reinsurance supply, and the market is segregated into strategic large actors that influence market prices and price-taker smaller firms. A regulation trade-off between market efficiency and resilience is identified and quantified: improving the ability of the market to cope with exceptional events increases the cost of reinsurance. This model provides an interesting basis to analyze further capacity needs for the insurance industry in view of growing worldwide exposure to catastrophic risks and climate change.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 5807.

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Date of creation: 01 Sep 2011
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Handle: RePEc:wbk:wbrwps:5807

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Keywords: Markets and Market Access; Insurance&Risk Mitigation; Climate Change Economics; Debt Markets; Emerging Markets;

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  1. Julien Hardelin & Sabine Lemoyne de Forges, 2012. "Raising Capital in an Insurance Oligopoly Market," The Geneva Risk and Insurance Review, Palgrave Macmillan, vol. 37(1), pages 83-108, March.
  2. Cummins, J. David & Danzon, Patricia M., 1997. "Price, Financial Quality, and Capital Flows in Insurance Markets," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 6(1), pages 3-38, January.
  3. Guillaume Plantin, 2006. "Does Reinsurance Need Reinsurers?," Journal of Risk & Insurance, The American Risk and Insurance Association, The American Risk and Insurance Association, vol. 73(1), pages 153-168.
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  5. J. David Cummins & Neil A. Doherty & Anita Lo, 1999. "Can Insurers Pay for the "Big One"? Measuring the Capacity of an Insurance Market to Respond to Catastrophic Losses," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 98-11, Wharton School Center for Financial Institutions, University of Pennsylvania.
  6. Neil Doherty & Kent Smetters, 2002. "Moral Hazard in Reinsurance Markets," NBER Working Papers 9050, National Bureau of Economic Research, Inc.
  7. J. David Cummins & Philippe Trainar, 2009. "Securitization, Insurance, and Reinsurance," Journal of Risk & Insurance, The American Risk and Insurance Association, The American Risk and Insurance Association, vol. 76(3), pages 463-492.
  8. Mayers, David & Smith, Clifford W, Jr, 1990. "On the Corporate Demand for Insurance: Evidence from the Reinsurance Market," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 63(1), pages 19-40, January.
  9. 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, Elsevier, vol. 32(1), pages 69-85, January.
  10. Kenneth A. Froot & Jeremy C. Stein, 1996. "Risk Management, Capital Budgeting and Capital Structure Policy for Financial Institutions: An Integrated Approach," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 96-28, Wharton School Center for Financial Institutions, University of Pennsylvania.
  11. Doherty, N A & Tinic, S M, 1981. "Reinsurance under Conditions of Capital Market Equilibrium: A Note," Journal of Finance, American Finance Association, American Finance Association, vol. 36(4), pages 949-53, September.
  12. Froot, Kenneth A., 2001. "The market for catastrophe risk: a clinical examination," Journal of Financial Economics, Elsevier, Elsevier, vol. 60(2-3), pages 529-571, May.
  13. Susan Hanson & Robert Nicholls & N. Ranger & S. Hallegatte & J. Corfee-Morlot & C. Herweijer & J. Chateau, 2011. "A global ranking of port cities with high exposure to climate extremes," Climatic Change, Springer, Springer, vol. 104(1), pages 89-111, January.
  14. Winter Ralph A., 1994. "The Dynamics of Competitive Insurance Markets," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 3(4), pages 379-415, September.
  15. J. David Cummins & Richard D. Phillips, 2005. "Estimating the Cost of Equity Capital for Property-Liability Insurers," Journal of Risk & Insurance, The American Risk and Insurance Association, The American Risk and Insurance Association, vol. 72(3), pages 441-478.
  16. Mary A. Weiss & Joon-Hai Chung, 2004. "U.S. Reinsurance Prices, Financial Quality, and Global Capacity," Journal of Risk & Insurance, The American Risk and Insurance Association, The American Risk and Insurance Association, vol. 71(3), pages 437-467.
  17. 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.
  18. Cagle, Julie A B & Harrington, Scott E, 1995. "Insurance Supply with Capacity Constraints and Endogenous Insolvency Risk," Journal of Risk and Uncertainty, Springer, Springer, vol. 11(3), pages 219-32, December.
  19. Andrei Shleifer & Robert W. Vishny, 1996. "A Survey of Corporate Governance," NBER Working Papers 5554, National Bureau of Economic Research, Inc.
  20. Hallegatte, Stephane, 2011. "How economic growth and rational decisions can make disaster losses grow faster than wealth," Policy Research Working Paper Series 5617, The World Bank.
  21. Jean-Baptiste, Eslyn L. & Santomero, Anthony M., 2000. "The Design of Private Reinsurance Contracts," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 9(3), pages 274-297, July.
  22. J. David Cummins & Mary A. Weiss, 2009. "Convergence of Insurance and Financial Markets: Hybrid and Securitized Risk-Transfer Solutions," Journal of Risk & Insurance, The American Risk and Insurance Association, The American Risk and Insurance Association, vol. 76(3), pages 493-545.
  23. Cummins, J. David & Doherty, Neil & Lo, Anita, 2002. "Can insurers pay for the "big one"? Measuring the capacity of the insurance market to respond to catastrophic losses," Journal of Banking & Finance, Elsevier, Elsevier, vol. 26(2-3), pages 557-583, March.
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As found by EconAcademics.org, the blog aggregator for Economics research:
  1. The imperfect market for re-insurance
    by Economic Logician in Economic Logic on 2011-10-18 14:31:00

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