The Market for Catastrophe Risk: A Clinical Examination

45 Pages Posted: 8 Feb 2000 Last revised: 31 Aug 2022

See all articles by Kenneth Froot

Kenneth Froot

Harvard University Graduate School of Business; National Bureau of Economic Research (NBER)

Multiple version iconThere are 4 versions of this paper

Date Written: February 2001

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. Risk management theory suggests protection by insurers and other corporations against the largest cat events is most valuable. We show, however, that historically most insurers have purchased relatively little cat reinsurance against large events. We also find that premiums are high relative to expected losses, especially after cat events. We then examine clinical evidence to understand why the theory fails. Specifically, we examine transactions that look to capital markets, rather than traditional reinsurance markets, for risk-bearing capacity. These provide hints as to why the theory fails. We explore these hints in eight theoretical explanations and find the most compelling to be supply restrictions associated with capital market imperfections and market power exerted by traditional reinsurers.

Suggested Citation

Froot, Kenneth, The Market for Catastrophe Risk: A Clinical Examination (February 2001). NBER Working Paper No. w8110, Available at SSRN: https://ssrn.com/abstract=198972

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