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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, pages 110-127.
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    Citations

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    Cited by:

    1. Torben Andersen, 2001. "Managing Economic Exposures of Natural Disasters: Exploring Alternative Financial Risk Management Opportunities and Instruments," IDB Publications (Working Papers) 8934, Inter-American Development Bank.
    2. Harrington, Scott E. & Niehaus, Greg, 2003. "Capital, corporate income taxes, and catastrophe insurance," Journal of Financial Intermediation, Elsevier, pages 365-389.
    3. David J Hofman & Patricia A Brukoff, 2006. "Insuring Public Finances Against Natural Disasters; A Survey of Options and Recent Initiatives," IMF Working Papers 06/199, International Monetary Fund.
    4. Parente, Ronaldo & Choi, Byeongyong Paul & Slangen, Arjen H.L. & Ketkar, Sonia, 2010. "Distribution system choice in a service industry: An analysis of international insurance firms operating in the United States," Journal of International Management, Elsevier, pages 275-287.
    5. Dimitri Vayanos & Peter Kondor, 2014. "Liquidity Risk and the Dynamics of Arbitrage Capital," 2014 Meeting Papers 912, Society for Economic Dynamics.
    6. Brown, Jeffrey R. & Cummins, J. David & Lewis, Christopher M. & Wei, Ran, 2004. "An empirical analysis of the economic impact of federal terrorism reinsurance," Journal of Monetary Economics, Elsevier, pages 861-898.
    7. Xiong, Wei, 2001. "Convergence trading with wealth effects: an amplification mechanism in financial markets," Journal of Financial Economics, Elsevier, vol. 62(2), pages 247-292, November.
    8. He, Zhiguo & Xiong, Wei, 2013. "Delegated asset management, investment mandates, and capital immobility," Journal of Financial Economics, Elsevier, vol. 107(2), pages 239-258.
    9. Cummins, J. David & Lalonde, David & Phillips, Richard D., 2004. "The basis risk of catastrophic-loss index securities," Journal of Financial Economics, Elsevier, vol. 71(1), pages 77-111, January.
    10. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2009. "Carry Trades and Currency Crashes," NBER Chapters,in: NBER Macroeconomics Annual 2008, Volume 23, pages 313-347 National Bureau of Economic Research, Inc.
    11. Darrell Duffie & Bruno Strulovici, 2012. "Capital Mobility and Asset Pricing," Econometrica, Econometric Society, vol. 80(6), pages 2469-2509, November.
    12. Brown, Jeffrey R. & Cummins, J. David & Lewis, Christopher M. & Wei, Ran, 2004. "An empirical analysis of the economic impact of federal terrorism reinsurance," Journal of Monetary Economics, Elsevier, pages 861-898.
    13. Zanjani, George, 2002. "Pricing and capital allocation in catastrophe insurance," Journal of Financial Economics, Elsevier, vol. 65(2), pages 283-305, August.
    14. repec:eee:jfinec:v:126:y:2017:i:1:p:97-121 is not listed on IDEAS
    15. Baker, Malcolm & Savasoglu, Serkan, 2002. "Limited arbitrage in mergers and acquisitions," Journal of Financial Economics, Elsevier, vol. 64(1), pages 91-115, April.
    16. Sahin, Cenkhan & de Haan, Jakob, 2016. "Market reactions to the ECB’s Comprehensive Assessment," Economics Letters, Elsevier, pages 1-5.
    17. Emil Siriwardane, 2014. "Using proprietary credit default swap (CDS) data from 2010 to 2014, I show that capital fluctuations for sellers of CDS protection are an important determinant of CDS spread movements. I first establi," Working Papers 14-10, Office of Financial Research, US Department of the Treasury, revised 12 Feb 2015.
    18. Officer, Micah S., 2007. "Are performance based arbitrage effects detectable? Evidence from merger arbitrage," Journal of Corporate Finance, Elsevier, pages 793-812.
    19. repec:eee:jfinec:v:126:y:2017:i:1:p:1-35 is not listed on IDEAS

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