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Catastrophe Bonds and Reinsurance: The Competitive Effect of Information‐Insensitive Triggers

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  • Silke Finken
  • Christian Laux

Abstract

We identify a new benefit of index or parametric triggers. Asymmetric information between reinsurers on an insurer's risk affects competition in the reinsurance market: reinsurers are subject to adverse selection, since only high‐risk insurers may find it optimal to change reinsurers. The result is high reinsurance premiums and cross‐subsidization of high‐risk insurers by low‐risk insurers. A contract with a parametric or index trigger (such as a catastrophe bond) is insensitive to information asymmetry and therefore alters the equilibrium in the reinsurance market. Provided that basis risk is not too high, the introduction of contracts with parametric or index triggers provides low‐risk insurers with an alternative to reinsurance contracts, and therefore leads to less cross‐subsidization in the reinsurance market.

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  • Silke Finken & Christian Laux, 2009. "Catastrophe Bonds and Reinsurance: The Competitive Effect of Information‐Insensitive Triggers," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 76(3), pages 579-605, September.
    • Handle: RePEc:bla:jrinsu:v:76:y:2009:i:3:p:579-605
    DOI: 10.1111/j.1539-6975.2009.01317.x
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    References listed on IDEAS

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