When Should a Cat Index Futures Be Created?

Abstract

Traditionally, insurance risks are borne in reinsurance markets. In 1990s, however, after the sequence of huge natural disasters and huge insurance payments, the reinsurance markets reduced its capability to bear risks, especially those related to catastrophic natural disasters. Catastrophe-Linked Securities (CLS) were invented in order to fill the need for additional reinsurance capacity by transferring insurance risks to the capital markets. The CAT (catastrophe) index futures is one of the several types of CLS's. This paper investigates conditions under which the index derivatives, such as the CAT index futures, of the insurance risks can be traded by the non-insurance investors and is beneficial from the insurers' and the exchange's viewpoints.

Keywords: security design, CAT index futures, asymmetric information

JEL Classification: D52, D82, G14