Catastrophe Bonds and Reinsurance: The Competitive Effect of Information-Insensitive Triggers
Silke N. Finken
DZ Bank AG; Goethe University Frankfurt
Vienna University of Economics and Business Administration
Journal of Risk and Insurance, Vol. 76, Issue 3, pp. 579-605, September 2009
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.
Number of Pages in PDF File: 27Accepted Paper Series
Date posted: October 13, 2009
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